The following presents management's discussion and analysis of the financial condition and results of operations ofLive Oak Bancshares, Inc. (the "Company" or "LOB"). This discussion should be read in conjunction with the financial statements and related notes included elsewhere in this quarterly report on Form 10-Q and with the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 (the "2019 Annual Report"). Results of operations for the periods included in this quarterly report on Form 10-Q are not necessarily indicative of results to be obtained during any future period.
Important Note Regarding Forward-Looking Statements
This quarterly report on Form 10-Q contains statements that management believes are forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. These statements generally relate to the Company's financial condition, results of operations, plans, objectives, future performance or business. They usually can be identified by the use of forward-looking terminology, such as "believes," "expects," or "are expected to," "plans," "projects," "goals," "estimates," "will," "may," "should," "could," "would," "continues," "intends to," "outlook" or "anticipates," or variations of these and similar words, or by discussions of strategies that involve risks and uncertainties. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to, those described in this quarterly report on Form 10-Q. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements management may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information actually known to the Company at the time. Management undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Forward-looking statements contained in this quarterly report on Form 10-Q are based on current expectations, estimates and projections about the Company's business, management's beliefs and assumptions made by management. These statements are not guarantees of the Company's future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in the forward-looking statements. These risks, uncertainties and assumptions include, without limitation:
• deterioration in the financial condition of borrowers resulting in
significant increases in the Company's loan and lease losses and provisions
for those losses and other adverse impacts to results of operations and financial condition;
• changes in SBA rules, regulations and loan products, including specifically
the Section 7(a) program, changes in SBA standard operating procedures or
changes to the status ofLive Oak Banking Company (the "Bank") as an SBA Preferred Lender;
• changes in rules, regulations or procedures for other government loan
programs, including those of the
• changes in interest rates that affect the level and composition of deposits,
loan demand and the values of loan collateral, securities, and interest
sensitive assets and liabilities;
• the failure of assumptions underlying the establishment of reserves for
possible loan and lease losses;
• changes in loan underwriting, credit review or loss reserve policies
associated with economic conditions, examination conclusions, or regulatory
developments;
• the potential impacts of the Coronavirus Disease 2019 (COVID-19) pandemic on
trade (including supply chains and export levels), travel, employee
productivity and other economic activities that may have a destabilizing and
negative effect on financial markets, economic activity and customer behavior;
• a reduction in or the termination of the Company's ability to use the
technology-based platform that is critical to the success of the Company's
business model or to develop a next-generation banking platform, including a
failure in or a breach of the Company's operational or security systems or
those of its third-party service providers;
• changes in financial market conditions, either internationally, nationally
or locally in areas in which the Company conducts operations, including
reductions in rates of business formation and growth, demand for the
Company's products and services, commercial and residential real estate
development and prices, premiums paid in the secondary market for the sale of loans, and valuation of servicing rights;
• changes in accounting principles, policies, and guidelines applicable to
bank holding companies and banking; 38
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• fluctuations in markets for equity, fixed-income, commercial paper and other
securities, which could affect availability, market liquidity levels, and pricing;
• the effects of competition from other commercial banks, non-bank lenders,
consumer finance companies, credit unions, securities brokerage firms,
insurance companies, money market and mutual funds, and other financial
institutions operating in the Company's market area and elsewhere, including
institutions operating regionally, nationally and internationally, together
with such competitors offering banking products and services by mail, telephone and the Internet; • the Company's ability to attract and retain key personnel;
• changes in governmental monetary and fiscal policies as well as other
legislative and regulatory changes, including with respect to SBA or
lending programs and investment tax credits; • changes in political and economic conditions; • the impact of heightened regulatory scrutiny of financial products and services, primarily led by theConsumer Financial Protection Bureau and various state agencies;
• the Company's ability to comply with any requirements imposed on it by
regulators, and the potential negative consequences that may result;
• operational, compliance and other factors, including conditions in local
areas in which the Company conducts business such as inclement weather or a
reduction in the availability of services or products for which loan
proceeds will be used, that could prevent or delay closing and funding loans
before they can be sold in the secondary market;
• the effect of any mergers, acquisitions or other transactions, to which the
Company or the Bank may from time to time be a party, including management's
ability to successfully integrate any businesses acquired;
• other risk factors listed from time to time in reports that the Company
files with the
• the Company's success at managing the risks involved in the foregoing.
Except as otherwise disclosed, forward-looking statements do not reflect: (i) the effect of any acquisitions, divestitures or similar transactions that have not been previously disclosed; (ii) any changes in laws, regulations or regulatory interpretations; or (iii) any change in current dividend or repurchase strategies, in each case after the date as of which such statements are made. All forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any statement, to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. Amounts in all tables in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") have been presented in thousands, except percentage, time period, stock option, share and per share data or where otherwise indicated. Nature of Operations LOB is a bank holding company headquartered inWilmington, North Carolina incorporated under the laws ofNorth Carolina inDecember 2008 . The Company conducts business operations primarily through its commercial bank subsidiary,Live Oak Banking Company (the "Bank"). The Bank was incorporated inFebruary 2008 as aNorth Carolina -chartered commercial bank. The Bank specializes in providing lending services to small businesses nationwide. The Bank identifies and grows within selected industry sectors, or verticals, by leveraging expertise within those industries, and more broadly to select borrowers outside of those industries. A significant portion of the loans originated by the Bank are guaranteed by the SBA under the 7(a) Loan Program and theU.S. Department of Agriculture ("USDA") Rural Energy for America Program ("REAP"), Water and Environmental Program ("WEP") and Business & Industry ("B&I") loan programs. 39
-------------------------------------------------------------------------------- EffectiveJuly 29, 2016 , the Company elected to become a "financial holding company" within the meaning of the Bank Holding Company Act. A financial holding company, and the nonbank companies under its control, are permitted to engage in activities considered financial in nature or incidental to financial activities. For the Company to become and remain eligible for financial holding company status, it and the Bank must meet certain criteria, including capital, management and Community Reinvestment Act ("CRA") requirements. The failure to meet such criteria could, depending on which requirements were not met, result in the Company facing restrictions on new financial activities or acquisitions or being required to discontinue existing activities that are not otherwise permissible for bank holding companies. In 2018, the Company formedCanapi Advisors, LLC for the purpose of providing investment advisory services to a series of new funds focused on providing venture capital to new and emerging financial technology companies. In 2019,Live Oak Clean Energy Financing LLC ("LOCEF") became a subsidiary of the Bank. LOCEF was formed inNovember 2016 as a subsidiary of the Company for the purpose of providing financing to entities for renewable energy applications. In 2018, the Bank formedLive Oak Private Wealth, LLC , a registered investment advisor that provides high-net-worth individuals and families with strategic wealth and investment management services, and onApril 1, 2020 , it acquiredJolley Asset Management, LLC to broaden service offerings for existing high-net-worth individuals and families, attract new clients from an expanded footprint and benefit from economies of scale. In 2017, the Bank entered into a joint venture,Apiture LLC ("Apiture"), with First Data Corporation for the purpose of creating next generation technology for financial institutions. In addition to the Bank, the Company ownsLive Oak Ventures, Inc. , formed inAugust 2016 for the purpose of investing in businesses that align with the Company's strategic initiative to be a leader in financial technology;Live Oak Grove, LLC , formed inFebruary 2015 for the purpose of providing Company employees and business visitors an on-site restaurant location; andGovernment Loan Solutions, Inc. ("GLS"), a management and technology consulting firm that specializes in the settlement, accounting, and securitization processes for government guaranteed loans, including loans originated under the SBA 7(a) loan program andUSDA -guaranteed loans. In 2019, 504Fund Advisors, LLC ("504FA") exited as the advisor to The 504 Fund, and the Company dissolved this legal entity. The Company generates revenue primarily from net interest income and secondarily through origination and sale of government guaranteed loans. Income from the retention of loans is comprised principally of interest income. The Company elects to account for certain loans under the fair value option with interest reported in interest income and changes in fair value reported in the net (loss) gain on loans accounted for under the fair value option line item of the consolidated statements of income. Income from the sale of loans is comprised of loan servicing revenue and revaluation of related servicing assets along with net gains on sales of loans. Offsetting these revenues are the cost of funding sources, provision for loan and lease credit losses, any costs related to foreclosed assets and other operating costs such as salaries and employee benefits, travel, professional services, advertising and marketing and tax expense.
