ESQUIRE FINANCIAL HOLDINGS, INC. General
Management's discussion and analysis of financial condition atJune 30, 2022 andDecember 31, 2021 and results of operations for the three and six months endedJune 30, 2022 and 2021 is intended to assist in understanding the financial condition and results of operations ofEsquire Financial Holdings, Inc. The information contained in this section should be read in conjunction with the unaudited Consolidated Financial Statements and the audited Consolidated Financial Statements as ofDecember 31, 2021 and the notes thereto appearing in Part I, Item 1, of this quarterly report on Form 10-Q.
Cautionary Note Regarding Forward-Looking Statements
This quarterly report contains forward-looking statements, which can be identified by the use of words such as "may," "might," "should," "could," "predict," "potential," "believe," "expect," "attribute," "continue," "will," "anticipate," "seek," "estimate," "intend," "plan," "projection," "goal," "target," "outlook," "aim," "would," "annualized" and "outlook," or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. These forward-looking statements include, but are not limited to:
? statements of our goals, intentions and expectations;
? statements regarding our business plans, prospects, growth and operating
strategies;
? statements regarding the quality of our loan and investment portfolios; and
? estimates of our risks and future costs and benefits.
These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this quarterly report.
The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:
? our ability to manage our operations under the current economic conditions
nationally and in our market area;
? adverse changes in the financial industry, securities, credit and national
local real estate markets (including real estate values);
? risks related to a high concentration of loans secured by real estate located
in our market area;
? the continuing impact of the COVID-19 pandemic on our business and results of
operation;
? risks related to a high concentration of loans and deposits dependent upon the
legal and "litigation" market;
? the impact of any potential strategic transactions;
? our ability to enter new markets successfully and capitalize on growth
opportunities;
24
Table of Contents
significant increases in our loan losses, including as a result of our
? inability to resolve classified and nonperforming assets or reduce risks
associated with our loans, and management's assumptions in determining the
adequacy of the allowance for loan losses;
? interest rate fluctuations, which could have an adverse effect on our
profitability;
external economic and/or market factors, such as changes in monetary and fiscal
policies and laws, including the interest rate policies of the Board of
? Governors of the
changes in the demand for loans, and fluctuations in consumer spending,
borrowing and savings habits, which may have an adverse impact on our financial
condition;
continued or increasing competition from other financial institutions, credit
? unions, and non-bank financial services companies, many of which are subject to
different regulations than we are;
credit risks of lending activities, including changes in the level and trend of
? loan delinquencies and write-offs and in our allowance for loan losses and
provision for loan losses;
? our success in increasing our legal and "litigation" market lending;
? our ability to attract and maintain deposits and our success in introducing new
financial products;
? losses suffered by merchants or Independent Sales Organizations (ISOs) with
whom we do business;
? our ability to effectively manage risks related to our payment processing
business;
? our ability to leverage the professional and personal relationships of our
board members and advisory board members;
changes in interest rates generally, including changes in the relative
? differences between short-term and long-term interest rates and in deposit
interest rates, that may affect our net interest margin and funding sources;
? fluctuations in the demand for loans;
? technological changes that may be more difficult or expensive than expected;
? changes in consumer spending, borrowing and savings habits;
? declines in the yield on our assets resulting from a low interest rate
environment;
declines in our payment processing income as a result of reduced demand,
competition and changes in laws or government regulations or policies affecting
financial institutions, including the Dodd-Frank Act and the JOBS Act, which
? could result in, among other things, increased deposit insurance premiums and
assessments, capital requirements, regulatory fees and compliance costs,
particularly the new capital regulations, and the resources we have available
to address such changes;
changes in accounting policies and practices, as may be adopted by the bank
? regulatory agencies, the
and
? loan delinquencies and changes in the underlying cash flows of our borrowers;
25
Table of Contents
? the impairment of our investment securities;
? our ability to control costs and expenses, particularly those associated with
operating as a publicly traded company;
? the failure or security breaches of computer systems on which we depend;
? political instability;
? acts of war, terrorism, natural disasters or global market disruptions,
including global pandemics;
competition and innovation with respect to financial products and services by
? banks, financial institutions and non-traditional providers, including retail
businesses and technology companies;
? changes in our organization and management and our ability to retain or expand
our management team and our board of directors, as necessary;
the costs and effects of legal, compliance and regulatory actions, changes and
? developments, including the initiation and resolution of legal proceedings,
regulatory or other governmental inquiries or investigations, and/or the
results of regulatory examinations and reviews;
? the ability of key third-party service providers to perform their obligations
to us; and
other economic, competitive, governmental, regulatory and operational factors
? affecting our operations, pricing, products and services described elsewhere in
this Quarterly Report on Form 10-Q.
