FIRST BUSINESS FINANCIAL SERVICES, INC. General
Unless otherwise indicated or unless the context requires otherwise, all
references in this Report to the "Corporation," "we," "us," "our," or similar
references mean
Forward-Looking Statements
This report may include forward-looking statements as defined in the Private
Securities Litigation Reform Act of 1995, which reflect our current views with
respect to future events and financial performance. Forward-looking statements
are not based on historical information, but rather are related to future
operations, strategies, financial results, or other developments.
Forward-looking statements are based on management's expectations as well as
certain assumptions and estimates made by, and information available to,
management at the time the statements are made. Such statements are subject to
risks and uncertainties, including among other things:
• Adverse changes in the economy or business conditions, either nationally
or in our markets, including, without limitation, the adverse effects of
the COVID-19 pandemic on the global, national, and local economy.
• The effect of the COVID-19 pandemic on the Corporation's credit quality,
revenue, and business operations.
• Competitive pressures among depository and other financial institutions
nationally and in our markets.
• Increases in defaults by borrowers and other delinquencies.
• Our ability to manage growth effectively, including the successful
expansion of our client support, administrative infrastructure, and
internal management systems.
• Fluctuations in interest rates and market prices.
• The consequences of continued bank acquisitions and mergers in our
markets, resulting in fewer but much larger and financially stronger
competitors.
• Changes in legislative or regulatory requirements applicable to us and our
subsidiaries.
• Changes in tax requirements, including tax rate changes, new tax laws, and
revised tax law interpretations.
• Fraud, including client and system failure or breaches of our network
security, including our internet banking activities.
• Failure to comply with the applicable SBA regulations in order to maintain
the eligibility of the guaranteed portions of SBA loans.
These risks could cause actual results to differ materially from what we have anticipated or projected. These risk factors and uncertainties should be carefully considered by our stockholders and potential investors. See Part I, Item 1A - Risk Factors in our Annual Report on Form 10-K for the year endedDecember 31, 2019 and Part II, Item 1A - Risk Factors in our Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2020 , for discussion relating to risk factors impacting us. Investors should not place undue reliance on any such forward-looking statements, which speak only as of the date made. The factors described within this Form 10-Q could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods. Where any such forward-looking statement includes a statement of the assumptions or bases underlying such forward-looking statement, we caution that, while our management believes such assumptions or bases are reasonable and are made in good faith, assumed facts or bases can vary from actual results, and the differences between assumed facts or bases and actual results can be material, depending on the circumstances. Where, in any forward-looking statement, an expectation or belief is expressed as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will be achieved or accomplished. We do not intend to, and specifically disclaim any obligation to, update any forward-looking statements. The following discussion and analysis is intended as a review of significant events and factors affecting our financial condition and results of operations for the periods indicated. The discussion should be read in conjunction with the unaudited Consolidated Financial Statements and the Notes thereto presented in this Form 10-Q. 38
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Overview
We are a registered bank holding company incorporated under the laws of the
State of Wisconsin and are engaged in the commercial banking business through
our wholly-owned banking subsidiary, FBB. All of our operations are conducted
through the Bank and certain subsidiaries of FBB. We operate as a business bank
focusing on delivering a full line of commercial banking products and services
tailored to meet the specific needs of small and medium-sized businesses,
business owners, executives, professionals, and high net worth individuals. Our
products and services include those for business banking, private wealth, and
bank consulting. Within business banking, we offer commercial lending, consumer
and other lending, asset-based lending, accounts receivable financing, equipment
financing, vendor financing, floorplan financing, SBA lending and servicing,
treasury management services, and company retirement plans. Our private wealth
services for executives and individuals include trust and estate administration,
financial planning, investment management, and private banking. For other
financial institutions, our bank consulting experts provide investment portfolio
administrative services, asset liability management services, and asset
liability management process validation. We do not utilize a branch network to
attract retail clients. Our operating philosophy is predicated on deep client
relationships fostered by local banking partners and specialized business lines
where we provide skilled expertise, combined with the efficiency of centralized
administrative functions such as information technology, loan and deposit
operations, finance and accounting, credit administration, compliance,
marketing, and human resources. Our focused model allows experienced staff to
provide the level of financial expertise needed to develop and maintain
long-term relationships with our clients.
Operational Summary
Results as of and for the three and six months ended
• Net income totaled
for the three months ended June 30, 2020 , compared to $6.6 million , or
diluted earnings per share of $0.75 , for the same period in 2019. Net
income totaled $6.6 million , or diluted earnings per share of $0.77 , for
the six months ended
earnings per share of
• During the second quarter of 2020, the Corporation disbursed
million in Paycheck Protection Program ("PPP") loans and received
processing fee income from the Small Business Administration ("SBA") of
$8.7 million . The processing fee income is deferred and recognized overthe contractual life of the loan, or accelerated at forgiveness. During
the second quarter of 2020, $859,000 was recognized in interest income.
• Record pre-tax, pre-provision adjusted earnings, which excludes certain
one-time and discrete items, totaled
ended
pre-provision adjusted return on average assets was 1.61% for the three
months ended
Pre-tax, pre-provision adjusted earnings totaled
months ended
pre-provision adjusted return on average assets was 1.53% for the six
months ended June 30, 2020 , compared 1.46% for the same period in 2019.
• Period-end gross loans and leases receivable were $2.057 billion as of
utilization was significantly impacted by PPP loan proceeds and was
million as of
2019. Gross loans and leases receivable, excluding PPP loans and lines of
credit, were
• The allowance for loan and lease losses increased
compared to
million increase in the general and specific reserves, respectively,
driven by the COVID-19 pandemic. The allowance for loan and lease losses
increased to 1.33% of total loans, compared to1.14% at
Excluding PPP loans, the allowance for loan and lease losses increased to
1.58% of total loans as of June 30, 2020 .
• Provision for loan and lease losses totaled $5.5 million for the three
months ended
for the same period in 2019. Provision for loan and lease losses totaled
$8.7 million for the six months endedJune 30, 2020 , compared to a provision benefit of$736,000 for the same period in 2019.
• Robust liquidity position includes record in-market deposits of
billion, total deposits of
of
securities available-for-sale, and unencumbered pledged loans. In-market
deposit balances were inflated due to PPP loan proceeds.
• Net interest margin was 3.34% and 3.39% for the three and six months ended
six months ended
margin, which excludes certain one-time and discrete items, was 3.33% for
the three and six months ended June 30, 2020 , respectively, compared to
3.31% and 3.33% for the three and six months ended June 30, 2019 ,
respectively.
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• Fees in lieu of interest, defined as prepayment fees, asset-based loan
fees, non-accrual interest, and loan fee amortization, totaled
million and
respectively, compared to
six months ended
• Top line revenue, defined as net interest income plus non-interest income,
totaled $25.2 million for the three months ended June 30, 2020 , up 11.3%
from the same period in 2019. Top line revenue totaled $48.7 million for
the six months ended June 30, 2020 , up 8.0% from the same period in 2019.
• Non-interest income totaled
the three months ended
25% for the fifth consecutive quarter. Non-interest income totaled
million, or 26.2% of total revenue, for the six months ended June 30,
2020 .
• Non-interest expense was
six months ended
and
respectively. Operating expense, which excludes certain one-time and
discrete items, totaled
six months ended
and $30.5 million for the three and six months ended June 30, 2019 ,
respectively.
• The Corporation incurred a
second quarter of 2020, as the Corporation lowered wholesale funding costs
and improved the Corporation's funding position with the expectation of a
low interest rate environment for an extended period of time.
• The efficiency ratio improved to 61.22% and 64.36% for the three and six
months ended
the three and six months ended
• Historic tax credit programs contributed
during the three months ended June 30, 2020 , compared to $446,000 , or
$0.05 per share for the same period in 2019.
COVID-19 Update
Business Continuity
The Corporation continues to strictly adhere to COVID-19 health and
safety-related requirements and best practices across all of our locations.
During the second quarter of 2020, employees slowly resumed business travel, as
necessary, while business development efforts have continued to be somewhat
negatively affected by limitations on in-person appointments.
Portions of the Corporation's workforce started returning to the office, subject
to local mandates and restrictions, on a rotating basis. Management will monitor
the activity closely and adjust accordingly as the health and safety of our
employees and clients remain our highest priority.
The Corporation had no furloughs or layoffs related to COVID-19 to date.