Recent Developments
The COVID-19 pandemic inthe United States continues to have a complex and significant adverse impact on the economy, the banking industry and the Company, all subject to a high degree of uncertainty. While it is still not possible to know the full universe or extent of these impacts as of the date of this filing, we are disclosing potentially material items of which we are currently aware. 40 --------------------------------------------------------------------------------
Financial position and results of operations
Relating to ourJune 30, 2020 financial condition and results of operations, COVID-19 had a significant impact on the allowance for credit losses ("ACL") on loans and leases, loans carried at fair value, loan servicing asset revaluation, net gains on sales of loans and net interest income. While the Company has not yet experienced any charge-offs related to COVID-19, the ACL and loan fair value calculation and resulting provision for loan and lease credit losses and net loss on loans accounted for under the fair value option were significantly impacted by changes in forecasted economic conditions. Given that forecasted economic scenarios continued to be negative with substantial uncertainty since the pandemic was declared in early March combined with effects surfacing in certain pandemic-at-risk verticals and the risk that payments being made by the SBA for borrowers under its programs may be skewing actual indications of ability to repay, the need for additional credit related reserves increased significantly by the end of the second quarter. Refer to the discussion of the ACL and loans at fair value in Notes 5 and 9, respectively, of the unaudited condensed consolidated financial statements as well as further discussion below in MD&A. Also impacted by deteriorating market conditions was the Company's valuation of the loan servicing asset as discussed in Note 7 of the unaudited condensed consolidated financial statements and net gains on sales of loans, both of which are further discussed below in MD&A. The secondary market improved at the end of the second quarter which offset earlier negative COVID-19 adjustments for loans carried at fair value and the loan servicing asset valuation. In the second quarter the net interest margin was negatively impacted by significant rate cuts in response to stimulus efforts combined with heightened levels of liquidity at the Company as a part of pandemic preparedness, while the Paycheck Protection Program (the "PPP") lending had a positive impact on net interest margin, as discussed more fully below in MD&A. Should economic conditions worsen, the Company could experience further increases in the required ACL and negative fair value marks and record additional credit or market related loss expense. It is also possible that the Company's asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged. While there are current signs of recovery in the secondary market pricing, the income from gain on sale of loans in future periods could be reduced due to COVID-19. Impacts began to be felt in the latter part of March and early April with loan sales executed at that time as secondary markets conditions began to weaken. At this time, the Company is unable to project the materiality of such an impact but recognizes the breadth of the economic impact is likely to impact gains in future periods. Interest income could be further reduced due to COVID-19. In keeping with guidance from banking regulators, the Company has and continues to actively work with COVID-19 affected borrowers to help defer their payments, interest, and fees. In addition to regulatory relief on deferrals from banking regulators, six months of payment relief are also available from the SBA for certain loans guaranteed by that agency. While interest and fees will still accrue to interest, should eventual credit losses on these loans with deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact may affect our borrowers' ability to repay in future periods. Capital and liquidity As ofJune 30, 2020 , all of the Company's capital ratios, and the Bank's capital ratios, were in excess of all regulatory requirements. While the Company believes that capital is sufficient to withstand an extended economic recession brought about by COVID-19, reported and regulatory capital ratios could be adversely impacted by further credit losses. The Company relies on cash on hand as well as dividends from the Bank to service any debt at the Company. If our capital deteriorates such that the Bank is unable to pay dividends to the Company for an extended period of time, the Company may not be able to service its debt. The Company maintains access to multiple sources of liquidity. Wholesale funding markets have remained open to the Company, but rates for short term funding have recently been volatile and the secondary market for guaranteed loans has shown reactionary and varying responses to the changing economic environment. In addition to increased levels of loan sales, the Company also increased its levels of deposits and borrowings in the first half of the year, as discussed further in MD&A. If funding costs are elevated for an extended period of time, it could have an adverse effect on the Company's net interest margin. If an extended recession causes large numbers of the Company's deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding. 41
-------------------------------------------------------------------------------- TheFederal Reserve has created the Paycheck Protection Program Liquidity Facility ("PPPLF") to help provide financing for the origination of PPP loans. The PPPLF extends loans to banks that have loaned money to small businesses under the PPP, discussed in more detail below. Amounts borrowed are non-recourse and have a 100% advance rate equal to the principal amount of PPP loans pledged as security. In addition, loans financed under the PPPLF have a neutral impact on regulatory leverage capital ratios. The maturity date of a borrowing under the PPPLF is equal to the maturity date of the PPP loan pledged to secure the borrowing and would be accelerated (i) if the underlying PPP loan goes into default and is transferred to the SBA to realize on the SBA guarantee or (ii) to the extent that any loan forgiveness reimbursement is received from the SBA. Borrowings under the PPPLF bear interest at a rate of 0.35%, and there are no fees paid by the Company. As ofJune 30, 2020 , the Company had borrowed$1.72 billion from the PPPLF.
Lending operations and accommodations to borrowers
With the passage of the PPP, administered by the SBA, the Company has actively interpreted and implemented new loan programs and systems using its technology platform while participating in assisting its customers and other small businesses in need of resources through the program. PPP loans earn interest at 1% and currently have a two-year or five-year contractual term depending on the origination date. For the earlier loans with a two-year term there is an option to extend to five years if requested by the borrower and approved by the lender. The Company expects that some portion of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As ofJune 30, 2020 , the Company has secured funding from the SBA for 10,847 PPP loans representing$1.74 billion in originations. Loans funded through the PPP are fully guaranteed by the SBA, subject to the terms and conditions of the program. Should those circumstances change, the Company could be required to record additional credit loss expense through earnings. With the passage of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) onMarch 27, 2020 , the SBA will be making six months of principal and interest payments on all fully disbursed SBA 7(a) and SBA Express loans in regular servicing status that close bySeptember 27, 2020 . In addition, with regulatory guidance to work with borrowers during this unprecedented situation, the Company has also mobilized to provide a payment deferral program when needed by customers that are adversely affected by the pandemic. Depending on the demonstrated need of the client, the Company is deferring either the full loan payment or the principal component of the loan payment for 60 or 90 days. In accordance with interagency guidance issued inMarch 2020 , these short-term deferrals are not considered troubled debt restructurings. AtJune 30, 2020 the Company estimated that as a percentage to total loans and leases at amortized cost, excluding PPP, 60% of its loans were receiving the six months of payments from the SBA and that 9% of its loans had a payment deferral in place. OnJune 5, 2020 , the Paycheck Protection Program Flexibility Act (the "new Act") was signed into law, and made significant changes to the PPP to provide additional relief for small businesses. The new Act increased flexibility for small businesses that have been unable to rehire employees due to lack of employee availability, or have been unable to operate as normal due to COVID-19 related restrictions. It extended the period that businesses have to use PPP funds to qualify for loan forgiveness to 24 weeks, up from 8 weeks under the original rules. The new Act also relaxed the requirements that loan recipients must adhere to in order to qualify for loan forgiveness. In addition, the new Act extended the payment deferral period for PPP loans until the date when the amount of loan forgiveness is determined and remitted to the lender. For PPP recipients who do not apply for forgiveness, the loan deferral period is 10 months after the applicable forgiveness period ends.
Credit
While all industries have and will continue to experience adverse impacts as a result of COVID-19, the Company has exposures in the following verticals considered to be "at-risk" of significant impact as ofJune 30, 2020 : hotels, wine and craft beverage, educational services, entertainment centers, fitness centers, and quick service restaurants each comprising$178.9 million or 8.1%,$101.6 million or 4.6%,$80.4 million or 3.6%,$56.8 million or 2.6%,$22.8 million or 1.0%, and$12.3 million or 0.6% of total unguaranteed loans and leases (all at amortized cost, inclusive of loans carried at fair value), respectively. The Company continues to work with customers directly affected by COVID-19 and is prepared to offer short-term assistance in accordance with regulatory guidelines. As a result of the uncertain economic environment caused by COVID-19, the Company is engaging in more frequent communication with borrowers to better understand their situation and the challenges faced and circumstances evolve, which the Company anticipates will allow it to respond proactively as needs and issues arise. 42
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Results of Operations Performance Summary
Three months ended
For the three months ended
• The provision for loan and lease credit losses increased
191.9%; and
• The net loss on loans accounted for under the fair value option increased
Outside of the continued effects of COVID-19, which was intensified by the adoption of new current expected credit losses model ("CECL") in the first quarter of 2020, salaries and employee benefits increased$8.8 million , or 40.0%, as the Company continued to invest in its workforce to support growth and a variety of initiatives including$7.2 million in expense for a performance bonus pool that was available to all employees other than executive officers.
The primary factors partially offsetting the decrease in net income for the
three months ended
• Increase in net interest income of
driven by significant growth in total loan and lease portfolios which was accentuated by the origination of$1.74 billion in PPP loans during the second quarter of 2020;
• Net gains on sales of loans increased
a higher volume of loans sold in the second quarter of 2020. The volume in
guaranteed loan sales in the second quarter of 2020 increased to
million, in line with the Company's balance sheet strategy, compared to$71.9 million in the second quarter of 2019; and
• Other noninterest income increased
result of$2.5 million in revenue resulting from the sale of services from co-developed technology for processing PPP loans.
Six months ended
For the six months endedJune 30, 2020 , the Company reported a net loss of$3.8 million , or$(0.10) per diluted share, as compared to net earnings of$7.3 million , or$0.18 per diluted share, for the six months endedJune 30, 2019 . This decrease in net income was largely the due to continuation of the above-mentioned risks and uncertainties related to the COVID-19 pandemic during the first half of 2020, as reflected below:
• The provision for loan and lease credit losses increased
237.6%; and
• The net loss on loans accounted for under the fair value option increased
Outside of COVID-19 effects on the first half of 2020, salaries and employee benefits increased$15.0 million , or 34.2%, as the Company continued to invest in its workforce to support growth and a variety of initiatives, as discussed more fully above.
