1ST CONSTITUTION BANCORP Overview
The following discussion and analysis is intended to provide information about the financial condition and results of operations of the Company and its subsidiaries on a consolidated basis and should be read in conjunction with the consolidated financial statements and the related notes and supplemental financial information appearing elsewhere in this report. The Company, which was incorporated in 1999, is the parent holding company for1st Constitution Bank , a commercial bank formed in 1989 that provides a wide range of financial services to consumers, businesses and government entities. The Bank's branch network primarily servesCentral New Jersey and offers consumer and business banking products delivered through a network of well-trained staff dedicated to a positive client experience and enhancing shareholder value. Much of the Company's lending activity is in Northern andCentral New Jersey and theNew York metropolitan area. For purposes of the discussion below, 1st Constitution Capital Trust II (Trust II), a subsidiary of the Company, is not included in the Company's consolidated financial statements as it is a variable interest entity and the Company is not the primary beneficiary.
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Critical Accounting Policies and Estimates
Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States of America ("U.S. GAAP"). The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Company's Consolidated Financial Statements for the years endedDecember 31, 2019 and 2018 contains a summary of the Company's significant accounting policies. Management believes that the Company's policies with respect to the methodologies for the determination of the allowance for loan losses and for determining other-than-temporary security impairment involve a higher degree of complexity and requires management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. These critical policies and their application are periodically reviewed with the Audit Committee and the Board of Directors. The provision for loan losses is based upon management's evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the portfolio, after giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans and current economic and market conditions. Although management uses the best information available, the level of the allowance for loan 30 -------------------------------------------------------------------------------- losses remains an estimate, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of the Company's loans are secured by real estate in theState of New Jersey . Accordingly, the collectability of a substantial portion of the carrying value of the Company's loan portfolio is susceptible to changes in local market conditions and may be adversely affected in the event that real estate values decline or the Company's primary market area of northern and centralNew Jersey and theNew York City metropolitan area experiences adverse economic conditions. Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Company's control. Real estate acquired through foreclosure, or a deed-in-lieu of foreclosure, is recorded at fair value less estimated selling costs at the date of acquisition or transfer and, subsequently, fair value less estimated selling costs. Adjustments to the carrying value at the date of acquisition or transfer are charged to the allowance for loan losses. The carrying value of the individual properties is subsequently adjusted to estimated fair value less estimated selling costs, at which time a provision for losses on such real estate is charged to operations if it is lower. Appraisals are critical in determining the fair value of the other real estate owned ("OREO") amount. Assumptions for appraisals are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly affect the valuation of a property. The assumptions supporting such appraisals are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable. Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity due to changes in interest rates, prepayment risk, liquidity or other factors. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Management utilizes various inputs to determine the fair value of its investment portfolio. To the extent they exist, unadjusted quoted market prices in active markets for identical investments (level 1) or quoted prices on similar assets (level 2) are utilized to determine the fair value of each investment in the portfolio. In the absence of quoted prices, valuation techniques would be used to determine fair value of any investments that require inputs that are both significant to the fair value measurement and unobservable (level 3). Valuation techniques are based on various assumptions, including, but not limited to, cash flows, discount rates, rate of return, adjustments for nonperformance and liquidity and liquidation values. A significant degree of judgment is involved in valuing investments using level 3 inputs. The use of different assumptions could have a positive or negative effect on the Company's consolidated financial condition or results of operations. Securities are evaluated on at least a quarterly basis to determine whether a decline in fair value is other-than-temporary. To determine whether a decline in value is other-than-temporary, management considers the reasons underlying the decline, including, but not limited to, the length of time an investment's book value is greater than fair value, the extent and duration of the decline and the near-term prospects of the issuer as well as any credit deterioration of the investment. If the decline in value of an investment is deemed to be other-than-temporary, the entire difference between amortized cost and fair value is recognized as impairment through earnings. The Company records income taxes using the asset and liability method. Accordingly, deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been recognized in the financial statements or tax returns; are attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases; and are measured using enacted tax rates expected to apply in the years when those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period of enactment. Deferred tax assets are recorded on the consolidated balance sheet at net realizable value. The Company periodically performs an assessment to evaluate the amount of deferred tax assets that it is more likely than not to realize. Realization of deferred tax assets is dependent upon the amount of taxable income expected in future periods as tax benefits require taxable income to be realized. If a valuation allowance is required, the deferred tax asset on the consolidated balance sheet is reduced via a corresponding income tax expense in the consolidated statement of income. 31 --------------------------------------------------------------------------------
Earnings Summary 2019 compared to 2018 The Company reported net income of$13.6 million for the year endedDecember 31, 2019 compared to net income of$12.0 million for the year endedDecember 31, 2018 . Diluted earnings per share were$1.53 for the year endedDecember 31, 2019 compared to diluted earnings per share of$1.40 for the year endedDecember 31, 2018 . For the year endedDecember 31, 2019 , net income increased$1.6 million , or 13.2%, and net income per diluted share increased$0.13 . OnNovember 8, 2019 , the Company completed the Shore Merger. As a result of the Shore Merger, merger-related expenses of$1.7 million were incurred and the after-tax effect of the merger-related expenses reduced net income for the year endedDecember 31, 2019 by$1.3 million . The acquisition method of accounting for the business combination resulted in the recognition of goodwill of$23.2 million . A core deposit intangible of$1.5 million and a credit risk discount of$3.6 million applicable to loans were also recorded. Adjusted net income, which excludes the after-tax effect of merger-related expenses, for the year endedDecember 31, 2019 was$15.0 million , or$1.68 per diluted share, compared to adjusted net income of$13.4 million , or$1.56 per diluted share, for the year endedDecember 31, 2018 . Adjusted net income for 2019 increased$1.6 million or 12.0% compared to adjusted net income for 2018. The increase was due primarily to an increase of$3.9 million in net interest income and an increase of$319,000 in non-interest income, which was partially offset by an increase of$450,000 in the provision for loan losses and an increase of$1.5 million in non-interest expense. The Shore Merger, excluding merger-related expenses, contributed$682,000 to the net income and adjusted net income for the year endedDecember 31, 2019 . Return on average total assets ("ROAA") and return on average shareholders' equity ("ROAE") were 1.06% and 9.87%, respectively, for the year endedDecember 31, 2019 compared to 1.06% and 10.11%, respectively, for the year endedDecember 31, 2018 . Excluding the merger-related expenses, ROAA and ROAE were 1.17% and 10.84%, respectively, for the year endedDecember 31, 2019 compared to 1.17% and 11.21%, respectively, for the year endedDecember 31, 2018 . 32 -------------------------------------------------------------------------------- Adjusted net income, adjusted net income per diluted share, adjusted ROAA and adjusted ROAE are non-GAAP financial measures. Each of these non-GAAP financial measures is the same as the corresponding GAAP measure, except that it excludes the after-tax effect of merger-related expenses from the Shore Merger in 2019 and the NJCB Merger in 2018. These non-GAAP financial measures should be considered in addition to, but not as a substitute for, the Company's GAAP financial results. Management believes that the presentation of these non-GAAP financial measures of the Company may be helpful to readers in understanding the Company's financial performance when comparing the Company's financial statements for the years endedDecember 31, 2019 and 2018 because these non-GAAP financial measures present the Company's financial performance excluding the financial impact of the merger-related expenses related to the Shore Merger in 2019 and the NJCB Merger in 2018.
The table below shows the major components of net income for the years ended
Change in
(Dollars in thousands) 2019 2018 $ %
Net interest income $ 47,336 $ 43,432 $ 3,904 9.0 %
Provision for loan losses 1,350 900 450 50.0 %
Non-interest income 8,237 7,918 319 4.0 %
Non-interest expense 35,549 34,085 1,464 4.3 %
Net income before income taxes 18,674 16,365 2,309 14.1 %
Income taxes 5,040 4,317 723 16.7 %
Net income 13,634 12,048 1,586 13.2 %
Adjustments:
Revaluation of deferred tax assets - (28 ) 28 N.M.
Merger-related expenses 1,730 2,141 (411 ) (19.2 )%
Gain from bargain purchase - (230 ) 230 N.M.
Income tax effect of adjustments (394 ) (568 ) 174 (30.6 )%
Total adjustments 1,336 1,315 21 1.60 %
Adjusted net income $ 14,970 $ 13,363 $ 1,607 12.0 %
Earnings per common share:
Basic, as reported $ 1.54 $ 1.45 $ 0.09 6.2 %
Adjustments 0.15 0.16 (0.01 ) (6.3 )%
Basic, as adjusted $ 1.69 $ 1.61 $ 0.08 5.0 %
Diluted, as reported $ 1.53 1.40 $ 0.13 9.3 %
Adjustments 0.15 0.16 (0.01 ) (6.3 )%
Diluted, as adjusted $ 1.68 $ 1.56 $ 0.12 7.7 %
Return on average total assets:
As reported 1.06 % 1.06 %
Adjusted net income $ 14,970 $ 13,363
Average assets 1,283,302 1,137,768
As adjusted 1.17 % 1.17 %
Return on average shareholders' equity:
As reported 9.87 % 10.11 %
Adjusted net income $ 14,970 $ 13,363
Average shareholders' equity 138,101 119,212
As adjusted 10.84 % 11.21 %
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2018 compared to 2017
The Company reported net income of$12.0 million for the year endedDecember 31, 2018 compared to net income of$6.9 million for the year endedDecember 31, 2017 . Diluted earnings per share were$1.40 for the year endedDecember 31, 2018 compared to diluted earnings per share of$0.83 for the year endedDecember 31, 2017 . For the year endedDecember 31, 2018 , net income increased$5.1 million , or 73.9%, and net income per diluted share increased$0.57 . OnApril 11, 2018 , the Company completed the merger of NJCB with and into the Bank. As a result of the NJCB merger, merger-related expenses of$2.1 million were incurred and the after-tax effect of the merger expenses reduced net income for the year endedDecember 31, 2018 by$1.6 million . The acquisition method of accounting for the business combination resulted in the recognition of a gain from the bargain purchase of$230,000 and no goodwill. For the year endedDecember 31, 2017 , the Company recorded$265,000 in merger-related expenses. As a result of the enactment of the Tax Cuts and Jobs Act ("Tax Act") onDecember 22, 2017 , which reduced the maximum federal corporate income tax rate from 35% to 21% beginning in 2018, the Company revalued its net deferred tax assets to reflect the lower federal corporate income tax rate that would be in effect in future years which resulted in an additional$1.7 million of income tax expense due to the revaluation of the Company's deferred tax assets. Excluding the gain from bargain purchase, the merger-related expenses and the additional income tax expense, adjusted net income for the year endedDecember 31, 2018 was$13.4 million , or$1.56 per diluted share, compared to adjusted net income of$8.8 million , or$1.06 per diluted share, for the year endedDecember 31, 2017 . Adjusted net income for 2018 increased$4.5 million or 51.4% compared to adjusted net income for 2017. The increase was due primarily to an increase of$7.3 million in net interest income, which was partially offset by an increase of$300,000 in the provision for loan losses, an increase of$3.1 million in non-interest expense and a decrease of$322,000 in non-interest income. The NJCB Merger contributed$960,000 to the net income and adjusted net income for the year endedDecember 31, 2018 . ROAA and ROAE were 1.06% and 10.11%, respectively, for the year endedDecember 31, 2018 compared to 0.67% and 6.36%, respectively, for the year endedDecember 31, 2017 . Excluding the gain from bargain purchase, the merger-related expenses and the additional income tax expense, ROAA and ROAE were 1.17% and 11.21%, respectively, for the year endedDecember 31, 2018 compared to 0.86% and 8.10%, respectively, for the year endedDecember 31, 2017 . 34 --------------------------------------------------------------------------------
The table below shows the major components of net income for the years ended
Change in
(Dollars in thousands) 2018 2017 $ %
Net interest income $ 43,432 $ 36,165 $ 7,267 20.1 %
Provision (credit) for loan losses 900 600 300 50.0
Non-interest income 7,918 8,240 (322 ) (3.9 )
Non-interest expense 34,085 31,006 3,079 9.9
Net income before income taxes 16,365 12,799 3,566 27.9
Income taxes 4,317 5,871 (1,554 ) (26.5 )
Net income 12,048 6,928 5,120 73.9 %
Adjustments:
Revaluation of deferred tax assets (28 ) 1,712 (1,740 ) N.M.
Merger-related expenses 2,141 265 1,876 N.M.
Gain from bargain purchase (230 ) - (230 )
Income tax effect of adjustments (568 ) (77 ) (491 ) N.M.
Total adjustments 1,315 1,900 (585 ) N.M.