Paycheck Protection Program
During the second quarter of 2020, the Corporation processed over 700
applications from existing and new clients, disbursed $327.9 million in funds,
and received processing fee income from the SBA of $8.7 million . The processing
fee income is deferred and recognized over the contractual life of the loan, or
accelerated at forgiveness, as an adjustment of yield using the interest method.
During the second quarter of 2020, $859,000 was recognized in interest income.
The SBA provides a guaranty to the lender of 100% of principal and interest,
unless the lender violated an obligation under the agreement. As loan losses are
expected to be immaterial, if any at all, due to the guaranty, management
excluded the PPP loans from the allowance for loan and lease losses calculation.
Management funded these short-term loans through a combination of excess cash
held at the Federal Reserve and the increase in in-market deposits.
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Liquidity Sources Management has reviewed all primary and secondary sources of liquidity in preparation for any unforeseen funding needs due to the COVID-19 pandemic and prioritized based on available capacity, term flexibility, and cost. As ofJune 30, 2020 , the Corporation had the following sources of liquidity, including the Corporation's ability to participate in theFederal Reserve's Paycheck Protection Program Liquidity Facility ("PPPLF"): As of June 30, 2020 (In Thousands) Short-term investments$ 27,839 PPPLF availability 298,327
Collateral value of unencumbered pledged loans (FHLB borrowing availability)
178,587
Market value of unencumbered securities (Fed Discount Window and FHLB borrowing availability) 106,808 Total sources of liquidity$ 611,561 In addition to the above primary sources of liquidity, as ofJune 30, 2020 , the Corporation also had access to$53.5 million in federal funds lines with various correspondent banks and significant experience accessing the highly liquid brokered certificate of deposit market. Capital Strength The Corporation's capital ratios continued to exceed the highest required regulatory benchmark levels. • Total capital to risk-weighted assets atJune 30, 2020 , was 11.97%, tier 1 capital to risk-weighted assets was 9.57%, tier 1 leverage capital to adjusted average assets was 8.29%, and common equity tier 1 capital to
risk-weighted assets was 9.08%. Tangible common equity to tangible assets
was 7.56%. Excluding PPP loans, tier 1 leverage capital to adjusted
average assets and tangible common equity to tangible assets were 9.19%
and 8.72%, respectively.
• Management suspended the Corporation's stock repurchase program in March
2020 due to the uncertainty surrounding the COVID-19 pandemic. As of March
16, 2020, the Corporation had repurchased 141,137 shares of its common
stock at a weighted average price of
of
remaining.
• As previously announced, during the second quarter of 2020, theCorporation's Board of Directors declared a regular quarterly dividend of
record at the close of business on
quarter 2020 diluted earnings per share of
a 43.4% payout ratio. The Board of Directors routinely considers dividend
declarations as part of its normal course of business.
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Deferral Requests The Corporation provided loan modifications up to six months to certain borrowers impacted by COVID-19 who were current in their payments at the inception of the Corporation's loan modification program. As ofJune 30, 2020 , the Corporation had processed 448 deferral requests on loans totaling$323.2 million , or 18.6% of gross loans and leases. Loan deferrals of six months accounted for 60.2% of the total$323.2 million in deferral requests and the remaining balance were primarily for three months. Management anticipates the loan modifications may continue throughout 2020. The following tables represent a breakdown of the deferred loan balances by industry segment and collateral type: As of June 30, 2020 Collateral Type % Deferred of Non Real Industries Description Balance Total Industry
Real Estate Estate
(Dollars in Thousands)
Real Estate and Rental and Leasing $ 147,584 18.8 % $ 142,519 $ 5,065
Accommodation and Food Services 52,468 52.7 % 49,198 3,270
Manufacturing 34,214 17.5 % 20,253 13,961
Health Care and Social Assistance 19,552 15.9 % 12,136 7,416
Transportation and Warehousing 19,402 21.3 % 422 18,980
Retail Trade 14,851 29.7 % 11,355 3,496
Information 11,228 64.1 % 2,430 8,798
Utilities 7,129 96.4 % - 7,129
Construction 6,448 6.7 % 6,359 89
Wholesale Trade 5,695 5.7 % 569 5,126
Other Services (except Public
Administration) 1,673 3.0 % 50 1,623
Professional, Scientific, and Technical
Services 933 2.3 % - 933
Administrative and Support and Waste
Management and Remediation Services 831 9.9 % 728 103
Finance and Insurance 743 1.8 % 715 28
Arts, Entertainment, and Recreation 300 1.7 % 292 8
Agriculture, Forestry, Fishing and Hunting 165 1.3 % - 165
Total deferred loan balances $ 323,216 The following table is a further breakdown of the deferred loan balances by certain credit quality indicators. Please refer to Note 6 - Loan and Lease Receivables, Impaired Loans and Leases and Allowance for Loan and Lease Losses for the risk category definitions.
As of
June 30, 2020
Category
I II III Total
(Dollars in Thousands)
Total deferred loan balances $ 221,414 $ 66,554 $ 35,248 $ 323,216
% of Total 68.5 % 20.6 % 10.9 % 100.0 %
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The following table is a further breakdown of the deferred loan balances and collateral type for the Real Estate and Rental and Leasing industry:
As of
June 30, 2020
Collateral Type
% Deferred of Non Real
Real Estate and Rental and Leasing Detail: Balance Sub-Industry
Real Estate Estate
(Dollars in Thousands)
Office - Class A $ 23,204 15.3 % $ 23,204 $ -
Retail - Non-Credit Tenant - Shopping Center 22,657 73.5 % 22,657 -
Office - Class B 17,652 32.1 % 17,652 -
1-4 Family 16,887 64.5 % 16,887 -
Multi-Family - Market Rent 16,174 8.5 % 16,174 -
Retail - Non-Credit Tenant - Strip Center 11,389 59.7 % 11,389 -
Multi-Family - Student Housing 8,466 20.2 % 8,466 -
Retail - Non-Credit Tenant - Restaurant 6,621 64.9 % 6,621 -
Retail - Other 6,110 13.9 % 6,110 -
Retail - Non-Credit-Tenant - Big Box 5,629 100.0 % 5,629 -
Other 12,795 5.6 % 7,730 5,065
Total Real Estate and Rental and Leasing $ 147,584 The following table is a further breakdown of the deferred loan balances and collateral type for the Accommodation and Food Services industry:
As of
June 30, 2020
Collateral Type
% Deferred of Non Real
Accommodation and Food Services Detail: Balance Sub-Industry
Real Estate Estate
(Dollars in Thousands)
Hotel - Flag $ 43,011 63.1 % $ 43,011 $ -
Hotel - No Flag 1,862 46.0 % 1,862 -
Other 5,594 22.7 % 2,324 3,270
Retail - Restaurant/Bar 2,001 13.0 % 2,001 -
Total Accommodation and Food Service $ 52,468 Exposure toStressed Industries Certain industries are widely expected to be particularly impacted by social distancing, quarantines, and the economic impact of the COVID-19 pandemic, such as the following: As of June 30, 2020 Industries: Balance % Gross Loans and Leases (1) (Dollars in Thousands) Retail (2)$ 70,028 4.0 % Hospitality 73,502 4.2 % Entertainment 16,675 1.0 % Restaurants & food service 24,884 1.4 % Total outstanding exposure$ 185,089 10.7 %
(1) Excluding PPP loans.
