MIDDLEFIELD BANC CORP Management Report and Analysis of Financial Position and Operating Results (Form 10-Q)
The information contained or incorporated by reference in this report on Form 10-Q contains forward-looking statements, including certain plans, expectations, goals, and projections, which are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those contained or implied by such statements for a variety of factors, including changes in economic conditions, movements in interest rates, competitive pressures on product pricing and services, success and timing of business strategies, the nature, extent, and timing of government actions and reforms, and extended disruption of vital infrastructure and the impact of the COVID-19 pandemic. The Company could experience further adverse effects on its business, financial condition, results of operations, and cash flows. While it is impossible to know the impact of COVID-19 on the Company's future operations, the Company is disclosing potentially material items of which it is aware. All forward-looking statements included in this report on Form 10-Q are based on information available at the time of the report.Middlefield Banc Corp. assumes no obligation to update any forward-looking statement. 32 --------------------------------------------------------------------------------
CHANGES IN FINANCIAL POSITION
Overview The following is management's discussion and analysis of certain significant factors which have affected the financial condition and results of operations of the Company as reflected in the unaudited consolidated balance sheet as ofSeptember 30, 2021 , as compared withDecember 31, 2020 , and operating results for the three and nine-month periods endedSeptember 30, 2021 , and 2020. These comments should be read in conjunction with the Company's unaudited consolidated financial statements and accompanying notes appearing elsewhere herein. This discussion contains certain performance measures determined by methods other than under GAAP. Management of the Company uses these non-GAAP measures in its analysis of the Company's performance. These measures are useful when evaluating the underlying performance and efficiency of the Company's operations and balance sheet. The Company's management believes that these non-GAAP measures provide a greater understanding of ongoing operations, enhance comparability of results with prior periods and demonstrate the effects of significant gains and charges in the current period. The Company's management believes that investors may use these non-GAAP financial measures to evaluate the Company's financial performance without the impact of unusual items that may obscure trends in the Company's underlying performance. These disclosures should not be viewed as a substitute for financial measures determined under GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Non-GAAP measures include tangible book value per common share, return on average tangible common equity, and pre-tax, pre-provision income. The Company calculates the regulatory capital ratios using current regulatory report instructions. The Company's management uses these measures to assess the quality of capital and believes that investors may find them useful in their evaluation of the Company. These capital measures may or may not be necessarily comparable to similar capital measures that may be presented by other companies.
Nine-month 2021 Financial Highlights (on an annual basis, unless otherwise noted):
? Net result of
third quarter result of
? Net interest margin improved 23 basis points to 3.79% from 3.56%
? Total noninterest income was up 29.5% to$5.7 million ? Pre-tax, pre-provision(1) income increased 22.0% to$17.7 million ? Return on average assets increased to 1.34% from 0.61% ? Return on average equity increased to 12.58% from 5.48%
? Return on average tangible equity (1) increased to 14.20% from 6.22%
? The efficiency ratio improved to 56.42%, compared to 58.59% ? Year-to-date net charge-offs declined 96.0% to$125,000
? Middlefield has repurchased 346,103 shares since the start of the year, including
165,058 shares repurchased during the 2021 third quarter
(1) See reconciliation of non-GAAP measures in following tables
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(Dollar amounts in thousands, except per share and share amounts, unaudited)
For the Three Months Ended For the Nine Months Ended
September 30, June 30, March 31, December 31, September 30, September 30, September 30,
2021 2021 2021 2020 2020 2021 2020
Per common share data
Net income per common
share - basic $ 0.85 $ 0.70 $ 0.65 $ 0.39 $ 0.29 $ 2.20 $ 0.92
Net income per common
share - diluted $ 0.85 $ 0.70 $ 0.65 $ 0.39 $ 0.29 $ 2.19 $ 0.92
Dividends declared
per share $ 0.16 $ 0.16 $ 0.16 $ 0.15 $ 0.15 $ 0.48 $ 0.45
Book value per share
(period end) $ 24.13 $ 23.50 $ 22.80 $ 22.54 $ 22.27 $ 24.13 $ 22.27
Tangible book value
per share (period
end) (2) (3) $ 21.39 $ 20.82 $ 20.17 $ 19.91 $ 19.63 $ 21.39 $ 19.63
Dividends declared $ 978 $ 1,004 $ 1,016 $ 957 $ 957 $ 2,998 $ 2,877
Dividend yield 2.66 % 2.72 % 3.10 % 2.65 % 3.09 % 2.69 % 3.11 %
Dividend payout ratio 18.79 % 22.69 % 24.38 % 38.45 % 51.65 % 21.73 % 49.10 %
Average shares
outstanding - basic 6,136,648 6,297,071 6,364,132 6,378,706 6,376,291 6,265,803 6,387,581
Average shares
outstanding - diluted 6,157,181 6,312,230 6,378,493 6,397,681 6,385,765 6,287,556 6,397,674