Adjusted net income $ 13,363 $ 8,828 $ 4,535 51.4 %
Earnings per common share:
Basic, as reported $ 1.45 $ 0.86 $ 0.59 68.6 %
Adjustments 0.16 0.24 (0.08 ) N.M.
Basic, as adjusted $ 1.61 $ 1.10 $ 0.51 46.4 %
Diluted, as reported $ 1.40 0.83 $ 0.57 68.7 %
Adjustments 0.16 0.23 (0.07 ) N.M.
Diluted, as adjusted $ 1.56 $ 1.06 $ 0.50 47.2 %
Return on average total assets:
As reported 1.06 % 0.67 %
Adjusted net income $ 13,363 $ 8,828
Average assets 1,137,768 1,031,796
As adjusted 1.17 % 0.86 %
Return on average shareholders' equity:
As reported 10.11 % 6.36 %
Adjusted net income $ 13,363 $ 8,828
Average shareholders' equity 119,212 108,925
As adjusted 11.21 % 8.10 %
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Net Interest Income and Net Interest Margin
Net interest income, the Company's largest and most significant component of operating income, is the difference between interest and fees earned on loans, investment securities and other earning assets and interest paid on deposits and borrowed funds. This component represented 85%, 85% and 81% of the Company's net revenues (net interest income plus non-interest income) for the years endedDecember 31, 2019 , 2018 and 2017, respectively. Net interest income is determined by the difference between the yields earned on earning assets and the rates paid on interest-bearing liabilities ("net interest spread") and the relative amounts of average earning assets and average interest-bearing liabilities. The Company's net interest spread is affected by the monetary policy of theFederal Reserve Board , and regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows as well as general levels of nonperforming assets.
The following table summarizes the Company's net interest income and related spread and margin for the periods indicated:
Years ended December 31 ,
(Dollars in thousands) 2019 2018 2017
Net interest income
36
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The following tables compare the Company's consolidated average balance sheets,
interest income and expense, net interest spreads and net interest margins for
the years ended December 31, 2019 , 2018 and 2017 (on a fully tax-equivalent
basis). The average rates are derived by dividing interest income and expense by
the average balance of assets and liabilities, respectively.
December 31, 2019
Average Average
(In thousands except yield/cost information) Balance Interest Yield/Cost Assets Interest-earning assets: Federal funds sold/short term investments$ 8,142 $ 176 2.16 % Investment securities: Taxable 163,415 4,710 2.88 Tax-exempt (1) 57,005 2,110 3.70 Total investment securities 220,420 6,820 3.09 Loans: (2) Commercial real estate 426,929 22,129 5.11 Mortgage warehouse lines 174,151 9,543 5.48 Construction 156,467 10,576 6.76 Commercial business 121,985 7,295 5.98 Residential real estate 56,745 2,591 4.50 Loans to individuals 23,312 1,195 5.06 Loans held for sale 4,280 170 3.97 All other loans 1,051 38 3.57 Total loans 964,920 53,537 5.55 Total interest-earning assets 1,193,482 60,533 5.07 % Non-interest-earning assets: Allowance for loan losses (8,796 ) Cash and due from bank 11,729 Other assets 86,887 Total non-interesting-earning assets 89,820 Total assets$ 1,283,302 Liabilities and Shareholders' Equity Interest-bearing liabilities: Money market and NOW accounts$ 349,663 $ 2,750 0.79 % Savings accounts 201,738 1,952 0.97 Certificates of deposit 286,419 6,392 2.23 Other borrowed funds 38,594 912 2.36 Redeemable subordinated debentures 18,557 748
4.03
Total interest-bearing liabilities 894,971 12,754 1.43 % Non-interest-bearing liabilities: Demand deposits 226,701 Other liabilities 23,529 Total non-interest-bearing liabilities 250,230 Shareholders' equity 138,101
Total liabilities and shareholders' equity
3.65 %
Net interest income and margin (4) $ 47,779 4.00 %
(1) Tax-equivalent basis, using 21% federal tax rate in 2019.
(2) Loan origination fees and costs are considered an adjustment to interest
income. For the purpose of calculating loan yields, average loan balances
include non-accrual loans with no related interest income and average
balance of loans held for sale.
(3) The net interest spread is the difference between the average yield on
interest earning assets and the average rate paid on interest bearing
liabilities.
(4) The net interest margin is equal to net interest income divided by average
interest earning assets.
37
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December 31, 2018
Average Average
(In thousands except yield/cost information) Balance Interest Yield/Cost Assets Interest-earning assets: Federal funds sold/short term investments$ 20,157 $ 258 1.28 % Investment securities: Taxable 146,631 4,024 2.74 Tax-exempt (1) 74,477 2,518 3.38 Total investment securities 221,108 6,542 2.96 Loans: (2) Commercial real estate 356,581 18,318 5.07 Mortgage warehouse lines 153,868 8,403 5.46 Construction 137,976 9,090 6.59 Commercial business 111,150 6,059 5.45 Residential real estate 46,301 2,085 4.44 Loans to individuals 23,155 1,083 4.61 Loans held for sale 2,738 123 4.49 All other loans 1,197 41 3.38 Total loans 832,966 45,202 5.38 Total interest-earning assets 1,074,231 52,002 4.81 % Non-interest-earning assets: Allowance for loan losses (8,314 ) Cash and due from bank 5,595 Other assets 66,256 Total non-interesting-earning assets 63,537 Total assets$ 1,137,768 Liabilities and Shareholders' Equity Interest-bearing liabilities: Money market and NOW accounts$ 356,906 $ 1,978 0.55 % Savings accounts 203,940 1,467 0.72 Certificates of deposit 189,521 3,066 1.62 Other borrowed funds 36,612 836 2.28 Redeemable subordinated debentures 18,557 694
3.74
Total interest-bearing liabilities 805,536 8,041 1.00 % Non-interest-bearing liabilities: Demand deposits 204,002 Other liabilities 9,018 Total non-interest-bearing liabilities 213,020 Shareholders' equity 119,212
Total liabilities and shareholders' equity
3.81 %
Net interest income and margin (4) $ 43,961 4.09 %
(1) Tax-equivalent basis, using 21% federal tax rate in 2018.
(2) Loan origination fees and costs are considered an adjustment to interest
income. For the purpose of calculating loan yields, average loan balances
include non-accrual loans with no related interest income and average
balance of loans held for sale.
(3) The net interest spread is the difference between the average yield on
interest earning assets and the average rate paid on interest bearing
liabilities.
(4) The net interest margin is equal to net interest income divided by average
interest earning assets.
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December 31, 2017
Average Average
(In thousands except yield/cost information) Balance Interest Yield/Cost Assets Interest-earning assets: Federal funds sold/short term investments$ 27,533 $ 230 0.84 % Investment securities: Taxable 140,431 3,326 2.37 Tax-exempt (1) 90,186 3,167 3.51 Total investment securities 230,617 6,493 2.82 Loans: (2) Commercial real estate 274,192 13,851 4.98 Mortgage warehouse lines 160,756 6,937 4.26 Construction 115,913 6,780 5.77 Commercial business 96,193 5,474 5.63 Residential real estate 41,898 1,777 4.24 Loans to individuals 22,171 903 4.07 Loans held for sale 4,197 202 4.81 All other loans 1,690 43 2.51 Total loans 717,010 35,967 4.96 Total interest-earning assets 975,160 42,690 4.33 % Non-interest-earning assets: Allowance for loan losses (7,703 ) Cash and due from bank 5,371 Other assets 58,968 Total non-interesting-earning assets 56,636 Total assets$ 1,031,796 Liabilities and Shareholders' Equity Interest-bearing liabilities: Money market and NOW accounts$ 336,445 $ 1,440 0.43 % Savings accounts 210,798 1,332 0.63 Certificates of deposit 145,539 1,778 1.22 Other borrowed funds 21,139 429 2.03 Redeemable subordinated debentures 18,557 519
2.80
Total interest-bearing liabilities 732,478 5,498 0.75 % Non-interest-bearing liabilities: Demand deposits 183,802 Other liabilities 6,591 Total non-interest-bearing liabilities 190,393 Shareholders' equity 108,925
Total liabilities and shareholders' equity
3.58 %
Net interest income and margin (4) $ 37,192 3.81 %
(1) Tax-equivalent basis, using 34% federal tax rate in 2017.
(2) Loan origination fees and costs are considered an adjustment to interest
income. For the purpose of calculating loan yields, average loan balances
include non-accrual loans with no related interest income and average
balance of loans held for sale.
(3) The net interest spread is the difference between the average yield on
interest earning assets and the average rate paid on interest bearing
liabilities.
(4) The net interest margin is equal to net interest income divided by average
interest earning assets.
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Changes in net interest income and net interest margin result from the
interaction between the volume and composition of interest earning assets,
interest bearing liabilities, related yields and funding costs. The effect of
volume and rate changes on net interest income (on a tax-equivalent basis) for
the periods indicated are shown below:
Year ended 2019 compared with 2018 Year ended 2018 compared with 2017
Due to Change in: Due to Change in:
(Dollars in thousands) Volume Rate Total Volume Rate Total
Assets
Federal funds sold/short term investments$ (154 ) $ 72$ (82 ) $ (62 ) $ 90 $ 28 Investment securities: Taxable 461 225 686 148 550 698 Tax-exempt(1) (591 ) 183 (408 ) (552 ) (97 ) (649 ) Total investment securities (130 ) 408 278 (404 ) 453 49 Loans: Commercial real estate 3,564 247 3,811 4,105 362 4,467 Mortgage warehouse lines 1,108 32 1,140 (293 ) 1,759 1,466 Construction 1,218 268 1,486 1,273 1,037 2,310 Commercial business 591 645 1,236 842 (257 ) 585 Residential real estate 464 42 506 187 121 308 Loans to individuals 7 105 112 40 140 180 Loans held for sale 69 (22 ) 47 (70 ) (9 ) (79 ) Other (5 ) 2 (3 ) (12 ) 10 (2 ) Total loans 7,016 1,319 8,335 6,072 3,163 9,235 Total interest income$ 6,732 $ 1,799 $ 8,531 $ 5,606 $ 3,706 $ 9,312 Liabilities Money market and NOW accounts (40 ) 812 772 88 450 538 Savings accounts (16 ) 501 485 (43 ) 178 135 Certificates of deposit 1,568 1,758 3,326 537 751 1,288 Other borrowed funds 45 31 76 314 93 407 Redeemable subordinated debentures - 54 54 - 175 175 Total interest expense 1,557 3,156 4,713 896 1,647 2,543 Net interest income$ 5,175 $ (1,357 ) $ 3,818 $ 4,710 $ 2,059 $ 6,769
(1) Tax-equivalent basis, using 21% federal tax rate in 2019.
2019 compared to 2018 For the year endedDecember 31, 2019 , the Company's net interest income, on a fully tax-equivalent basis, increased by$3.8 million , or 8.7%, to$47.8 million compared to$44.0 million for the year endedDecember 31, 2018 . This increase was due primarily to an increase in average earning assets, as well as an increase in the average yield on earning assets, which were partially offset by an increase in interest expense on average interest-bearing liabilities. Average earning assets were$1.2 billion with a yield of 5.07% for 2019 compared to average earning assets of$1.1 billion with a yield of 4.81% for 2018. The generally higher interest rate environment during the first half of 2019 compared to 2018 had a positive effect on the yields of construction, commercial business and home equity loans despite a decline of 75 basis points in theFederal Reserve Board's targeted federal funds rate and the corresponding decrease in the Prime Rate in the third and fourth quarters of 2019. For the year endedDecember 31, 2019 , interest income on interest earning assets increased by$8.5 million and interest income on average loans increased by$8.3 million as the average total loans increased$132.0 million year over year, reflecting growth in all segments of the loan portfolio. The Shore Merger contributed approximately$33.5 million to the increase in average loans for 2019, which consisted primarily of commercial real estate loans. 40 -------------------------------------------------------------------------------- Interest expense on average interest-bearing liabilities was$12.8 million , or 1.43%, for the year endedDecember 31, 2019 compared to$8.0 million , or 1.00%, for the year endedDecember 31, 2018 . The increase of$4.7 million in interest expense on average interest-bearing liabilities primarily reflected higher deposit interest rates and higher borrowing interest rates in 2019 compared to 2018. During the year endedDecember 31, 2019 , average interest-bearing liabilities increased$89.4 million to$895.0 million . The change in the mix of deposits, with the average balance of money market, NOW and savings accounts lower than, and certificates of deposits higher than, in 2018 also increased the cost of total deposits because certificates of deposit generally have a higher interest cost than non-maturity deposits. The Shore Merger contributed approximately$26.1 million to the increase in average interest-bearing liabilities for 2019.