The foregoing factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included in our Annual Report on Form 10-K for the year endedDecember 31, 2021 , as supplemented by subsequent Quarterly Reports on Form 10-Q. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. New risks and uncertainties arise from time to time, and it is not possible for us to predict those events or how they may affect us. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
Summary of Significant Accounting Policies
A summary of our accounting policies is described in Note 1 to the Consolidated
Financial Statements included in our annual report. Critical accounting
estimates are necessary in the application of certain accounting policies and
procedures and are particularly susceptible to significant change. Critical
accounting policies are defined as those involving significant judgments and
assumptions by management that could have a material impact on the carrying
value of certain assets or on income under different assumptions or conditions.
Management believes that the most critical accounting policies, which involve
the most complex or subjective decisions or assessments, are as follows:
Allowance for Loan Losses. Management considers the accounting policy relating
to the allowance for loan losses to be a critical accounting policy given the
inherent subjectivity and uncertainty in estimating the levels of the allowance
required to cover loan losses in the portfolio and the material effect that such
judgements can have on the results of operations.
26
Table of Contents
Emerging Growth Company. Pursuant to the JOBS Act, an emerging growth company is provided the option to adopt new or revised accounting standards that may be issued by theFinancial Accounting Standards Board ("FASB") or theSEC either (i) within the same periods as those otherwise applicable to non-emerging growth companies or (ii) within the same time periods as private companies. We have irrevocably elected to adopt new accounting standards within the public company adoption period. We have taken advantage of some of the reduced regulatory and reporting requirements that are available to it so long as we qualify as an emerging growth company, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation, and exemptions from the requirements of holding non-binding advisory votes on executive compensation and golden parachute payments. A company loses emerging growth company status on the earlier of: (i) the last day of the fiscal year of the company during which it had total annual gross revenues of$1.07 billion or more; (ii) the last day of the fiscal year of the issuer following the fifth anniversary of the date of the first sale of common equity securities of the company pursuant to an effective registration statement under the Securities Act of 1933; (iii) the date on which such company has, during the previous three-year period, issued more than$1.0 billion in non-convertible debt; or (iv) the date on which such company is deemed to be a "large accelerated filer" underSecurities and Exchange Commission regulations (generally, at least$700 million of voting and non-voting equity held by non-affiliates). The Company will lose its emerging growth company status onDecember 31, 2022 since that would be the last day of the fiscal year of the Company following the fifth anniversary of the date of the first sale of the common equity securities of the Company pursuant to an effective registration statement under the Securities Act of 1933.
Overview
We are a financial holding company headquartered inJericho, New York and registered under the Bank Holding Company Act of 1956, as amended. Through our wholly owned bank subsidiary,Esquire Bank , National Association ("Esquire Bank " or the "Bank"), we are a full service commercial bank dedicated to serving the financial needs of the litigation industry and small businesses nationally, as well as commercial and retail customers in theNew York metropolitan market. We offer tailored financial and payment processing solutions to the litigation community and their clients as well as dynamic and flexible payment processing solutions to small business owners, both on a national basis. We also offer traditional banking products for businesses and consumers in our local market area. Our results of operations depend primarily on our net interest income which is the difference between the interest income we earn on our interest-earning assets and the interest we pay on our interest-bearing liabilities. Our results of operations also are affected by our provision for loan losses, noninterest income and noninterest expense. Noninterest income currently consists primarily of payment processing fees and customer related fees and charges. Noninterest expense currently consists primarily of employee compensation and benefits and professional and consulting services. Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies, the litigation market and actions of regulatory authorities. The Company's foundation for success has been our nationwide branchless litigation and payment processing verticals supported by our forward-thinking senior managers, outstanding client service teams, and inclusive corporate culture. The future of our success will be the ability to continue developing and embracing cutting-edge technology to significantly leverage these verticals, differentiating us from other technology enabled financial firms and creating the catalyst for industry leading growth and returns. Litigation Market Commercial Banking. The litigation market has been and will continue to be a significant growth opportunity for our Company as we offer focused and tailored products and services to law firms nationally.U.S. tort actions alone are estimated to consume 1.5%-2.0% ofU.S. GDP annually(1) or$429 billion (2) (the total addressable market or "TAM"). We do not compete directly with non-bank finance companies, the primary funders in this market, and believe there are various and significant barriers to entry including, but not limited to, our clear industry track record for 27
Table of Contents
15 years, extensive in-house experience, deep relationships with respected firms nationally, and unique products tailored to commercial law firms' needs and wants.