Period ending shares
outstanding 6,054,083 6,215,511 6,344,657 6,379,323 6,378,110 6,054,083 6,378,110
Selected ratios
Return on average
assets 1.51 % 1.30 % 1.22 % 0.72 % 0.54 % 1.34 % 0.61 %
Return on average
equity 13.95 % 12.10 % 11.65 % 6.76 % 5.11 % 12.58 % 5.48 %
Return on average
tangible common
equity (2) (4) 15.71 % 13.65 % 13.17 % 7.64 % 5.79 % 14.20 % 6.22 %
Efficiency (1) 54.15 % 57.28 % 57.91 % 59.29 % 51.96 % 56.42 % 58.59 %
Equity to assets at
period end 10.69 % 10.74 % 10.42 % 10.33 % 10.41 % 10.69 % 10.41 %
Noninterest expense
to average assets 0.58 % 0.58 % 0.60 % 0.57 % 0.52 % 1.76 % 1.70 %
(1) The efficiency ratio is calculated
by dividing noninterest expense less
amortization of intangibles by the sum
of net interest income on a fully
taxable equivalent basis plus
noninterest income
(2) See reconciliation of non-GAAP
measures below
(3) Calculated by dividing tangible
common equity by shares outstanding
(4) Calculated by dividing annualized
net income for each period by average
tangible common equity
For the Three Months Ended For the Nine Months Ended
September 30, June 30, March 31, December 31, September 30, September 30, September 30,
Yields 2021 2021 2021 2020 2020 2021 2020
Interest-earning
assets:
Loans receivable (2) 4.74 % 4.43 % 4.48 % 4.28 % 4.48 % 4.54 % 4.64 %
Investment
securities (2) 3.37 % 3.47 % 3.75 % 3.65 % 3.66 % 3.51 % 3.68 %
Interest-earning
deposits with other
banks 0.21 % 0.18 % 0.20 % 0.21 % 0.27 % 0.20 % 0.56 %
Total
interest-earning
assets 4.20 % 4.05 % 4.11 % 4.00 % 4.23 % 4.12 % 4.38 %
Deposits:
Interest-bearing
demand deposits 0.12 % 0.12 % 0.16 % 0.21 % 0.32 % 0.13 % 0.36 %
Money market
deposits 0.46 % 0.46 % 0.47 % 0.53 % 0.70 % 0.47 % 1.00 %
Savings deposits 0.06 % 0.06 % 0.07 % 0.11 % 0.20 % 0.06 % 0.29 %
Certificates of
deposit 1.08 % 1.19 % 1.28 % 1.56 % 1.77 % 1.19 % 1.97 %
Total
interest-bearing
deposits 0.41 % 0.46 % 0.53 % 0.70 % 0.93 % 0.47 % 1.14 %
Non-Deposit Funding:
Borrowings 1.13 % 1.18 % 1.10 % 0.95 % 0.45 % 1.14 % 0.73 %
Total
interest-bearing
liabilities 0.42 % 0.47 % 0.54 % 0.71 % 0.91 % 0.48 % 1.12 %
Cost of deposits 0.30 % 0.34 % 0.40 % 0.54 % 0.72 % 0.35 % 0.89 %
Cost of funds 0.31 % 0.35 % 0.41 % 0.55 % 0.71 % 0.35 % 0.88 %
Net interest margin
(1) 3.91 % 3.72 % 3.73 % 3.49 % 3.57 % 3.79 % 3.56 %
(1) Net interest margin represents net
interest income as a percentage of average
interest-earning assets.
(2) Tax-equivalent adjustments to calculate
the yield on tax-exempt securities and
loans were determined using an effective
tax rate of 21%.
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Reconciliation of Common Stockholders' Equity to Tangible Common Equity For the Three Months Ended For the Nine Months Ended (Dollar amounts in thousands, unaudited) September 30, June 30, March 31,
2021 2021 2021 2020 2020 2021 2020 Stockholders' Equity (GAAP)$ 146,055 $ 146,044 $ 144,670 $ 143,810 $ 142,056 $ 146,055 $ 142,056 Less Goodwill and other intangibles 16,555 16,635 16,715 16,795 16,878 16,555 16,878 Tangible Common Equity (Non-GAAP)$ 129,500 $ 129,409 $ 127,955 $ 127,015 $ 125,178 $ 129,500 $ 125,178 Shares outstanding 6,054,083 6,215,511 6,344,657 6,379,323 6,378,110 6,054,083 6,378,110 Tangible book value per share (Non-GAAP) $ 21.39$ 20.82 $ 20.17 $ 19.91 $ 19.63$ 21.39 $ 19.63 Reconciliation of Average Equity to Return on Average Tangible Common Equity For the Three Months Ended For the Nine Months Ended September 30, June 30, March 31, December 31, September 30, September 30, September 30, 2021 2021 2021 2020 2020 2021 2020 Average Stockholders' Equity (GAAP)$ 148,048 $ 146,719 $ 145,065 $ 146,374 $ 144,167 $ 146,611 $ 142,949 Less Average Goodwill and other intangibles 16,594 16,674 16,754 16,836 16,919 16,674 17,002 Average Tangible Common Equity (Non-GAAP)$ 131,454 $ 130,045 $ 128,311 $ 129,538 $ 127,248 $ 129,937 $ 125,947 Net income $ 5,204$ 4,425 $ 4,167 $ 2,489 $ 1,853$ 13,796 $ 5,860 Return on average tangible common equity (annualized) (Non-GAAP) 15.71 % 13.65 % 13.17 % 7.64 % 5.79 % 14.20 % 6.22 % Reconciliation of Pre-Tax Pre-Provision Income (PTPP) For the Three Months Ended For the Nine Months Ended September 30, June 30, March 31, December 31, September 30, September 30, September 30, 2021 2021 2021 2020 2020 2021 2020 Net income $ 5,204$ 4,425 $ 4,167 $ 2,489 $ 1,853$ 13,796 $ 5,860 Add Income Taxes 1,174 968 896 467 295 3,038 934 Add Provision for loan losses - 200 700 2,100 4,000 900 7,740 PTPP $ 6,378$ 5,593 $ 5,763 $ 5,056 $ 6,148$ 17,734 $ 14,534 General. The Company's total assets ended theSeptember 30, 2021 quarter at$1.37 billion , a decrease of$26.1 million fromDecember 31, 2020 . For the same period, cash and cash equivalents increased$19.9 million , or 17.7%, while net loans decreased$94.6 million , or 8.7%, offset by an increase of$48.7 million in investments. Total liabilities decreased$28.4 million or 2.3%, while stockholders' equity increased$2.2 million , or 1.6%. Cash and cash equivalents. Cash and cash equivalents increased$19.9 million to$132.4 million onSeptember 30, 2021 , from$112.4 million onDecember 31, 2020 . Deposits from customers into savings and checking accounts, loan and securities repayments, and proceeds from borrowed funds typically increase these accounts. Decreases result from customer withdrawals, new loan originations, security purchases, and repayments of borrowed and