BANKWELL FINANCIAL GROUP, INC. This section presents management's perspective on our financial condition and results of operations. The following discussion and analysis should be read in conjunction with the unaudited interim consolidated financial statements and related notes contained elsewhere in this report on Form 10-Q. To the extent that this discussion describes prior performance, the descriptions relate only to the periods listed, which may not be indicative of future financial outcomes. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management's expectations. Factors that could cause such differences are discussed in the Company's Form 10-K filed for the year endedDecember 31, 2020 in the sections titled "Cautionary Note Regarding Forward-Looking Statements" and "Risk Factors." We assume no obligation to update any of these forward-looking statements.
General
Bankwell Financial Group, Inc. is a bank holding company headquartered inNew Canaan, Connecticut . Through our wholly owned subsidiary,Bankwell Bank , or the Bank, we serve small and medium-sized businesses and retail customers. We have a history of building long-term customer relationships and attracting new customers through what we believe is our strong customer service and our ability to deliver a diverse product offering. The following discussion and analysis presents our results of operations and financial condition on a consolidated basis. However, because we conduct all of our material business operations through the Bank, the discussion and analysis relates to activities primarily conducted at the Bank. We generate most of our revenue from interest on loans and investments and fee-based revenues. Our primary source of funding for our loans is deposits. Our largest expenses are interest on deposits and salaries and related employee benefits. We measure our performance primarily through our net interest margin, efficiency ratio, ratio of allowance for loan losses to total loans, return on average assets and return on average equity, among other metrics, while maintaining appropriate regulatory leverage and risk-based capital ratios.
Executive Overview
We are focused on being the banking provider of choice and to serve as an alternative to our larger competitors. We aim to do this through:
•Responsive, customer-centric products and services and a community focus;
•Organic growth and strategic acquisitions when market opportunities present themselves;
•Utilization of efficient and scalable infrastructure; and
•Disciplined focus on risk management.
Impact of COVID-19
The COVID-19 pandemic has resulted in significant economic disruption affecting
our business and the clients we serve. As vaccination efforts continue,
restrictions on businesses have been lifted and a return to more normal economic
activity has begun. However, a significant degree of uncertainty still exists
concerning the ultimate duration and magnitude of the COVID-19 pandemic and
subsequent outbreaks, including whether restrictions that have been lifted will
need to be imposed again or tightened in the future. Given the ongoing and
dynamic nature of the circumstances, it is still difficult to predict the full
impact of the COVID-19 pandemic on our business. The extent of such impact will
depend on future developments, including but not limited to the continued
roll-out of vaccinations, which play an important role as to when the
coronavirus can be controlled and abated.
43
--------------------------------------------------------------------------------Critical Accounting Policies and Estimates
The discussion and analysis of our results of operations and financial condition are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires us to make significant estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from our current estimates, as a result of changing conditions and future events. We believe that accounting estimates related to the measurement of the allowance for loan losses, the valuation of derivative instruments, investment securities and deferred income taxes, and the evaluation of investment securities for other than temporary impairment are particularly critical and susceptible to significant near-term change.
Earnings and Performance Overview
For the three months endedSeptember 30, 2021 , we had net interest income of$17.7 million , an increase of$4.1 million or 30.2% when compared to the same period in 2020. For the nine months endedSeptember 30, 2021 , we had net interest income of$49.0 million , an increase of$8.4 million , or 20.8% when compared to the same period in 2020. The increase in net interest income for the three and nine months endedSeptember 30, 2021 was primarily due to lower interest expense on deposits and an increase in interest and fees on loans due to loan growth when compared to the same periods in 2020. Noninterest income increased$0.8 million to$1.4 million for the three months endedSeptember 30, 2021 compared to the same period in 2020. Noninterest income increased$2.6 million to$4.8 million for the nine months endedSeptember 30, 2021 compared to the same period in 2020. The increase in noninterest income was primarily a result of the resumption of loan sales. In the fourth quarter of 2020, the Company recognized a$3.9 million one-time charge recorded in noninterest expense for office consolidation, vendor contract termination and employee severance costs. As ofSeptember 30, 2021 , the Company has paid a total of$0.7 million in employee severance costs and a total of$1.1 million in vendor contract termination costs. Reference the 2020 Form 10-K for further discussion on these charges. Net income available to common shareholders was$6.9 million , or$0.87 per diluted share, and$3.0 million , or$0.38 per diluted share, for the three months endedSeptember 30, 2021 and 2020, respectively. Net income available to common shareholders was$18.8 million , or$2.37 per diluted share, and$5.6 million , or$0.71 per diluted share, for the nine months endedSeptember 30, 2021 and 2020, respectively. The increase in net income was primarily impacted by the aforementioned increases in net interest income and noninterest income and a decrease in the provision for loan losses resulting from lower loan loss reserves in 2021 when compared to 2020, which saw a large increase in reserves due to the COVID-19 pandemic. Returns on average stockholders' equity and average assets for the three months endedSeptember 30, 2021 were 14.09% and 1.22%, respectively, compared to 6.87% and 0.55%, respectively, for the three months endedSeptember 30, 2020 . Returns on average stockholders' equity and average assets for the nine months endedSeptember 30, 2021 were 13.29% and 1.12%, respectively, compared to 4.23% and 0.36%, respectively, for the nine months endedSeptember 30, 2020 .
Results of Operations
Net Interest Income
Net interest income is the difference between interest earned on loans and
securities and interest paid on deposits and other borrowings, and is the
primary source of our operating income. Net interest income is affected by the
level of interest rates, changes in interest rates and changes in the amount and
composition of interest earning assets and interest bearing liabilities.