We currently have clients in 27 states and our larger markets include theNew York metro area,California ,Texas ,New Jersey , andFlorida . Our success is tied to our unique ability to couple traditional commercial underwriting with non-traditional asset-based underwriting. Our team understands law firms' contingent case inventory valuation process (as well as traditional hourly billing firms). Typically, these inventories of claims for injured consumers have a duration of 2-3 years, significantly longer than traditional accounts receivables or inventories of goods that can have a duration of 30-60 days or 120 days, respectively. These factors (the unique industry, contingent collateral, longer durations of the law firms' inventories, atypical revenue streams of the law firms and more) coupled with the TAM create a unique and valuable opportunity for the Company with minimal incumbent competition. This unique risk profile translates into a blended 7.6% variable rate asset yield on these commercial loans for the quarter endedJune 30, 2022 . More importantly, for every$1.00 we advance on these loans we receive on average$1.91 of low-cost (our cost of funds for the quarter endedJune 30, 2022 is 10 basis points) core operating and escrow deposits through our branchless platform, fueling and funding additional growth in our other asset classes. Our extremely low historic delinquency rates and low charge-off rates clearly demonstrate our strong underwriting process and expertise in this vertical. Coupling this with our off-balance sheet commercial litigation funds of$496.8 million atJune 30, 2022 , this vertical represents a highly desirable core low-cost funding platform for the entire company fueling growth in other lending areas. Payment Processing. The payment processing (merchant acquiring) market has also been and will continue to be a significant growth opportunity for our company, as we offer focused and tailored products and services to small businesses nationally. The payment industry grew 9.7% from 2019 to 2021 with payment volumes or TAM of$9.5 trillion (3). Couple this with the fact that there are less than 85 acquiring financial institutions in theU.S. and this vertical clearly represents a significant growth opportunity for our company. We believe there are various and significant barriers to entry to this market including, but not limited to, our clear industry track record for 10 years, extensive in-house experience, deep relationships with non-bank acquirers, and our unique approach to servicing these small business merchants and their respective verticals. We use proprietary and industry leading technology to ensure card brand and regulatory compliance, support multiple processing platforms, manage daily risk across approximately 72,000 small business merchants in all 50 states, and perform commercial treasury clearing services for approximately$7.1 billion in processing volume across 136.1 million transactions in the most recent quarter. Proprietary Technology. We are a branchless digital first company with best-in-class technology to fuel future growth with industry leading client retention rates. We have built a customized and fully integrated customer relationship management ("CRM") platform, integrated into our digital marketing cloud and our nCino loan platform (all built onSalesforce for excellence in client service and operational efficiency) and have begun to invest in artificial intelligence ("AI") to facilitate precision marketing and client acquisition across both national verticals. The success of our nationwide branchless technology enabled litigation and payment processing verticals has led to industry leading performance. Our branchless commercial banking loans and deposits have compound annual growth rates of 23% since 2015, a net interest margin of 4.46% for the quarter endedJune 30, 2022 , and drives a company wide efficiency ratio of 52.3% for the quarter endedJune 30, 2022 . Our payment processing vertical has a compound annual growth rate of 58% since 2017 and diversifies our product offerings with stable fee income comprising 31% of revenues. The integration of these competencies and businesses has provided a sustainable average return on assets and tangible common equity of 2.00% and 17.81%, respectively, for the quarter endedJune 30, 2022 .