2018 compared to 2017
For the year endedDecember 31, 2018 , the Company's net interest income, on a fully tax-equivalent basis, increased by$6.8 million , or 18.2%, to$44.0 million compared to$37.2 million for the year endedDecember 31, 2017 . This increase was due primarily to an increase in average earning assets, as well as an increase in the average yield on earning assets, which were partially offset by an increase in interest expense on average interest-bearing liabilities. Average earning assets were$1.1 billion with a yield of 4.81% for 2018 compared to average earning assets of$975.2 million with a yield of 4.33% for 2017. The 100 basis point increase in theFederal Reserve Board's targeted federal funds rate and the corresponding increase in the Prime Rate since December of 2017 had a positive effect on the yields of construction and warehouse loans with variable interest rate terms. The generally higher interest rate environment in 2018 compared to 2017 also had a positive effect on the yields of commercial real estate and residential real estate loans. For the year endedDecember 31, 2018 , interest income on interest earning assets increased by$9.3 million and interest income on average loans increased by$9.2 million as the average balances of commercial real estate, construction and commercial business loans grew by$82.4 million ,$22.1 million and$15.0 million , respectively. For 2018, average loans increased$116.0 million to$833.0 million . The NJCB Merger contributed approximately$63.0 million to the increase in average loans for the year endedDecember 31, 2018 , which consisted primarily of commercial real estate loans. Interest expense on average interest-bearing liabilities was$8.0 million , or 1.00%, for the year endedDecember 31, 2018 compared to$5.5 million , or 0.75%, for the year endedDecember 31, 2017 . The increase of$2.5 million in interest expense on interest-bearing liabilities for 2018 compared to 2017 primarily reflects higher short-term market interest rates and increased competition for deposits in 2018 compared to 2017. For 2018, average interest-bearing liabilities increased$73.1 million to$805.5 million . The NJCB Merger contributed approximately$60.9 million to the increase in average interest-bearing liabilities for the year endedDecember 31, 2018 .
Provision for Loan Losses
Management considers a complete review of the following specific factors in determining the provisions for loan losses: historical losses by loan category, non-accrual loans and problem loans as identified through internal classifications, collateral values and the growth, size and risk elements of the loan portfolio. In addition to these factors, management takes into consideration current economic conditions and local real estate market conditions. In general, over the last five years, the Company experienced an improvement in loan credit quality and achieved a steady resolution of non-performing loans and assets related to the severe recession, which was reflected in the current level of non-performing loans atDecember 31, 2019 . Net charge-offs of commercial business and commercial real estate loans since 2016 have declined significantly from prior periods, which has resulted in a reduction of the historical loss factors for these segments of the loan portfolio that were applied by management to estimate the allowance for loan losses atDecember 31, 2019 .
2019 compared to 2018
The Company recorded a provision for loan losses of$1.4 million for the year endedDecember 31, 2019 compared to a provision of$900,000 for the year endedDecember 31, 2018 . For 2019, net charge-offs of$481,000 were recorded compared to net charge-offs of$511,000 recorded in 2018. The allowance for loan losses atDecember 31, 2019 and 2018 totaled$9.3 million and$8.4 million , respectively. The increase in the provision for loan losses for 2019 was primarily attributed to the growth in commercial real estate and mortgage warehouse loans. . 41 -------------------------------------------------------------------------------- AtDecember 31, 2019 , non-performing loans totaled$4.5 million compared to$6.6 million atDecember 31, 2018 , a decrease of$2.1 million , or 31.7%, and the ratio of non-performing loans to total loans decreased to 0.37% atDecember 31, 2019 from 0.75% atDecember 31, 2018 .
2018 compared to 2017
The Company recorded a provision for loan losses of$900,000 for the year endedDecember 31, 2018 compared to a provision of$600,000 for the year endedDecember 31, 2017 . For 2018, net charge-offs of$511,000 were recorded compared to net charge-offs of$81,000 in 2017. The allowance for loan losses atDecember 31, 2018 and 2017 totaled$8.4 million and$8.0 million , respectively. The increase in the provision for loan losses for 2018 was primarily attributed to the growth of commercial real estate, construction and commercial business loans and the change in the mix of loans in the loan portfolio. AtDecember 31, 2018 , non-performing loans totaled$6.6 million compared to$7.1 million atDecember 31, 2017 , a decrease of$534,000 , or 7.5%, and the ratio of non-performing loans to total loans decreased to 0.75% atDecember 31, 2018 from 0.90% atDecember 31, 2017 . Non-Interest Income 2019 compared to 2018 Total non-interest income for the year endedDecember 31, 2019 increased$319,000 to$8.2 million from$7.9 million for the year endedDecember 31, 2018 . This revenue component represented 15% of the Company's net revenues for the years endedDecember 31, 2019 and 2018. Service charges on deposit accounts increased by$25,000 to$663,000 for the year endedDecember 31, 2019 compared to$638,000 for the year endedDecember 31, 2018 due in part to the increase in deposit accounts as a result of the Shore Merger. Gains on sales of loans held for sale increased$410,000 to$4.9 million for the year endedDecember 31, 2019 compared to$4.5 million for the year endedDecember 31, 2018 . The Company sells both residential mortgage loans and portions of commercial business loans guaranteed by the SBA in the secondary market. Gains on the sale of residential mortgage loans were$3.9 million in 2019 compared to$2.6 million in 2018. In 2019,$132.2 million of residential mortgage loans were sold compared to$89.1 million in 2018. The increase in residential mortgage loans sold was due primarily to higher residential mortgage lending activity during 2019 compared to 2018 due in part to a higher level of refinancing activity.
In 2019,
Non-interest income also includes income from Bank-owned life insurance
("BOLI"), which totaled $623,000 for the year ended December 31, 2019 compared
to $575,000 for the year ended December 31, 2018 . The increase was due primarily
to a $7.2 million increase in BOLI resulting from the Shore Merger.
The Company also generates non-interest income from a variety of fee-based
services. These include safe deposit box rentals, wire transfer service fees and
ATM fees for non-Bank customers. The other income component of non-interest
income was
2018 compared to 2017
Total non-interest income for the year endedDecember 31, 2018 decreased$322,000 to$7.9 million from$8.2 million for the year endedDecember 31, 2017 . This revenue component represented 15% and 19% of the Company's net revenues for the years endedDecember 31, 2018 and 2017, respectively. Service charges on deposit accounts increased by$42,000 to$638,000 for the year endedDecember 31, 2018 compared to$596,000 for the year endedDecember 31, 2017 due primarily to the increase in deposit accounts as a result of the NJCB Merger. 42
-------------------------------------------------------------------------------- Gains on sales of loans held for sale decreased$674,000 to$4.5 million for the year endedDecember 31, 2018 compared to$5.1 million for the year endedDecember 31, 2017 . The Company sells both residential mortgage loans and portions of commercial business loans guaranteed by the SBA in the secondary market. Gains on the sale of residential mortgage loans were$2.6 million in 2018 compared to$3.9 million in 2017. In 2018,$89.1 million of residential mortgage loans were sold compared to$121.1 million in 2017. The decrease in the residential lending activity and gains on the sale of loans was due primarily to the lower volume of residential lending and loans sold in 2018 as a result of higher mortgage interest rates in 2018 compared to 2017.
In 2018,
Non-interest income also includes income fromBOLI, which totaled$575,000 for the year endedDecember 31, 2018 compared to$522,000 for the year endedDecember 31, 2017 . The increase was due primarily to a$3.7 million increase in BOLI resulting from the NJCB Merger.
The acquisition method of accounting for the business combination with NJCB
resulted in the recognition of a gain on bargain purchase of
The Company also generates non-interest income from a variety of fee-based services. These include safe deposit box rentals, wire transfer service fees and ATM fees for non-Bank customers. The other income component of non-interest income was$2.0 million for the year endedDecember 31, 2018 compared to$1.8 million for the year endedDecember 31, 2017 .
Non-Interest Expenses
The following table presents the major components of non-interest expense:
Year ended December 31,
(In thousands) 2019 2018 2017
Salaries and employee benefits $ 21,304 $ 19,853 $ 18,804
Occupancy expense 4,100 3,623 3,169
Data processing expenses 1,507 1,332 1,314
Equipment expense 1,286 1,175 1,008
Marketing 302 280 225
Telephone 400 391 389
Regulatory, professional and consulting fees 1,806 1,713 2,263
Insurance 391 375 373
Merger-related expenses 1,730 2,141 265
FDIC insurance expense 154 486 360
Other real estate owned expenses 171 158 42
Amortization of intangible assets 140 318 384
Supplies 275 294 259
Other expenses 1,983 1,946 2,151
Total $ 35,549 $ 34,085 $ 31,006
2019 compared to 2018
For the year ended December 31, 2019 , non-interest expenses totaled $35.5
million , an increase of $1.5 million , or 4.3%, when compared to $34.1 million
for the year ended December 31, 2018 . The increase in non-interest expenses
included increases in salaries and employee benefit expenses, occupancy expense,
data processing expenses and other expenses related to the addition of the Shore
operations, offset by a decrease in merger-related expenses and FDIC insurance
expense.
Salaries and employee benefits, which represent the largest portion of
non-interest expenses, increased by $1.5 million , or 7.3%, to $21.3 million
compared to $19.9 million for the year ended December 31, 2018 due primarily to
a $585,000 increase in commissions paid as a result of the higher level of
residential mortgage lending activity, salaries for former Shore employees
($298,000 ) who joined the Company following the Shore Merger in November 2019 ,
salaries for former NJCB employees
43
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($169,000 ) who joined the Company following the NJCB Merger in the second
quarter of 2018, merit increases and increases in employee benefits expenses.
Cash incentive compensation and employee health benefits increased $241,000 and
$162,000 , respectively, during 2019. At December 31, 2019 , there were 218
full-time equivalent employees compared to 189 full-time equivalent employees at
December 31, 2018 .
Occupancy expense totaled $4.1 million in 2019 compared to $3.6 million in 2018,
increasing $477,000 , or 13.2%, from 2018 to 2019 due primarily to the addition
of the five former Shore branch offices ($129,000 ) in the fourth quarter of 2019
and the addition of two former NJCB branch offices ($123,000 ) in the second
quarter of 2018.
For the years ended
The cost of data processing services increased
Regulatory, professional and consulting fees increased by$93,000 to$1.8 million for the year endedDecember 31, 2019 compared to$1.7 million for the year endedDecember 31, 2018 , due primarily to general increases in legal and consulting fees.
The Company recordedFDIC insurance expense of$154,000 for the year endedDecember 31, 2019 compared to$486,000 for the year endedDecember 31, 2018 , representing a decrease of$332,000 , due primarily to the receipt fromFDIC of the small bank assessment credit for the second and the third quarters of 2019 and the reduction in theFDIC assessment rate. The Bank has a remaining credit of approximately$123,000 that may be applied by theFDIC to future quarters' assessments. The application and receipt of future credits will depend on future reserve calculations for theDeposit Insurance Fund of the FDIC . Amortization of intangible assets decreased$178,000 to$140,000 for the year endedDecember 31, 2019 compared to$318,000 for the year endedDecember 31, 2018 due primarily to the full amortization of the core deposit intangible in 2018 related to the acquisition of three branch offices and their deposits in 2011.
Other expenses totaled
2018 compared to 2017 For the year endedDecember 31, 2018 , non-interest expenses totaled$34.1 million , an increase of$3.1 million , or 9.9%, when compared to$31.0 million for the year endedDecember 31, 2017 . The increase in non-interest expenses included increases in salaries and employee benefit expenses, occupancy expense, NJCB merger-related expenses and expenses related to the addition of the NJCB operations, which were partially offset by a decrease in regulatory, professional and consulting fees. Salaries and employee benefits, which represents the largest portion of non-interest expenses, increased by$1.0 million , or 5.6%, to$19.9 million compared to$18.8 million for the year endedDecember 31, 2017 due primarily to salaries for former NJCB employees who joined the Company, merit increases and increases in employee benefits expenses. Cash incentive compensation and employee health benefits increased$90,000 and$155,000 , respectively, during 2018. AtDecember 31, 2018 , there were 189 full-time equivalent employees compared to 179 full-time equivalent employees atDecember 31, 2017 . Occupancy expense totaled$3.6 million in 2018 compared to$3.2 million in 2017, increasing$454,000 , or 14.3%, from 2017 to 2018 due primarily to the addition of the two former NJCB branch offices.
For the years ended
The cost of data processing services remained relatively flat at
44
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Marketing expenses were
Regulatory, professional and consulting fees decreased by$550,000 , or 24.3%, to$1.7 million for the year endedDecember 31, 2018 compared to$2.3 million for the year endedDecember 31, 2017 . The level of professional and consulting fees declined due primarily to lower legal and consulting fees related to loan collections and litigation expenses.