The primary factors partially offsetting the net loss for the six months ended
• Increase in net interest income of
driven by significant growth in total loan and lease portfolios which was accentuated by the origination of$1.74 billion in PPP loans during the second quarter of 2020;
• Net gains on sales of loans increased
to higher sale volumes in the first quarter to strengthen the Company's
capital and liquidity profile in preparation for pandemic uncertainties. The
volume in guaranteed loan sales in the first half of 2020 increased to$317.3 million compared to$134.9 million in the first half of 2019; 43
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• Other noninterest income increased
result of$2.5 million in revenue resulting from the sale of services from co-developed technology for processing PPP loans; and
• Income tax benefit increased
million estimated benefit related to the enactment of the CARES Act which
allows the carryback of certain net operating losses for five years combined
with the Company's overall net pretax loss in the first half of 2020.
Net Interest Income and Margin
Net interest income represents the difference between the income that the Company earns on interest-earning assets and the cost it incurs on interest-bearing liabilities. The Company's net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rates that the Company earns or pays on them, respectively. Net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume changes." It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as "rate changes." As a bank without a branch network, the Bank gathers deposits over the Internet and in the community in which it is headquartered. Due to the nature of a branchless bank and the relatively low overhead required for deposit gathering, the rates that the Bank offers are generally above the industry average.
Three months ended
For the three months endedJune 30, 2020 , net interest income increased$7.0 million , or 20.5%, to$40.9 million compared to$33.9 million for the three months endedJune 30, 2019 . The increase was principally due to the significant growth in the held for investment loan and lease portfolio reflecting the Company's ongoing initiative to grow recurring revenue sources and strengthen liquidity. This increase over the prior year was primarily a product of the aforementioned origination of$1.74 billion in PPP loans in the second quarter of 2020 with$8.7 million in interest income coming from recognition of net deferred fees combined with a 1% annualized interest rate. Accordingly, average interest earning assets increased by$2.73 billion , or 74.6%, to$6.40 billion for the three months endedJune 30, 2020 , compared to$3.66 billion for the three months endedJune 30, 2019 , while the yield on average interest earning assets decreased 185 basis points to 4.19%. The cost of funds on interest bearing liabilities for the three months endedJune 30, 2020 decreased 76 basis points to 1.65%, and the average balance of interest bearing liabilities increased by$2.78 billion , or 78.8%, over the same period in 2019. The increase in average interest bearing liabilities was largely driven by strategically heightened levels of liquidity related to COVID-19 risks and uncertainties and funding for PPP loans. As indicated in the rate/volume table below, increased interest earning asset volume more than offset lower yields outpacing the higher volume and lower levels of cost declines for interest bearing liabilities, resulting in increased interest income of$11.7 million and increased interest expense of$4.7 million for the three months endedJune 30, 2020 compared to the three months endedJune 30, 2019 . For the three months endedJune 30, 2019 compared to the three months endedJune 30, 2020 , net interest margin decreased from 3.71% to 2.56%, respectively, principally due to the Company's interest earning assets repricing more rapidly from lower fed funds rates than its interest bearing liabilities, combined with above mentioned impacts of PPP related activities and heightened liquidity.
Six Months Ended
For the six months endedJune 30, 2020 , net interest income increased$16.5 million , or 25.6%, to$81.1 million compared to$64.5 million for the six months endedJune 30, 2019 . This increase was principally due to the significant growth in the combined held for sale and held for investment loan and lease portfolios along with higher investment security holdings reflecting the Company's ongoing initiative to grow recurring revenue sources and strengthen liquidity. This increase over the first half of 2019 was also enhanced by the above mentioned origination of PPP loans in the second quarter. Accordingly, average interest earning assets increased by$1.93 billion , or 54.7%, to$5.47 billion for the six months endedJune 30, 2020 , compared to$3.53 billion for the six months endedJune 30, 2019 , while the yield on average interest earning assets decreased 122 basis points to 4.78%. The cost of funds on interest bearing liabilities for the six months endedJune 30, 2020 decreased 54 basis points to 1.85%, and the average balance of interest bearing liabilities increased by$1.93 billion , or 56.5%, over the same period in 2019. The increase in average interest bearing liabilities was also largely impacted by strategically heightened levels of liquidity in the first half of 2020 related to COVID-19 risks and uncertainties and funding sources for PPP loans. As indicated in the rate/volume table below, the increase in interest earning assets and corresponding yields outpaced the higher volume and decreased cost of interest bearing liabilities, resulting in increased interest income of$25.2 million and increased interest expense of$8.7 million for the six months endedJune 30, 2020 compared to the six months endedJune 30, 2019 . For the six months endedJune 30, 2019 compared to the six months endedJune 30, 2020 , net interest margin decreased from 3.68% to 2.97%, respectively, principally due to lower fed funds rates impacting the yield on interest earning assets more rapidly than the cost of interest bearing liabilities in the first half of 2020, combined with the above mentioned impacts of PPP related activities and heightened levels of liquidity. 44
-------------------------------------------------------------------------------- Average Balances and Yields. The following table presents information regarding average balances for assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amount of interest expense on average interest-bearing liabilities, and the resulting average yields and costs. The yields and costs for the periods indicated are derived by dividing the income or expense by the average balances for assets or liabilities, respectively, for the periods presented and annualizing that result. Loan fees are included in interest income on loans. Three Months Ended June 30, 2020 2019 Average Average Average Average Balance Interest Yield/Rate Balance Interest Yield/Rate Interest earning assets: Federal funds sold and interest earning balances in other banks$ 711,916 $ 1,009 0.57 %$ 184,986 $ 1,108 2.40 % Investment securities 556,014 3,786 2.73 566,159 4,116 2.92 Loans held for sale 921,956 13,115 5.71 839,724 14,333 6.85 Loans and leases held for investment(1) 4,208,109 48,907 4.66 2,073,297 35,581 6.88 Total interest earning assets 6,397,995 66,817 4.19 3,664,166 55,138 6.04 Less: Allowance for credit losses on loans and leases (35,875 ) (19,196 ) Non-interest earning assets 603,610 472,529 Total assets$ 6,965,730 $ 4,117,499 Interest bearing liabilities: Interest bearing checking$ 462,977 $ 646 0.56 % $ - $ - - % Savings 1,398,378 4,814 1.38 989,512 5,235 2.12 Money market accounts 82,908 89 0.43 85,982 161 0.75 Certificates of deposit 3,689,041 19,572 2.13 2,452,159 15,807 2.59 Total deposits 5,633,304 25,121 1.79 3,527,653 21,203 2.41 Borrowings 676,849 798 0.47 1,409 - - Total interest bearing liabilities 6,310,153 25,919 1.65 3,529,062 21,203 2.41 Non-interest bearing deposits 41,218 49,466 Non-interest bearing liabilities 50,554 26,580 Shareholders' equity 563,805 512,391 Total liabilities and shareholders' equity$ 6,965,730 $ 4,117,499 Net interest income and interest rate spread$ 40,898 2.54 %$ 33,935 3.63 % Net interest margin 2.56 % 3.71 % Ratio of average interest-earning assets to average interest-bearing liabilities 101.39 % 103.83 %
(1) Average loan and lease balances include non-accruing loans and leases.
45 --------------------------------------------------------------------------------
Six Months Ended June 30, 2020 2019 Average Average Average Average Balance Interest Yield/Rate Balance Interest Yield/Rate Interest earning assets: Federal funds sold and interest earning balances in other banks$ 470,901 $ 1,759 0.75 %$ 233,904 $ 2,747 2.37 % Investment securities 546,110 7,548 2.77 514,038 7,433 2.92 Loans held for sale 963,359 28,980 6.03 794,919 26,934 6.83 Loans and leases held for investment(1) 3,485,135 92,003 5.29 1,990,054 67,946 6.89 Total interest earning assets 5,465,505 130,290 4.78 3,532,915 105,060 6.00 Less: Allowance for credit losses on loans and leases (31,439 ) (17,600 ) Non-interest earning assets 555,469 473,512 Total assets$ 5,989,535 $ 3,988,827 Interest bearing liabilities: Interest bearing checking$ 231,489 $ 646 0.56 %$ 84 $ - - % Savings 1,261,131 9,658 1.54 958,716 10,021 2.11 Money market accounts 80,265 189 0.47 84,648 269 0.64 Certificates of deposit 3,425,850 37,883 2.22 2,367,902 30,230 2.57 Total deposits 4,998,735 48,376 1.94 3,411,350 40,520 2.40 Borrowings 342,002 855 0.50 1,436 - - Total interest bearing liabilities 5,340,737 49,231 1.85 3,412,786 40,520 2.39 Non-interest bearing deposits 45,071 47,294 Non-interest bearing liabilities 52,024 20,548 Shareholders' equity 551,703 508,199 Total liabilities and shareholders' equity$ 5,989,535 $ 3,988,827 Net interest income and interest rate spread$ 81,059 2.93 %$ 64,540 3.61 % Net interest margin 2.97 % 3.68 % Ratio of average interest-earning assets to average interest-bearing liabilities 102.34 % 103.52 %
(1) Average loan and lease balances include non-accruing loans and leases.