(1) Towers Watson
(2)
(3)
COVID-19 Pandemic Programs
We elected to participate in the Paycheck Protection Program administered by the
SBA with the intention to provide our customer base access to this critical
program. The PPP provides borrower guarantees for lenders, as well as loan
forgiveness incentives for borrowers that utilize the loan proceeds to cover
employee compensation-related costs and
28
Table of Contents
other qualifying business costs. As ofMarch 31, 2022 , we had been fully repaid on our PPP loan portfolio cumulatively totaling$45.5 million , which concluded our participation in the program. In 2020, management implemented a customer payment deferral program (principal and interest) under the CARES Act to assist business borrowers and certain consumers that may have been experiencing financial hardship due to COVID-19 related challenges. As ofJune 30, 2022 , there were no participants in our payment deferral program, which is now closed.
Comparison of Financial Condition at
Assets. Our total assets were$1.3 billion atJune 30, 2022 , an increase of$130.9 million , or 11.1%, from$1.2 billion atDecember 31, 2021 , due to growth in our securities portfolio funded with low cost deposits where securities held-to-maturity increased$76.3 million , and increases in loans held for investment of$74.8 million , or 9.5%, offset by net paydowns and unrealized losses on securities available-for-sale of$25.7 million , or 17.3%.
Loans. The following table provides information regarding the composition of our loans held for investment portfolio at the dates indicated:
At June 30, At December 31,
2022 2021
Amount Percent Amount Percent
(Dollars in thousands)
Real estate:
Multifamily $ 259,579 30.2 % $ 254,852 32.5 %
Commercial real estate 80,488 9.3 48,589 6.1
1 - 4 family 33,565 3.9 40,753 5.2
Total real estate 373,632 43.4 344,194 43.8
Commercial 478,149 55.6 427,859 54.6
PPP - - 4,249 0.5
Consumer 8,327 1.0 8,681 1.1
Total loans held for investment
100.0 % Deferred loan fees and unearned premiums, net (778) (466) Allowance for loan losses (10,271) (9,076) Loans, held for investment$ 849,059 $ 775,441 Loans held for sale, net (included in Other assets) $ -$ 14,100 AtJune 30, 2022 , loans were$859.3 million , or 74.4% of total deposits, compared to$784.5 million , or 76.3% of total deposits, atDecember 31, 2021 . The growth in loans was primarily driven by net production in commercial and commercial real estate loans. Commercial loans increased$50.3 million , or 11.8%, to$478.1 million atJune 30, 2022 from$427.9 million atDecember 31, 2021 , driven by both our litigation related loans and other commercial relationships. Commercial real estate loans increased$31.9 million , or 65.7%, to$80.5 million atJune 30, 2022 from$48.6 million atDecember 31, 2021 . 29
Table of Contents
The following table sets forth the composition of our Litigation-Related loans held for investment portfolio by type of loan at the dates indicated:
June 30, 2022 December 31, 2021
Amount Percent Amount Percent
(Dollars in thousands)
Litigation-Related Loans
Commercial Litigation-Related:
Working capital lines of credit $ 195,224 49.1 % $ 210,148
54.4 %
Case cost lines of credit 134,974 34.0 127,859 33.1
Term loans 64,654 16.3 45,415 11.8Total Commercial Litigation-Related 394,852 99.4 383,422
99.3
Consumer Litigation-Related: Post-settlement consumer loans 2,366 0.6 2,451
0.7
Structured settlement loans 75 0.0 116
0.0
Total Consumer Litigation-Related 2,441 0.6 2,567
0.7
Total Litigation-Related Loans
100.0 %
AtJune 30, 2022 , our Litigation-Related loans, which include commercial loans to law firms and consumer lending to plaintiffs/claimants and attorneys, totaled$397.3 million , or 46.2% of our total loan portfolio, compared to$386.0 million , or 49.2% of our total loan portfolio atDecember 31, 2021 . We remain focused on prudently growing our Litigation-Related loan portfolio. Securities. Securities available-for-sale decreased$25.7 million , or 17.3%, to$122.7 million atJune 30, 2022 from$148.4 million atDecember 31, 2021 , driven by unrealized losses of$14.4 million and paydowns of$12.9 million , offset by purchases of$1.7 million . Commencing in the first quarter of 2022, we invested a portion of our excess liquidity in held-to-maturity securities, totaling$76.3 million atJune 30, 2022 . Funding. Total deposits increased$127.1 million , or 12.4%, to$1.2 billion atJune 30, 2022 from$1.0 billion atDecember 31, 2021 . We continue to focus on the acquisition and expansion of core deposit relationships, which we define as all deposits except certificates of deposit. Core deposits totaled$1.1 billion atJune 30, 2022 , or 98.4% of total deposits at that date, compared to$1.0 billion or 98.1% of total deposits atDecember 31, 2021 . Of which, litigation and payment processing deposits represent 64% and 15%, respectively, of total deposits. Demand deposits (noninterest bearing) increased$103.8 million , or 25.4%, to$513.1 million , representing 44.4% of total deposits.