Included in interest income are certain loan fees, such as deferred origination
fees and late charges. We convert tax-exempt income to a fully taxable
equivalent ("FTE") basis using the statutory federal income tax rate adjusted
for applicable state income taxes net of the related federal tax benefit. The
average balances are principally daily averages. Interest income on loans
includes the effect of deferred loan fees and costs accounted for as yield
adjustments. Premium amortization and discount accretion are included in the
respective interest income and interest expense amounts.
FTE net interest income for the three months ended September 30, 2021 and 2020
was $17.8 million and $13.7 million , respectively. FTE net interest income for
the nine months ended September 30, 2021 and 2020 was $49.1 million and $40.7
million , respectively.
FTE interest income for the three months ended September 30, 2021 increased by
$1.7 million , or 8.9%, to $20.7 million , compared to FTE interest income for the
three months ended September 30, 2020 . FTE interest income for the nine months
44
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ended September 30, 2021 increased by $1.1 million , or 1.9%, to $59.6 million ,
compared to FTE interest income for the nine months ended September 30, 2020 .
This increase was due to commercial real estate and commercial business loan
growth.
Interest expense for the three months ended September 30, 2021 decreased by $2.4
million , or 45.6%, compared to interest expense for the three months ended
September 30, 2020 . Interest expense for the nine months ended September 30,
2021 decreased by $7.3 million , or 40.9%, compared to interest expense for the
nine months ended September 30, 2020 . This decrease is due to lower interest
rates on deposits.
The net interest margin increased by 72 basis points to 3.39% for the three
months ended September 30, 2021 , compared to the three months ended September
30, 2020 and the net interest margin increased by 27 basis points to 3.08% for
the nine months ended September 30, 2021 , compared to the nine months ended
September 30, 2020 . The increase in net interest margin was primarily due to
lower interest expense on deposits and a greater percentage of noninterest
bearing deposits. In addition, the net interest margin for the three months
ended September 30, 2021 was positively impacted by a reduction in excess
liquidity when compared to the three months ended September 30, 2020 .
45
--------------------------------------------------------------------------------Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential
The following tables present the average balances and yields earned on interest earning assets and average balances and weighted average rates paid on our funding liabilities for the three and nine months endedSeptember 30, 2021 and 2020. Three Months Ended September 30, 2021 2020 Yield / Rate Yield / Rate (Dollars in thousands) Average Balance Interest (4) Average Balance Interest (4) Assets: Cash and Fed funds sold$ 209,500 $ 88 0.17 %$ 312,078 $ 96 0.12 % Securities (1) 105,030 766 2.92 96,448 776 3.22 Loans: Commercial real estate 1,270,375 14,345 4.42 1,087,765 12,570 4.52 Residential real estate 95,100 809 3.40 125,069 1,097 3.51 Construction 88,728 845 3.73 94,984 1,029 4.24 Commercial business 314,484 3,707 4.61 322,066 3,329 4.04 Consumer 8,870 89 3.99 121 2 7.37 Total loans 1,777,557 19,795 4.36 1,630,005 18,027 4.33 Federal Home Loan Bank stock 3,133 16 2.04 7,835 77 3.91 Total earning assets 2,095,220$ 20,665 3.86 % 2,046,366$ 18,976 3.63 % Other assets 131,670 132,617 Total assets$ 2,226,890 $ 2,178,983 Liabilities and shareholders' equity: Interest bearing liabilities: NOW$ 111,813 $ 51 0.18 % $ 87,890$ 40 0.18 % Money market 824,203 1,053 0.51 517,638 859 0.66 Savings 182,848 96 0.21 163,135 237 0.58 Time 448,218 1,187 1.05 757,176 2,968 1.56 Total interest bearing deposits 1,567,082 2,387 0.60 1,525,839 4,104 1.07 Borrowed money 72,960 503 2.70 200,237 1,210 2.36 Total interest bearing liabilities 1,640,042$ 2,890 0.70 % 1,726,076$ 5,314 1.22 % Noninterest bearing deposits 341,303 226,473 Other liabilities 52,552 53,272 Total Liabilities 2,033,897 2,005,821 Shareholders' equity 192,993 173,162 Total liabilities and shareholders' equity$ 2,226,890 $ 2,178,983 Net interest income (2)$ 17,775 $ 13,662 Interest rate spread 3.16 % 2.41 % Net interest margin (3) 3.39 % 2.67 % (1)Average balances and yields for securities are based on amortized cost. (2)The adjustment for securities and loans taxable equivalency amounted to$51 thousand and$54 thousand for the three months endedSeptember 30, 2021 and 2020, respectively. (3)Annualized net interest income as a percentage of earning assets. (4)Yields are calculated using the contractual day count convention for each respective product type. 46 --------------------------------------------------------------------------------
Nine Months Ended September 30,
2021 2020
Yield / Rate Yield / Rate
(Dollars in thousands) Average Balance Interest (4) Average Balance Interest (4)
Assets:
Cash and Fed funds sold $ 315,102 $ 286 0.12 % $ 207,058 $ 468 0.30 %
Securities (1) 103,192 2,315 2.99 96,761 2,289 3.15
Loans:
Commercial real estate 1,188,049 40,802 4.53 1,094,956 38,460 4.61
Residential real estate 104,320 2,669 3.41 134,369 3,636 3.61
Construction 97,828 2,769 3.73 98,539 3,350 4.47
Commercial business 302,019 10,495 4.58 289,959 10,017 4.54
Consumer 7,601 226 3.97 130 8 8.15
Total loans 1,699,817 56,961 4.42 1,617,953 55,471 4.50
Federal Home Loan Bank stock 4,608 72 2.09 7,547 272 4.81
Total earning assets 2,122,719 $ 59,634 3.70 % 1,929,319 $ 58,500 3.98 %
Other assets 119,098 125,957
Total assets $ 2,241,817 $ 2,055,276
Liabilities and shareholders'
equity:
Interest bearing liabilities:
NOW $ 110,637 $ 148 0.18 % $ 76,661 $ 99 0.17 %
Money market 781,178 2,944 0.50 473,485 3,213 0.91
Savings 170,749 313 0.24 170,262 1,204 0.94
Time 532,278 4,840 1.22 721,051 10,107 1.87
Total interest bearing deposits 1,594,842 8,245 0.69 1,441,459 14,623 1.36
Borrowed money 108,737 2,280 2.77 187,177 3,187 2.24
Total interest bearing
liabilities 1,703,579 $ 10,525 0.83 % 1,628,636 $ 17,810 1.46 %
Noninterest bearing deposits 303,421 201,384
Other liabilities 46,023 49,418
Total Liabilities 2,053,023 1,879,438
Shareholders' equity 188,794 175,838
Total liabilities and
shareholders' equity $ 2,241,817 $ 2,055,276
Net interest income (2) $ 49,109 $ 40,690
Interest rate spread 2.87 % 2.52 %
Net interest margin (3) 3.08 % 2.81 %
(1)Average balances and yields for securities are based on amortized cost.