46 -------------------------------------------------------------------------------- Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, increases or decreases attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume. Three Months Ended June 30, Six Months Ended June 30, 2020 vs. 2019 2020 vs. 2019 Increase (Decrease) Due to Increase (Decrease) Due to Rate Volume Total Rate Volume Total Interest income: Federal funds sold and interest earning balances in other banks$ (2,050 ) $ 1,951 $ (99 ) $ (2,822 ) $ 1,834 $ (988 ) Investment securities (259 ) (71 ) (330 ) (339 ) 454 115 Loans held for sale (2,505 ) 1,287 (1,218 ) (3,341 ) 5,387 2,046 Loans and leases held for investment (17,398 ) 30,724 13,326 (21,200 ) 45,257 24,057 Total interest income (22,212 ) 33,891 11,679 (27,702 ) 52,932 25,230 Interest expense: Interest bearing checking - 646 646 - 646 646 Savings (2,206 ) 1,785 (421 ) (3,101 ) 2,738 (363 ) Money market accounts (67 ) (5 ) (72 ) (68 ) (12 ) (80 ) Certificates of deposit (3,503 ) 7,268 3,765 (4,950 ) 12,603 7,653 Borrowings 2 796 798 4 851 855 Total interest expense (5,774 ) 10,490 4,716 (8,115 ) 16,826 8,711 Net interest income$ (16,438 ) $ 23,401 $ 6,963 $ (19,587 ) $ 36,106 $ 16,519
Provision for Loan and Lease Credit Losses
The provision for loan and lease credit losses represents the amount necessary to be charged against the current period's earnings to maintain the allowance for credit losses ("ACL") on loans and leases at a level that is appropriate in relation to the estimated losses inherent in the loan and lease portfolio. Losses inherent in loan relationships are mitigated if a portion of the loan is guaranteed by the SBA orUSDA . A typical SBA 7(a) loan carries a 75% guarantee whileUSDA guarantees range from 50% to 90% depending on loan size, which serve to reduce the risk profile of these loans. The Company believes that its focus on compliance with regulations and guidance from the SBA andUSDA are key factors to managing this risk. For the second quarter of 2020, the provision for loan and lease credit losses was$10.0 million compared to$3.4 million for the same period in 2019, an increase of$6.5 million . For the first half of 2020, the provision for loan and lease credit losses was$21.8 million compared to$6.4 million for the same period in 2019, an increase of$15.3 million . The Company adopted the new current expected credit losses ("CECL") standard effectiveJanuary 1, 2020 and accordingly determined to use forecasted levels of unemployment as a primary economic variable in forecasting future expected losses. The majority of the provision for the second quarter of 2020 was due to the effects of the COVID-19 pandemic, while approximately$15.5 million of the first half of 2020 provision was estimated to be based upon the severity of ongoing developments resulting from the COVID-19 pandemic. Loans and leases held for investment at historical cost were$3.82 billion as ofJune 30, 2020 , increasing by$2.45 billion , or 178.7%, compared toJune 30, 2019 . This growth was largely fueled by$1.74 billion in PPP loan originations in the second quarter of 2020. Excluding PPP loan originations and net unearned fees on those loans, the balance in loans and leases held for investment at historical cost was$2.13 billion atJune 30, 2020 , an increase of$758.2 million , or 55.4%, overJune 30, 2019 . This growth, outside of PPP activity in the second quarter of 2020, was fueled by continued origination volumes combined with retention of substantially more loans on the balance sheet. 47 -------------------------------------------------------------------------------- Net charge-offs for loans and leases carried at historical cost were$1.8 million , or 0.21% of average quarterly loans and leases held for investment, carried at historical cost, on an annualized basis, for the three months endedJune 30, 2020 , compared to$121 thousand , or 0.04%, for the three months endedJune 30, 2019 . Net charge-offs for loans and leases carried at historical cost for the second quarter of 2020 was 0.25% of average quarterly loans and leases held for investment, excluding PPP loans, on an annualized basis. For the six months endedJune 30, 2020 , net charge-offs totaled$4.6 million compared to$34 thousand for the six months endedJune 30, 2019 , an increase of$4.5 million , or 13,370.6%. The increase in net charge-offs largely consisted of a number of loans in theGovernment Contracting , Healthcare,Family Entertainment , and Independent Pharmacies verticals. Net charge-offs are a key element of historical experience in the Company's estimation of the allowance for credit losses on loans and leases. In addition, nonperforming loans and leases not guaranteed by the SBA orUSDA , excluding$6.4 million and$7.7 million accounted for under the fair value option atJune 30, 2020 and 2019, respectively, totaled$13.1 million , which was 0.34% of the held for investment loan and lease portfolio carried at historical cost atJune 30, 2020 , compared to$6.5 million , or 0.48% of loans and leases held for investment atJune 30, 2019 . Nonperforming loans and leases carried at historical cost which are not guaranteed by the SBA orUSDA were 0.62% of the historical cost portion of the held for investment loan and lease portfolio, excluding PPP loans, atJune 30, 2020 .
Noninterest Income
Noninterest income is principally comprised of net gains from the sale of SBA andUSDA -guaranteed loans along with loan servicing revenue and related revaluation of the servicing asset. Revenue from the sale of loans depends upon the volume, maturity structure and rates of underlying loans as well as the pricing and availability of funds in the secondary markets prevailing in the period between completed loan funding and closing of sale. In addition, the loan servicing revaluation is significantly impacted by changes in market rates and other underlying assumptions such as prepayment speeds and default rates. Net (loss) gain on loans accounted for under the fair value option is also significantly impacted by changes in market rates, prepayment speeds and inherent credit risk. Other less common elements of noninterest income include nonrecurring gains and losses on investments.
The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.
Three Months Ended June 30, 2020/2019 Increase (Decrease) 2020 2019 Amount Percent Noninterest income Loan servicing revenue$ 6,691 $ 7,063 $ (372 ) (5.27 )% Loan servicing asset revaluation (1,571 ) (3,245 ) 1,674 51.59 Net gains on sales of loans 10,695 6,015 4,680 77.81 Net (loss) gain on loans accounted for under the fair value option (1,089 ) 2,791 (3,880 ) (139.02 ) Equity method investments income (loss) (2,243 ) (1,736 ) (507 ) 29.21 Equity security investments gains (losses), net 161 32 129 403.13
Gain on sale of investment securities
available-for-sale, net 734 - 734 100.00 Lease income 2,635 2,369 266 11.23 Management fee income 1,206 91 1,115 1,225.27 Construction supervision fee income 684 386 298 77.20 Other noninterest income 4,508 884 3,624 409.95 Total noninterest income$ 22,411 $ 14,650 $ 7,761 52.98 % 48
-------------------------------------------------------------------------------- Six Months Ended June 30, 2020/2019 Increase (Decrease) 2020 2019 Amount Percent Noninterest income Loan servicing revenue$ 13,113 $ 14,473 $ (1,360 ) (9.40 )% Loan servicing asset revaluation (6,263 ) (7,285 ) 1,022 14.03 Net gains on sales of loans 21,807 10,213 11,594 113.52 Net (loss) gain on loans accounted for under the fair value option (11,727 ) 4,874 (16,601 ) (340.60 ) Equity method investments income (loss) (4,721 ) (3,750 ) (971 ) 25.89 Equity security investments gains (losses), net 97 135 (38 ) (28.15 )
Gain on sale of investment securities
available-for-sale, net 655 5 650 13,000.00 Lease income 5,259 4,694 565 12.04 Management fee income 2,850 91 2,759 3,031.87 Construction supervision fee income 1,074 1,165 (91 ) (7.81 ) Other noninterest income 6,009 3,351 2,658 79.32 Total noninterest income$ 28,153 $ 27,966 $ 187 0.67 % For the three months endedJune 30, 2020 , noninterest income increased by$7.8 million , or 53.0%, compared to the three months endedJune 30, 2019 . The increase from the prior year is primarily the result of the aforementioned increase in net gains on sales of loans combined with a$3.6 million increase in other noninterest income largely comprised of$2.5 million in revenue resulting from the sale of services from co-developed technology for processing PPP loans. Other items contributing to the increase in noninterest income were a lower net loss on the loan servicing asset revaluation of$1.7 million and management fee income earned byCanapi Advisors , the Company's investment advisor subsidiary, increasing by$1.1 million . Offsetting the increases in noninterest income for the second quarter of 2020 was the aforementioned net negative valuation adjustment related to loans measured at fair value which increased by$3.9 million . For the six months endedJune 30, 2020 , noninterest income increased by$187 thousand , or 0.7%, compared to the six months endedJune 30, 2019 . The slight increase from the prior year is also primarily the result of the aforementioned increase in net gains on sales of loans combined with a$2.7 million increase in other noninterest income largely comprised of$2.5 million in revenue resulting from the sale of services from co-developed technology for processing PPP loans. Other items contributing to the increase in noninterest income were a lower net loss on the loan servicing asset revaluation of$1.0 million and management fee income earned byCanapi Advisors , the Company's investment advisor subsidiary, increasing by$2.8 million . Offsetting the increases in noninterest income for the first half of 2020 was the aforementioned net negative valuation adjustment related to loans measured at fair value which increased by$16.6 million and decreased loan servicing revenue of$1.4 million .
The following table reflects loan and lease production, sales of guaranteed loans and the aggregate balance in guaranteed loans sold. These components are key drivers of the Company's noninterest income.
Three months endedJune 30 ,
Three months ended
2020 2019 2020 2019
Amount of loans and leases
originated$ 2,175,055 $ 525,088 $ 500,634 $ 390,851 Guaranteed portions of loans sold 154,980 71,934 162,297 62,940
Outstanding balance of
guaranteed loans sold (1) 2,840,429 2,870,108 2,761,015
2,952,774 49
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Six Months EndedJune 30 , For
years ended December 31, 2020 2019 2019 2018 2017 2016 Amount of loans and leases originated$ 2,675,689 $ 915,939 $ 2,001,886 $ 1,765,680 $ 1,934,238 $ 1,537,010 Guaranteed portions of loans sold 317,277 134,874 340,374 945,178 787,926 761,933 Outstanding balance of guaranteed loans sold (1) 2,840,429 2,870,108 2,746,840 3,045,460 2,680,641 2,278,618
(1) This represents the outstanding principal balance of guaranteed loans
serviced, as of the last day of the applicable period, which have been sold
into the secondary market.