brokered funds. Cash remains elevated and can be traced to pandemic-related government stimulus. This resulted in increased deposits, as both retail and commercial customers keep excess funds in liquid deposits accounts. The increase in cash and cash equivalents sinceDecember 31, 2020 , is due to the forgiveness of PPP loans. The Company will continue to hold elevated levels of cash and cash equivalents to meet the demands of customers during the economic downturn. The Company monitors cash and cash equivalents daily to ensure adequate liquidity positions are maintained while searching for quality earning assets for excess funds. Investment securities. Investment securities available for sale onSeptember 30, 2021 , totaled$163.1 million , an increase of$48.7 million , or 42.6%, from$114.4 million onDecember 31, 2020 . During this period, the Company recorded repayments, calls, and maturities of$9.5 million and a net unrealized holding loss through AOCI of$853,000 . Securities purchased were$59.4 million , and there were no sales of securities for the nine months endedSeptember 30, 2021 . The Company recorded$223,000 in gains on equity securities as ofSeptember 30, 2021 , on the Company's Consolidated Statement of Income and Consolidated Statement of Cash Flows. The gain on equity securities is the result of fair value marks of the equity securities held during these nine months. OnSeptember 30, 2021 , the Company held$32.3 million of subordinated debt in other banks, as compared to$21.3 million onDecember 31, 2020 . The average yield on this portfolio was 4.90% onSeptember 30, 2021 , as compared to 5.19% onDecember 31, 2020 . Periodically, management reviews the entire municipal bond portfolio to assess credit quality. Each security held in this portfolio is assessed 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. Municipal bonds compose 73% of the overall portfolio. These investments have historically proven to have extremely low credit risk. 35 -------------------------------------------------------------------------------- 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 receivable decreased$94.6 million , or 8.7%, to$996.0 million as ofSeptember 30, 2021 . The following table summarizes fluctuation within the primary segments of the loan portfolio (in thousands): September 30, December 31, 2021 2020 $ change % change Commercial real estate: Owner occupied$ 110,883 $ 103,121 $ 7,762 7.5 % Non-owner occupied 310,222 309,424 798 0.3 % Multifamily 30,762 39,562 (8,800 ) -22.2 % Residential real estate 232,020 233,995 (1,975 ) -0.8 % Commercial and industrial 163,052 232,044 (68,992 ) -29.7 % Home equity lines of credit 105,450 112,543 (7,093 ) -6.3 % Construction and Other 49,378 63,573 (14,195 ) -22.3 % Consumer installment 8,515 9,823 (1,308 ) -13.3 % Total loans$ 1,010,282 $ 1,104,085 $ (93,803 ) -8.5 % The decrease in the commercial and industrial portfolio includes the forgiveness of PPP loans of$129.8 million during the nine months endedSeptember 30, 2021 . The Company expects muted loan growth through the remainder of the year as a result of excess liquidity throughout the economy. The Company's Mortgage Banking operation generates loans for sale to the Federal Home Loan Mortgage Corporation ("Freddie Mac"). Loans held for sale onSeptember 30, 2021 totaled$676,000 , a decrease of$202,000 , or 23.0%, fromDecember 31, 2020 . This decrease is the result of decreased activity due to fewer refinance opportunities. The Company recorded proceeds from the sale of$31.6 million of these loans for$1.1 million in gains on the sale of loans as ofSeptember 30, 2021 , on the Company's Consolidated Statement of Cash Flows. 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. OnSeptember 30, 2021 , non-owner-occupied commercial real estate loans (including construction, land, and land development loans) represent 270.3% of total risk-based capital. Construction, land, and land development loans represent 32.6% 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 strong 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 as a result of our commercial real estate concentrations, which could require us to obtain additional capital, and may adversely affect shareholder returns. The Company has an extensive capital planning policy, which includes pro forma projections including stress testing within which the Board of Directors has established internal minimum targets for regulatory capital ratios that are more than well-capitalized ratios. 36 --------------------------------------------------------------------------------
The Company monitors fluctuations in unused commitments on a daily basis in order to identify potentially significant drawdowns on existing credit lines. At