(2)The adjustment for securities and loans taxable equivalency amounted to $151
thousand and $159 thousand for the nine months ended September 30, 2021 and
2020, respectively.
(3)Annualized net interest income as a percentage of earning assets.
(4)Yields are calculated using the contractual day count convention for each
respective product type.
47--------------------------------------------------------------------------------
Effect of changes in interest rates and volume of average earning assets and average interest bearing liabilities
The following table shows the extent to which changes in interest rates and
changes in the volume of average earning assets and average interest bearing
liabilities have affected net interest income. For each category of earning
assets and interest bearing liabilities, information is provided relating to:
changes in volume (changes in average balances multiplied by the prior year's
average interest rates); changes in rates (changes in average interest rates
multiplied by the prior year's average balances); and the total change. Changes
attributable to both volume and rate have been allocated proportionately based
on the relationship of the absolute dollar amount of change in each.
Three Months Ended September 30, 2021 vs
2020 Nine Months Ended
Increase (Decrease) Increase (Decrease)
(In thousands) Volume Rate Total Volume Rate Total
Interest and dividend income:
Cash and Fed funds sold $ (37) $ 29 $ (8) $ 176 $ (358) $ (182)
Securities 66 (76) (10) 148 (122) 26
Loans:
Commercial real estate 2,067 (292) 1,775 3,220 (878) 2,342
Residential real estate (256) (32) (288) (777) (190) (967)
Construction (65) (119) (184) (24) (557) (581)
Commercial business (80) 458 378 420 58 478
Consumer 88 (1) 87 224 (6) 218
Total loans 1,754 14 1,768 3,063 (1,573) 1,490
Federal Home Loan Bank stock (34) (27) (61) (82) (118) (200)
Total change in interest and
dividend income 1,749 (60) 1,689 3,305 (2,171) 1,134
Interest expense:
Deposits:
NOW 11 - 11 46 3 49
Money market 423 (229) 194 1,537 (1,806) (269)
Savings 26 (167) (141) 3 (894) (891)
Time (991) (790) (1,781) (2,250) (3,017) (5,267)
Total deposits (531) (1,186) (1,717) (664) (5,714) (6,378)
Borrowed money (857) 150 (707) (1,534) 627 (907)
Total change in interest
expense (1,388) (1,036) (2,424) (2,198) (5,087) (7,285)
Change in net interest income
$ 5,503 $ 2,916 $ 8,419 Provision for Loan Losses The provision for loan losses is based on management's periodic assessment of the adequacy of our allowance for loan losses which, in turn, is based on interrelated factors such as the composition of our loan portfolio and its inherent risk characteristics, the level of nonperforming loans and net charge-offs, both current and historic, local economic and credit conditions, the direction of real estate values, and regulatory guidelines. The provision for loan losses is charged against earnings in order to maintain our allowance for loan losses and reflects management's best estimate of probable losses inherent in our loan portfolio as of the balance sheet date. The provision for loan losses for the three months endedSeptember 30, 2021 was$0.1 million compared to a provision for loan losses of$0.7 million for the three months endedSeptember 30, 2020 . The credit for loan losses for the nine months endedSeptember 30, 2021 was$0.2 million compared to a provision for loan losses of$6.9 million for the nine months endedSeptember 30, 2020 . The decrease in the provision for loan losses for the three and nine months endedSeptember 30, 2021 was driven by lower loan loss reserves in 2021 when compared to 2020, which saw a large increase in reserves due to the COVID-19 pandemic. 48 --------------------------------------------------------------------------------
Noninterest Income
Noninterest income is a component of our revenue and is comprised primarily of fees generated from deposit relationships with our customers, fees generated from sales and referrals of loans, income earned on bank-owned life insurance and gains on sales of investment securities.