Changes in various components of noninterest income are discussed in more detail below.
Loan Servicing Revenue: While portions of the loans that the Bank originates are sold and generate gain on sale revenue, servicing rights for those sold portions are retained by the Bank. In exchange for continuing to service sold loans, the Bank receives fee income represented in loan servicing revenue equivalent to 1.0% of the outstanding balance of SBA loans sold and 0.40% of the outstanding balance ofUSDA loans sold. In addition, the standard cost (adequate compensation) for servicing sold loans is approximately 0.40% of the balance of the loans sold, which is included in the loan servicing revaluation computations. Unrecognized servicing revenue above the standard cost to service is reflected in a servicing asset recorded on the balance sheet. Revenues associated with the servicing of loans are recognized over the expected life of the loan through the income statement, and the servicing asset is reduced as this revenue is recognized. For the quarter endedJune 30, 2020 , loan servicing revenue decreased$372 thousand , or 5.27%, to$6.7 million as compared to the quarter endedJune 30, 2019 . For the six months endedJune 30, 2020 , loan servicing revenue decreased$1.4 million , or 9.4% to$13.1 million as compared to the six months endedJune 30, 2019 . The lower servicing revenue for the second quarter and first half of 2020 has been a result of the declining balance of the serviced portfolio. AtJune 30, 2020 , the outstanding balance of guaranteed loans sold in the secondary market was$2.84 billion compared to$2.87 billion atJune 30, 2019 . Loan Servicing Revaluation: The Company revalues its serviced loan portfolio at least quarterly. The revaluation considers the amortization of the portfolio, current market conditions for loan sale premiums, and current prepayment speeds. For the three months endedJune 30, 2020 , there was a net negative loan servicing revaluation adjustment of$1.6 million compared to a net negative adjustment of$3.2 million for the three months endedJune 30, 2019 . For the six months endedJune 30, 2020 , there was a net negative loan servicing revaluation adjustment of$6.3 million compared to a net negative adjustment of$7.3 million for the six months endedJune 30 , 2019.The lower revaluation amount for the second quarter and first half of 2020 as compared to the corresponding period of 2019 was primarily a result of improving market conditions.Net Gains on Sale of Loans: For the three months endedJune 30, 2020 , net gains on sales of loans increased$4.7 million , or 77.8%, compared to the three months endedJune 30, 2019 . For the three months endedJune 30, 2020 , the volume of guaranteed loans sold increased$83.0 million , or 115.4%, to$155.0 million from$71.9 million for the three months endedJune 30, 2019 . For the six months endedJune 30, 2020 , net gains on sales of loans increased$11.6 million , or 113.5%, compared to the six months endedJune 30, 2019 . For the six months endedJune 30, 2020 , the volume of guaranteed loans sold increased$182.4 million , or 135.2%, to$317.3 million from$134.9 million for the six months endedJune 30, 2019 . The average net gain on guaranteed loan sales decreased from$80.1 thousand to$66.8 thousand , per million sold, in the second quarters of 2019 and 2020, respectively, and decreased from$71.3 thousand to$65.2 thousand , per million sold, in the first half of 2019 and 2020, respectively. With this overall decrease in market value due to loan sales earlier in the second quarter combined with the mix of loan sales, the increase in net gains on sales of loans in the second quarter and second half of 2020 is due to a higher volume of loans sold. Secondary market values continued to recover as the second quarter of 2020 progressed. The volume of sales in the first quarter of 2020 was heightened to strengthen the Company's capital and liquidity profile in light of uncertain market conditions while the second quarter of 2020 sales volume is in-line with the Company's balance sheet strategy. Also enhancing the increase in net gains on sale of loans in the second quarter of 2020 are$1.1 million in decreased losses from fair value changes in exchange-traded interest rate futures contracts. This decrease in volatility of exchange-traded interest rate futures contracts was the product of the Company preemptively exiting such contracts in the first quarter. 50
-------------------------------------------------------------------------------- Net (Loss) Gain on Loans Accounted for Under the Fair Value Option: For the three months endedJune 30, 2020 , the net loss on loans accounted for under the fair value option increased$3.9 million , or 139.0%, compared to the three months endedJune 30, 2019 . For the six months endedJune 30, 2020 , the net loss on loans accounted for under the fair value option increased$16.6 million , or 340.6%, compared to the six months endedJune 30, 2019 . The carrying amount of loans accounted for under the fair value option atJune 30, 2020 and 2019 was$866.7 million ($32.1 million classified as held for sale and$834.6 million classified as held for investment) and$865.7 million ($26.6 million classified as held for sale and$839.1 million classified as held for investment), respectively, an increase of$990 thousand , or 0.1%. The first half of 2020 net loss on loans accounted for under the fair value option was estimated to be approximately$9.7 million related to the severity of ongoing developments of the COVID-19 pandemic. The magnitude of COVID-19 related impacts on loan fair value adjustments in the second quarter of 2020 was dampened by improving market conditions for unguaranteed loans.
Noninterest Expense
Noninterest expense comprises all operating costs of the Company, such as employee related costs, travel, professional services, advertising and marketing expenses, exclusive of interest and income tax expense.
The following table shows the components of noninterest expense and the related dollar and percentage changes for the periods presented.
Three Months Ended June 30, 2020/2019 Increase (Decrease) 2020 2019 Amount Percent Noninterest expense Salaries and employee benefits$ 30,782 $ 21,990 $ 8,792 39.98 % Non-staff expenses: Travel expense 364 1,541 (1,177 ) (76.38 ) Professional services expense 1,385 1,621 (236 ) (14.56 ) Advertising and marketing expense 624 1,665 (1,041 ) (62.52 ) Occupancy expense 1,955 1,848 107 5.79 Data processing expense 2,764 1,947 817 41.96 Equipment expense 4,652 4,239 413 9.74 Other loan origination and maintenance expense 2,492 1,708 784 45.90 Renewable energy tax credit investment impairment - 602 (602 ) (100.00 ) FDIC insurance 1,721 699 1,022 146.21 Other expense 1,361 1,716 (355 ) (20.69 ) Total non-staff expenses 17,318 17,586 (268 ) (1.52 ) Total noninterest expense$ 48,100 $ 39,576 $ 8,524 21.54 % Six Months Ended June 30, 2020/2019 Increase (Decrease) 2020 2019 Amount Percent Noninterest expense Salaries and employee benefits$ 58,845 $ 43,845 $ 15,000 34.21 % Non-staff expenses: Travel expense 2,145 2,741 (596 ) (21.74 ) Professional services expense 3,322 3,803 (481 ) (12.65 ) Advertising and marketing expense 1,985 3,029 (1,044 ) (34.47 ) Occupancy expense 4,376 3,457 919 26.58 Data processing expense 5,921 4,346 1,575 36.24 Equipment expense 9,287 7,564 1,723 22.78 Other loan origination and maintenance expense 4,948 3,347 1,601 47.83 Renewable energy tax credit investment impairment - 602 (602 ) (100.00 ) FDIC insurance 3,231 1,334 1,897 142.20 Other expense 3,531 3,709 (178 ) (4.80 ) Total non-staff expenses 38,746 33,932 4,814 14.19 Total noninterest expense$ 97,591 $ 77,777 $ 19,814 25.48 % 51
-------------------------------------------------------------------------------- Total noninterest expense for the three and six months endedJune 30, 2020 increased$8.5 million , or 21.5%, and$19.8 million , or 25.5%, respectively, compared to the same periods in 2019. The increase in noninterest expense was largely driven by salaries and employee benefits. Changes in various components of noninterest expense are discussed below. Salaries and employee benefits: Total personnel expense for the three and six months endedJune 30, 2020 increased by$8.8 million , or 40.0%, and$15.0 million , or 34.2%, respectively, compared to the same periods in 2019. While personnel expense is carefully managed, this increase is principally due to the Company's commitment to and investment in its workforce to support growth and a variety of initiatives combined with$7.2 million in expense for a performance bonus pool that was available to all employees other than executive officers. Total full-time equivalent employees increased from 531 atJune 30, 2019 to 640 atJune 30, 2020 . Salaries and employee benefits expense included$3.3 million and$6.2 million of stock-based compensation for the three and six months endedJune 30, 2020 , respectively, compared to$2.9 million and$5.8 million for the three and six months endedJune 30, 2019 , respectively. Expenses related to the employee stock purchase program, stock grants, stock option compensation and restricted stock expense are all considered stock-based compensation. Data processing expense: Total data processing expense for the three and six months endedJune 30, 2020 increased by$817 thousand , or 42.0%, and$1.6 million , or 36.2%, respectively, compared to the same periods in 2019. The increase was predominantly driven by third party costs incurred in internal software development and with additional software subscriptions to help maximize operational efficiencies. Equipment expense: For the three and six months endedJune 30, 2020 , equipment expense increased$413 thousand , or 9.7%, and$1.7 million , or 22.8%, respectively, compared to the same periods in 2019. Primary factors contributing to this increase were the depreciation of technology and infrastructure investments to support the Company's growth initiatives. Other loan origination and maintenance expense: For the three and six months endedJune 30, 2020 , other loan origination and maintenance expense increased$784 thousand , or 45.9%, and$1.6 million , or 47.8%, respectively, compared to the same periods in 2019 due to increased levels of SBA loans.FDIC insurance: For the three and six months endedJune 30, 2020 ,FDIC insurance increased$1.0 million , or 146.2%, and$1.9 million , or 142.2%, respectively, compared to the same periods in 2019 due to higher required premiums. Travel & Advertising and marketing expenses: For the three and six months endedJune 30, 2020 , travel & advertising and marketing expenses in aggregate decreased$2.2 million , or 69.2%, and$1.6 million , or 