Allowance for Loan and Lease Losses and Asset Quality. The allowance for loan and lease losses increased$775,000 , or 5.8%, to$14.2 million onSeptember 30, 2021 , from$13.5 million onDecember 31, 2020 . For the three months endedSeptember 30, 2021 , net loan recoveries totaled$34,000 , or 0.01% of average loans, annualized, compared to net charge-offs of$2.9 million , or 1.01% of average loans, annualized, for the same period in 2020. No provision was needed during the three months endedSeptember 30, 2021 , to maintain the allowance for loan and lease losses. For the nine months endedSeptember 30, 2021 , net loan charge-offs totaled$125,000 , or 0.02% of average loans, annualized, compared to net charge-offs of$3.1 million , or 0.39% of average loans, annualized, for the same period in 2020. To maintain the allowance for loan and lease losses, the Company recorded a provision for loan loss of$900,000 during the nine months endedSeptember 30, 2021 . The ratio of the allowance for loan and lease losses to nonperforming loans was 209.1% for the three months endedSeptember 30, 2021 , compared to 169.8% for the same period in the prior year. This is due to the allowance being adjusted to address the economic slowdown since the beginning of the COVID-19 pandemic. Additionally, the decrease in the PPP loans increased the reserve percentage because these loans had low reserve. Management analyzes the adequacy of the allowance for loan and lease losses regularly through reviews of the performance of the loan portfolio considering economic conditions, changes in interest rates and the effect of such changes on real estate values, and changes in the amount and composition of the loan portfolio. The allowance for loan and lease losses is a significant estimate that is particularly susceptible to changes in the near term. Management's analysis includes a review of all loans designated as impaired, historical loan loss experience, the estimated fair value of the underlying collateral, economic conditions, current interest rates, trends in the borrower's industry, and other factors that management believes warrant recognition in providing for an appropriate allowance for loan and lease losses. Future additions or reductions to the allowance for loan and lease losses will be dependent on these factors. Additionally, the Company uses an outside party to conduct an independent review of commercial and commercial real estate loans that is designed to validate management conclusions of risk ratings and the appropriateness of the allowance allocated to these loans. The Company uses the results of this review to help determine the effectiveness of policies and procedures and to assess the adequacy of the allowance for loan and lease losses allocated to these types of loans. Management believes the allowance for loan and lease losses is appropriately stated onSeptember 30, 2021 . Based on the variables involved and management's judgments about uncertain outcomes, the determination of the allowance for loan and lease losses is considered a critical accounting policy.Goodwill . The carrying value of goodwill was$15.1 million onSeptember 30, 2021 , andDecember 31, 2020 . The Company performs a periodic quantitative analysis of goodwill using multiple approaches. The primary methodology is 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. 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 most recent analysis performed as ofMarch 31, 2020 , the Company determined that goodwill was not impaired. The Company also performed a qualitative assessment of goodwill as ofSeptember 30, 2021 , with no resulting goodwill impairment. Nonperforming assets. Nonperforming assets include nonaccrual loans, loans 90 days or more past due, other real estate owned, 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, after considering economic and business conditions, the borrower's financial condition is such that collection of principal and interest is doubtful. Payments received on nonaccrual loans are applied against the principal until doubt about collectability ceases. 37 --------------------------------------------------------------------------------
Asset Quality History
(Dollar amounts in September 30, December 31, September 30,
thousands) 2021 June 30, 2021 March 31, 2021 2020 2020
Non-performing loans
Other real estate held
7,090 7,090 7,372 7,387 7,391
Non-performing assets
Allowance for loan and lease losses 14,234 14,200 14,122 13,459 11,359
Reports :
Nonperforming loans to total loans 0.67 % 0.73 % 0.81 % 0.71 % 0.59 % Nonperforming assets to total assets 1.02 % 1.09 % 1.18 % 1.10 % 1.03 % Allowance for loan and lease losses to total loans 1.41 % 1.34 % 1.28 % 1.22 % 1.01 % Allowance for loan and lease losses to nonperforming loans 209.14 % 182.99 % 157.65 % 171.28 % 169.79 % Nonperforming loans exclude TDRs that are performing under 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 27 TDRs accruing interest with a balance of$2.4 million as ofSeptember 30, 2021 . A TDR that yields a market interest rate at the time of restructuring and is in compliance with its modified terms is no longer reported as a TDR in calendar years after the year in which the restructuring took place. To comply with its modified terms, a loan that is a TDR must not be in nonaccrual status and must be current or less than 30 days past due on its contractual principal and interest payments under the modified repayment terms. Nonperforming loans secured by real estate totaled$6.4 million as ofSeptember 30, 2021 , from$7.2 million onDecember 31, 2020 . A major factor in determining the appropriateness of the allowance for loan and lease losses is the type of collateral that secures the loans. Of the total nonperforming loans onSeptember 30, 2021 , 94.5% were secured by real estate. Although this does not insure against all losses, real estate typically provides for at least partial recovery, even in a distressed-sale and declining-value environment. The Company's objective is to minimize the future loss exposure of the Company.