(2) Includes
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As ofJune 30, 2020 , the Corporation had no meaningful direct exposure to the energy sector, airline industry or retail consumer, and does not participate in shared national credits. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on our clients and prospects, and on the national and local economy as a whole, there can be no assurances as to how the crisis may ultimately affect the Corporation's loan portfolio. Results of Operations Top Line Revenue Top line revenue, comprised of net interest income and non-interest income, increased 11.3% for the three months endedJune 30, 2020 compared to the same period in the prior year primarily due to an increase in fees in lieu of interest and a reduction in interest rate paid on deposits, partially offset by lower loan yields. Top line revenue increased 8.0% for the six months endedJune 30, 2020 compared to the same period in the prior year primarily due to an increase in commercial loan interest rate swap fee income and a reduction in interest rates paid on deposits, partially offset by lower loan yields and a reduction in fees in lieu of interest. The components of top line revenue were as follows: For the Three Months Ended June 30, For the Six Months Ended June 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change (Dollars in Thousands) Net interest income$ 18,888 $ 16,852 $ 2,036 12.1 %
514 8.9 12,733 10,443 2,290 21.9
Top line revenue
Annualized Return on Average Assets and Annualized Return on Average Equity ROAA for the three months endedJune 30, 2020 decreased to 0.55% compared to 1.30% for the three months endedJune 30, 2019 . ROAA for the six months endedJune 30, 2020 decreased to 0.58% compared to 1.25% for the six months endedJune 30, 2019 . The decrease in ROAA was primarily due to an increase in the provision for loan and lease losses related to the COVID-19 pandemic. This reduction in profitability was partially offset by an increase in commercial loan interest rate swap fee income, a decrease in SBA recourse provision, an overall decrease in operating expenses, and net interest income improvement mainly due to lower rates paid on deposits. We consider ROAA a critical metric to measure the profitability of our organization and how efficiently our assets are deployed. ROAA also allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage which can ultimately influence return on equity measures. ROAE for the three months endedJune 30, 2020 was 6.70% compared to 14.09% for the three months endedJune 30, 2019 . ROAE for the six months endedJune 30, 2020 was 6.92% compared to 13.89% for the six months endedJune 30, 2019 . The reasons for the decrease in ROAE are consistent with the explanations discussed above with respect to ROAA. We view ROAE as an important measurement for monitoring profitability and continue to focus on improving our return to our shareholders by enhancing the overall profitability of our client relationships, controlling our expenses, and minimizing our costs of credit. Efficiency Ratio Efficiency ratio is a non-GAAP measure representing non-interest expense excluding the effects of the SBA recourse provision, impairment of tax credit investments, losses on foreclosed properties, amortization of other intangible assets, losses on early extinguishment of debt, and other discrete items, if any, divided by operating revenue, which is equal to net interest income plus non-interest income less realized gains or losses on securities, if any. The efficiency ratio was 61.22% and 64.36% for the three and six months endedJune 30, 2020 compared to 67.41% and 67.72% for the three and six months endedJune 30, 2019 . Operating revenue growth outpaced the change in operating expense for the three and six months endedJune 30, 2020 , resulting in positive operating leverage. Results for the three and six months endedJune 30, 2020 have benefited from PPP interest income, PPP loan processing fee recognition, and below average business-related expenses due to the COVID-19 pandemic. For the three months endedJune 30, 2020 compared to the three 44
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months endedJune 30, 2019 , operating revenue increased 11.2% while operating expense increased 1.0%. Similarly, for the six months endedJune 30, 2020 compared to the six months endedJune 30, 2019 , operating revenue increased 8.0% while operating expense increased 2.7%. We believe we will continue to generate modest positive operating leverage and progress towards enhancing our long-term efficiency ratio at a measured pace as we focus on strategic initiatives directed toward revenue growth; although this growth may be muted somewhat by the current health crisis and its effect on the economy. These initiatives include efforts to expand our specialty finance lines of business, increase our commercial banking market share, and scale our private wealth management business in less mature markets. We believe the efficiency ratio allows investors and analysts to better assess the Corporation's operating expenses in relation to its top line revenue by removing the volatility that is associated with certain non-recurring and other discrete items. The efficiency ratio also allows management to benchmark performance of our model to our peers without the influence of the loan loss provision and tax considerations, which will ultimately influence other traditional financial measurements, including ROAA and ROAE. The information provided below reconciles the efficiency ratio to its most comparable GAAP measure. Please refer to the Non-Interest Income and Non-Interest Expense sections below for discussion on additional drivers of the year-over-year change in the efficiency ratio. For the Three Months EndedJune 30 ,
For the Six Months Ended
2020 2019 $ Change % Change 2020 2019 $ Change % Change
(Dollars in Thousands)
Total
non-interest
expense $ 18,343 $ 17,464 $ 879 5.0 % $ 34,488 $ 35,206 $ (718 ) (2.0 )%
Less:
Net loss (gain)
on foreclosed
properties 348 (21 ) 369 NM 450 (21 ) 471 NM
Amortization of
other intangible
assets 9 11 (2 ) (18.2 ) 18 21 (3 ) (14.3 )
SBA recourse
(benefit)
provision (30 ) 113 (143 ) NM (5 ) 594 (599 ) NM
Tax credit
investment
impairment 1,841 2,088 (247 ) (11.8 ) 1,954 4,102 (2,148 ) (52.4 )
Loss on early
extinguishment
of debt 744 - 744 NM 744 - 744 NM
Total operating
expense $ 15,431 $ 15,273 $ 158 1.0 $ 31,327 $ 30,510 $ 817 2.7
Net interest
income 18,888 16,852 2,036 12.1 $ 35,937 $ 34,606 $ 1,331 3.8
Total
non-interest
income 6,319 5,805 514 8.9 12,733 10,443 2,290 21.9
Less:
Net loss on sale
of securities - (1 ) 1 NM (4 ) (1 ) (3 ) NM
Total operating
revenue $ 25,207 $ 22,658 $ 2,549 11.2 $ 48,674 $ 45,050 $ 3,624 8.0
Pre-tax,
pre-provision
adjusted
earnings $ 9,776 $ 7,385 $ 2,391 32.4 $ 17,347 $ 14,540 $ 2,807 19.3
Efficiency ratio 61.22 % 67.41 % 64.36 % 67.72 %
NM = Not Meaningful
Net Interest Income
Net interest income levels depend on the amount of and yield on interest-earning
assets as compared to the amount of and rate paid on interest-bearing
liabilities. Net interest income is sensitive to changes in market rates of
interest and the asset/liability management processes to prepare for and respond
to such changes.
The following table provides information with respect to (1) the change in net
interest income attributable to changes in rate (changes in rate multiplied by
prior volume) and (2) the change in net interest income attributable to changes
in volume (changes in volume multiplied by prior rate) for the three and six
months ended June 30, 2020 compared to the same period in 2019. The change in
net interest income attributable to changes in rate and volume (changes in rate
multiplied by changes in
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volume) has been allocated to the rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.
Increase (Decrease) for the Three Months Ended Increase (Decrease) for the Six Months Ended June
June 30, 30,
2020 Compared to 2019 2020 Compared to 2019
Rate Volume Net Rate Volume Net
(In Thousands)
Interest-earning assets
Commercial real estate and other
mortgage loans(1) $ (2,972 ) $ 667 $ (2,305 ) $ (4,654 ) $ 1,183 $ (3,471 )
Commercial and industrial
loans(1) (3,364 ) 3,234 (130 ) (5,495 ) 4,384 (1,111 )
Direct financing leases(1) 122 (51 ) 71 (64 ) (84 ) (148 )
Consumer and other loans(1) (55 ) 63 8 (83 ) 99 16
Total loans and leases
receivable (6,269 ) 3,913 (2,356 ) (10,296 ) 5,582 (4,714 )
Mortgage-related securities (186 ) 74 (112 ) (267 ) 277 10
Other investment securities (1 ) 8 7 7 (29 ) (22 )
FHLB and FRB Stock (9 ) 50 41 83 73 156
Short-term investments (223 ) 95 (128 ) (422 ) 135 (287 )
Total net change in income on
interest-earning assets (6,688 ) 4,140 (2,548 ) (10,895 ) 6,038 (4,857 )
Interest-bearing liabilities
Transaction accounts (1,075 ) 377 (698 ) (1,508 ) 586 (922 )
Money market accounts (2,680 ) 198 (2,482 ) (3,791 ) 655 (3,136 )
Certificates of deposit (170 ) (228 ) (398 ) (231 ) (375 ) (606 )
Wholesale deposits 114 (870 ) (756 ) 359 (1,709 ) (1,350 )
Total deposits (3,811 ) (523 ) (4,334 ) (5,171 ) (843 ) (6,014 )
FHLB advances (3,062 ) 2,834 (228 ) (1,039 ) 926 (113 )
Federal reserve PPP lending
facility - 18 18 - 18 18
Other borrowings (44 ) 4 (40 ) (85 ) 3 (82 )
Junior subordinated notes - - - 2 1 3
Total net change in expense on
interest-bearing liabilities (6,917 ) 2,333 (4,584 ) (6,293 ) 105 (6,188 )
Net change in net interest
income $ 229 $ 1,807 $ 2,036 $ (4,602 ) $ 5,933 $ 1,331
(1) The average balances of loans and leases include non-accrual loans and
leases and loans held for sale.