28.4%, respectively. This decrease was the result of certain activities being paused due to the impact of COVID-19. Income Tax Expense For the three months endedJune 30, 2020 , income tax expense increased by$812 thousand compared to the same period in 2019, and the Company's effective tax rates were 28.1% and 11.8%, respectively. The increase in the second quarter of 2020 over the second quarter of 2019 is primarily due to the absence of expected tax credits during 2020. For the six months endedJune 30, 2020 , the Company had an income tax benefit of$(6.3) million with an effective tax rate of (62.2)% while the first half of 2019 had income tax expense of$979 thousand with an effective tax rate of 11.8%. The negative effective tax rate during the first half of 2020 was a result of a discrete, estimated income tax benefit of$3.7 million related to the enactment of the CARES Act onMarch 27, 2020 . The CARES Act allows taxpayers to carryback certain net operating losses to each of the five taxable years preceding the taxable year of such losses. As a result, the Company will be allowed to carryback its 2018 net operating loss which had been utilized and measured under the prior law using a 21% corporate income tax rate to pre-2018 taxable years during which the corporate income tax rate was 35%. The remaining income tax benefit in the first half of 2020 was predominantly driven by the Company's overall net pretax loss. Based upon current projections, the effective tax rate for the remainder of 2020 is expected to be approximately 26.0% to 28.0%; however, there can be no assurance as to the actual amount because it will be dependent upon the nature and amount of future income and expenses, investments generating investment tax credits and transactions with discrete tax effects. 52
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Discussion and Analysis of Financial Condition
Total assets atJune 30, 2020 were$8.21 billion , an increase of$3.40 billion , or 70.6%, compared to total assets of$4.81 billion atDecember 31, 2019 . The growth in total assets was principally driven by the following:
• Cash and cash equivalents, comprised of cash and due from banks and federal
funds sold, increased
borrowings, deposits and loan sales arising from strategically heightened
levels of liquidity related to COVID-19 risks and uncertainties and funding
for PPP loans originated in the second quarter;
• Increased investment securities available-for-sale of
increase in investment securities was due to availability of excess surplus
liquidity, discussed above related to pandemic readiness, accelerating 2020
investment growth in accordance with the Company's asset-liability and liquidity management plan; and
• Growth in loans and leases held for sale and held for investment of
billion resulting from strong origination activity in the first half of 2020, largely comprised of$1.74 billion in PPP loans. Cash and cash equivalents, comprised of cash and due from banks and federal funds sold, was$1.35 billion atJune 30, 2020 , an increase of$1.13 billion , or 508.9%, compared to$221.4 million atDecember 31, 2019 . As mentioned above, this increase reflects the impact of strategically heightened levels of liquidity related to COVID-19 risks and uncertainties and funding for PPP loans during the second quarter. Total investment securities increased$239.7 million during the first six months of 2020, from$540.0 million atDecember 31, 2019 , to$779.8 million atJune 30, 2020 , an increase of 44.4%. The Company increased its investment securities position during the first half of 2020 largely as a part of improving returns on excess liquidity and meeting annual investment asset-liability plans, as discussed above. AtJune 30, 2020 , the investment portfolio was comprised ofU.S. treasury,U.S. government agency,U.S. government- sponsored entity mortgage-backed securities and municipal bonds. Loans and leases held for investment increased$2.02 billion , or 77.0%, during the first six months of 2020, from$2.63 billion atDecember 31, 2019 , to$4.65 billion atJune 30, 2020 . The increase was primarily the result of$1.74 billion in PPP loan originations combined with$930.8 million in other loan originations in the first half of 2020. Premises and equipment, net, decreased$10.0 million , or 3.6%, during the first six months of 2020 which was primarily driven by increased levels of depreciation of facilities and infrastructure to accommodate Company growth and solar panels to meet leasing obligations in prior periods. Other assets increased$23.8 million , or 15.3%, from$156.1 million atDecember 31, 2019 to$180.0 million atJune 30, 2020 . This increase was due to a variety of items, principally comprised of a$7.7 million increase in accrued interest receivable driven by higher levels of interest earning assets combined with$4.6 million in increased receivables from the SBA for guarantee recoveries,$4.1 million in new intangibles added as a result of the acquisition ofJolley Asset Management, LLC (as discussed more fully in Note 1. Basis of Presentation under the subheading Business Combination),$2.5 million in additional receivables for co-developed technology PPP loan processing services and$2.3 million in capitalized software development and implementation costs.
Total deposits were
Borrowings increased to$1.72 billion atJune 30, 2020 from$14 thousand atDecember 31, 2019 . This increase was related to$1.72 billion in new borrowings through the PPPLF in the second quarter of 2020. These PPPLF borrowings were used to help fund PPP loans and complement the defensive strategy to build liquidity which commenced in the first quarter of 2020 due to the uncertainty of the effects of COVID-19. Shareholders' equity atJune 30, 2020 was$548.4 million as compared to$532.4 million atDecember 31, 2019 . The book value per share was$13.53 atJune 30, 2020 compared to$13.20 atDecember 31, 2019 . Average equity to average assets was 9.2% for the six months endedJune 30, 2020 compared to 12.2% for the year endedDecember 31, 2019 . The increase in shareholders' equity was principally the result of other comprehensive income of$13.6 million and stock-based compensation expense of$6.2 million , partially offset by a net loss of$3.8 million and$2.4 million in dividends. 53 -------------------------------------------------------------------------------- During the first half of 2020, 200,000 shares of Class B common stock (non-voting) were converted to Class A common stock (voting) under a private sale. The conversion decreased the value of Class B common stock (non-voting) and increased the value of Class A common stock (voting) by$2.1 million .
Asset Quality
Management considers asset quality to be of primary importance. A formal loan
review function, independent of loan origination, is used to identify and
monitor problem loans. This function reports directly to the
Nonperforming Assets
The Bank places loans and leases on nonaccrual status when they become 90 days past due as to principal or interest payments, or prior to that if management has determined based upon current information available to them that the timely collection of principal or interest is not probable. When a loan or lease is placed on nonaccrual status, any interest previously accrued as income but not actually collected is reversed and recorded as a reduction of loan or lease interest and fee income. Typically, collections of interest and principal received on a nonaccrual loan or lease are applied to the outstanding principal as determined at the time of collection of the loan or lease. Troubled debt restructurings ("TDRs") occur when, because of economic or legal reasons pertaining to the debtor's financial difficulties, debtors are granted concessions that would not otherwise be considered. Such concessions would include, but are not limited to, the transfer of assets or the issuance of equity interests by the debtor to satisfy all or part of the debt, modification of the terms of debt or the substitution or addition of debtor(s). Total nonperforming assets and troubled debt restructurings, including loans measured at fair value, atJune 30, 2020 were$134.3 million , which represented a$23.2 million , or 20.9%, increase fromDecember 31, 2019 . These nonperforming assets, atJune 30, 2020 were comprised of$90.1 million in nonaccrual loans and leases and$5.7 million in foreclosed assets. Of the$134.3 million of nonperforming assets and TDRs,$100.9 million carried an SBA guarantee, leaving an unguaranteed exposure of$33.4 million in total nonperforming assets and TDRs atJune 30, 2020 . This represents an increase of$6.2 million , or 22.8%, from an unguaranteed exposure of$27.2 million atDecember 31, 2019 . The following table provides information with respect to nonperforming assets and troubled debt restructurings, excluding loans measured at fair value, at the dates indicated. December 31, June 30, 2020 (1) 2019 (1) Nonaccrual loans and leases: Total nonperforming loans and leases (all on nonaccrual) $ 40,275 $ 21,937 Total accruing loans and leases past due 90 days or more - - Foreclosed assets 5,660
5,612
Total troubled debt restructurings 26,781
16,566
Less nonaccrual troubled debt restructurings (7,477 ) (2,225 ) Total performing troubled debt restructurings 19,304
14,341
Total nonperforming assets and troubled debt restructurings $ 65,239 $ 41,890 Total nonperforming loans and leases to total loans and leases held for investment 1.06 % 1.22 % Total nonperforming loans and leases to total assets 0.55 % 0.55 % Total nonperforming assets and troubled debt restructurings to total assets 0.89 % 1.05 % 54
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December 31, June 30, 2020 (1) 2019 (1) Nonaccrual loans and leases guaranteed byU.S. government: Total nonperforming loans and leases guaranteed by the SBA (all on nonaccrual) $ 27,153 $ 14,713 Total accruing loans and leases past due 90 days or more guaranteed by the SBA - - Foreclosed assets guaranteed by the SBA 4,461
4,492
Total troubled debt restructurings guaranteed by the SBA 18,147
10,845
Less nonaccrual troubled debt restructurings guaranteed by the SBA (4,117 ) (385 ) Total performing troubled debt restructurings guaranteed by SBA 14,030
10,460
Total nonperforming assets and troubled debt restructurings guaranteed by the SBA $ 45,644 $ 29,665 Total nonperforming loans and leases not guaranteed by the SBA to total loans and leases held for investment 0.34 % 0.40 % Total nonperforming loans and leases not guaranteed by the SBA to total assets 0.18 % 0.18 % Total nonperforming assets and troubled debt restructurings not guaranteed by the SBA to total assets 0.27 % 0.31 %
(1) Excludes loans measured at fair value.