The following tables compare noninterest income for the three and nine months
ended
Three Months Ended
September 30, Change
(Dollars in thousands) 2021 2020 $ %
Gains and fees from sales of
loans $ 924 $ 27 $ 897 3,322.2 %
Bank-owned life insurance 271 242 29 12.0
Service charges and fees 199 190 9 4.7
Gain on sale of other real
estate owned, net - 19 (19) (100.0)
Other 43 136 (93) (68.4)
Total noninterest income $ 1,437 $ 614 $ 823 134.0 %
Nine Months Ended
September 30, Change
(Dollars in thousands) 2021 2020 $ %
Gains and fees from sales of loans $ 2,251 $ 27 $ 2,224 8,237.0 %
Bank-owned life insurance 753 726 27 3.7
Service charges and fees 615 578 37 6.4
Gain on sale of other real estate owned, net - 19 (19) (100.0)
Other 1,213 913 300 32.9
Total noninterest income $ 4,832 $ 2,263 $ 2,569 113.5 %
Noninterest income increased by $0.8 million to $1.4 million for the three
months ended September 30, 2021 compared to the three months ended September 30,
2020 . Noninterest income increased by $2.6 million to $4.8 million for the nine
months ended September 30, 2021 compared to the nine months ended September 30,
2020 .
The increase in noninterest income was driven by resumed loan sales, totaling
$0.9 million and $2.3 million for the three and nine months ended September 30,
2021 , respectively. In addition, the increase in noninterest income for the nine
months ended September 30, 2021 was impacted by a one-time federal payroll tax
credit for COVID-19 of $0.9 million , partially offset by $0.4 million of
non-recurring interest rate swap fees recognized during the nine months ended
September 30, 2020 .
49
--------------------------------------------------------------------------------Noninterest Expense
The following tables compare noninterest expense for the three and nine months
ended
Three Months Ended
September 30, Change
(Dollars in thousands) 2021 2020 $ %
Salaries and employee benefits
(9.7) % Occupancy and equipment 2,615 2,266 349 15.4 Data processing 632 529 103 19.5 Professional services 498 374 124 33.2 Director fees 324 301 23 7.6 FDIC insurance 298 176 122 69.3 Marketing 186 151 35 23.2 Other 1,035 637 398 62.5 Total noninterest expense$ 10,370 $ 9,729 $ 641 6.6 % Nine Months Ended September 30, Change (Dollars in thousands) 2021 2020 $ %
Salaries and employee benefits
(15.0) % Occupancy and equipment 8,271 6,410 1,861 29.0 Data processing 1,977 1,558 419 26.9 Professional services 1,632 1,519 113 7.4 FDIC insurance 1,001 529 472 89.2 Director fees 968 883 85 9.6 Marketing 317 512 (195) (38.1) Other 2,383 1,797 586 32.6 Total noninterest expense$ 30,060 $ 29,110 $ 950 3.3 % Noninterest expense increased by$0.6 million to$10.4 million for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 . The increase in noninterest expense was primarily driven by an increase in occupancy and equipment expense and other expense, partially offset by a decrease in salaries and employee benefits expense. Noninterest expense increased by$1.0 million to$30.1 million for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 . The increase in noninterest expense was primarily driven by an increase in occupancy and equipment expense, data processing expense,FDIC insurance expense and other expense, partially offset by a decrease in salaries and employee benefits expense. Occupancy and equipment expense totaled$2.6 million for the quarter endedSeptember 30, 2021 , an increase of$0.3 million when compared to the same period in 2020. Occupancy and equipment expense totaled$8.3 million for the nine months endedSeptember 30, 2021 , an increase of$1.9 million when compared to the same period in 2020. The increase in occupancy and equipment expense was primarily due to additional one-time charges associated with office consolidation activity (previously disclosed in the fourth quarter of 2020) and an increase in lease expense resulting from the commencement of the lease on the Company's new headquarters building. Data processing expense totaled$2.0 million for the nine months endedSeptember 30, 2021 , an increase of$0.4 million when compared to the same period in 2020. The increase in data processing expense was primarily due to$0.4 million in costs associated with the conversion to a new online banking system implemented in the second quarter of 2021. 50 --------------------------------------------------------------------------------FDIC insurance expense totaled$1.0 million for the nine months endedSeptember 30, 2021 , an increase of$0.5 million when compared to the same period in 2020. The increase inFDIC insurance expense was due to the absence of availableFDIC insurance credits recognized in the first quarter of 2020 and elevated expense due to liquidity driven balance sheet growth in the first half 2021. Salaries and employee benefits expense totaled$4.8 million for the quarter endedSeptember 30, 2021 , a decrease of$0.5 million when compared to the same period in 2020. Salaries and employee benefits expense totaled$13.5 million for the nine months endedSeptember 30, 2021 , a decrease of$2.4 million when compared to the same period in 2020. The decrease in salaries and employee benefits expense was primarily driven by a decrease in full time equivalent employees as a direct result of the Voluntary Early Retirement Incentive Plan offered to eligible employees and other employee actions taken during the fourth quarter of 2020. Full time equivalent employees totaled 134 atSeptember 30, 2021 compared to 142 for the same period in 2020. Average full time equivalent employees totaled 127 for the nine months endedSeptember 30, 2021 compared to 151 for the same period in 2020. In addition, salaries and employee benefits expense also benefited by one-time deferrals of$0.6 million for the nine months endedSeptember 30, 2021 in costs associated with a new online banking and other systems. Income Taxes Income tax expense for the three months endedSeptember 30, 2021 and 2020 totaled$1.8 million and$0.8 million , respectively. The effective tax rates for the three months endedSeptember 30, 2021 and 2020 were 20.8% and 20.9%, respectively. Income tax expense for the nine months endedSeptember 30, 2021 and 2020 totaled$5.1 million and$1.2 million , respectively. The effective tax rates for the nine months endedSeptember 30, 2021 and 2020 were 21.5% and 18.0%, respectively. The increase in the effective tax rate for the nine months endedSeptember 30, 2021 was primarily attributable to the absence of a discrete benefit recognized in the first quarter of 2020, and to a lesser extent, other permanent differences. The impact of these items on the effective tax rate varies with changes in pre-tax income.