Merger-related expenses of
FDIC insurance expense increased to$486,000 for the year endedDecember 31, 2018 compared to$360,000 for the year endedDecember 31, 2017 due primarily to the internal growth of assets and the increase in assets as a result of the NJCB Merger. OREO expenses increased to$158,000 in 2018 from$42,000 for 2017 due primarily to an increase in OREO assets held during 2018. AtDecember 31, 2018 , the Company held$2.5 million in OREO compared to no OREO held atDecember 31, 2017 . The Company incurred expenses in connection with general maintenance, insurance and real estate taxes. OREO atDecember 31, 2018 was comprised of one residential property with a carrying value of$1.1 million acquired in the NJCB Merger, land with a carrying value of$93,000 and a commercial real estate property that was foreclosed in the third quarter of 2018 with a fair value of$1.3 million . Amortization of intangible assets decreased$66,000 to$318,000 for the year endedDecember 31, 2018 compared to$384,000 for the year endedDecember 31, 2017 due to the lower amortization of core deposit intangible assets.
Supplies increased
Other expenses were$1.9 million for the year endedDecember 31, 2018 compared to$2.2 million for the year endedDecember 31, 2017 . The decrease in other expenses was due primarily to the absence in the 2018 period of any write-off of deferred loan origination costs, which were approximately$500,000 in 2017, which was partially offset by increases in various other expense categories. Income Taxes 2019 compared to 2018 The Company recorded income tax expense of$5.0 million in 2019, resulting in an effective tax rate of 27.0%, compared to income tax expense of$4.3 million in 2018, which resulted in an effective tax rate of 26.4%. The higher effective tax rate in 2019 was primarily the result of the higher amount of pre-tax income taxed at the combined marginal federal and state statutory tax rate of 30.08% and the non-taxable gain from the bargain purchase in the NJCB Merger in 2018.
2018 compared to 2017
The Company recorded income tax expense of$4.3 million in 2018, resulting in a effective tax rate of 26.4%, compared to income tax expense of$5.9 million in 2017, which resulted in an effective tax rate of 45.9%. Income tax expense for 2017 includes$1.7 million of additional income tax expense due to the revaluation of the deferred tax assets as a result of the enactment of the Tax Act inDecember 2017 . Absent the$1.7 million of additional income tax expense, the effective tax rate would have been 32.5% for 2017. The Tax Act reduced the maximum federal corporate income tax rate to 21% from 35%, effectiveJanuary 1, 2018 , which explains the lower effective tax rate in 2018. Partially offsetting the lower federal corporate income tax rate was the enactment of legislation by theState of New Jersey inJuly 2018 , which increased the corporate income tax rate to 11.5% from 9% for taxable income of$1.0 million or more effectiveJanuary 1, 2018 and resulted in a 2% higher effective tax rate in 2018.
Financial Condition
Cash and Cash Equivalents
At
45
--------------------------------------------------------------------------------Amortized cost, gross unrealized gains and losses and the fair value by security type for the available for sale portfolio atDecember 31, 2019 and 2018 were as follows: 2019 Gross Gross Amortized Unrealized Unrealized Fair (In thousands) Cost Gains Losses ValueU.S. treasury securities and obligations ofU.S. government-sponsored corporations ("GSE")$ 774 $ -$ (10 ) $ 764 Residential collateralized mortgage obligations - GSE 53,223 194 (242 ) 53,175 Residential mortgage-backed securities - GSE 18,100 292 (5 ) 18,387 Obligations of state and political subdivisions 33,177 342 - 33,519 Single-issuer trust preferred debt securities 1,492 - (50 ) 1,442 Corporate debt securities 23,224 139 (84 ) 23,279 Other debt securities 25,378 80 (242 ) 25,216 Total$ 155,368 $ 1,047 $ (633 ) $ 155,782 2018 Gross Gross Amortized Unrealized Unrealized Fair (In thousands) Cost Gains Losses ValueU.S. treasury securities and obligations ofU.S. government-sponsored corporations ("GSE")$ 2,993 $ -$ (41 ) $ 2,952 Residential collateralized mortgage obligations-GSE 48,789 70 (676 ) 48,183 Residential mortgage backed securities - GSE 13,945 37 (100 ) 13,882 Obligations of state and political subdivisions 23,506 85 (249 ) 23,342 Trust preferred debt securities - single issuer 1,490 - (161 ) 1,329 Corporate debt securities 28,323 - (1,037 ) 27,286 Other debt securities 15,383 11 (146 ) 15,248 Total$ 134,429 $ 203 $ (2,410 ) $ 132,222 Amortized cost, carrying value, gross unrealized gains and losses and the fair value by security type for the held to maturity portfolio atDecember 31, 2019 and 2018 were as follows: 2019 Other-Than- Temporary Impairment Recognized In Accumulated Other Gross Gross Amortized Comprehensive Carrying Unrealized Unrealized Fair (In thousands) Cost Loss Value Gains Losses Value Residential collateralized mortgage obligations - GSE$ 5,117 $ -$ 5,117 $ 76$ (35 ) $ 5,158 Residential mortgage backed securities- GSE 36,528 - 36,528 481 (54 ) 36,955 Obligations of state and political subdivisions 32,533 - 32,533 690 (25 ) 33,198 Trust preferred debt securities - pooled 657 (492 ) 165 479 - 644 Other debt securities 2,277 - 2,277 - (9 ) 2,268 Total$ 77,112 $ (492 ) $ 76,620 $ 1,726 $ (123 ) $ 78,223 46
--------------------------------------------------------------------------------
2018
Other-Than-
Temporary
Impairment
Recognized In
Accumulated
Other Gross Gross
Amortized Comprehensive Carrying Unrealized Unrealized Fair
(Dollars in thousands) Cost Loss Value Gains Losses Value
Residential
collateralized mortgage obligations - GSE$ 6,701 $ -$ 6,701 $ 30$ (143 ) $ 6,588 Residential mortgage backed securities - GSE 31,343 - 31,343 84 (346 ) 31,081 Obligations of state and political subdivisions 38,494 - 38,494 634 (118 ) 39,010 Trust preferred debt securities - pooled 657 (501 ) 156 569 - 725 Other debt securities 2,878 - 2,878 - (78 ) 2,800 Total$ 80,073 $ (501 )$ 79,572 $ 1,317 $ (685 ) $ 80,204 The investment securities portfolio totaled$232.4 million , or 14.7% of total assets, atDecember 31, 2019 compared to$211.8 million , or 18.0% of total assets, atDecember 31, 2018 . Proceeds from maturities and prepayments for the year endedDecember 31, 2019 totaled$58.0 million while purchases of investment securities totaled$50.2 million during this period. On an average balance basis, the investment securities portfolio represented 18.5% and 20.6% of average interest-earning assets for the years endedDecember 31, 2019 and 2018, respectively. Securities available for sale are investments that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk and to take advantage of market conditions that create more economically attractive returns. AtDecember 31, 2019 , available-for-sale securities amounted to$155.8 million , which was an increase of$23.6 million from$132.2 million atDecember 31, 2018 . The following table sets forth certain information regarding the amortized cost, carrying value, fair value, weighted average yields and contractual maturities of the Company's investment portfolio as ofDecember 31, 2019 . Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized (Dollars in thousands) cost Fair Value Yield Available for sale Due in one year or less$ 10,690 $ 10,662 2.66 % Due after one year through five years 26,621 26,824 2.75 Due after five years through ten years 34,136 34,193 2.55 Due after ten years 83,921 84,103 2.75 Total$ 155,368 $ 155,782 2.70 % (Dollars in thousands) Carrying Value Fair Value Yield Held to maturity Due in one year or less $ 6,594$ 6,664 3.88 % Due after one year through five years 13,573 13,803
3.67
Due after five years through ten years 18,410 18,766 3.15 Due after ten years 38,043 38,990 3.11 Total$ 76,620 $ 78,223 3.28 %
Proceeds from maturities and prepayments of securities available for sale
amounted to
47
--------------------------------------------------------------------------------
net unrealized gains of $414,000 compared to net unrealized losses of $2.2
million at December 31, 2018 . These unrealized gains or losses are reflected net
of tax in shareholders' equity as a component of accumulated other comprehensive
income (loss).
Securities held to maturity, which are carried at amortized historical cost, are
investments for which there is the positive intent and ability to hold to
maturity. At December 31, 2019 , securities held to maturity were $76.6 million ,
reflecting a decrease of $3.0 million from $79.6 million at December 31,
2018 . The fair value of the held-to-maturity portfolio at December 31, 2019 was
$78.2 million .
The Company regularly reviews the composition of the investment securities
portfolio, taking into account market risks, the current and expected interest
rate environment, liquidity needs and its overall interest rate risk profile and
strategic goals.
On a quarterly basis, management evaluates each security in the portfolio with
an individual unrealized loss to determine if that loss represents
other-than-temporary impairment. During the fourth quarter of 2009, management
determined that it was necessary, following other-than-temporary impairment
requirements, to write down the cost basis of the Company's only pooled trust
preferred security. This trust preferred debt security was issued by a two
issuer pool (Preferred Term Securities XXV, Ltd. co-issued by Keefe, Bruyette
and Woods, Inc. and First Tennessee ("PreTSL XXV")) consisting primarily of
financial institution holding companies. During 2009, the Company recognized an
other-than-temporary impairment charge of $865,000 with respect to this
security. No other-than-temporary impairment losses were recorded during 2019
and 2018. See Note 3-"Investment Securities " to the consolidated financial
statements for additional information.
Loans Held for Sale
Loans held for sale atDecember 31, 2019 totaled$5.9 million compared to$3.0 million atDecember 31, 2018 . The total loans originated for sale was$146.8 million and$111.1 million for 2019 and 2018, respectively. AtDecember 31, 2019 , residential mortgage loans held for sale totaled$5.7 million and SBA loans held for sale totaled$225,000 . The amount of loans held for sale varies from period to period due to changes in the amount and timing of sales of residential mortgage loans and SBA loans.
Loans
The loan portfolio, which represents the Company's largest asset, is a significant source of both interest and fee income. Elements of the loan portfolio are subject to differing levels of credit and interest rate risk. The Company's primary lending focus continues to be mortgage warehouse lines, construction loans, commercial business loans, owner-occupied commercial real estate mortgage loans and income producing commercial real estate loans. Total loans averaged$964.9 million for the year endedDecember 31, 2019 , representing an increase of$132.0 million , or 15.8%, compared to an average of$833.0 million for the year endedDecember 31, 2018 . AtDecember 31, 2019 , total loans were$1.2 billion , representing an increase of$332.9 million , or 37.7%, compared to$883.2 million atDecember 31, 2018 . Loans acquired in the Shore Merger were$206.2 million atDecember 31, 2019 , compared to$63.0 million in loans acquired in the NJCB Merger atDecember 31, 2018 .
The average yield earned on the loan portfolio was 5.55% for the year ended
The following table represents the components of the loan portfolio as of the
dates indicated.