The ratio of the allowance for losses on loans and leases to total loans increased from 1.22% to
Deposits. The Company considers various sources when evaluating funding needs, including but not limited to deposits, which are a significant source of funds, totaling$1.20 billion or 98.9% of the Company's total average funding sources atSeptember 30, 2021 . Total deposits decreased$24.6 million onSeptember 30, 2021 , from$1.23 billion onDecember 31, 2020 . The following table summarizes fluctuation within the primary segments of the deposit portfolio (in thousands): September 30, December 31 2021 2020 $ Change % Change Deposits: Noninterest-bearing demand$ 316,770 $ 291,347 $ 25,423 8.7 % Interest-bearing demand 237,576 195,722 41,854 21.4 % Money market 178,423 198,493 (20,070 ) -10.1 % Savings 256,114 243,888 12,226 5.0 % Time 211,674 295,750 (84,076 ) -28.4 % Total deposits 1,200,557 1,225,200 (24,643 ) -2.0 %
The Company has experienced an outflow of maturing term deposits into other products due to the current low interest rate environment. The Company uses certain non-core financing instruments to increase its balance sheet and maintain liquidity. These deposits, either from a broker or from a registration service, were
Borrowed funds. The Company uses short-term and long-term borrowings as another source of funding for asset growth and liquidity needs. These borrowings primarily include advances from theFederal 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 23.9%, to$13.0 million as ofSeptember 30, 2021 , from$17.0 million as ofDecember 31, 2020 . 38
-------------------------------------------------------------------------------- Stockholders' equity. Stockholders' equity increased$2.2 million , or 1.6%, to$146.0 million atSeptember 30, 2021 from$143.8 million atDecember 31, 2020 . This increase was mostly the result of an increase in retained earnings of$10.8 million , net of a decrease in AOCI of$674,000 , and an increase in treasury stock of$8.1 million . The change in retained earnings is due to the year-to-date net income offset by dividends paid, the change in AOCI is due to fair value adjustments of available-for-sale securities, and the change in treasury stock is due to the Company repurchasing 346,103 of its outstanding shares during the nine months endedSeptember 30, 2021 . RESULTS OF OPERATIONS General. Net income for the three months endedSeptember 30, 2021 , was$5.2 million , a$3.4 million , or 180.8%, increase from the amount earned during the same period in 2020. Diluted earnings per share for the quarter increased to$0.85 , compared to$0.29 from the same period in 2020. Net income for the nine months endedSeptember 30, 2021 , was$13.8 million , a$7.9 million , or 135.4%, increase from the amount earned during the same period in 2020. Diluted earnings per share for these nine months increased to$2.19 , compared to$0.92 from the same period in 2020. The Company's annualized return on average assets ("ROA") and return on average equity ("ROE") for the quarter were 1.51% and 13.95%, respectively, compared with 0.54% and 5.11% for the same period in 2020. The Company's ROA and ROE for the nine months were 1.34% and 12.58%, respectively, compared with 0.61% and 5.48% for the same period in 2020. Net interest income. Net interest income, the primary source of revenue for the Company, is determined by the interest rate spread, which is defined as the difference between income on earning assets and the cost of funds supporting those assets, and the relative amounts of interest-earning assets and interest-bearing liabilities. Management periodically adjusts the mix of assets and liabilities, as well as the rates earned or paid on those assets and liabilities, to manage and improve net interest income. The level of interest rates and changes in the amount and composition of interest-earning assets and liabilities affect the Company's net interest income. Management's goal is to maintain a balance between steady net interest income growth and the risks associated with interest rate fluctuations. Net interest income for the three months endedSeptember 30, 2021 , totaled$12.5 million , an increase of 10.0% from that reported in the comparable period of 2020. The net interest margin was 3.91% for the third quarter of 2021, an increase from the 3.57% reported for the same quarter of 2020. The increase in the net interest margin is attributable to a decrease in the average balance of certificates of deposit of$131.7 million , an increase in the average balance of investments of$42.7 million , an increase of 26 basis points in the yield on loans, and a decrease of 69 basis points on the yield on certificates of deposit. These are partially offset by a decrease in the average loan balance of$93.8 million . Net interest income for the nine months endedSeptember 30, 2021 , totaled$36.3 million , an increase of 13.0% from that reported in the comparable period of 2020. The net interest margin was 3.79% for the nine months endedSeptember 30, 2021 , an increase from the 3.56% reported for the same period of 2020. The increase in the net interest margin is attributable to a decrease in yield on certificates of deposits and money market deposits of 78 and 53 basis points, respectively, as well as a decrease in the average balance of certificates of deposits of$117.5 million . These are partially offset by a decrease in the loan yield of 10 basis points. The Company's net interest margin is subject to fluctuation as a result of 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 that have variable interest rates. Both loan types have floor rates. The benefit of these floors is more evident if theFederal Reserve maintains short-term interest rates at current levels. Interest and dividend income. Interest and dividend income decreased$60,000 , or 0.4%, for the three months endedSeptember 30, 2021 , compared to the same period in the prior year. This is attributable to a decrease in interest and fees on loans of$345,000 and is partially offset by an increase in taxable interest on investment securities of$212,000 . Net interest earned on securities increased by$267,000 for the three months endedSeptember 30, 2021 , when compared to the same period in the prior year. The average balance of investment securities increased$42.7 million , or 38.2%, while the 3.37% yield on the investment portfolio decreased by 29 basis points, from 3.66%, for the same period in the prior year. The decrease in the average loan balance for the three months endedSeptember 30, 2021 , is due in part to the forgiveness of PPP loans, from which the related gross deferred fee income was$1.3 million . 39 -------------------------------------------------------------------------------- Interest and dividend income decreased$146,000 , or 0.4%, for the nine months endedSeptember 30, 2021 , compared to the same period in the prior year. This is attributable to a decrease in interest and fees on loans of$652,000 , partially offset by an increase in taxable interest on investment securities of$629,000 . Net interest earned on securities increased by$581,000 for the nine months endedSeptember 30, 2021 , when compared to the same period in the prior year. The average balance of investment securities increased$27.0 million , or 24.9%, while the 3.51% yield on the investment portfolio decreased by 17 basis points, from 3.68%, for the same period in the prior year. The change in the average loan balance for the nine months endedSeptember 30, 2021 , is due in part to the issuance of PPP loans, from which the related gross deferred fee income was$3.6 million . Interest expense. Interest expense decreased by$1.2 million , or 55.7%, for the three months endedSeptember 30, 2021 , compared to the same period in the prior year. This decrease is attributable to a decrease in the average balance of certificates of deposits of$131.7 million , or 37.6%. This decrease is further attributable to decreases of 69, 24, and 20 basis points in certificates of deposit, money markets, and interest-bearing demand deposits, respectively. Interest expense decreased by$4.3 million , or 57.0%, for the nine months endedSeptember 30, 2021 , compared to the same period in the prior year. This decrease is attributable to a decrease in the average balance of certificates of deposits of$117.5 million , or 32.8%. This decrease is further attributable to decreases of 78, 53, 23, and 23 basis points in certificates of deposit, money markets, savings, and interest-bearing demand deposits, respectively.