Financial Condition
Summary
AtSeptember 30, 2021 total assets were$2.2 billion , a$27.1 million decrease, or 1.2%, compared toDecember 31, 2020 . The change in assets remained relatively flat as the decrease in excess liquidity was offset by an increase in loans. Gross loans totaled$1.8 billion atSeptember 30, 2021 , an increase of$198.9 million compared toDecember 31, 2020 . Excluding PPP loans, gross loans increased by$232.1 million atSeptember 30, 2021 when compared toDecember 31, 2020 . Deposits totaled$1.9 billion atSeptember 30, 2021 , compared to$1.8 billion atDecember 31, 2020 . Total shareholders' equity atSeptember 30, 2021 andDecember 31, 2020 was$196.2 million and$176.6 million , respectively. The increase in shareholders' equity was primarily driven by (i) net income of$18.8 million for the nine months endedSeptember 30, 2021 and (ii) a$6.2 million favorable impact to accumulated other comprehensive income driven by fair value marks related to hedge positions involving interest rate swaps. The Company's interest rate swaps are used to hedge interest rate risk. The Company's current interest rate swap positions will cause a decrease to other comprehensive income in a falling interest rate environment and an increase in a rising interest rate environment. The increase in shareholders' equity was partially offset by dividends paid of$3.6 million and common stock repurchases of$3.2 million .
Loan Portfolio
We originate commercial real estate loans, including construction loans, commercial business loans and other consumer loans. Our loan portfolio is the largest category of our earning assets.
Total loans before deferred loan fees and the allowance for loan losses were$1.82 billion atSeptember 30, 2021 and$1.63 billion atDecember 31, 2020 . Total gross loans increased$198.9 million as ofSeptember 30, 2021 compared to the year endedDecember 31, 2020 . 51 -------------------------------------------------------------------------------- The following table compares the composition of our loan portfolio for the dates indicated: (In thousands) At September 30, 2021 At December 31, 2020 Change Real estate loans: Residential $ 90,110 $ 113,557$ (23,447) Commercial 1,337,896 1,148,383 189,513 Construction 94,665 87,007 7,658 1,522,671 1,348,947 173,724 Commercial business 292,825 276,601 16,224 Consumer 9,050 79 8,971 Total loans $ 1,824,546 $ 1,625,627$ 198,919 Asset Quality We actively manage asset quality through our underwriting practices and collection operations. Our Board of Directors monitors credit risk management. The Directors Loan Committee ("DLC") has primary oversight responsibility for the credit-granting function including approval authority for credit-granting policies, review of management's credit-granting activities and approval of large exposure credit requests, as well as loan review and problem loan management and resolution. The committee reports the results of its respective oversight functions to our Board of Directors. In addition, our Board of Directors receives information concerning asset quality measurements and trends on a monthly basis. While we continue to adhere to prudent underwriting standards, our loan portfolio is not immune to potential negative consequences as a result of general economic weakness, such as a prolonged downturn in the housing market on a national scale. Decreases in real estate values could adversely affect the value of property used as collateral for loans. In addition, adverse changes in the economy could have a negative effect on the ability of borrowers to make scheduled loan payments, which would likely have an adverse impact on earnings. The Company has established credit policies applicable to each type of lending activity in which it engages. The Company evaluates the creditworthiness of each customer and extends credit of up to 80% of the market value of the collateral, depending on the borrower's creditworthiness and the type of collateral. The borrower's ability to service the debt is monitored on an ongoing basis. Real estate is the primary form of collateral. Other important forms of collateral are business assets, time deposits and marketable securities. While collateral provides assurance as a secondary source of repayment, the Company ordinarily requires the primary source of repayment for commercial loans, to be based on the borrower's ability to generate continuing cash flows. In the fourth quarter of 2017 management made the strategic decision to no longer originate residential mortgage loans. As of the beginning of the third quarter of 2019, the Company no longer offered home equity loans or lines of credit. The Company's policy for residential lending generally required that the amount of the loan may not exceed 80% of the original appraised value of the property. In certain situations, the amount may have exceeded 80% LTV either with private mortgage insurance being required for that portion of the residential loan in excess of 80% of the appraised value of the property or where secondary financing is provided by a housing authority program second mortgage, a community's low/moderate income housing program, or a religious or civic organization. Credit risk management involves a partnership between our relationship managers and our credit approval, portfolio management, credit administration and collections personnel. Disciplined underwriting, portfolio monitoring and early problem recognition are important aspects of maintaining our high credit quality standards and low levels of nonperforming assets since our inception in 2002. 