December 31,
2019 2018 2017 2016 2015
(Dollars in
thousands) Amount % Amount % Amount % Amount % Amount % Commercial real estate
$ 567,655 47 %$ 388,431 44 %$ 308,924
39 %
24 216,259 30 216,572 32 Construction 148,939 12 149,387 17 136,412
17 96,035 13 93,745 14 Commercial business
139,271 11 120,590 14 92,906 12 99,650 14 99,277 15 Residential real estate
90,259 7 47,263 5 40,494 5 44,791 6 40,744 6 Loans to individuals
32,604 3 22,962 3 21,025 3 23,736 3 23,074 3
Other 137 - 181 - 183 - 207 - 233 -
Deferred loan
costs, net 491 - 167 - 550 - 1,737 - 1,226 -
Total $ 1,216,028 100 % $ 883,164 100 % $ 789,906 100 % $ 724,808 100 % $ 682,121 100 %
48-------------------------------------------------------------------------------- Commercial real estate loans averaged$426.9 million for the year endedDecember 31, 2019 , representing an increase of$70.3 million , or 19.7%, compared to the average of$356.6 million for the year endedDecember 31, 2018 . Commercial real estate loans consist primarily of loans to businesses that are collateralized by real estate assets employed in the operation of the business (owner-occupied properties) and loans to real estate investors to finance the acquisition and/or improvement of income producing commercial properties. The average yield on commercial real estate loans was 5.11% and 5.07% for 2019 and 2018, respectively. The Company'sMortgage Warehouse Funding Group offers revolving lines of credit that are available to licensed mortgage banking companies (the "warehouse line of credit"). The warehouse line of credit is used by the mortgage banker to originate one-to-four family residential mortgage loans that are pre-sold to the secondary mortgage market, which includes state and national banks, national mortgage banking firms, insurance companies and government-sponsored enterprises, including the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and others. On average, an advance under the warehouse line of credit remains outstanding for a period of less than 30 days, with repayment coming directly from the sale of the loan into the secondary mortgage market. Interest and a transaction fee are collected by the Company at the time of repayment. The Company had outstanding warehouse line of credit advances of$236.7 million atDecember 31, 2019 compared to$154.2 million atDecember 31, 2018 . During 2019 and 2018, warehouse lines of credit advances averaged$174.2 million and$153.9 million , respectively, and yielded 5.48% and 5.46%, respectively. During 2019,$3.5 billion of mortgage loans were financed through ourMortgage Warehouse Funding Group compared to$3.4 billion of mortgage loans financed in 2018. The increase in the warehouse lines of credit advances in 2019 compared to 2018 reflected the increased residential mortgage refinancing activity in 2019 compared to 2018 due to generally stable to lower market interest rates for residential mortgages in 2019 than in 2018. The number of active mortgage banking customers were 38 and 44 in 2019 and 2018, respectively. Construction loans averaged$156.5 million for the year endedDecember 31, 2019 , representing an increase of$18.5 million , or 13.4%, compared to the average of$138.0 million for the year endedDecember 31, 2018 . Generally, these loans represent owner-occupied or investment properties and usually complement a broader commercial relationship between the Company and the borrower. Construction loans are structured to provide for advances only after work is completed and inspected by qualified professionals. The average yield on the construction loan portfolio was 6.76% for 2019 compared to 6.59% for 2018. Commercial business loans averaged$122.0 million for the year endedDecember 31, 2019 , representing an increase of$10.8 million , or 9.7%, compared to the average of$111.2 million for the year endedDecember 31, 2018 . Commercial business loans consist primarily of loans to small and middle market businesses and are typically working capital loans used to finance inventory, receivables or equipment needs. These loans are generally secured by business assets of the commercial borrower. The average yield on the commercial business loans was 5.98% in 2019 compared to 5.45% in 2018. Average residential real estate loans increased$10.4 million to$56.7 million atDecember 31, 2019 compared to$46.3 million atDecember 31, 2018 . The average yield on residential real estate loans was 4.50% in 2019 compared to 4.44% in 2018. Loans to individuals, which are comprised primarily of home equity loans, averaged$23.3 million duringDecember 31, 2019 compared to$23.2 million during 2018. The average yield on loans to individuals was 5.06% in 2019 compared to 4.61% in 2018. 49
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The following table provides information concerning the maturities and interest
rate sensitivity of the loan portfolio at
Maturity Range
Within After One But After
One Within Five
(Dollars in thousands) Year Five Years Years Total
Commercial real estate $ 60,881 $ 444,702 $ 62,072 $ 567,655
Mortgage warehouse lines 236,672 - - 236,672
Construction 145,189 2,357 1,393 148,939
Commercial business 58,886 39,022 41,363 139,271
Residential real estate 17,944 32,247 40,068 90,259
Loans to individuals and other loans 30,509 778 1,454 32,741
Total $ 550,081 $ 519,106 $ 146,350 $ 1,215,537
Fixed rate loans $ 34,813 $ 100,502 $ 123,824 $ 259,139
Floating rate loans 515,268 418,604 22,526 956,398
Total $ 550,081 $ 519,106 $ 146,350 $ 1,215,537
Non-Performing Assets
Non-performing assets consist of non-performing loans and other real estate
owned. Non-performing loans are composed of (1) loans on a non-accrual basis and
(2) loans that are contractually past due 90 days or more as to interest and
principal payments but have not been classified as non-accrual. Included in
non-accrual loans are loans whose terms have been previously restructured to
provide a reduction or deferral of interest and/or principal due to financial
difficulties of the borrower that have not performed in accordance with the
restructured terms.
The Company's policy with regard to non-accrual loans is that, generally, loans
are placed on a non-accrual status when they are 90 days past due, unless these
loans are well secured and in the process of collection or, regardless of the
past due status of the loan, when management determines that the complete
recovery of principal or interest is in doubt. Consumer loans are generally
charged off after they become 120 days past due. Subsequent payments on loans in
non-accrual status are credited to income only if collection of principal is not
in doubt.
Non-performing loans were $4.5 million at December 31, 2019 compared to $6.6
million at December 31, 2018 . During the year ended December 31, 2019 , $2.3
million of non-performing loans were resolved, $481,000 of loans were
charged-off and $3.7 million of loans were placed on non-accrual. In the first
quarter of 2019, the Bank was notified that a shared national credit syndicated
loan in which it was a participant in a $4.3 million facility was upgraded to
pass rating from substandard rating and was no longer classified as a
non-accrual loan. As of the date of notification, the Bank upgraded the loan,
which had a balance of $2.8 million at that time, and returned the loan to
accrual status. The loan subsequently was paid in full.
At December 31, 2019 , non-performing loans were comprised of six commercial real
estate loans totaling $2.6 million , three residential mortgage loans totaling
$708,000 , three commercial business loans totaling $501,000 and five home equity
loans totaling $692,000 .
50--------------------------------------------------------------------------------
The table below sets forth non-performing assets and risk elements in the Bank's loan portfolio for the years indicated.
December 31,
(Dollars in thousands) 2019 2018 2017 2016 2015
Non-Performing loans:
Loans 90 days or more past due and still
accruing $ - $ 55 $ - $ 24 $ -
Non-accrual loans 4,497 6,525 7,114 5,174 6,020
Total non-performing loans 4,497 6,580 7,114 5,198 6,020
Other real estate owned 571 2,515 - 166 966
Other repossessed assets - - - - -
Total non-performing assets 5,068 9,095 7,114 5,364 6,986
Performing troubled debt restructurings 6,132 4,003 3,728 864 1,535
Performing troubled debt restructurings and
total non-performing assets $ 11,200 $ 13,098 $
10,842
Non-performing loans to total loans 0.37 % 0.75 % 0.90 % 0.72 % 0.88 % Non-performing loans to total loans excluding warehouse lines 0.46 0.90 1.18 1.02 1.29 Non-performing assets to total assets 0.32 0.77 0.66 0.52 0.72 Non-performing assets to total assets excluding mortgage warehouse lines 0.38 0.89 0.80 0.65 0.93 Total non-performing assets and performing troubled debt restructurings to total assets 0.71 1.11 1.00 0.60 0.88 As the table demonstrates, non-performing loans to total loans decreased to 0.37% atDecember 31, 2019 from 0.75% atDecember 31, 2018 . Loan quality was stable and the loan portfolio is considered to be sound. This was accomplished through quality loan underwriting, a proactive approach to loan monitoring and aggressive workout strategies.
Additional interest income before taxes amounting to
Non-performing assets decreased$4.0 million to$5.1 million atDecember 31, 2019 from$9.1 million atDecember 31, 2018 and were 0.32% of total assets atDecember 31, 2019 compared to 0.77% atDecember 31, 2018 . Non-performing loans decreased$2.1 million to$4.5 million atDecember 31, 2019 from$6.6 million atDecember 31, 2018 . OREO decreased by$1.9 million to$571,000 atDecember 31, 2019 compared to$2.5 million atDecember 31, 2018 . OREO is comprised of six residential lots with a carrying value of$478,000 acquired in the Shore Merger and land with a carrying value of$93,000 .
In 2019, the Company sold two OREO properties with a carrying value of
AtDecember 31, 2019 , the Company had 13 loans totaling$6.4 million that were troubled debt restructurings. Three of these loans totaling$345,000 are included in the above table as non-accrual loans and the remaining nine loans totaling$6.1 million are considered performing. AtDecember 31, 2018 , the Company had 12 loans totaling$7.3 million that were troubled debt restructurings. Four of these loans totaling$3.3 million are included in the above table as non-accrual loans and the remaining eight loans totaling$4.0 million were considered performing. In accordance withU.S. GAAP, the excess of cash flows expected at acquisition over the initial investment in the purchase of a credit impaired loan is recognized as interest income over the life of the loan. AtDecember 31, 2019 , there were 11 loans acquired with evidence of deteriorated credit quality totaling$4.6 million that were not classified as non-performing loans and there were two loans acquired with evidence of deteriorated credit quality totaling$865,000 that were not classified as non-performing loans atDecember 31, 2018 . Management takes a proactive approach in addressing delinquent loans. The Company's President and Chief Executive Officer meets weekly with all loan officers to review the status of credits past-due ten days or more. An action plan is discussed for delinquent loans to determine the steps necessary to induce the borrower to cure the delinquency and restore the loan to a current status. In addition, delinquency notices are system generated when loans are five days past-due and again at 15 days past-due. 51 -------------------------------------------------------------------------------- In most cases, the Company's loan collateral is real estate and when the collateral is foreclosed upon, the real estate is carried at fair market value less the estimated selling costs. The amount, if any, by which the recorded amount of the loan exceeds the fair market value of the collateral less estimated selling costs is a loss that is charged to the allowance for loan losses at the time of foreclosure or repossession. Resolution of a past-due loan can be delayed if the borrower files a bankruptcy petition because a collection action cannot be continued unless the Company first obtains relief from the automatic stay provided by the bankruptcy code.
Allowance for Loan Losses and Related Provision
The allowance for loan losses is maintained at a level sufficient to absorb estimated credit losses in the loan portfolio as of the date of the financial statements. The allowance for loan losses is a valuation reserve available for losses incurred or inherent in the loan portfolio and other extensions of credit. The determination of the adequacy of the allowance for loan losses is a critical accounting policy of the Company. The Company's primary lending emphasis is the origination of commercial business, commercial real estate and construction loans and mortgage warehouse lines of credit. Based on the composition of the loan portfolio, the inherent primary risks are deteriorating credit quality, a decline in the economy and a decline inNew Jersey real estate market values. Any one, or a combination, of these events may adversely affect the loan portfolio and may result in increased delinquencies, loan losses and increased future provision levels. All, or part, of the principal balance of commercial business, commercial real estate and construction loans are charged off against the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Consumer loans are generally charged off no later than 120 days past due on a contractual basis, earlier in the event of bankruptcy, or if there is an amount deemed uncollectible. Because all identified losses are charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans and the entire allowance is available to absorb any and all loan losses. Management reviews the adequacy of the allowance on at least a quarterly basis to ensure that the provision for loan losses has been charged against earnings in an amount necessary to maintain the allowance at a level that is adequate based on management's assessment of probable estimated losses. The Company's methodology for assessing the adequacy of the allowance for loan losses consists of several key elements and is consistent withU.S. GAAP and interagency supervisory guidance. The allowance for loan losses methodology consists of two major components. The first component represents an estimation of losses associated with individually identified impaired loans. The second major component estimates losses on groups of loans with similar risk characteristics. The Company's methodology results in an allowance for loan losses that includes a specific reserve for impaired loans, an allocated reserve and an unallocated portion. When analyzing groups of loans, the Company follows the Interagency Policy Statement on the Allowance for Loan and Lease Losses. The methodology considers the Company's historical loss experience, adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans as of the evaluation date. These adjustment factors, known as qualitative factors, include: •Delinquencies and non-accruals; •Portfolio quality; •Concentration of credit; •Trends in volume of loans; •Quality of collateral; •Policy and procedures; •Experience, ability and depth of management; •Economic trends - national and local; and •External factors - competition, legal and regulatory. The methodology includes the segregation of the loan portfolio into loan types with a further segregation into risk rating categories, such as special mention, substandard, doubtful and loss. This allows for an allocation of the allowance for loan losses by loan type; however, the allowance is available to absorb any loan loss without restriction. Larger balance, non-homogeneous loans representing significant individual credit exposures are evaluated individually through the internal loan review process. It is this process that produces the watch list. The borrower's overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated. Based on these reviews, an estimate of probable losses for the individual larger-balance loans are determined, whenever possible, and used to establish specific loan loss reserves. In general, for non-homogeneous loans not individually assessed and for homogeneous groups, such as residential mortgages and consumer credits, the loans are 52 --------------------------------------------------------------------------------
collectively evaluated based on delinquency status, loan type, and historical losses. These loan groups are then internally risk rated.