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The table below shows our average balances, interest, average yields/rates, net interest margin, and the spread between the combined average yields earned on interest-earning assets and average rates on interest-bearing liabilities for the three and six months endedJune 30, 2020 and 2019. The average balances are derived from average daily balances. For the Three Months Ended June 30, 2020 2019 Average Average Average Average Balance Interest Yield/Rate(4) Balance Interest Yield/Rate(4) (Dollars in Thousands) Interest-earning assets Commercial real estate and other mortgage loans(1)$ 1,192,530 $ 12,450 4.18 %$ 1,139,036 $ 14,755 5.18 % Commercial and industrial loans(1) 726,862 8,347 4.59 493,093 8,477 6.88 Direct financing leases(1) 27,115 395 5.83 31,610 324 4.10 Consumer and other loans(1) 36,614 356 3.89 30,555 348 4.56 Total loans and leases receivable(1) 1,983,121 21,548 4.35 1,694,294 23,904 5.64 Mortgage-related securities(2) 174,113 912 2.10 161,827 1,024 2.53 Other investment securities(3) 30,194 158 2.09 28,723 151 2.10 FHLB and FRB stock 10,301 127 4.93 6,875 86 5.00 Short-term investments 61,030 16 0.10 22,570 144 2.55 Total interest-earning assets 2,258,759 22,761 4.03 1,914,289 25,309 5.29 Non-interest-earning assets 167,008 110,516 Total assets$ 2,425,767 $ 2,024,805 Interest-bearing liabilities Transaction accounts$ 368,844 291 0.32$ 234,241 989 1.69 Money market accounts 637,714 368 0.23 593,431 2,850 1.92 Certificates of deposit 123,581 627 2.03 164,537 1,025 2.49 Wholesale deposits 105,597 638 2.42 251,060 1,394 2.22 Total interest-bearing deposits 1,235,736 1,924 0.62 1,243,269 6,258 2.01 FHLB advances 409,281 1,283 1.25 266,137 1,511 2.27 Federal reserve PPPLF 20,821 18 0.35 - - - Other borrowings 24,681 371 6.01 24,463 411 6.72 Junior subordinated notes 10,052 277 11.02 10,038 277 11.04 Total interest-bearing liabilities 1,700,571 3,873 0.91 1,543,907 8,457 2.19 Non-interest-bearing demand deposit accounts 440,413 254,177 Other non-interest-bearing liabilities 86,504 40,110 Total liabilities 2,227,488 1,838,194 Stockholders' equity 198,279 186,611 Total liabilities and stockholders' equity$ 2,425,767 $ 2,024,805 Net interest income$ 18,888 $ 16,852 Interest rate spread 3.12 % 3.10 % Net interest-earning assets$ 558,188 $ 370,382 Net interest margin 3.34 % 3.52 % Average interest-earning assets to average interest-bearing liabilities 132.82 % 123.99 % Return on average assets(4) 0.55 1.30 Return on average equity(4) 6.70 14.09 Average equity to average assets 8.17 9.22 Non-interest expense to average assets(4) 3.02 3.45 (1) The average balances of loans and leases include non-accrual loans and
leases and loans held for sale. Interest income related to non-accrual
loans and leases is recognized when collected. Interest income includes
net loan fees collected in lieu of interest.
(2) Includes amortized cost basis of assets available-for-sale and
held-to-maturity.
(3) Yields on tax-exempt municipal securities are not presented on a
tax-equivalent basis in this table.
(4) Represents annualized yields/rates.
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For the Six Months Ended June 30,
2020 2019
Average Average Average Average
Balance Interest Yield/Rate(4) Balance Interest Yield/Rate(4)
(Dollars in Thousands)
Interest-earning assets
Commercial real estate and
other mortgage loans(1) $ 1,173,251 $ 25,973 4.43 % $ 1,126,449 $ 29,444 5.23 %
Commercial and industrial
loans(1) 621,399 16,204 5.22 479,644 17,315 7.22
Direct financing leases(1) 27,538 503 3.65 31,927 651 4.08
Consumer and other
loans(1) 36,244 717 3.96 31,491 701 4.45
Total loans and leases
receivable(1) 1,858,432 43,397 4.67 1,669,511 48,111 5.76
Mortgage-related
securities(2) 177,352 1,973 2.22 153,981 1,963 2.55
Other investment
securities(3) 26,737 285 2.13 29,423 307 2.09
FHLB and FRB stock 9,407 331 7.04 6,965 175 5.03
Short-term investments 48,396 146 0.60 33,818 433 2.56
Total interest-earning
assets 2,120,324 46,132 4.35 1,893,698 50,989 5.39
Non-interest-earning
assets 144,991 103,196
Total assets $ 2,265,315 $ 1,996,894
Interest-bearing
liabilities
Transaction accounts $ 320,188 938 0.59 $ 224,873 1,860 1.65
Money market accounts 653,598 2,237 0.68 574,666 5,373 1.87
Certificates of deposit 128,791 1,377 2.14 162,082 1,983 2.45
Wholesale deposits 119,032 1,488 2.50 259,379 2,838 2.19
Total interest-bearing
deposits 1,221,609 6,040 0.99 1,221,000 12,054 1.97
FHLB advances 367,604 2,842 1.55 267,058 2,955 2.21
Federal reserve PPPLF 10,410 18 0.35 - - -
Other borrowings 24,533 740 6.03 24,456 822 6.72
Junior subordinated notes 10,050 555 11.04 10,036 552 11.00
Total interest-bearing
liabilities 1,634,206 10,195 1.25 1,522,550 16,383 2.15
Non-interest-bearing
demand deposit accounts 365,771 255,691
Other non-interest-bearing
liabilities 74,436 39,017
Total liabilities 2,074,413 1,817,258
Stockholders' equity 190,902 179,636
Total liabilities and
stockholders' equity $ 2,265,315 $ 1,996,894
Net interest income $ 35,937 $ 34,606
Interest rate spread 3.10 % 3.23 %
Net interest-earning
assets $ 486,118 $ 371,148
Net interest margin 3.39 % 3.66 %
Average interest-earning
assets to average
interest-bearing
liabilities 129.75 % 124.38 %
Return on average
assets(4) 0.58 1.25
Return on average
equity(4) 6.92 13.89
Average equity to average
assets 8.43 9.00
Non-interest expense to
average assets 3.04 3.53
(1) The average balances of loans and leases include non-accrual loans and
leases and loans held for sale. Interest income related to non-accrual
loans and leases is recognized when collected. Interest income includes
net loan fees collected in lieu of interest.
(2) Includes amortized cost basis of assets available-for-sale and
held-to-maturity.
(3) Yields on tax-exempt municipal securities are not presented on a
tax-equivalent basis in this table.
(4) Represents annualized yields/rates.
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Comparison of Net Interest Income for the Three and Six Months Ended
2020 and 2019
Net interest income increased $2.0 million , or 12.1%, during the three months
ended June 30, 2020 compared to the three months ended June 30, 2019 . The
increase in net interest income reflected a reduction in the rate paid on
deposits, interest income received from PPP loans, and an increase in fees
collected in lieu of interest, partially offset by a decrease in the yield on
loans and leases. Fees in lieu of interest, which can vary from quarter to
quarter, totaled $2.3 million , compared to $1.2 million . Excluding fees in lieu
of interest, interest income from PPP loans, and interest expense from Federal
Reserve PPPLF advances, net interest income increased $364,000 , or 2.3%. Average
gross loans and leases for the three months ended June 30, 2020 increased $288.8
million , or 17.0%, compared to the three months ended June 30, 2019 . Excluding
PPP loans and lines of credit, average gross loans and leases for the three
months ended June 30, 2020 increased $113.0 million , or 8.1%, compared to the
three months ended June 30, 2019 . Net interest income for the six months ended
June 30, 2020 increased $1.3 million , or 3.8%, compared to the six months ended
June 30, 2019 . The increase in net interest income reflected a reduction in the
rate paid on deposits and interest income received from PPP loans, partially
offset by lower loan yields and a decrease in fees collected in lieu of
interest. Fees in lieu of interest totaled $3.1 million for the six months ended
June 30, 2020 compared to $3.5 million in the prior year period. Excluding fees
in lieu of interest, interest income from PPP loans, and interest expense from
Federal Reserve PPPLF advances, net interest income for the six months ended
June 30, 2020 increased $1.2 million , or 3.9%. Average gross loans and leases
for the six months ended June 30, 2020 increased $188.9 million , or 11.3%,
compared to the six months ended June 30, 2019 . Excluding PPP loans and lines of
credit, average gross loans and leases for the six months ended June 30, 2020
increased $107.8 million , or 15.6% annualized, compared to the six months ended
June 30, 2019 .