Variations in costs are due to falling interest rates on deposit products in response to the unprecedented reduction in the target federal funds interest rate, as well as other lingering effects of the COVID pandemic -19.
Provision for loan losses. The provision for loan losses represents the charge to income necessary to adjust the allowance for loan and lease losses to an amount that represents management's assessment of the estimated probable incurred credit losses inherent in the loan portfolio. Each quarter, management reviews estimated probable incurred credit losses in the loan portfolio. Based on this review, no provision was recorded for the quarter endedSeptember 30, 2021 , a decrease of$4.0 million from the quarter endedSeptember 30, 2020 . While the prior period provision was mostly attributable to the pandemic, the lack of provision for this quarter was impacted by credit quality and low loan growth. A provision for loan losses of$900,000 was recorded for the nine months endedSeptember 30, 2021 , a decrease of$6.8 million from the same period in 2020. While the prior period provision was mostly attributable to the pandemic, the provision for this period was impacted by credit quality and low loan growth. The ALLL to total loans for the quarter endedSeptember 30, 2021 , was 1.41%, compared to 1.01% during the same period in the prior year. The Company remains confident in its conservative and disciplined approach to credit and risk management. With the passage of the PPP, administered by theSmall Business Administration ("SBA"), the Company has actively participated in assisting its customers with applications for resources through the program. OnSeptember 30, 2021 , the Company carried$54.2 million of PPP loans classified as C&I loans for reporting purposes. Loans funded through the PPP program are fully guaranteed by theU.S. government. This guarantee exists at the inception of the loans and throughout the lives of the loans and was not entered into separately and apart from the loans. ASC 326 requires credit enhancements that mitigate credit losses, such as theU.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 theU.S. government and absent any specific loss information about any of our PPP loans, the Company does provide a$217,000 qualitative provision for loan losses on its PPP loans onSeptember 30, 2021 . Noninterest income. Noninterest income increased by$10,000 , or 0.55%, for the three months endedSeptember 30, 2021 , over the comparable 2020 period. This increase was the result of an increase in service charges on deposit accounts of$185,000 , or 26.8%, which is partially due to cash management fees relating to cannabis-related business. The increase is also the result of an increase of a$130,000 gain on equity securities. These increases are offset by a decrease of$351,000 in gain on loan sales, resulting from the decrease in demand for residential refinances. Noninterest income increased$1.3 million , or 29.5%, during the nine months endedSeptember 30, 2021 , over the comparable 2020 period. This increase was the result of increases in service charges on deposit accounts and earnings on bank-owned life insurance of$709,000 , or 39.2%, and$119,000 , or 37.1%, respectively. There was also an increase in gain on equity securities of$380,000 . The increase in service charges is due to cash management fees on cannabis-related business accounts and the increase in earnings on bank-owned life insurance is due to a payout on a claim. Noninterest expense. Noninterest expense of$7.9 million for the third quarter of 2021 was 13.0%, or$916,000 , higher than the third quarter of 2020. Salaries and employee benefits increased$1.0 million , or 29.1%, and gain on other real estate owned increased$234,000 , partially offset by a decrease in professional fees of$153,000 , or 52.9%. The salary increase is mostly due to an increase in profit sharing expense, recognition of deferred PPP costs, and a restricted stock expense. The change in gains on other real estate owned was the result of an aggregate loss in the previous year. The decrease in consulting fees results from lower legal and consulting fees relative to the same period in the previous year. 40
-------------------------------------------------------------------------------- Noninterest expense of$24.2 million for the nine months endedSeptember 30, 2021 , was 10.3%, or$2.3 million , higher than the same period in 2020. Salaries and employee benefits increased$1.9 million , or 16.7%, and gain on other real estate owned increased$334,000 , partially offset by a decrease in professional fees of$129,000 , or 12.8%. The salary increase is mostly due to an increase in profit sharing expense, recognition of deferred PPP costs, and a restricted stock expense. The change in gains on other real estate owned was the result of an aggregate loss in the previous year. The decrease in consulting fees results from lower legal and consulting fees relative to the same period in the previous year. Provision for income taxes. The Company recognized$1.2 million in income tax expense, which reflected an effective tax rate of 18.4% for the three months endedSeptember 30, 2021 , as compared to$295,000 with an effective tax rate of 13.7% for the comparable 2020 period. The Company recognized$3.0 million in income tax expense, which reflected an effective tax rate of 18.0% for the nine months endedSeptember 30, 2021 , as compared to$934,000 with an effective tax rate of 13.7% for the comparable 2020 period. The increase in the effective tax rate is due to the increase in taxable income. 41 -------------------------------------------------------------------------------- Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages and the average loan balances include nonaccrual loans and exclude the allowance for loan and lease losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities and loans (tax-exempt for federal income tax purposes) are shown on a fully tax-equivalent basis utilizing a federal tax rate of 21%. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts. For the Three Months Ended September 30, 2021 2020 Average Average Average Average (Dollars in thousands) Balance Interest Yield/Cost Balance Interest Yield/Cost Interest-earning assets: Loans receivable (3)$ 1,027,935 $ 12,258 4.74 %$ 1,121,763 $ 12,603 4.48 % Investment securities (3) 154,718 1,134 3.37 % 111,994 867 3.66 % Interest-earning deposits with other banks (4) 105,910 55 0.21 % 53,826 37 0.27 % Total interest-earning assets 1,288,563 13,447 4.20 % 1,287,583 13,507 4.23 % Noninterest-earning assets 82,952 66,836 Total assets$ 1,371,515 $ 1,354,419 Interest-bearing liabilities: Interest-bearing demand deposits$ 225,264 $ 67 0.12 %$ 149,048 $ 120 0.32 % Money market deposits 182,831 214 0.46 % 176,136 312 0.70 % Savings deposits 253,960 38 0.06 % 223,507 113 0.20 % Certificates of deposit 218,323 596 1.08 % 349,981 1,561 1.77 % Short-term borrowings - - 0.00 % 19,740 14 0.28 % Other borrowings 12,999 37 1.13 % 17,130 28 0.65 % Total interest-bearing liabilities 893,377 952 0.42 % 935,542 2,148 0.91 % Noninterest-bearing liabilities: Noninterest-bearing demand deposits 323,726 270,868 Other liabilities 6,364 1,756 Stockholders' equity 148,048 146,253 Total liabilities and stockholders' equity$ 1,371,515 $ 1,354,419 Net interest income$ 12,495 $ 11,359 Interest rate spread (1) 3.78 % 3.32 % Net interest margin (2) 3.91 % 3.57 % Ratio of average interest-earning assets to average interest-bearing liabilities 144.24 % 137.63 %
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(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$195 and$186 for the three months endedSeptember 30, 2021 and 2020, respectively. (4) Includes dividends received on restricted stock. 42
-------------------------------------------------------------------------------- Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense, between the three-month periods endedSeptember 30, 2021 , and 2020, in terms of (1) changes in the volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Company's interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior period volume), changes in volume (changes in volume multiplied by prior period rate), and changes attributable to the combined impact of volume/rate (change in rate multiplied by the change in volume). The changes attributable to the combined impact of volume/rate are allocated consistently between the volume and rate variances. 2021 versus 2020 Increase (decrease) due to (Dollars in thousands) Volume Rate Total Interest-earning assets: Loans receivable$ (1,060 ) $ 715 $ (345 ) Investment securities 394 (127 ) 267 Interest-earning deposits with other banks 35 (17 )
18
Total interest-earning assets (631 ) 571
(60)
Interest-bearing liabilities: Interest-bearing demand deposits 61 (114 ) (53 ) Money market deposits 12 (110 ) (98 ) Savings deposits 15 (90 ) (75 ) Certificates of deposit (587 ) (378 ) (965 ) Short-term borrowings (14 ) - (14 ) Other borrowings (7 ) 16 9 Total interest-bearing liabilities (520 ) (676 ) (1,196 ) Net interest income$ (111 ) $ 1,247 $ 1,136 43
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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 resultant 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%. Yields and rates have been calculated on an annualized
basis utilizing monthly interest amounts.
For the Nine Months Ended September 30,
2021 2020
Average Average Average Average
(Dollars in thousands) Balance Interest Yield/Cost Balance Interest Yield/Cost
Interest-earning assets:
Loans receivable (3) $ 1,070,058 $ 36,310 4.54 % $ 1,065,964 $ 36,962 4.64 %
Investment securities (3) 135,522 3,074 3.51 % 108,551 2,493 3.68 %
Interest-earning deposits with
other banks (4) 94,955 141 0.20 % 51,361 216 0.56 %
Total interest-earning assets 1,300,535 39,525 4.12 % 1,225,876 39,671 4.38 %
Noninterest-earning assets 74,883 64,938
Total assets $ 1,375,418 $ 1,290,814
Interest-bearing liabilities:
Interest-bearing demand
deposits $ 211,797 209 0.13 % $ 130,886 $ 349 0.36 %
Money market deposits 187,945 655 0.47 % 166,193 1,246 1.00 %
Savings deposits 254,574 123 0.06 % 201,871 443 0.29 %
Certificates of deposit 240,582 2,143 1.19 % 358,048 5,269 1.97 %
Short-term borrowings 113 - - 30,174 81 0.36 %
Other borrowings 13,440 115 1.14 % 15,149 166 1.46 %
Total interest-bearing
liabilities 908,451 3,245 0.48 % 902,321 7,554 1.12 %
Noninterest-bearing
liabilities:
Noninterest-bearing demand
deposits 314,172 242,951
Other liabilities 6,184 2,593
Stockholders' equity 146,611 142,949
Total liabilities and
stockholders' equity $ 1,375,418 $ 1,290,814
Net interest income $ 36,280 $ 32,117
Interest rate spread (1) 3.64 % 3.26 %
Net interest margin (2) 3.79 % 3.56 %
Ratio of average
interest-earning assets to
average interest-bearing
liabilities 143.16 % 135.86 %
--------------------------------------------------------------------------------
(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$542 and$565 for the nine months endedSeptember 30, 2021 and 2020, respectively. (4) Includes dividends received on restricted stock. 44
-------------------------------------------------------------------------------- Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense, between the nine-month periods endedSeptember 30, 2021 , and 2020, in terms of (1) changes in the volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Company's interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior period volume), changes in volume (changes in volume multiplied by prior period rate), and changes attributable to the combined impact of volume/rate (change in rate multiplied by the change in volume). The changes attributable to the combined impact of volume/rate are allocated consistently between the volume and rate variances. 2021 versus 2020 Increase (decrease) due to (Dollars in thousands) Volume Rate Total Interest-earning assets: Loans receivable$ 142 $ (794 ) $ (652 ) Investment securities 742 (161 ) 581