The watch list includes loans that are assigned a rating of special mention, substandard, doubtful and loss. Loans criticized as special mention have potential weaknesses that deserve management's close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as doubtful have all the weaknesses inherent in loans classified as substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans rated as doubtful in whole, or in part, are placed on non-accrual status. Loans classified as a loss are considered uncollectible and are charged off against the allowance for loan losses. The specific allowance for impaired loans is established for specific loans that have been identified by management as being impaired. These loans are considered to be impaired primarily because the loans have not performed according to payment terms and there is reason to believe that repayment of the loan principal in whole, or in part, is unlikely. The specific portion of the allowance is the total amount of potential unconfirmed losses for these individual impaired loans. To assist in determining the fair value of loan collateral, the Company often utilizes independent third party qualified appraisal firms, which, in turn, employ their own criteria and assumptions that may include occupancy rates, rental rates and property expenses, among others. The second category of reserves consists of the allocated portion of the allowance. The allocated portion of the allowance is determined by taking pools of outstanding loans that have similar characteristics and applying historical loss experience for each pool. This estimate represents the potential unconfirmed losses within the portfolio. Individual loan pools are created for commercial and commercial real estate loans, construction loans, warehouse lines of credit and various types of loans to individuals. The historical estimation for each loan pool is then adjusted for qualitative factors, such as economic trends, concentrations of credit, trends in the volume of loans, portfolio quality, delinquencies and non-accrual trends. These factors are evaluated for each class of the loan portfolio and may have positive or negative effects on the allocated allowance for the loan portfolio segment. The aggregate amount resulting from the application of these qualitative factors determines the overall risk for the portfolio and results in an allocated allowance for each of the loan segments. The Company also maintains an unallocated allowance. The unallocated allowance is used to cover any factors or conditions that may cause a potential loan loss but are not specifically identifiable. It is prudent to maintain an unallocated portion of the allowance because no matter how detailed an analysis of potential loan losses is performed, these estimates, by definition, lack precision. Management must make estimates using assumptions and information that is often subjective and changing rapidly.
The following discusses the risk characteristics of each of our loan portfolios.
Commercial Business
The Company offers a variety of commercial loan services, including term loans, lines of credit and loans secured by equipment and receivables. A broad range of short-to-medium term commercial loans, both secured and unsecured, are made available to businesses for working capital (including inventory and receivables), business expansion (including acquisition and development of real estate and improvements) and the purchase of equipment and machinery. Commercial business loans are granted based on the borrower's ability to generate cash flow to support its debt obligations and other cash related expenses. A borrower's ability to repay commercial business loans is substantially dependent on the success of the business itself and on the quality of its management. As a general practice, the Company takes, as collateral, a security interest in any available real estate, equipment, inventory, receivables or other personal property of its borrowers, although the Company occasionally makes commercial business loans on an unsecured basis. Generally, the Company requires personal guarantees of its commercial business loans to offset the risks associated with such loans. Much of the Company's lending is in northern and centralNew Jersey and theNew York City metropolitan area. As a result of this geographic concentration, a significant broad-based deterioration in economic conditions inNew Jersey and theNew York City metropolitan area could have a material adverse impact on the Company's loan portfolio. A prolonged decline in economic conditions in our market area could restrict borrowers' ability to pay outstanding principal and interest on loans when due. The value of assets pledged as collateral may decline and the proceeds from the sale or liquidation of these assets may not be sufficient to repay the loan. 53
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Commercial real estate loans are made to businesses to expand their facilities and operations and to real estate operators to finance the acquisition of income producing properties. The Company's loan policy requires that borrowers have sufficient cash flow to meet the debt service requirements and the value of the property meets the loan-to-value criteria set in the loan policy. The Company monitors loan concentrations by borrower, by type of property and by location and other criteria. The Company's commercial real estate portfolio is largely secured by real estate collateral located in theState of New Jersey and theNew York City metropolitan area. Conditions in the real estate markets in which the collateral for the Company's loans are located strongly influence the level of the Company's non-performing loans. A decline in theNew Jersey andNew York City metropolitan area real estate markets could adversely affect the Company's loan portfolio. Decreases in local real estate values would adversely affect the value of property used as collateral for the Company's loans. Adverse changes in the economy also may have a negative effect on the ability of our borrowers to make timely repayments of their loans.
Construction Financing
Construction financing is provided to businesses to expand their facilities and operations and to real estate developers for the acquisition, development and construction of residential and commercial properties. First mortgage construction loans are made to developers and builders primarily for single family homes and multi-family buildings that are presold or are to be sold or leased on a speculative basis. The Company lends to builders and developers with established relationships, successful operating histories and sound financial resources. Management has established underwriting and monitoring criteria to minimize the inherent risks of real estate construction lending. The risks associated with speculative construction lending include the borrower's inability to complete the construction process on time and within budget, the sale or rental of the project within projected absorption periods and the economic risks associated with real estate collateral. Such loans may include financing the development and/or construction of residential subdivisions. This activity may involve financing land purchases and infrastructure development (i.e., roads, utilities, etc.) as well as construction of residences or multi-family dwellings for subsequent sale by the developer/builder. Because the sale or rental of developed properties is integral to the success of developer business, loan repayment may be especially subject to the volatility of real estate market values.
Mortgage Warehouse Lines of Credit
The Company'sMortgage Warehouse Funding Group provides revolving lines of credit that are available to licensed mortgage banking companies. The warehouse line of credit is used by the mortgage banker to originate one-to-four family residential mortgage loans that are pre-sold to the secondary mortgage market, which includes state and national banks, national mortgage banking firms, insurance companies and government-sponsored enterprises, including the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and others. On average, an advance under the warehouse line of credit remains outstanding for a period of less than 30 days, with repayment coming directly from the sale of the loan into the secondary mortgage market. Interest and a transaction fee are collected by the Bank at the time of repayment. As a separate class of the total loan portfolio, the warehouse loan portfolio is individually analyzed as a whole for allowance for loan losses purposes. Warehouse lines of credit are subject to the same inherent risks as other commercial lending, but the overall degree of risk differs. While the Company's loss experience with this type of lending has been non-existent since the product was introduced in 2008, there are other risks unique to this lending that still must be considered in assessing the adequacy of the allowance for loan losses. These unique risks may include, but are not limited to, (i) credit risks relating to the mortgage bankers that borrow from us, (ii) the risk of intentional misrepresentation or fraud by any of such mortgage bankers, (iii) changes in the market value of mortgage loans originated by the mortgage banker, the sale of which is the expected source of repayment of the borrowings under a warehouse line of credit, due to changes in interest rates during the time in warehouse or (iv) unsalable or impaired mortgage loans so originated, which could lead to decreased collateral value and the failure of a purchaser of the mortgage loan to purchase the loan from the mortgage banker.
Consumer
The Company's consumer loan portfolio segment is comprised of residential real
estate loans, home equity loans and other loans to individuals. Individual loan
pools are created for the various types of loans to individuals. The principal
risk is the borrower becomes unemployed or has a significant reduction in
income.
54
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In general, for homogeneous groups such as residential mortgages and consumer
credits, the loans are collectively evaluated based on delinquency status, loan
type and historical losses. These loan groups are then internally risk rated.
The Company considers the following credit quality indicators in assessing the risk in the loan portfolio:
•Consumer credit scores; •Internal credit risk grades; •Loan-to-value ratios; •Collateral; and •Collection experience.
The following table presents, for the years indicated, an analysis of the allowance for loan losses and other related data: (Dollars in thousands)
2019 2018 2017 2016 2015
Balance, beginning of year
$ 7,560 $ 6,925 Provision (credit) charged to operating expenses 1,350 900 600 (300 ) 1,100 Loans charged off: Residential real estate loans - - (101 ) - - Commercial business and commercial real estate loans (463 ) (553 ) (61 ) (157 ) (477 ) Loans to individuals (7 ) (16 ) - - (14 ) All other loans (43 ) (17 ) - (1 ) - (513 ) (586 ) (162 ) (158 ) (491 ) Recoveries: Commercial business and commercial real estate loans 26 74 64 386 20 Loans to individuals 6 1 4 6 6 All other loans - - 13 - - 32 75 81 392 26 Net (charge offs) recoveries (481 ) (511 ) (81 ) 234 (465 ) Balance, end of year$ 9,271 $ 8,402 $ 8,013 $ 7,494 $ 7,560 Loans: At year end$ 1,216,028 $ 883,164 $ 789,906 $ 724,808 $ 682,121 Average during the year 964,920 832,966 717,010 698,436 684,485 Net recoveries (charge offs) to average loans outstanding (0.05 )% (0.06 )% (0.01 )% 0.03 % (0.07 )% Net recoveries (charge-offs) to average loans, excluding mortgage warehouse loans (0.06 )% (0.08 )% (0.01
)% 0.05 % (0.10 )%
Allowance for loan losses to: Total loans at year end 0.76 % 0.95 % 1.01 % 1.03 % 1.11 % Total loans at year end excluding mortgage warehouse lines and related allowance 0.84 % 1.05 % 1.19 % 1.28 % 1.44 % Non-performing loans 206.16 % 127.69 % 112.64 % 144.17 % 125.59 % AtDecember 31, 2019 , the allowance for loan losses was$9.3 million compared to$8.4 million atDecember 31, 2018 , representing an increase of$869,000 . The ratio of the allowance for loan losses to total loans atDecember 31, 2019 and 2018 was 0.76% and 0.95%, respectively. The allowance for loan losses as a percentage of non-performing loans was 206.16% atDecember 31, 2019 compared to 127.69% atDecember 31, 2018 . The allowance for loan losses increased in 2019 due primarily to a provision of$1.4 million , which reflected net charge-offs of$481,000 , compared to a provision for loan losses in the amount of$900,000 in 2018, which reflected net charge-offs of$511,000 . 55 -------------------------------------------------------------------------------- The allowance for loan losses decreased as a percentage of total loans to 0.76% atDecember 31, 2019 from 0.95% atDecember 31, 2018 due primarily to acquisition accounting for the Shore Merger, which resulted in the Shore loans being recorded at their fair value and included a credit risk adjustment of approximately$3.6 million at the effective date of the Shore Merger.
Management believes that the quality of the loan portfolio remains sound,
considering the economic climate and economy in the
The following tables present the allocation of the allowance for loan losses
among loan classes and certain other information as of the dates indicated. The
total allowance is available to absorb losses from any segment of loans.
December 31,
(Dollars in
thousands) 2019 2018 2017
ALL Loans as a % ALL Loans as a ALL Loans as a %
as a % of Total as a % % of Total as a % of Total
Amount of Loans Loans Amount of Loans Loans Amount of Loans Loans Commercial real estate
$ 4,524 0.80 % 47 %$ 3,439
0.89 % 44 %
1,829 1.52 14 1,720 1.85 12
Construction loans 1,389 0.93 12 1,732 1.16 17 1,703 1.25 17
Residential real
estate 412 0.46 7 431 0.91 5 392 0.97 5
Loans to
individuals and
other 185 0.57 3 148 0.64 3 114 0.54 3
Subtotal 7,919 0.81 80 7,579 1.09 83 6,878 1.15 76
Mortgage warehouse
lines 1,083 0.46 20 731 0.47 17 852 0.45 24
Unallocated
reserves 269 - - 92 - - 283 - - Total$ 9,271 0.76 % 100 %$ 8,402 0.95 % 100 %$ 8,013 1.01 % 100 % December 31, 2016 2015 ALL ALL as a % % of as a % % of Amount of Loans Loans Amount of Loans Loans Commercial real estate$ 2,574 1.06 % 34 %$ 3,049 1.47 % 30 % Commercial business 1,732 1.74 14 2,005 2.02 15 Construction loans 1,204 1.25 13 1,025 1.09 14 Residential real estate 367 0.82 6 288 0.71 6 Loans to individuals and other 112 0.47 3 109 0.47 3 Subtotal 5,989 1.18 70 6,476 1.39 68 Mortgage warehouse lines 973 0.45 30 866 0.40 32 Unallocated reserves 532 - - 218 - - Total$ 7,494 1.03 % 100 %$ 7,560 1.11 % 100 %
The allowance for loan losses, excluding the portion related to mortgage
warehouse lines, increased to
56
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The following table sets forth the balances and contractual rates payable to our
customers, by account type, as of
December 31, 2019 December 31, 2018
Weighted Weighted
Average Average
Percent Contractual Percent Contractual
(Dollars in thousands) Amount Of Total Rate Amount Of Total Rate
Non-interest bearing demand
- % $ 212,981 22 % - %
Interest bearing demand 393,392 31 % 0.79 % 323,503 34 % 0.63 %
Savings 259,033 20 % 0.97 % 189,612 20 % 0.81 %
Total core deposits $ 939,980 74 % 0.60 % $ 726,096 76 % 0.51 %
Certificates of deposit $ 337,382 26 % 2.23 % $ 224,576 24 % 1.98 %
Total $ 1,277,362 100 % 1.04 % $ 950,672 100 % 0.85 %
The following table indicates the amount of certificates of deposit by time
remaining until maturity as of
3 Months Over 3 to Over 6 to Over 12
(In thousands) or Less 6 Months 12 Months Months Total
Certificates of deposit
of $100,000 or more $ 54,368 $ 60,652 $ 76,136 $ 48,225 $ 239,381
Certificates of deposit less
than $100,000 17,080 18,815 24,999 37,107 98,001
Total $ 71,448 $ 79,467 $ 101,135 $ 85,332 $ 337,382
The following table illustrates the components of average total deposits for the
years indicated:
2019 2018 2017
Average Percentage Average Percentage Average Percentage
(Dollars in thousands) Balance of Total Balance of Total Balance of Total
Non-interest bearing demand $ 226,701 21 % $ 204,002 21 % $ 183,802 21 %
Interest bearing demand 349,663 33 % 356,906 38 % 336,445 38 %
Savings 201,738 19 % 203,940 21 % 210,798 24 %
Certificates of deposit 286,419 27 % 189,521 20 % 145,539 17 %
Total $ 1,064,521 100 % $ 954,369 100 % $ 876,584 100 %
Deposits, which include demand deposits (interest bearing and non-interest
bearing), savings deposits and certificates of deposit, are a fundamental and
cost-effective source of funding. The flow of deposits is influenced
significantly by general economic conditions, changes in market interest rates
and competition. The Company offers a variety of products designed to attract
and retain customers, with the Company's primary focus on the building and
expanding of long-term relationships. Deposits for the year ended December 31,
2019 averaged $1.1 billion , representing an increase of $110.2 million , or
11.5%, compared to $954.4 million for the year ended December 31, 2018 . The
Shore Merger provided $35.7 million in average deposits for the year ended
December 31, 2019 .