The yield on average loans and leases for the three and six months ended
June 30, 2020 declined to 4.35% and 4.67%, respectively, compared to 5.64% and
5.76% for the three and six months ended June 30, 2019 , respectively. Both
periods were impacted by fees collected in lieu of interest and the current
period was impacted by PPP loan interest income. Without the impact of these
fees and PPP loan interest income, the yield on average loans and leases
excluding PPP loans for the three and six months ended June 30, 2020 was 4.33%
and 4.59%, respectively, compared to 5.36% and 5.34% for the three and six
months ended, June 30, 2019 , respectively. Similarly, the yield on average
interest-earning assets for the three and six months ended June 30, 2020
measured 4.03% and 4.35%, respectively, compared to 5.29% and 5.39% for the
three and six months ended June 30, 2019 , respectively. Excluding fees collected
in lieu of interest and PPP loan interest income, the yield on average
interest-earning assets excluding PPP loans for the three and six months ended
June 30, 2020 was 3.97% and 4.26%, respectively, compared to 5.03% and 5.01% for
the three and six months ended June 30, 2019 , reflecting a decrease in LIBOR and
Prime.
The average rate paid on total interest-bearing liabilities for the three and
six months ended June 30, 2020 decreased to 0.91% and 1.25%, respectively,
compared to 2.19% and 2.15% for the three and six months ended June 30, 2019 ,
respectively. Total interest-bearing liabilities include interest-bearing
deposits, federal funds purchased, FHLB advances, Federal Reserve PPPLF
advances, subordinated and junior subordinated notes payable, and other
borrowings.
The average rate paid on total in-market deposits - comprised of all transaction
accounts, money market accounts, and non-wholesale deposits - for the three and
six months ended June 30, 2020 decreased to 0.33% and 0.62%, respectively, down
from 1.56% and 1.51%, for the three and six months ended June 30, 2019 ,
respectively. The average rate paid on total in-market deposits declined as the
Corporation decreased deposit rates in response to the Federal Open Market
Committee's ("FOMC") decision to decrease the target federal funds rate 225
basis points from July 2019 to June 2020 . The average target federal funds rate
decreased 234 basis points.
Consistent with the Corporation's longstanding funding strategy to manage
interest rate risk and match fund long-term, fixed-rate loans, wholesale funds
are used at various maturity terms to meet the Corporation's funding needs.
Average FHLB advances for the three months ended June 30, 2020 increased $143.1
million to $409.3 million at an average rate paid of 1.25%, compared to $266.1
million at an average rate paid of 2.27% for the three months ended June 30,
2019 . Average FHLB advances for the six months ended June 30, 2020 increased
$100.5 million to $367.6 million at an average rate paid of 1.55%, compared to
$267.1 million at an average rate paid of 2.21% for the six months ended
June 30, 2019 . As of June 30, 2020 , the weighted average original maturity of
our FHLB term advances was 5.3 years. Average wholesale deposits, consisting
of brokered certificates of deposit and deposits gathered from internet listing
services, for the three months ended June 30, 2020 decreased $145.5
million to $105.6 million at an average rate paid of 2.42%, compared to $251.1
million at an average rate paid of 2.22%. Average wholesale deposits for the six
months ended June 30, 2020 decreased $140.3 million to $119.0 million at an
average rate paid of 2.50%, compared to $259.4 million at an average rate paid
of 2.19% for the six months ended June 30, 2019 . The existing wholesale deposit
portfolio is maturing and being replaced, as needed, by lower cost FHLB advances
to match fund long-term, fixed-rate loans. As of June 30, 2020 , the weighted
average original maturity of our wholesale deposits was 4.6 years.
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The average rate paid on total bank funding for the three and six months endedJune 30, 2020 decreased to 0.61% and 0.91%, respectively, compared to 1.76% and 1.72% for the three and six months endedJune 30, 2019 . Total bank funding is defined as total deposits plus FHLB advances and Federal Reserve PPPLF advances. Net interest margin decreased 18 basis points to 3.34% for the three months endedJune 30, 2020 compared to 3.52% for the three months endedJune 30, 2019 . The decrease was primarily due to the decrease in the average yield on loans and leases receivable, partially offset by a decrease in the average rate paid on in-market deposits and wholesale funding and increase in fees collected in lieu of interest. Excluding fees collected in lieu of interest and PPP loan interest income, net interest margin measured 3.33% for the second quarter of 2020, compared to 3.31% in the second quarter of 2019. Net interest margin decreased 27 basis points to 3.39% for the six months endedJune 30, 2020 compared to 3.66% for the six months endedJune 30, 2019 . The decrease was primarily due to the decrease in average yield on loans and leases receivable and a decrease in fees in lieu of interest. These unfavorable variances were partially offset by a decrease in the average rate paid on in-market deposits and wholesale funding. Excluding fees collected in lieu of interest and PPP loan interest income, net interest margin measured 3.33% for the six months endedJune 30, 2020 andJune 30, 2019 . The Corporation incurred a$744,000 loss, recognized through non-interest expense, on the early extinguishment of$59.5 million in FHLB term advances late in the second quarter of 2020, as the Corporation lowered wholesale funding costs and improved the Corporation's funding position. Management believes this strategy will help stabilize net interest margin with the expectation of a low interest rate environment for an extended period of time. Management believes its success in growing in-market deposits, disciplined loan pricing, and increased production in our higher-yielding specialty finance lines of business will allow the Corporation to achieve a net interest margin of at least 3.50%, on average. However, the collection of loan fees in lieu of interest is an expected source of volatility to quarterly net interest income and net interest margin, particularly given the nature of the Corporation's asset-based lending business and the Corporation's participation in the PPP. Net interest margin may also experience volatility due to events such as the collection of interest on loans previously in non-accrual status or the accumulation of significant short-term deposit inflows. Provision for Loan and Lease Losses We determine our provision for loan and lease losses pursuant to our allowance for loan and lease loss methodology, which is based on the magnitude of current and historical net charge-offs recorded throughout the established look-back period, the evaluation of several qualitative factors for each portfolio category, and the amount of specific reserves established for impaired loans that present collateral shortfall positions. Refer to Allowance for Loan and Lease Losses, below, for further information regarding our allowance for loan and lease loss methodology. The full impact of COVID-19 is unknown and rapidly evolving. It has caused substantial disruption in international andU.S. economies, markets, and employment. The outbreak is having a significant adverse impact on certain industries the Corporation serves, including retail, hospitality, entertainment, and restaurants and food services. Due to COVID-19 and the economic impact it could have on the Corporation's loan portfolio, additional detail about certain exposure to stressed industries is included in the section titled COVID-19 Update, above. Based on management's current assessment of the increased inherent risk in the loan portfolio, the allowance for loan and leases losses increased$7.9 million , or 40.7%, compared toDecember 31, 2019 . The provision for loan and lease losses totaled$5.5 million and$8.7 million for the three and six months endedJune 30, 2020 , respectively, compared to a provision benefit of$784,000 and$736,000 for the three and six months endedJune 30, 2019 , respectively. For the six months endedJune 30, 2020 , the increase in the allowance for loan and lease losses was in large part due to an increase in several qualitative factors after careful evaluation by management. Most notably, a$4.3 million increase was due to the economic conditions caused by the pandemic, including the increase in the unemployment rate, and an additional$953,000 stemmed from the other qualitative factors, such as management's ongoing review and grading of the loan and lease portfolios, consideration of delinquency experience, and the level of loans and leases subject to more frequent review by management. Additionally, an increase in specific reserves of$2.1 million was driven by deterioration of two existing legacy SBA impaired relationships. The legacy on-balance sheet SBA portfolio, defined as SBA 7(a) and Express loans originated in 2016 and prior, has been a source of elevated non-performing assets. Additional information on our legacy SBA portfolio is as follows: 50
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As of
June 30, March 31, June 30,
2020 2020 2019
(In Thousands)
Performing loans:
Off-balance sheet loans $ 28,843 $ 31,212 $ 44,385
On-balance sheet loans 16,554 17,935 23,406
Gross loans 45,397 49,147 67,791
Non-performing loans:
Off-balance sheet loans 1,640 4,887 8,294
On-balance sheet loans 9,725 13,833 16,940
Gross loans 11,365 18,720 25,234
Total loans:
Off-balance sheet loans 30,483 36,099 52,679
On-balance sheet loans 26,279 31,768 40,346
Gross loans $ 56,762 $ 67,867 $ 93,025
The addition of specific reserves on impaired loans represent new specific
reserves established when collateral shortfalls or government guaranty
deficiencies are present, while conversely the release of specific reserves
represent the reduction of previously established reserves that are no longer
required. Changes in the allowance for loan and lease losses due to subjective
factor changes reflect management's evaluation of the level of risk within the
portfolio based upon several factors for each portfolio segment. Charge-offs in
excess of previously established specific reserves require an additional
provision for loan and lease losses to maintain the allowance for loan and lease
losses at a level deemed appropriate by management. This amount is net of the
release of any specific reserve that may have already been provided. Change in
the inherent risk of the portfolio is primarily influenced by the overall growth
in gross loans and leases and an analysis of loans previously charged off, as
well as movement of existing loans and leases in and out of an impaired loan
classification where a specific evaluation of a particular credit may be
required rather than the application of a general reserve loss rate. Refer
to Asset Quality, below, for further information regarding the overall credit
quality of our loan and lease portfolio.