Interest-bearing deposits with other banks 183 (258)
(75 ) Total interest-earning assets 1,067 (1,213 )
(146)
Interest-bearing liabilities: Interest-bearing demand deposits 218 (358 ) (140 ) Money market deposits 163 (754 ) (591 ) Savings deposits 114 (434 ) (320 ) Certificates of deposit (1,731 ) (1,395 ) (3,126 ) Short-term borrowings (81 ) - (81 ) Other borrowings (19 ) (32 ) (51 ) Total interest-bearing liabilities (1,336 ) (2,973 ) (4,309 ) Net interest income$ 2,403 $ 1,760 $ 4,163 45
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LIQUIDITY Management's objective in managing liquidity is maintaining the ability to continue meeting the cash flow needs of banking customers, such as borrowings or deposit withdrawals, as well as 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. The Company offers a line of retail deposit products created to align with customer expectations while expanding the Company's core funding base. Along with its liquid assets, the Company has additional sources of liquidity available to ensure that 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 and a borrowing agreement with the FHLB, and the adjustment of interest rates to obtain depositors. Management believes the Company has the capital adequacy, profitability, and reputation to meet the current and projected needs of its customers. OnSeptember 30, 2021 , the additional borrowing capacity at the FHLB was$424.6 million , as compared to$401.7 million onDecember 31, 2020 . For the nine months endedSeptember 30, 2021 , wholesale funding decreased by$51.6 million . The Company also has the option of borrowing from theFederal Reserve discount window with any assets not currently pledged elsewhere. Management believes that the combination of high levels of potentially liquid assets, cash flows from operations, and additional borrowing capacity providedMiddlefield Bank with strong liquidity as ofSeptember 30, 2021 . Although the Company currently exhibits strong liquidity, management will continue to monitor liquidity in future periods to look for signs of stress resulting from the COVID-19 pandemic. For the nine months endedSeptember 30, 2021 , the adjustments to reconcile net income to net cash from operating activities consisted mainly of depreciation and amortization of premises and equipment and software, the provision for loan losses, net amortization of securities, earnings on bank-owned life insurance, accretion of net deferred loan fees, and net changes in other assets and liabilities. For a more detailed illustration of sources and uses of cash, refer to the Condensed Consolidated Statements of Cash Flows. INFLATION Substantially all of the Company's assets and liabilities relate to banking activities and are monetary. The consolidated financial statements and related financial data are presented following GAAP. GAAP currently requires the Company to measure the financial position and results of operations in terms of historical dollars, except securities available for sale, impaired loans, and other real estate loans that are measured at fair value. Changes in the value of money due to rising inflation can cause purchasing power loss. Management's opinion is that movements in interest rates affect the financial condition and results of operations to a greater degree than changes in the rate of inflation. It should be noted that interest rates and inflation do affect each other, but do not always move in correlation with each other. The Company's ability to match the interest sensitivity of its financial assets to the interest sensitivity of its liabilities in its asset/liability management may tend to minimize the effect of changes in interest rates on the Company's performance. REGULATORY MATTERS The Company is subject to the regulatory requirements of theFederal Reserve System as a bank holding company. The bank subsidiary is subject to regulations of theFederal Deposit Insurance Corporation ("FDIC") and theOhio Division of Financial Institutions . TheFederal Reserve Board and theFDIC have extensive authority to prevent and remedy unsafe and unsound practices and violations of applicable laws and regulations by institutions and holding companies. The agencies may assess civil money penalties, issue cease-and-desist or removal orders, seek injunctions, and publicly disclose those actions. In addition, theOhio Division of Financial Institutions possesses enforcement powers to address violations ofOhio banking law byOhio -chartered banks.
REGULATORY CAPITAL REQUIREMENTS
Financial institution regulators have established guidelines for minimum capital ratios for banks, thrifts, and bank and thrift holding companies. The net unrealized gain or loss on available-for-sale securities is generally not included in computing regulatory capital. To avoid limitations on capital distributions, including dividend payments,Middlefield Bank and the Company must each hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. Within the tabular presentation that follows is the adequately capitalized ratio plus a 2.50% capital conservation buffer. 46 --------------------------------------------------------------------------------Middlefield Bank and the Company met each of the well-capitalized ratio guidelines onSeptember 30, 2021 . The following table indicates the capital ratios forMiddlefield Bank and the Company onSeptember 30, 2021 , andDecember 31, 2020 . As of September 30, 2021 Tier 1 Risk Common Total Risk Leverage Based Equity Tier 1 Based The Middlefield Banking Company 9.69 % 12.31 % 12.31 % 13.56 % Middlefield Banc Corp. 9.94 % 12.63 % 11.87 % 13.88 % 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 % As of December 31, 2020 Tier 1 Risk Common Total Risk Leverage 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%
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