At December 31, 2019 , total deposits were $1.3 billion , representing an increase
of $326.7 million , or 34.4%, from $950.7 million at December 31, 2018 . The Shore
Merger provided $244.3 million in deposits at December 31, 2019 . The increase in
total deposits in 2019 was due principally to an increase of $74.6 million in
non-interest bearing demand deposits, an increase of $69.9 million in
interest-bearing demand deposits, an increase of $69.4 million in savings and an
increase of $112.8 million in certificates of deposit. Total deposits, excluding
Shore deposits, increased $82.4 million during the year ended December 31, 2019 .
Municipal deposits, primarily interest-bearing demand deposits and savings
accounts, increased approximately $55.3 million from December 31, 2018 . The
average cost of the Company's interest-bearing deposit accounts for 2019 was
1.32%, representing an increase from the average cost of 0.87% for 2018.
57
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Average non-interest bearing demand deposits increased by $22.7 million , or
11.1%, to $226.7 million for the year ended December 31, 2019 from $204.0
million for the year ended December 31, 2018 . At December 31, 2019 , non-interest
bearing demand deposits totaled $287.6 million , representing an increase of
$74.6 million , or 35.0%, compared to $213.0 million at December 31,
2018 . Non-interest bearing demand deposits made up 22.5% of total deposits at
December 31, 2019 compared to 22.4% at December 31, 2018 and represent a stable,
interest-free source of funds.
In 2019, the average balance of savings accounts decreased by $2.2 million to
$201.7 million compared to an average balance of $203.9 million in 2018. Savings
accounts increased by $69.4 million , or 36.6%, to $259.0 million at December 31,
2019 from $189.6 million at December 31, 2018 . The average cost of savings
deposits was 0.97% for 2019 compared to 0.72% in 2018.
Interest-bearing demand deposits, which include interest-bearing checking
accounts, money market and NOW accounts and the Company's premier money market
product, 1st Choice account, decreased by $7.2 million , or 2.0%, to an average
of $349.7 million for 2019 from an average of $356.9 million for 2018. At
December 31, 2019 , interest-bearing demand deposits were $393.4 million compared
to $323.5 million at December 31, 2018 . The average cost of interest-bearing
demand deposits was 0.79% for 2019 compared to 0.55% in 2018.
Certificates of deposit at December 31, 2019 were $337.4 million , an increase of
$112.8 million from $224.6 million at December 31, 2018 . The average cost of
certificates of deposits increased to 2.23% in 2019 from 1.62% in 2018.
Borrowings
Borrowings are comprised ofFederal Home Loan Bank ("FHLB") borrowings and overnight funds purchased and are primarily used to fund asset growth not supported by deposit generation. The average balance of other borrowed funds increased by$2.0 million to$38.6 million for 2019 from an average balance of$36.6 million for 2018 due to an increase in overnight borrowings in 2019 to meet the need for funding of the Bank's loan growth. The average cost of other borrowed funds increased 8 basis points to 2.36% for 2019 compared to 2.28% for 2018 because of the increase in short-term market interest rates.
Shareholders' Equity and Dividends
Shareholders' equity increased by$43.5 million , or 34.2%, to$170.6 million atDecember 31, 2019 from$127.1 million atDecember 31, 2018 . Book value per common share was$16.74 atDecember 31, 2019 compared to$14.77 atDecember 31, 2018 . The ratio of average shareholders' equity to total average assets was 10.76% and 10.48% for 2019 and 2018, respectively. The increase in shareholders' equity fromDecember 31, 2018 toDecember 31, 2019 was primarily the result of the issuance of common stock in connection with the Shore Merger and net income of$13.6 million , which was partially offset by dividends paid.
On
In lieu of cash dividends, the Company (and its predecessor, the Bank) declared a stock dividend every year for the years 1992 through 2012 and paid such dividends every year for the years 1993 through 2013. The Company declared two stock dividends in 2015 and did not declare a stock dividend in 2014 or 2013. . The Company began declaring and paying cash dividends inSeptember 2016 and has declared and paid a cash dividend each quarter since then. Most recently, the Company paid a cash dividend of$0.09 per share of common stock onFebruary 27, 2020 , representing an increase of 20% compared to the dividend of$0.075 per share of common stock paid onNovember 5, 2019 . Although the Company intends to continue to pay comparable cash dividends, the timing and the amount of the payment of future cash dividends, if any, on the Company's common shares will be at the discretion of the Company's Board of Directors and will be determined after consideration of various factors, including the level of earnings, cash requirements, regulatory capital and financial condition. Federal banking regulations on the payment of dividends and the Company's compliance with said regulations are discussed in Item 1 of this Form 10-K under the section titled "Restrictions on Dividends and Redemption of Stock for the Company and the Bank."
The Company's common stock is quoted on the Nasdaq Global Market under the symbol "FCCY."
58
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The Company and the Bank are subject to various regulatory capital requirements
administered by the Federal Reserve Board and the FDIC . For information on
regulatory capital, see "Capital Adequacy of the Company and the Bank" in the
"Supervision and Regulation" section under Item 1. "Business" and Note 19,
"Regulatory Capital Requirements" of the Notes to Consolidated Financial
Statements.
The Company believes that its shareholders' equity and regulatory capital position are adequate to support the planned operations of the Company for the next 12 months.
Capital Resources The Company and the Bank are subject to various regulatory capital requirements administered by the Federal and state banking agencies. 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 the Company's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and the Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Common Equity Tier 1, Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and Tier I capital to average assets (Leverage ratio, as defined). As ofDecember 31, 2019 , the Company and the Bank met all capital adequacy requirements to which they are subject. To be categorized as adequately capitalized, the Company and the Bank must maintain minimum Common Equity Tier 1, Total capital to risk-weighted assets, Tier 1 capital to risk-weighted assets and Tier I leverage capital ratios as set forth in the below table. As ofDecember 31, 2019 , the Bank's capital ratios exceeded the regulatory standards for well-capitalized institutions. Certain bank regulatory limitations exist on the availability of the Bank's assets for the payment of dividends by the Bank without prior approval of bank regulatory authorities.
Federal regulatory capital adequacy requirements are discussed in Item 1 of this Form 10-K under the section titled "Capital Adequacy of the Company and the Bank."
The Company and Bank are also limited in paying dividends if they do not maintain the necessary "capital conservation buffer" as discussed in Item 1 of this Form 10-K under the sections titled "Capital Adequacy of the Company and the Bank" and "Restrictions on Dividends and Redemption of Stock for the Company and the Bank." As ofDecember 31, 2019 , the Company and the Bank maintained the required capital conservation buffer of 2.5%. 59 --------------------------------------------------------------------------------
The Company's and the Bank's regulatory capital ratios, excluding the impact of
the capital conservation buffer, as of
To Be Well Capitalized
Under Prompt
For Capital Corrective
Actual Adequacy Purposes Action Provisions(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Company Common Equity Tier 1$ 133,046 9.70 %$ 61,604 4.50 % N/A N/A Total capital to risk-weighted assets 160,317 11.69 % 109,519 8.00 % N/A N/A Tier 1 capital to risk-weighted assets 151,046 11.01 % 82,139 6.00 % N/A N/A Tier 1 leverage capital 151,046 10.56 % 57,245 4.00 % N/A N/A Bank Common Equity Tier 1$ 150,725 10.99 %$ 61,579 4.50 %$ 88,948 6.50 % Total capital to risk-weighted assets 159,996 11.67 % 109,474 8.00 % 136,843 10.00 % Tier 1 capital to risk-weighted assets 150,725 10.99 % 82,106 6.00 % 109,474 8.00 % Tier 1 leverage capital 150,725 10.54 % 57,222 4.00 % 71,528 5.00 % AtDecember 31, 2019 , the Company and the Bank met all the regulatory capital adequacy requirements to which they were subject and were classified as "well capitalized" under the regulatory framework for prompt corrective action. Management believes that no conditions or events have occurred sinceDecember 31, 2019 that would materially adversely change the Company's or the Bank's capital classifications. Management believes that the Company's and the Bank's capital resources are adequate to support the Company's and the Bank's current strategic and operating plans. The Company and the Bank do not expect any material changes in the mix and relative cost of their capital resources in 2020. OnSeptember 17, 2019 , the federal banking agencies adopted a final rule, effectiveJanuary 1, 2020 , creating a CBLR framework for institutions with total consolidated assets of less than$10 billion and that meet other qualifying criteria. The CBLR framework provides for a simpler measure of capital adequacy for qualifying institutions. Qualifying institutions that elect to use the CBLR framework and that maintain a leverage ratio of greater than 9% will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the federal banking agencies' capital rules and to have met the "well capitalized" ratio requirements. Management is still reviewing the CBLR framework, but does not expect that the Company or the Bank will elect to use the framework. A further discussion of the CBLR framework is provided in Item 1 of this Form 10-K under the section titled "Capital Adequacy of the Company and the Bank."
The Company and the Bank do not have material commitments for capital
expenditures at
Off-Balance Sheet Arrangements and Contractual Obligations
In the normal course of business the Company enters into various transactions that, in accordance withU.S. GAAP, are not included on the balance sheet. The Company issues off-balance sheet financial instruments in connection with its lending activities and to meet the financing needs of its customers. These financial instruments include commitments to fund loans, lines of credit and commercial and standby letters of credit. These instruments carry various degrees of credit risk and market risk, which are essentially the same risks involved in extending loans. The Company generally follows the same credit and collateral policies in making these commitments and conditional obligations as it does for instruments recorded on the Company's consolidated balance sheet. Many of these commitments and conditional obligations are expected to expire without being drawn, and the contractual amounts do not necessarily represent future cash requirements. These off-balance sheet arrangements have not had and are not reasonably likely to have a current or future material effect on the Company's financial position, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. 60 --------------------------------------------------------------------------------
The financial instrument commitments at
Less than One One to Three to Over Five
(In thousands) Year Three Years Five Years Years Total
Commercial and standby letters
of credit $ 4,290 $ - $ - $ - $ 4,290
Commitments to fund loans 54,325 180 44 - 54,549
Commitments to extend credit 233,756 31,998 6,260 54,456 326,470
Commitments to sell residential
loans 14,964 - - - 14,964
Total $ 307,335 $ 32,178 $ 6,304 $ 54,456 $ 400,273 Commercial and standby letters of credit
Letters of credit are conditional commitments issued by the Company to guarantee the performance of a specified financial obligation of a customer to a third party. In the event that the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential future payments that the Company could be required to make was$4.3 million atDecember 31, 2019 .
Commitments to fund loans
Commitments to fund loans are legally binding loan commitments with set expiration dates and specified interest rates as well as for specific purposes. These loan commitments are intended to be disbursed, subject to the satisfaction of certain conditions, upon the request of the borrower.
Commitments to extend credit
The Company issues lines of credit to commercial businesses, to owners of commercial real estate, for the construction or acquisition of real estate properties and to consumers for home equity and personal expenditures. Many of these commitments may not be drawn but are available to the borrower under the terms of the loan agreement.