Because of the significant uncertainties related to the ultimate duration of the
COVID-19 pandemic and its potential effects on clients and prospects, and on the
national and local economy as a whole, there can be no assurances as to how the
crisis may ultimately affect the Corporation's loan portfolio.
Comparison of Non-Interest Income for the Three and Six Months Ended
2020 and 2019
Non-Interest Income
Non-interest income primarily consists of fees earned for private wealth
management services, gains on sale of SBA loans, service charges on deposits,
loan fee income, and commercial loan interest rate swap fee income. For the
three months ended June 30, 2020 non-interest income increased by $514,000 , or
8.9%, to $6.3 million from $5.8 million for the same period in 2019. For the six
months ended June 30, 2020 non-interest income increased $2.3 million , or 21.9%,
to $12.7 million from $10.4 million for the same period in 2019. Management
continues to focus on revenue growth from multiple non-interest income sources
in order to maintain a diversified revenue stream through greater contribution
from fee-based revenues. Total non-interest income accounted for 25.1% and 26.2%
of our total revenues for the three and six months ended June 30, 2020 ,
respectively, compared to 25.6% and 23.2% for the three and six months ended
June 30, 2019 , respectively. Management believes the expected gradual expansion
of our SBA lending program, fees from commercial loan interest rate swap
activity with our commercial borrowers, and the geographic expansion of our
private wealth management division will allow us to sustain our strategic target
of 25% over the long-term.
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The components of non-interest income were as follows:
For the Three Months Ended June 30, For the Six Months Ended June 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
(Dollars in Thousands)
Private wealth
management service
fees $ 2,124 $ 2,138 $ (14 ) (0.7 )%
574 297 277 93.3 839 539 300 55.7
Service charges on
deposits 829 743 86 11.6 1,647 1,520 127 8.4
Loan fees 451 464 (13 ) (2.8 ) 936 877 59 6.7
Increase in cash
surrender value of
bank-owned life
insurance 377 297 80 26.9 672 589 83 14.1
Net loss on sale of
securities - (1 ) 1 NM (4 ) (1 ) (3 ) NM
Commercial loan swap
fees 1,655 1,051 604 57.5 3,336 1,523 1,813 NM
Other non-interest
income 309 816 (507 ) (62.1 ) 1,072 1,331 (259 ) (19.5 )
Total non-interest
income $ 6,319 $ 5,805 $ 514 8.9 $ 12,733 $ 10,443 $ 2,290 21.9
Fee income ratio(1) 25.1 % 25.6 % 26.2 % 23.2 %
(1) Fee income ratio is total non-interest income, per the above table,
divided by top line revenue (defined as net interest income plus
non-interest income).
Private wealth management service fees decreased $14,000 , or 0.7%, and increased
$170,000 , or 4.2% for the three and six months ended June 30, 2020 ,
respectively, compared to the three and six months ended June 30, 2019 . The
decrease for the three month comparison period was mainly driven by a decline in
equity market values stemming from the COVID-19 pandemic. The increase in the
six month comparison period was driven by growth in assets under management and
administration attributable to new client relationships. As of June 30, 2020 ,
trust assets under management and administration totaled $1.873 billion ,
decreasing $18.8 million , or 1.0%, compared to $1.892 billion as of December 31,
2019 and increasing $118.4 million , or 6.7%, compared to $1.755 billion as of
June 30, 2019 .
Commercial loan interest rate swap fee income was $1.7 million and $3.3 million
for the three and six months ended June 30, 2020 , respectively, compared to $1.1
million and $1.5 million for the three and six months ended June 30, 2019 ,
respectively. Interest rate swaps continue to be an attractive product for the
Bank's commercial borrowers, although associated fee income can vary period to
period based on client demand and the interest rate environment in any given
quarter.
Gains on sale of SBA loans increased $277,000 , or 93.3%, and increased $300,000 ,
or 55.7%, for the three and six months ended June 30, 2020 , respectively,
compared to the three and six months ended June 30, 2019 . The Corporation's
pipeline continues to grow period over period and management believes the gain
on sale of traditional SBA loans (i.e., SBA loans unrelated to PPP loans) will
increase at a measured pace over time. Loans held for sale, consisting entirely
of SBA loans closed but not fully funded, increased $7.3 million , or 116.0%, to
$13.7 million compared to March 31, 2020 .
Other non-interest income for the three and six months ended June 30, 2020
totaled $309,000 and $1.1 million , respectively, compared to $816,000 and $1.3
million , respectively, for three and six months ended June 30, 2019 . Decreases
in both periods of comparison were primarily due to gains recognized on
end-of-term buyout agreements from the Corporation's equipment financing
business line during the three months ended June 30, 2019 .
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Comparison of Non-Interest Expense for the Three and Six Months Ended
2020 and 2019
Non-Interest Expense
The components of non-interest expense were as follows:
For the Three Months Ended June 30, For the Six Months Ended June 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
(Dollars in Thousands)
Compensation $ 10,796 $ 10,503 $ 293 2.8 % $ 21,848 $ 20,667 $ 1,181 5.7 %
Occupancy 554 559 (5 ) (0.9 ) 1,126 1,149 (23 ) (2.0 )
Professional fees 859 784 75 9.6 1,678 1,994 (316 ) (15.8 )
Data processing 710 689 21 3.0 1,386 1,269 117 9.2
Marketing 352 581 (229 ) (39.4 ) 813 1,063 (250 ) (23.5 )
Equipment 304 272 32 11.8 595 661 (66 ) (10.0 )
Computer software 966 827 139 16.8 1,856 1,626 230 14.1
FDIC insurance 239 302 (63 ) (20.9 ) 448 595 (147 ) (24.7 )
Collateral
liquidation costs
(recovery) 115 89 26 29.2 236 (1 ) 237 NM
Net loss (gain) on
foreclosed
properties 348 (21 ) 369 NM 450 (21 ) 471 NM
Tax credit
investment
impairment 1,841 2,088 (247 ) (11.8 ) 1,954 4,102 (2,148 ) (52.4 )
SBA recourse
(benefit) provision (30 ) 113 (143 ) NM (5 ) 594 (599 ) NM
Loss on early
extinguishment of
debt 744 - 744 NM 744 - 744 NM
Other non-interest
expense 545 678 (133 ) (19.6 ) 1,359 1,508 (149 ) (9.9 )
Total non-interest
expense $ 18,343 $ 17,464 $ 879 5.0 $ 34,488 $ 35,206 $ (718 ) (2.0 )
Total operating
expense(1) $ 15,431 $ 15,273 $ 158 1.0 $ 31,327 $ 30,510 $ 817 2.7
Full-time
equivalent
employees 283 275 283 275
(1) Total operating expense represents total non-interest expense, adjusted to
exclude the impact of discrete items as previously defined in the non-GAAP
efficiency ratio calculation, above.