In addition to our core deposits as a source of funding, the Company continues
to prudently manage its balance sheet through deposit sweep programs,
maintaining off-balance sheet funds totaling
AtJune 30, 2022 , we had the ability to borrow a total of$157.1 million from theFederal Home Loan Bank of New York . We also had an available line of credit with theFederal Reserve Bank of New York discount window of$39.6 million . AtJune 30, 2022 , we also had$67.5 million in aggregate unsecured lines of credit with unaffiliated correspondent banks. No amounts were outstanding on any of the aforementioned lines of credit atJune 30, 2022 . Equity. Total stockholders' equity increased$1.8 million to$145.5 million atJune 30, 2022 , from$143.7 million atDecember 31, 2021 , primarily due to net income of$11.7 million and amortization of share based compensation of$1.1 million , partially offset by other comprehensive losses of$10.4 million due to the decline in fair value of available-for-sale securities reflective of the recent increases in short-term market interest rates and a common stock dividend of$727 thousand . Asset Quality. Nonperforming assets, totaling$4 thousand , consisted of two nonaccrual consumer loans as ofJune 30, 2022 . As ofJune 30, 2022 , the allowance for loan losses was$10.3 million , or 1.20% of total loans, as compared to$9.1 million , or 1.16% of total loans atDecember 31, 2021 . The increase in the allowance as a percentage of loans was related to qualitative factors due to the current economic and inflationary environment. AtJune 30, 2022 , special mention 30 Table of Contents and substandard loans totaled$22.5 million and$721 thousand , respectively. AtDecember 31, 2021 , special mention and substandard loans totaled$24.8 million and$4.3 million , respectively.
Average Balance Sheets and Rate/Volume Analysis
The following tables present average balance sheet information, interest income,
interest expense and the corresponding average yields earned and rates paid for
periods indicated. The average balances are daily averages and, for loans,
include both performing and nonperforming balances. Interest income on loans
includes the effects of net premium amortization and net deferred loan
origination fees accounted for as yield adjustments. No tax-equivalent yield
adjustments were made, as we have no tax exempt investments.
For the Three Months Ended June 30,
2022 2021
(Dollars in thousands)
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
INTEREST EARNING ASSETS
Loans, held for investment $ 841,336 $ 12,423 5.92 % $ 700,349 $ 10,120 5.80 %
Securities, includes
restricted stock 208,091 1,033 1.99 % 134,828 538 1.60 %
Securities purchased under
agreements to resell 48,536 190 1.57 % 51,142 160 1.25 %
Interest earning cash and
other 132,487 309 0.94 % 65,947 42 0.26 %
Total interest earning assets 1,230,450 13,955 4.55 % 952,266 10,860 4.57 %
NONINTEREST EARNING ASSETS 45,672 31,519
TOTAL AVERAGE ASSETS $ 1,276,122 $ 983,785
INTEREST BEARING LIABILITIES
Savings, NOW, Money Market
deposits $ 608,817 $ 255 0.17 % $ 416,389 $ 173 0.17 %
Time deposits 19,178 26 0.54 % 10,980 19 0.69 %
Total interest bearing
deposits 627,995 281 0.18 % 427,369 192 0.18 %
Borrowings 103 1 3.89 % 104 1 3.86 %
Total interest bearing
liabilities 628,098 282 0.18 % 427,473 193 0.18 %© Edgar Online, source