Commitments to sell residential loans
The Company enters into best efforts forward sales commitments to sell
residential mortgage loans that it has closed (loans held for sale), or it
expects to close (commitments to originate loans to be sold). These commitments
are utilized to reduce the Company's market price risk from the date of
commitment to the date of sale. The notional amount of the forward sales
commitments was approximately
The following table presents additional information regarding the Company's
outstanding contractual obligations as of
Payments Due by Period
Less than One One to Three to More than Five
(In thousands) Year Three Years Five Years Years Total
Operating leases $ 1,663 $ 3,169 $ 2,195 $ 1,866 $ 8,893
Borrowed funds and subordinated
debentures 92,050 - - 18,557 110,607
Certificates of deposit 252,050 83,191 2,141 - 337,382
Retirement benefit obligation
projected 4,719 - - - 4,719
Total contractual obligations:
Liquidity AtDecember 31, 2019 , the amount of liquid assets held by the Company remained at a level management deemed adequate to ensure that contractual liabilities, depositors' withdrawal requirements and other operational and customer credit needs could be satisfied. 61
-------------------------------------------------------------------------------- Liquidity management refers to the Company's ability to support asset growth while satisfying the borrowing needs and deposit withdrawal requirements of its customers. In addition to maintaining liquid assets, factors such as capital position, profitability, asset quality and availability of funding affect a bank's ability to meet its liquidity needs. On the asset side, liquid funds are maintained in the form of cash and cash equivalents, federal funds sold, deposits at theFederal Reserve Bank , investment securities held to maturity maturing within one year, securities available for sale and loans held for sale. Additional asset-based liquidity is derived from scheduled loan repayments as well as investment repayments of principal and interest from mortgage-backed securities. On the liability side, the primary source of liquidity is the ability to generate core deposits. Short-term and long-term borrowings are used as supplemental funding sources when growth in the core deposit base does not keep pace with that of earnings assets. The Company has established a borrowing relationship with the FHLB, which further supports and enhances liquidity. During 2010, the FHLB replaced its Overnight Line of Credit and One-Month Overnight Repricing Line of Credit facilities available to member banks with a fully secured line of up to 50 percent of a bank's quarter-end total assets. Under the terms of this facility, the Bank's total credit exposure to the FHLB cannot exceed 50 percent, or$793.0 million , of its total assets atDecember 31, 2019 . In addition, the aggregate outstanding principal amount of the Bank's advances, letters of credit, the dollar amount of the FHLB's minimum collateral requirement for off balance sheet financial contracts and advance commitments cannot exceed 30 percent of the Bank's total assets, unless the Bank obtains approval from the FHLB's Board of Directors or its Executive Committee. These limits are further restricted by a member bank's ability to provide eligible collateral to support its obligations to the FHLB, as well as a member bank's ability to meet the FHLB's stock requirement. ADecember 31, 2019 andDecember 31, 2018 , the Bank pledged approximately$308.5 million and$270.9 million of loans, respectively, to support the FHLB borrowing capacity. AtDecember 31, 2019 andDecember 31, 2018 , the Bank had available borrowing capacity of$160.7 million and$131.2 million , respectively, at the FHLB ofNew York . The Bank also maintains unsecured federal funds lines of$46.0 million with two correspondent banks, of which$25.0 million was available atDecember 31, 2019 .
The Consolidated Statements of Cash Flows present the changes in cash from
operating, investing and financing activities. At
Net cash provided by operating activities totaled$13.3 million for the year endedDecember 31, 2019 compared to net cash provided by operating activities of$17.3 million for the year endedDecember 31, 2018 . The primary source of funds was net income from operations, adjusted for activity related to loans originated for sale, the provision for loan losses, depreciation expense and net amortization of premiums on securities. Cash was used in operations primarily for originating loans held for sale. The decrease in net cash provided by operating activities was due primarily to net cash used in the origination and sale of loans totaling$2.9 million in 2019 compared to$1.2 million of cash provided by the origination and sale of loans in 2018.$2.5 million of cash was used to reduce accrued expenses and other liabilities in 2019. Net cash used in investing activities totaled$109.9 million for the year endedDecember 31, 2019 compared to$9.9 million for the year endedDecember 31, 2018 . The cash used in lending activities was$127.1 million in 2019 compared to$19.8 million in 2018. The cash provided by investment activities was$7.8 million in 2019 compared to$12.9 million in 2018. Net cash provided by financing activities totaled$94.7 million for the year endedDecember 31, 2019 compared to net cash used in financing activities of$9.3 million for the year endedDecember 31, 2018 . The net cash provided by financing activities in 2019 was due primarily to the net increase in deposits and short-term borrowings, which was used in funding the lending activity. The Company paid dividends totaling$2.6 million in 2019 compared to$2.1 million in 2018. The investment securities portfolios are also a source of liquidity, providing cash flows from maturities and periodic repayments of principal. For the year endedDecember 31, 2019 , sales, repayments and maturities of investment securities totaled$58.0 million compared to$55.9 million in 2018. Another source of liquidity is the loan portfolio, which provides a flow of payments and maturities.
Management believes that the Company's liquidity position is adequate to service the needs of its borrowers and depositors and provide for its planned operations.
Interest Rate Sensitivity Analysis
The largest component of the Company's total income is net interest income and
the majority of the Company's financial instruments are composed of interest
rate sensitive assets and liabilities with various terms and maturities. The
primary objective of management is to maximize net interest income while
minimizing interest rate risk. The Company's assets consist primarily of
floating rate construction loans, commercial lines of credit and fixed rate
commercial real estate loans and its liabilities consist primarily of
deposits. Interest rate risk is derived from timing differences and the
magnitude of relative changes in the repricing
62
--------------------------------------------------------------------------------
of assets and liabilities, loan prepayments, deposit withdrawals and differences
in lending and funding rates. Management actively seeks to monitor and control
the mix of interest rate sensitive assets and liabilities.
The following table sets forth certain information relating to the Company's
financial instruments that are sensitive to changes in interest rates,
categorized by expected maturity or repricing of such instruments, at
December 31, 2019 .
Interest Sensitivity Period Total Within One Year to Over Non-interest
(In thousands) 30 Day 90 Day 180 Day 365 Day One Year Five Years Five Years Sensitive Total
Assets :
Cash and due from
banks $ 12,176 $ - $ - $ - $ 12,176 $ - $ - $ 2,666 $ 14,842
Federal funds sold - - - - - - - - -
Investment
securities 50,475 21,932 12,011 22,701 107,119 93,400 25,025 6,858 232,402
Loans held for sale 5,927 - - - 5,927 - - - 5,927
Loans, net of
allowance for loan
losses 521,744 33,910 43,390 95,680 694,724 465,353 42,763 13,188 1,216,028
Other assets - - - - - - - 117,063 117,063
$ 590,322 $ 55,842 $ 55,401 $ 118,381 $ 819,946 $ 558,753 $ 67,788 $ 139,775 $ 1,586,262
Liabilities and
Equity:
Demand deposits -
non-interest bearing $ - $ - $ - $ - $ - $ - $ - $ 287,555 $ 287,555
Demand deposits -
interest bearing 189,640 - - - 189,640 159,460 44,292 - 393,392
Savings deposits 134,996 - - 58 135,054 72,201 51,778 - 259,033
Certificates of
deposits 19,750 50,140 80,878 101,282 252,050 85,332 - - 337,382
Borrowings 92,050 - - - 92,050 - - - 92,050
Redeemable
subordinated
debentures - 18,000 - - 18,000 - - 557 18,557
Non-interest-bearing
sources - - - - - - - 198,293 198,293
$ 436,436 $ 68,140 $ 80,878 $ 101,340$ 686,794 $ 316,993 $ 96,070 $ 486,405 $ 1,586,262 Asset (Liability) Sensitivity Gap : Period Gap$ 153,886 $ (12,298 ) $ (25,477 ) $
17,041
-
Cumulative Gap $ 153,886 $ 141,588 $ 116,111 $ 133,152 $ 133,152 $ 374,912 $ 346,630 - -
Cumulative Gap to
Total Assets 9.7 % 8.9 % 7.3 % 8.4 % 8.4 % 23.6 % 21.9 % - -
Under the Company's interest rate risk policy established by its Board of
Directors, quantitative guidelines have been established with respect to the
Company's interest rate risk and how interest rate shocks are projected to
affect the Company's net interest income and economic value of equity
("EVE"). The Company engages the services of an outside consultant to assist
with the measurement and analysis of interest rate risk. The Company uses a
combination of analyses to monitor its exposure to changes in interest rates.
The EVE analysis is a financial model that estimates the change in EVE over a
range of instantaneously shocked interest rate scenarios. EVE is the discounted
present value of expected cash flows from assets, liabilities and off-balance
sheet contracts. In calculating changes in EVE, assumptions estimating loan
prepayment rates, reinvestment rates and deposit decay rates that seem most
likely based on historical experience during prior interest rate changes are
employed. The net interest income simulation uses data derived from an asset and
liability analysis and applies several elements, including actual interest rate
indices and margins, contractual limitations and the U.S. Treasury yield curve
as of the balance sheet date. The financial model uses immediate parallel yield
curve shocks (in both directions) to determine possible changes in net interest
income as if the theoretical rate shocks occurred. The EVE analysis and net
interest income simulation model results are presented quarterly to the
Asset/Liability Committee of the Board of Directors.Summarized below are the
projected effects of a parallel shift of
63
--------------------------------------------------------------------------------increases of 200 and 300 basis points, respectively, and a decrease of 200 basis points in market rates on the Company's net interest income and EVE.
Next 12 Months
Change in Interest Rates Economic Value of Equity (2) Net Interest Income
Basis Point (bp) (1) Dollar Dollar Percentage Dollar Dollar Percentage
(Dollars in thousands) Amount Change Change Amount Change Change
+300 bp $ 205,647 $ (5,573 ) (2.64 )% $ 60,187 $ 3,547 6.26 %
+200 bp 208,882 (2,338 ) (1.11 )% 59,071 2,431 4.29 %
0 bp 211,220 - - 56,640 - -
-200 bp 201,629 (9,591 ) (4.54 )% 54,965 (1,675 ) (2.96 )%
(1) Assumes an instantaneous and parallel shift in interest rates at all
maturities.
(2) EVE is the discounted present value of expected cash flows from
assets, liabilities and off-balance sheet contracts.
The above table indicates that, as of December 31, 2019 , in the event of a 200
basis point increase in interest rates, the Company would be expected to
experience a 1.11% decrease in EVE and a $2.4 million , or 4.29%, increase in net
interest income over the next twelve months. As of December 31, 2019 , in the
event of a 200 basis points decrease in interest rates, the Company would be
expected to experience a $9.6 million , or 4.54% decrease in EVE and a $1.7
million , or 2.96% decrease in net interest income. This data does not reflect
any future actions that management may take in response to changes in interest
rates, such as changing the mix of assets and liabilities, which could change
the results of the EVE and net interest income calculations.
Certain shortcomings are inherent in any methodology used in the above interest
rate risk measurements. Modeling changes in EVE and net interest income require
certain assumptions that may or may not reflect the manner in which actual
yields and costs respond to changes in market interest rates. In this regard,
the estimated EVE and net interest income presented above assumes that the
composition of the Company's interest-rate sensitive assets and liabilities
existing at the beginning of a period remains constant over the period being
measured and, accordingly, the data does not reflect any actions that the
Company may take in response to changes in interest rates. The estimates also
assume a particular change in interest rates is reflected uniformly across the
yield curve regardless of the duration to maturity or the repricing
characteristics of specific assets and liabilities. Although the estimated EVE
and net interest income provide an indication of the Company's sensitivity to
interest rate changes at a particular point in time, such measurement is not
intended to and does not provide a precise forecast of the effects of changes in
market interest rates on the Company's EVE and net interest income and will
differ from actual results.
On July 27, 2017 , the FCA , a regulator of financial services firms in the United
Kingdom , announced that it intends to stop persuading or compelling banks to
submit LIBOR rates after 2021. The FCA and submitting LIBOR banks have indicated
they will support the LIBOR indices through 2021 to allow for an orderly
transition to an alternative reference rate. In the United States , efforts to
identify a set of alternative U.S. dollar reference interest rates include
proposals by the Alternative Reference Rates Committee of the Federal Reserve
Board . Other financial services regulators and industry groups are evaluating
the possible phase-out of LIBOR and the development of alternate reference rate
indices or reference rates. Some of our assets and liabilities are indexed to
LIBOR. We are evaluating the potential impact of the possible replacement of the
LIBOR benchmark interest rate, but are not able to predict whether LIBOR will
cease to be available after 2021, whether the alternative rates the Federal
Reserve Board proposes to publish will become market benchmarks in place of
LIBOR, or what the impact of such a transition will have on our business,
financial condition, or results of operations. Reform of, or the replacement or
phasing out of, LIBOR and proposed regulation of LIBOR and other "benchmarks"
may materially adversely affect the amount of interest paid on any LIBOR-based
loans, investment securities and borrowings of the Company and the Company's
business, financial condition and results of operations.
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