Non-interest expense for the three months endedJune 30, 2020 increased by$879,000 , or 5.0%, to$18.3 million compared to$17.5 million for the same period in 2019. Non-interest expense for the six months endedJune 30, 2020 decreased by$718,000 , or 2.0%, to$34.5 million compared to$35.2 million for the same period in 2019. Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table above, increased$158,000 , or 1.0%, to$15.4 million for the three months endedJune 30, 2020 compared to$15.3 million for the same period in 2019. Operating expense increased$817,000 , or 2.7%, to$31.3 million compared to$30.5 million for the same period in 2019. The increase in operating expense for both periods of comparison was primarily due to an increase in compensation expense and collateral liquidation costs, partially offset by a decrease in general business-related expenses due to the Corporation's adherence to COVID-19 stay-at-home orders. Compensation expense for the three months endedJune 30, 2020 was$10.8 million , an increase of$293,000 , or 2.8%, compared to the three months endedJune 30, 2019 . Compensation expense for six months endedJune 30, 2020 was$21.8 million , an increase of$1.2 million , or 5.7%, compared to the six months endedJune 30, 2019 . The increase in compensation expense in both periods of comparison reflects an increase in employees and annual merit increases. Average full-time equivalent employees were 281 for the quarter endedJune 30, 2020 compared to 274 for the quarter endedJune 30, 2019 . Collateral liquidation costs increased$26,000 to$115,000 for the three monthsJune 30, 2020 compared to$89,000 for the three months endedJune 30, 2019 , and increased$237,000 to$236,000 for the six months endedJune 30, 2020 compared to a recovery of$1,000 for the six months endedJune 30, 2019 . The first half of 2019 included the recovery of various workout expenses following the successful resolution of an impaired asset-based loan relationship. 53
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Tax credit investment impairment expense was$1.8 million and$2.0 million for the three and six months endedJune 30, 2020 , respectively, compared to$2.1 million and$4.1 million for the three and six months endedJune 30, 2019 , respectively. During the second quarter of 2020, the Corporation recognized a total of$1.7 million in expense due to the impairment of in-market federal historic tax credit investments, which corresponded with the recognition of a$2.5 million in tax credits during the quarter. During the six months endedJune 30, 2019 , the Corporation recognized$3.9 million in expense due to the impairment of in-market federal historic tax credit investments, which corresponded with the recognition of$5.3 million in tax credits. Management intends to continue actively pursuing in-market tax credit opportunities throughout 2020 and beyond. SBA recourse benefit was$30,000 and$5,000 for the three and six months endedJune 30, 2020 , respectively, compared to recourse provision of$113,000 and$594,000 for the three and six months endedJune 30, 2019 , respectively. The decrease for the three and six months endedJune 30, 2020 was primarily due to the declining balance of the outstanding legacy SBA loan sold portfolio and a reduction in the historic loss rate applied to the portfolio. Changes to SBA recourse reserves may be a source of non-interest expense volatility in future quarters, though the magnitude of this volatility should diminish over time as the outstanding balance of sold legacy SBA loans continues to decline. The total recourse reserve balance was$1.0 million , or 1.4% of total sold SBA loans outstanding, atJune 30, 2020 , compared to$1.3 million , or 1.8%, atDecember 31, 2019 , and$2.1 million , or 2.7%, atJune 30, 2019 . Income Taxes Income tax benefit totaled$1.1 million for the six months endedJune 30, 2020 compared to an income tax benefit of$1.9 million for the six months endedJune 30, 2019 . The income tax benefit for the six months endedJune 30, 2020 primarily reflects the recognition of$2.5 million in tax credits which correspond with the$1.7 million impairment of relationship-based historic tax credit investments during the same period. The income tax benefit for the six months endedJune 30, 2019 primarily reflects the recognition of$5.3 million in federal historic tax credits, which correspond with the$3.9 million impairment of relationship-based historic tax credit investments during the same period. The effective tax rate for the six months endedJune 30, 2020 , excluding the discrete items, was 18.5%. Generally, the provision for income taxes is determined by applying an estimated annual effective income tax rate to income before taxes and adjusting for discrete items. The rate is based on the most recent annualized forecast of pre-tax income, book versus tax differences and tax credits, if any. If we conclude that a reliable estimated annual effective tax rate cannot be determined, the actual effective tax rate for the year-to-date period may be used. We re-evaluate the income tax rates each quarter. Therefore, the current projected effective tax rate for the entire year may change. Financial Condition
General
Total assets increased by$372.0 million , or 17.7%, to$2.469 billion as ofJune 30, 2020 compared to$2.097 billion atDecember 31, 2019 . The increase in total assets was primarily driven by PPP loan growth. Short-Term Investments Short-term investments decreased by$23.2 million , or 45.4%, to$27.8 million atJune 30, 2020 from$51.0 million atDecember 31, 2019 . Our short-term investments primarily consist of interest-bearing deposits held at the FRB and commercial paper. We value the safety and soundness provided by the FRB and therefore incorporate short-term investments in our on-balance sheet liquidity program. As ofJune 30, 2020 , we did not hold any commercial paper and as ofDecember 31, 2019 , our total investment in commercial paper was$5.9 million . Due to current economic conditions, we decided to temporarily exit this short-term investment. We approach our decisions to purchase commercial paper with similar rigor and underwriting standards as applied to our loan and lease portfolio. The original maturities of the commercial paper are usually 60 days or less and provide an attractive yield in comparison to other short-term alternatives. These investments also assist us in maintaining a shorter duration of our overall investment portfolio which we believe is necessary to be in a position to benefit from an anticipated change in the yield curve level and shape. In general, the level of our short-term investments will be influenced by the timing of deposit gathering, scheduled maturities of wholesale deposits, funding of loan and lease growth when opportunities are presented, and the level of our securities portfolio. Please refer to the section titled Liquidity and Capital Resources for further discussion. 54
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Securities
Total securities, including available-for-sale and held-to-maturity, decreased by$4.3 million , or 2.1%, to$201.5 million atJune 30, 2020 compared to$205.8 million atDecember 31, 2019 . During the six months endedJune 30, 2020 , due to declining interest rates, we recognized unrealized gains of$4.2 million before income taxes through other comprehensive income. As ofJune 30, 2020 andDecember 31, 2019 , our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted-average expected maturity of 3.7 years and 4.4 years, respectively. Generally, our investment philosophy remains as stated in our most recent Annual Report on Form 10-K. We use a third-party pricing service as our primary source of market prices for our securities portfolio. On a quarterly basis, we validate the reasonableness of prices received from this source through independent verification, data integrity validation primarily through comparison of current price to an expectation-based analysis of movement in prices based upon the changes in the related yield curves, and other market factors. No securities within our portfolio were deemed to be other-than-temporarily impaired as ofJune 30, 2020 . Loans and Leases Receivable Loans and leases receivable, net of allowance for loan and lease losses, increased by$334.3 million to$2.029 billion atJune 30, 2020 from$1.695 billion atDecember 31, 2019 which was driven by the aforementioned PPP loan growth. Loans and leases receivable, net of PPP loans and the allowance for loan and lease losses, increased by$6.4 million , or 0.4%, to$1.701 billion atJune 30, 2020 fromDecember 31, 2019 . Total commercial real estate ("CRE") contributed to growth, increasing$68.1 million to$1.222 billion from$1.154 billion atDecember 31, 2019 . Multifamily and construction loans were the largest contributors to CRE loan growth as ofJune 30, 2020 , increasing$27.2 million and$24.3 million , respectively fromDecember 31, 2019 . Commercial and industrial ("C&I") loans increased$277.8 million to$781.2 million from$503.4 million atDecember 31, 2019 . Excluding PPP loans, C&I loans decreased$50.1 million to$453.3 million from$503.4 million atDecember 31, 2019 . There continues to be a concentration in CRE loans, however, in general our composition of total loans and leases has remained relatively consistent due to balanced growth across our product offerings. CRE loans represented 70.3% and 67.3% of our total loans, excluding PPP loans, as ofJune 30, 2020 andDecember 31, 2019 , respectively. As ofJune 30, 2020 , 18.8% of the CRE loans were owner-occupied CRE, compared to 19.6% as ofDecember 31, 2019 . We consider owner-occupied CRE more characteristic of the Corporation's C&I portfolio as, in general, the client's primary source of repayment is the cash flow from the operating entity occupying the commercial real estate property. As mentioned above, excluding PPP loans, our C&I portfolio decreased$50.1 million , or 10.0%, to$453.3 million atJune 30, 2020 from$503.4 million atDecember 31, 2019 . Line of credit usage was$212.6 