52 -------------------------------------------------------------------------------- Nonperforming assets. Nonperforming assets include nonaccrual loans and property acquired through foreclosures or repossession. The following table presents nonperforming assets and additional asset quality data for the dates indicated: (In thousands) At September 30, 2021 At December 31, 2020 Nonaccrual loans: Real estate loans: Residential $ 1,849 $ 1,492 Commercial 16,314 21,093 Commercial business 1,754 1,834 Construction 8,997 8,997 Total nonaccrual loans 28,914 33,416 Other real estate owned - - Total nonperforming assets $ 28,914 $ 33,416 Nonperforming assets to total assets 1.30 % 1.48 % Nonaccrual loans to total gross loans 1.58 % 2.06 % Total past due loans to total gross loans 1.69 % 0.93 % Nonperforming assets totaled$28.9 million and represented 1.30% of total assets atSeptember 30, 2021 , compared to$33.4 million and 1.48% of total assets atDecember 31, 2020 . Nonaccrual loans totaled$28.9 million atSeptember 30, 2021 and$33.4 million atDecember 31, 2020 . The decrease in nonaccrual loans was partially a result of charge-offs primarily consisting of previously reserved commercial real estate exposure. The Bank continues work-out activity on its nonaccrual loan population. There was no other real estate owned atSeptember 30, 2021 orDecember 31, 2020 . Allowance for Loan Losses We evaluate the adequacy of the allowance for loan losses at least quarterly, and in determining our allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of our allowance for loan losses is based on internally assigned risk classifications of loans, the Bank's and peer banks' historical loss experience, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates. Our general practice is to identify problem credits early and recognize full or partial charge-offs as promptly as practicable when it is determined that it is probable that the loan will not be repaid according to its original contractual terms, including principal and interest. Full or partial charge-offs on collateral dependent impaired loans are recognized when the collateral is deemed to be insufficient to support the carrying value of the loan. We do not recognize a recovery when an updated appraisal indicates a subsequent increase in value of the collateral. Our charge-off policies, which comply with standards established by our banking regulators, are consistently applied from period to period. Charge-offs are recorded on a monthly basis, as incurred. Partially charged-off loans continue to be evaluated on a monthly basis and additional charge-offs or loan loss provisions may be recorded on the remaining loan balance based on the same criteria. 53 --------------------------------------------------------------------------------
The following table presents the activity in our allowance for loan losses and related ratios for the dates indicated:
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in thousands) 2021 2020 2021 2020
Balance at beginning of period $ 16,672 $ 19,662 $ 21,009 $ 13,509
Charge-offs:
Commercial real estate - - (3,977) -
Commercial business - - (51) (7)
Consumer (15) (4) (33) (29)
Total charge-offs (15) (4) (4,061) (36)
Recoveries:
Commercial business 11 - 27 1
Consumer 1 2 10 2
Total recoveries 12 2 37 3
Net charge-offs (3) (2) (4,024) (33)
Provision (credit) charged to earnings 134 712 (182) 6,896
Balance at end of period $ 16,803 $ 20,372 $ 16,803 $ 20,372
Net charge-offs to average loans - % - % 0.24 % - %
Allowance for loan losses to total gross
loans 0.92 % 1.25 % 0.92 % 1.25 %
At
The following table presents the allocation of the allowance for loan losses and the percentage of these loans to total loans for the dates indicated:
At September 30, 2021 At December 31, 2020
Percent of Loan Percent of Loan
(Dollars in thousands) Amount Portfolio Amount Portfolio
Residential real estate $ 476 4.94 % $ 610 6.99 %
Commercial real estate 13,246 73.33 16,425 70.64
Construction 142 5.19 221 5.35
Commercial business 2,903 16.05 3,753 17.02
Consumer 36 0.49 - -
Total allowance for loan losses $ 16,803 100.00 % $ 21,009 100.00 %
The allocation of the allowance for loan losses at September 30, 2021 reflects
our assessment of credit risk and probable loss within each portfolio. We
believe that the level of the allowance for loan losses at September 30, 2021 is
appropriate to cover probable losses.
Reserve for Unfunded Commitments
The reserve for unfunded commitments provides for probable losses inherent with
funding the unused portion of legal commitments to lend. The unfunded reserve
calculation is primarily based on our allowance for loan loss methodology for
funded loans, adjusted for utilization expectations. The reserve for unfunded
credit commitments is included within other liabilities in the accompanying
Consolidated Balance Sheets. Changes in the reserve are reported as a component
of other noninterest expense in the accompanying Consolidated Statements of
Income.
54
--------------------------------------------------------------------------------AtSeptember 30, 2021 , the carrying value of our investment securities portfolio totaled$105.9 million and represented 4.8% of total assets, compared to$106.9 million , or 4.7% of total assets, atDecember 31, 2020 . The net unrealized gain position on our investment portfolio atSeptember 30, 2021 was$5.0 million and included gross unrealized losses of$0.4 million . The net unrealized gain position on our investment portfolio atDecember 31, 2020 was$7.5 million and included no gross unrealized losses.