Nonperforming assets and TDRs, excluding loans measured at fair value, atJune 30, 2020 were$65.2 million , which represented a$23.3 million , or 55.7%, increase fromDecember 31, 2019 . These nonperforming assets, atJune 30, 2020 were comprised of$40.3 million in nonaccrual loans and leases and$5.7 million in foreclosed assets. Of the$65.2 million of nonperforming assets and TDRs,$45.6 million carried an SBA guarantee, leaving an unguaranteed exposure of$19.6 million in total nonperforming assets and TDRs atJune 30, 2020 . This represents an increase of$7.4 million , or 60.3%, from an unguaranteed exposure of$12.2 million atDecember 31, 2019 . See the below discussion related to the change in potential problem and impaired loans and leases for management's overall observations regarding growth in total nonperforming loans and leases. As a percentage of the Bank's total capital, nonperforming loans and leases, excluding loans measured at fair value, represented 8.1% atJune 30, 2020 , compared to 4.4% atDecember 31, 2019 . Adjusting the ratio to include only the unguaranteed portion of nonperforming loans and leases at historical cost to reflect management's belief that the greater magnitude of risk resides in this portion, the ratios atJune 30, 2020 andDecember 31, 2019 were 2.6% and 1.5%, respectively. 55
-------------------------------------------------------------------------------- As ofJune 30, 2020 , andDecember 31, 2019 , potential problem (also referred to as criticized) and classified loans and leases, excluding loans measured at fair value, totaled$146.9 million and$129.1 million , respectively. The following is a discussion of these loans and leases. Risk Grades 5 through 8 represent the spectrum of criticized and classified loans and leases. AtJune 30, 2020 , the portion of criticized and classified loans and leases guaranteed by the SBA orUSDA totaled$79.0 million resulting in unguaranteed exposure risk of$68.0 million , or 4.9% of total held for investment unguaranteed exposure carried at historical cost. This compares to theDecember 31, 2019 portion of criticized and classified loans and leases guaranteed by the SBA orUSDA which totaled$65.8 million resulting in unguaranteed exposure risk of$63.3 million , or 5.4% of total held for investment unguaranteed exposure carried at historical cost. As ofJune 30, 2020 , loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases: Healthcare at 20.8%, Wine andCraft Beverage at 15.1%, Hotels at 13.0%, Entertainment Centers at 9.6%, Veterinary at 9.2%, Self Storage at 5.8% and Educational Services at 5.0%. As ofDecember 31, 2019 , loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases: Healthcare at 20.8%, Hotels at 14.7%, Wine andCraft Beverage at 14.3%, Self Storage at 8.4%, Veterinary at 7.1%,Government Contracting at 6.1%, and Educational Services at 5.7%. Other than Hotels andGovernment Contracting which are a part of the Company's Specialty Lending division, all of the above listed verticals are within the Company's Small Business Banking division. Two previously impairedGovernment Contracting relationships were charged off in the first half of 2020 which resulted in a reduction in impaired loans for this vertical. The majority of the increase in potential problem and classified loans and leases was comprised of a relatively small number of borrowers largely concentrated in the Company's more mature verticals. Furthermore, the Company believes that its underwriting and credit quality standards have continued to tighten with emphasis on new production in pandemic resilient verticals and increased monitoring of existing loans in pandemic susceptible verticals as the impacts and uncertainties COVID-19 continue to evolve. With this emphasis, systemic issues which began to emerge during the latter part of 2019 related to higher than expected levels of competition in the Wine andCraft Beverage and Entertainment Center verticals combined with pandemic susceptibility continue to contribute to the increase in criticized and classified loans and leases. The Bank does not classify loans and leases that experience insignificant payment delays and payment shortfalls as impaired. The Bank generally considers an "insignificant period of time" from payment delays to be a period of 90 days or less, unless the borrower was not past due at the time of a modification as a part of a COVID-19 assistance program. In such instances this time period could extend to a period of three months or less. The Bank would consider a modification for a customer experiencing what is expected to be a short-term event that has temporarily impacted cash flow. This could be due, among other reasons, to illness, weather, impact from a one-time expense, slower than expected start-up, construction issues or other short-term issues. In all cases, credit personnel will review the request to determine if the customer is stressed and how the event has impacted the ability of the customer to repay the loan or lease long term. To date, the only types of short-term modifications the Bank has given are payment deferral and interest only extensions. The Bank does not typically alter the rate or lengthen the amortization of the note due to insignificant payment delays. Short term modifications are not classified as TDRs, because they do not meet the definition set by the applicable accounting standards and theFederal Deposit Insurance Corporation . Management endeavors to be proactive in its approach to identify and resolve problem loans and leases and is focused on working with the borrowers and guarantors of these loans and leases to provide loan and lease modifications when warranted. Management implements a proactive approach to identifying and classifying loans and leases as special mention (also referred to as criticized), Risk Grade 5. AtJune 30, 2020 , andDecember 31, 2019 , Risk Grade 5 loans and leases, excluding loans measured at fair value, totaled$94.4 million and$89.5 million , respectively. The increase in Risk Grade 5 loans and leases, exclusive of loans measured at fair value, during the first half of 2020 was principally confined to five verticals: Entertainment Centers ($9.2 million or 187.7%), Senior Care ($4.0 million or 82.6%), Healthcare ($4.0 million or 81.5%), Veterinary ($3.6 million or 74.2%), General Lending Solutions ($1.4 million or 29.4%), andFuneral Home & Cemetery ($1.1 million or 21.9%). Largely offsetting the increase in the above Risk Grade 5 loans and leases were decreases in Hotels ($10.5 million or 213.3%)Government Contracting ($3.8 million or 78.4%) and Self Storage ($2.1 million or 43.3%). Other than Hotels andGovernment Contracting which are a part of the Company's Specialty Lending division, all of the above listed verticals are within the Company's Small Business Banking division. The decrease in Hotels was due to two relationships moving to risk grade 6 (substandard) while the decrease inGovernment Contracting was due to loan paydowns which moved loans back to pass grades, and the decrease in Self Storage was due to one relationship being upgraded to a risk grade 4 (acceptable). AtJune 30, 2020 , approximately 100.0% of loans and leases classified as Risk Grade 5 are performing with no current payments past due more than 30 days. While the level of nonperforming assets fluctuates in response to changing economic and market conditions, in light of the relative size and composition of the loan and lease portfolio and management's degree of success in resolving problem assets, management believes that a proactive approach to early identification and intervention is critical to successfully managing a small business loan portfolio. In conjunction with this, management believes that volumes of delinquencies may be not be an accurate depiction of the borrower's repayment abilities under the current pandemic induced circumstances due to payments being made by the SBA on behalf of borrower with loans under its programs. This payment assistance commenced in the first quarter and will continue for six months. 56 --------------------------------------------------------------------------------
Allowance for Credit Losses on Loans and Leases
The allowance for credit losses ("ACL") on loans and leases is a valuation account that is deducted from, or added to, the amortized cost basis of loans and leases to present a net amount expected to be collected. The ACL excludes loans held for sale and loans accounted for under the fair value option. Loans and leases are charged-off against the ACL when management believes the uncollectibility of a loan or lease balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Judgment in determining the adequacy of the ACL is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available and as situations and information change. The ACL is evaluated on a quarterly basis by management and is estimated using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The Company's historical credit loss experience provides the basis for the estimation of expected credit losses. Management adjusts historical loss information for differences in current risk characteristics such as portfolio risk grading, delinquency levels, or portfolio mix as well as for changes in environmental conditions such as changes in unemployment rates. The ACL of$28.2 million atDecember 31, 2019 increased by$15.8 million , or 56.1%, to$44.1 million atJune 30, 2020 . The ACL, as a percentage of loans and leases held for investment at historical cost amounted to 1.2% atJune 30, 2020 and 1.6% atDecember 31, 2019 . Excluding PPP loans and related reserves, the ACL, as a percentage of loans and leases held for investment at historical cost amounted to 2.0% atJune 30, 2020 . As mentioned earlier, the Company adopted the new CECL standard effectiveJanuary 1, 2020 . Upon adoption, the Company recorded a$1.3 million decrease in the ACL. In implementing CECL, the Company accordingly determined to use forecasted levels of unemployment as a primary economic variable in forecasting future expected losses. Based upon the severity of ongoing developments resulting from the COVID-19 pandemic, the Company's allowance for credit losses on loans and leases increased significantly, combined with the effects of the above discussed increased levels of criticized and classified loans and leases and charge-offs, as addressed more fully in the Provision for Loan and Lease Credit Losses section of Results of Operations. Actual past due held for investment loans and leases, inclusive of loans measured at fair value, have decreased by$8.5 million sinceDecember 31, 2019 . This decrease was due to monthly payments being made by SBA for our SBA 7(a) borrowers. Total loans and leases 90 or more days past due increased$6.6 million , or 17.0%, compared toDecember 31, 2019 . The increase was the result of a$6.9 million increase in the guaranteed portion of past due loans compared toDecember 31, 2019 . AtJune 30, 2020 andDecember 31, 2019 , total held for investment unguaranteed loans and leases past due as a percentage of total held for investment unguaranteed loans and leases, inclusive of loans measured at fair value, was 0.9% and 1.7%, respectively. Total unguaranteed loans and leases past due were comprised of$9.4 million carried at historical cost, an increase of$1.4 million , and$4.1 million measured at fair value, a decrease of$7.6 million as ofJune 30, 2020 compared toDecember 31, 2019 . Management continues to actively monitor and work to improve asset quality. Management believes the ACL of$44.1 million atJune 30, 2020 is appropriate in light of the risk inherent in the loan and lease portfolio. Management's judgments are based on numerous assumptions about current and expected events that it believes to be reasonable, but which may or may not be valid, including but not limited to factors related to the above mentioned SBA delinquency effect and pandemic-susceptible verticals. Accordingly, no assurance can be given that management's ongoing evaluation of the loan and lease portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the ACL, thus adversely affecting the Company's operating results. Additional information on the ACL is presented in Note 5. Loans and Leases Held for Investment and Credit Quality of the Notes to the Unaudited Condensed Consolidated Financial Statements in this report.