Deposit Activities and Other Sources of Funds
September 30, 2021 December 31, 2020
(Dollars in thousands) Amount Percent Amount Percent
Noninterest bearing demand $ 338,705 17.99 % $ 270,235 14.79 %
NOW 103,180 5.48 101,737 5.57
Money market 835,210 44.36 669,364 36.63
Savings 188,581 10.02 158,750 8.69
Time 417,147 22.15 627,230 34.32
Total deposits $ 1,882,823 100.00 % $ 1,827,316 100.00 %
Total deposits were
Brokered certificates of deposits totaled$200.1 million atSeptember 30, 2021 and$238.9 million atDecember 31, 2020 . There were no certificates of deposits from national listing services atSeptember 30, 2021 . Certificates of deposits from national listing services totaled$18.4 million atDecember 31, 2020 . Brokered money market accounts totaled$104.0 million atSeptember 30, 2021 and$13.5 million atDecember 31, 2020 . Brokered deposits represent brokered certificates of deposit, brokered money market accounts, one way buy Certificate of Deposit Account Registry Service (CDARS), and one way buy Insured Cash Sweep (ICS). AtSeptember 30, 2021 andDecember 31, 2020 , time deposits with a denomination of$100 thousand or more, including CDARS and brokered deposits, totaled$348.3 million and$519.8 million , respectively, maturing during the periods indicated in the table below: (Dollars in thousands) September 30, 2021 December 31, 2020 Maturing: Within 3 months $ 92,640 $ 141,784 After 3 but within 6 months 28,059 67,064 After 6 months but within 1 year 35,142 118,880 After 1 year 192,430 192,051 Total $ 348,271 $ 519,779 We utilize advances from theFederal Home Loan Bank of Boston , or FHLB, as part of our overall funding strategy and to meet short-term liquidity needs, and to a lesser degree, manage interest rate risk arising from the difference in asset and liability maturities. Total FHLB advances were$80.0 million and$175.0 million atSeptember 30, 2021 andDecember 31, 2020 , respectively. The decrease of$95.0 million , or 54.3%, primarily reflects the substitution of lower cost brokered deposits in lieu of FHLB advances totaling$75.0 million and a permanent reduction in wholesale funding totaling$20.0 million . The Bank has additional borrowing capacity at the FHLB up to a certain percentage of the value of qualified collateral. In accordance with agreements with the FHLB, the qualified collateral must be free and clear of liens, pledges and encumbrances. AtSeptember 30, 2021 , the Bank had pledged$719.1 million of eligible loans as collateral to support borrowing capacity at the FHLB ofBoston . As ofSeptember 30, 2021 , the Bank had immediate availability to borrow an additional$359.2 million based on qualified collateral. 55 --------------------------------------------------------------------------------
Liquidity and Capital Resources
Liquidity Management
Liquidity is defined as the ability to generate sufficient cash flows to meet all present and future funding requirements at reasonable costs. Our primary source of liquidity is deposits. While our generally preferred funding strategy is to attract and retain low cost deposits, our ability to do so is affected by competitive interest rates and terms in the marketplace. Other sources of funding include discretionary use of purchased liabilities (e.g., FHLB term advances and other borrowings), cash flows from our investment securities portfolios, loan sales, loan repayments and earnings. Investment securities designated as available for sale may also be sold in response to short-term or long-term liquidity needs.
The Bank's liquidity positions are monitored daily by management. The Asset Liability Committee ("ALCO") establishes guidelines to ensure maintenance of prudent levels of liquidity. ALCO reports to the Company's Board of Directors.
The Bank has a detailed liquidity funding policy and a contingency funding plan that provide for the prompt and comprehensive response to unexpected demands for liquidity. We employ a stress testing methodology to estimate needs for contingent funding that could result from unexpected outflows of funds in excess of "business as usual" cash flows. The Bank has established unsecured borrowing capacity with theAtlantic Community Bankers Bank ("ACBB") (formerly Bankers'Bank Northeast ), Zion's Bank andTexas Capital Bank and also maintains additional collateralized borrowing capacity with the FHLB in excess of levels used in the ordinary course of business. Our sources of liquidity include cash, unpledged investment securities, borrowings from the FHLB, lines of credit from ACBB, Zion's Bank andTexas Capital Bank , the brokered deposit market and national CD listing services. The Company anticipates that it will have sufficient funds available to meet its current loan and other commitments. As ofSeptember 30, 2021 , the Company had cash and cash equivalents of$177.5 million and available-for-sale securities of$87.6 million . AtSeptember 30, 2021 , outstanding commitments to originate loans totaled$137.0 million and undisbursed funds from approved lines of credit, home equity lines of credit and secured commercial lines of credit totaled$268.3 million . Capital Resources Shareholders' equity totaled$196.2 million as ofSeptember 30, 2021 , an increase of$19.6 million compared toDecember 31, 2020 , primarily a result of (i) net income of$18.8 million for the nine months endedSeptember 30, 2021 and (ii) a$6.2 million favorable impact to accumulated other comprehensive income driven by fair value marks related to hedge positions involving interest rate swaps. The Company's interest rate swaps are used to hedge interest rate risk. The Company's current interest rate swap positions will cause a decrease to other comprehensive income in a falling interest rate environment and an increase in a rising interest rate environment. The increase in Shareholders' equity was partially offset by dividends paid of$3.6 million and common stock repurchases of$3.2 million . As ofSeptember 30, 2021 , the tangible common equity ratio and tangible book value per share were 8.70% and$25.25 , respectively. The Bank is subject to various regulatory capital requirements administered by the federal 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 financial statements. AtSeptember 30, 2021 , the Bank met all capital adequacy requirements to which it was subject and exceeded the regulatory minimum capital levels to be considered well-capitalized under the regulatory framework for prompt corrective action. AtSeptember 30, 2021 , the Bank's ratio of Common Equity Tier 1 capital to risk-weighted assets was 10.59%, total capital to risk-weighted assets was 11.44%, Tier 1 capital to risk-weighted assets was 10.59% and Tier 1 capital to average assets was 9.61%. InJuly 2013 , theFederal Reserve published Basel III rules establishing a new comprehensive capital framework ofU.S. banking organizations. Under the rules, effectiveJanuary 1, 2015 for the Company and Bank, the minimum capital ratios became a) 4.5% Common Equity Tier 1 to risk-weighted assets, b) 6.0% Tier 1 capital to risk weighted assets and c) 8.0% total capital to risk-weighted assets. In addition, the new regulations imposed certain limitations on dividends, share buy-backs, discretionary payments on Tier 1 instruments and discretionary bonuses to executive officers if the banking organization does not hold a "capital conservation buffer" consisting of 2.5% of common equity to risk weighted assets, in addition to the amounts necessary to meet the minimum risk-based capital requirements described above. 56 --------------------------------------------------------------------------------