Liquidity Management
Liquidity management refers to the ability to meet day-to-day cash flow requirements based primarily on activity in loan and deposit accounts of the Company's customers. Liquidity is immediately available from four major sources: (a) cash on hand and on deposit at other banks; (b) the outstanding balance of federal funds sold; (c) the market value of unpledged investment securities; and (d) availability under lines of credit. AtJune 30, 2020 , the total amount of these four items was$3.28 billion , or 40.0% of total assets, an increase of$2.09 billion from$1.19 billion , or 24.8% of total assets, atDecember 31, 2019 . Loans and other assets are funded by loan sales, wholesale deposits and core deposits. To date, an increasing retail deposit base and an increased long term wholesale deposit base have been adequate to meet loan obligations, while maintaining the desired level of immediate liquidity. Additionally, the investment securities portfolio is available for both immediate and secondary liquidity purposes. 57
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At
Contractual Obligations
The following table presents the Company's significant fixed and determinable contractual obligations by payment date as ofJune 30, 2020 . The payment amounts represent those amounts contractually due to the recipient. The table excludes liabilities recorded where management cannot reasonably estimate the timing of any payments that may be required in connection with these liabilities. Payments Due by Period Less than One to Three to More than Total One Year Three Years Five Years Five Years Contractual Obligations Deposits without stated maturity$ 2,247,774 $ 2,247,774 $ - $ - $ - Time deposits 3,625,518 2,396,055 812,146 340,346 76,971 Borrowings 1,721,029 5,004 1,716,025 - - Operating lease obligations 3,753 736 1,430 363 1,224 Total$ 7,598,074 $ 4,649,569 $ 2,529,601 $ 340,709 $ 78,195 As ofJune 30, 2020 , andDecember 31, 2019 , the Company had unfunded commitments to provide capital contributions for on-balance sheet investments in the amount of$16.8 million and$16.9 million , respectively.
Asset/Liability Management and Interest Rate Sensitivity
One of the primary objectives of asset/liability management is to maximize the net interest margin while minimizing the earnings risk associated with changes in interest rates. One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps. As ofJune 30, 2020 , the balance sheet's total cumulative gap position was slightly liability-sensitive at -1.5%. The shift to liability-sensitive versus the prior quarter asset-sensitive position is primarily due to the variable, short-term funding added in early in the second quarter of 2020 to provide initial funding for the Payroll Protection Program fixed rate loans. The interest rate gap method, however, addresses only the magnitude of asset and liability repricing timing differences as of the report date and does not address earnings, market value, changes in account behaviors based on the interest rate environment, nor growth. Therefore, management uses an earnings simulation model to prepare, on a regular basis, earnings projections based on a range of interest rate scenarios to measure interest rate risk more accurately. As ofJune 30, 2020 , the Company's interest rate risk profile under the earnings simulation model method remains asset-sensitive. An asset-sensitive position means that net interest income will generally move in the same direction as interest rates. For instance, if interest rates increase, net interest income can be expected to increase, and if interest rates decrease, net interest income can be expected to decrease. The Company attempts to mitigate interest rate risk by match funding assets and liabilities with similar rate instruments. The quarterly revaluation adjustment to the servicing asset, however, adjusts in an opposite direction to interest rate changes. Asset/liability sensitivity is primarily derived from the prime-based loans that adjust as the prime interest rate changes and the longer duration of indeterminate term deposits.
Capital
The maintenance of appropriate levels of capital is a management priority and is monitored on a regular basis. The Company's principal goals related to the maintenance of capital are to provide adequate capital to support the Company's risk profile consistent with the risk appetite approved by the Board of Directors; provide financial flexibility to support future growth and client needs; comply with relevant laws, regulations, and supervisory guidance; achieve optimal credit ratings for the Company and its subsidiaries; and provide a competitive return to shareholders. Management regularly monitors the capital position of the Company on both a consolidated and bank level basis. In this regard, management's goal is to maintain capital at levels that are in excess of the regulatory "well capitalized" levels. Risk-based capital ratios, which include Tier 1 Capital, Total Capital and Common Equity Tier 1 Capital, are calculated based on regulatory guidance related to the measurement of capital and risk-weighted assets. 58
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Capital amounts and ratios as of
Minimum To Be Well Capitalized Under Prompt Minimum Capital Corrective Action Actual Requirement Provisions (1) Amount Ratio Amount Ratio Amount Ratio Consolidated -June 30, 2020 Common Equity Tier 1 (to Risk-Weighted Assets)$ 498,283 12.84 %$ 174,660 4.50 % N/A N/A Total Capital (to Risk-Weighted Assets)$ 542,984 13.99 %$ 310,506 8.00 % N/A N/A Tier 1 Capital (to Risk-Weighted Assets)$ 498,283 12.84 %$ 232,879 6.00 % N/A N/A Tier 1 Capital (to Average Assets)$ 498,283 7.96 %$ 250,488 4.00 % N/A N/A Bank -June 30, 2020 Common Equity Tier 1 (to Risk-Weighted Assets)$ 453,473 11.85 %$ 172,243 4.50 %$ 248,795 6.50 % Total Capital (to Risk-Weighted Assets)$ 498,174 13.02 %$ 306,210 8.00 %$ 382,762 10.00 % Tier 1 Capital (to Risk-Weighted Assets)$ 453,473 11.85 %$ 229,657 6.00 %$ 306,210 8.00 % Tier 1 Capital (to Average Assets)$ 453,473 7.30 %$ 248,462 4.00 %$ 310,577 5.00 % Consolidated -December 31, 2019 Common Equity Tier 1 (to Risk-Weighted Assets)$ 499,513 14.90 %$ 150,927 4.50 % N/A N/A Total Capital (to Risk-Weighted Assets)$ 527,747 15.74 %$ 268,315 8.00 % N/A N/A Tier 1 Capital (to Risk-Weighted Assets)$ 499,513 14.90 %$ 201,236 6.00 % N/A N/A Tier 1 Capital (to Average Assets)$ 499,513 10.65 %$ 187,582 4.00 % N/A N/A Bank -December 31, 2019 Common Equity Tier 1 (to Risk-Weighted Assets)$ 451,807 13.66 %$ 148,950 4.50 %$ 215,150 6.50 % Total Capital (to Risk-Weighted Assets)$ 480,040 14.51 %$ 264,800 8.00 %$ 331,000 10.00 % Tier 1 Capital (to Risk-Weighted Assets)$ 451,807 13.66 %$ 198,600 6.00 %$ 264,800 8.00 % Tier 1 Capital (to Average Assets)$ 451,807 9.68 %$ 186,627 4.00 %$ 233,283 5.00 %
(1) Prompt corrective action provisions are not applicable at the bank holding
company level.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in accordance with GAAP requires the Company to make estimates and judgments that affect reported amounts of assets, liabilities, income and expenses and related disclosure of contingent assets and liabilities. The Company bases estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Estimates are evaluated on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions. Accounting policies, as described in detail in the Notes to the Company's Unaudited Condensed Consolidated Financial Statements in this report and in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , are an integral part of the Company's consolidated financial statements. A thorough understanding of these accounting policies is essential when reviewing the Company's reported results of operations and financial position. Management believes that the critical accounting policies and estimates listed below require the Company to make difficult, subjective or complex judgments about matters that are inherently uncertain. • Determination of the allowance for credit losses on loans and leases; • Valuation of loans accounted for under the fair value option; • Valuation of servicing assets; • Income taxes; • Restricted stock unit awards with market price conditions; • Valuation of foreclosed assets; 59
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• Business combination and goodwill; and • Unconsolidated joint ventures. Changes in these estimates, that are likely to occur from period to period, or the use of different estimates that the Company could have reasonably used in the current period, would have a material impact on the Company's financial position, results of operations or liquidity.
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