Asset/Liability Management and Interest Rate Risk
We measure interest rate risk using simulation analysis to calculate earnings and equity at risk. These risk measures are quantified using simulation software from one of the leading firms in the field of asset/liability modeling. Key assumptions relate to the behavior of interest rates and spreads, prepayment speeds and the run-off of deposits. From such simulations, interest rate risk, or IRR, is quantified and appropriate strategies are formulated and implemented. We model IRR by using two primary risk measurement techniques: simulation of net interest income and simulation of economic value of equity. These two measurements are complementary and provide both short-term and long-term risk profiles for the Company. Because both baseline simulations assume that our balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that ALCO could implement in response to rate shifts. The simulation analyses are updated quarterly. We use a net interest income at risk simulation to measure the sensitivity of net interest income to changes in market rates. This simulation captures underlying product behaviors, such as asset and liability repricing dates, balloon dates, interest rate indices and spreads, rate caps and floors, as well as other behavioral attributes. The simulation of net interest income also requires a number of key assumptions such as: (i) prepayment projections for loans and securities that are projected under each interest rate scenario using internal and external mortgage analytics; (ii) new business loan rates that are based on recent new business origination experience; and (iii) deposit pricing assumptions for non-maturity deposits reflecting the Bank's limited history, management judgment and core deposit studies. Combined, these assumptions can be inherently uncertain, and as a result, actual results may differ from simulation forecasts due to the timing, magnitude and frequency of interest rate changes, future business conditions, as well as unanticipated changes in management strategies. We use two sets of standard scenarios to measure net interest income at risk. For the Parallel Ramp Scenarios, rate changes are ramped over a twelve-month horizon based upon a parallel yield curve shift and then maintained at those levels over the remainder of the simulation horizon. Parallel Shock Scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Simulation analysis involves projecting a future balance sheet structure and interest income and expense under the various rate scenarios. Internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net interest income at risk for the subsequent one-year period should not decline by more than: 6% for a 100 basis point shift; 12% for a 200 basis point shift; and 18% for a 300 basis point shift. Per Company policy, the Bank should not be outside these limits for twelve consecutive months unless the Bank's forecasted capital ratios are considered to be "well capitalized". As ofSeptember 30, 2021 , the Bank has met all minimum regulatory capital requirements to be considered "well capitalized" (reference footnote 7 to the consolidated financial statements for more detail). The following tables set forth the estimated percentage change in our net interest income at risk over one-year simulation periods beginningSeptember 30, 2021 andDecember 31, 2020 : Parallel Ramp Estimated Percent Change in Net Interest Income Rate Changes (basis points) September 30, 2021 December 31, 2020 -100 (0.80) % 0.20 % +200 (3.40) (1.40) Parallel Shock Estimated Percent Change in Net Interest Income Rate Changes (basis points) September 30, 2021 December 31, 2020 -100 (1.50) % (0.30) % +100 (2.60) (1.00) +200 (4.80) (1.70) +300 (6.40) (2.00) The net interest income at risk simulation results indicate that, as ofSeptember 30, 2021 , we remain liability sensitive. The liability sensitivity is due to the fact that there are more liabilities than assets subject to repricing as market rates change. 57 -------------------------------------------------------------------------------- We conduct an economic value of equity at risk simulation in tandem with net interest income simulations, to ascertain a longer term view of our interest rate risk position by capturing longer-term repricing risk and options risk embedded in the balance sheet. It measures the sensitivity of economic value of equity to changes in interest rates. The economic value of equity at risk simulation values only the current balance sheet and does not incorporate the growth assumptions used in one of the income simulations. As with the net interest income simulation, this simulation captures product characteristics such as loan resets, repricing terms, maturity dates, rate caps and floors. Key assumptions include loan prepayment speeds, deposit pricing elasticity and non-maturity deposit attrition rates. These assumptions can have significant impacts on valuation results as the assumptions remain in effect for the entire life of each asset and liability. All key assumptions are subject to a periodic review.
Base case economic value of equity at risk is calculated by estimating the net present value of all future cash flows from existing assets and liabilities using current interest rates. The base case scenario assumes that future interest rates remain unchanged.
The following table sets forth the estimated percentage change in our economic value of equity at risk, assuming various shifts in interest rates:
Estimated Percent Change in Economic Value of Equity
("EVE")
Rate Changes (basis points) September 30, 2021 December 31, 2020 -100 (25.20) % (47.30) % +100 2.40 9.30 +200 2.20 13.80 +300 2.70 18.40 While ALCO reviews and updates simulation assumptions and also periodically back-tests the simulation results to ensure that the assumptions are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future net interest margin. Over time, the repricing, maturity and prepayment characteristics of financial instruments and the composition of our balance sheet may change to a different degree than estimated. ALCO recognizes that deposit balances could shift into higher yielding alternatives as market rates change. ALCO has modeled increased costs of deposits in the rising rate simulation scenarios presented above. In the minus 100 scenario above, the change in EVE of (25.2)% is outside of policy parameters, however, the Bank continues to be well-capitalized. The result of this simulation was discussed with the ALCO and the Company has decided to not take any further action at this time as this scenario is deemed unlikely in the current interest rate environment. It should be noted that the static balance sheet assumption does not necessarily reflect our expectation for future balance sheet growth, which is a function of the business environment and customer behavior. Another significant simulation assumption is the sensitivity of core deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. Lastly, mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments. Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value. Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income.
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