million as ofJune 30, 2020 , down from$281.4 million atDecember 31, 2019 , as line of credit usage significantly declined due to PPP loan proceeds. We will continue to emphasize actively pursuing C&I loans across the Corporation as this segment of our loan and lease portfolio provides an attractive yield commensurate with an appropriate level of credit risk and creates opportunities for in-market deposit, treasury management, and private wealth management relationships which generate additional fee revenue. While we continue to experience significant competition from banks operating in our primary geographic areas, we remain committed to our underwriting standards and will not deviate from those standards for the sole purpose of growing our loan and lease portfolio. We continue to believe our new loan and lease activity to be adequate to replace normal amortization, allowing us to continue growing in future quarters, although this will temporarily be more challenging due to the current economic conditions. The types of loans and leases we originate and the various risks associated with these originations remain consistent with information previously outlined in our most recent Annual Report on Form 10-K. Non -accrual loans increased$3.5 million , or 16.9%, to$24.1 million atJune 30, 2020 , compared to$20.6 million atDecember 31, 2019 . The increase in non-accrual loans was principally due to the impairment of one$5.0 million commercial relationship and the repurchase of$3.6 million of impaired legacy SBA loans, partially offset by the$4.0 million payoff of two impaired legacy SBA loan relationships. The Corporation's non-accrual loans as a percentage of total gross loans and leases measured 1.17% and 1.20% atJune 30, 2020 andDecember 31, 2019 , respectively. Non-accrual loans as a percentage of total gross loans and leases, excluding PPP loans, was 1.39% atJune 30, 2020 . Please refer to the sections titled COVID-19 Update and Asset Quality for additional information on credit quality. 55
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Deposits
As ofJune 30, 2020 , deposits increased by$180.0 million , or 11.8% to$1.710 billion from$1.530 billion atDecember 31, 2019 primarily due to a$279.5 million increase in transaction accounts partially offset by decreases of$61.7 million and$17.7 million in wholesale deposits and money market accounts, respectively. Transaction account balances were inflated as ofJune 30, 2020 due to PPP loan proceeds. Management attributes the recent transition from money market accounts to reciprocal transaction accounts with fullFDIC insurance to our clients' preferences for safety and soundness versus interest rate amid the economic uncertainty created by the COVID-19 pandemic. Period-end deposit balances associated with in-market relationships will fluctuate based upon maturity of time deposits, client demands for the use of their cash, and our ability to maintain existing and new client relationships. Our strategic efforts remain focused on adding in-market deposit relationships. We measure the success of in-market deposit gathering efforts based on the number and average balances of our deposit accounts as compared to ending balances due to the volatility of some of our larger relationships. The Bank's average in-market deposits, consisting of all transaction accounts, money market accounts, and certificates of deposit, were approximately$1.468 billion , or 74.7% of total bank funding for the six months endedJune 30, 2020 , compared to$1.271 billion , or 71.3% of total bank funding for the year endedDecember 31, 2019 . FHLB Advances and Other Borrowings As ofJune 30, 2020 , FHLB advances and other borrowings increased by$145.6 million , or 45.6%, to$465.0 million from$319.4 million atDecember 31, 2019 . While total wholesale funding as a percentage of total bank funding has decreased meaningfully overall due to significant in-market deposit growth, we continue to replace the majority of our maturing brokered certificates of deposit with FHLB advances at lower rates. Total bank funding is defined as total deposits plus FHLB advances, Federal Reserve Discount Window advances, and Federal Reserve PPPLF advances. The Corporation incurred a$744,000 loss, recognized through non-interest expense, on the early extinguishment of$59.5 million in FHLB term advances late in the second quarter of 2020, as the Corporation lowered wholesale funding costs and improved the Corporation's funding position. Management believes this strategy will help stabilize net interest margin with the expectation of a low interest rate environment for an extended period of time. During the second quarter of 2020, management tested the availability of the Federal Reserve PPPLF due to the uncertainty of when PPP loans would be required to close and fund. As ofJune 30, 2020 , the Corporation had one$29.6 million PPPLF advance outstanding. Consistent with our funding philosophy to manage interest rate risk, we will use the most efficient and cost effective source of wholesale funds. We will utilize FHLB advances to the extent we maintain an adequate level of excess borrowing capacity for liquidity and contingency funding purposes and pricing remains favorable in comparison to the wholesale deposit alternative. AtJune 30, 2020 , the ratio of wholesale funds to total bank funding was 24.7%. We will use FHLB advances and/or brokered certificates of deposit in specific maturity periods needed, typically three to five years, to match-fund fixed rate loans and effectively mitigate the interest rate risk measured through our asset/liability management process and to support asset growth initiatives while taking into consideration our operating goals and desired level of usage of wholesale funds. Please refer to the section titled Liquidity and Capital Resources, below, for further information regarding our use and monitoring of wholesale funds. 56
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Asset Quality
Impaired Assets
Total impaired assets consisted of the following at
June 30, December 31,
2020 2019
(Dollars in Thousands)
Non-accrual loans and leases
Commercial real estate:
Commercial real estate - owner occupied $ 7,503 $ 4,032
Commercial real estate - non-owner occupied - -
Land development 1,049 1,526
Construction - -
Multi-family - -
1-4 family 333 333
Total non-accrual commercial real estate 8,885 5,891
Commercial and industrial 15,034 14,575
Direct financing leases, net 49 -
Consumer and other:
Home equity and second mortgages - -
Other 127 147
Total non-accrual consumer and other loans 127
147
Total non-accrual loans and leases 24,095 20,613 Foreclosed properties, net 1,389 2,919 Total non-performing assets 25,484 23,532 Performing troubled debt restructurings 49
140
Total impaired assets$ 25,533
Total non-accrual loans and leases to gross loans and leases
1.17 % 1.20 % Total non-performing assets to gross loans and leases plus foreclosed properties, net
1.23 1.37
Total non-performing assets to total assets 1.03
1.12
Allowance for loan and lease losses to gross loans and leases
1.33 1.14
Allowance for loan and lease losses to non-accrual loans and leases
113.98 94.70
PPP loans outstanding as ofJune 30, 2020 , were$327.9 million . There were no PPP loans outstanding as ofDecember 31, 2019 . The asset quality ratios, excluding PPP loans as they are fully guaranteed by the SBA, atJune 30, 2020 andDecember 31, 2019 , were as follows:June 30 ,
2020 2019
Total non-accrual loans and leases to gross loans and leases
1.39 % 1.20 % Total non-performing assets to gross loans and leases plus foreclosed properties, net
1.47 1.37
Total non-performing assets to total assets 1.19
1.12
Allowance for loan and lease losses to gross loans and leases
1.58 1.14
As ofJune 30, 2020 andDecember 31, 2019 ,$16.3 million and$15.6 million of non-accrual loans and leases were considered troubled debt restructurings, respectively. This increase is the result of ongoing workout efforts on previously identified impaired loans and does not include any new troubled debt restructurings related to the COVID-19 pandemic. 57
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We use a wide variety of available metrics to assess the overall asset quality of the portfolio and no one metric is used independently to make a final conclusion as to the asset quality of the portfolio. Non-performing assets increased$2.0 million , or 8.3%, to$25.5 million atJune 30, 2020 from$23.5 million atDecember 31, 2019 . The increase in non-performing assets was principally due to the impairment of one$5.0 million commercial relationship and the repurchase of$3.6 million of impaired legacy SBA loans, partially offset by$4.0 million in payoffs on legacy SBA loans and a$1.5 million decrease in foreclosed properties, net of impairment, principally due to the sale of one legacy SBA property. We also monitor early stage delinquencies to assist in the identification of potential future problems. As ofJune 30, 2020 , 99.64% of the loan and lease portfolio, excluding non-accrual loans and leases, was in a current payment status, compared to 99.76% atDecember 31, 2019 . We also monitor asset quality through our established credit quality indicator categories. As we continue to actively monitor the credit quality of our loan and lease portfolios, we may identify additional loans and leases for which the borrowers or lessees are having difficulties making the required principal and interest payments based upon factors including, but not limited to, the inability to sell the underlying collateral, inadequate cash flow from the operations of the underlying businesses, liquidation events, or bankruptcy filings. We work proactively with our impaired loan borrowers to find solutions to difficult situations that are in the best interests of the Bank. 58
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The following represents additional information regarding our impaired loans and
leases:
As of and for the
As of and for the Six Months Ended Year Ended
June 30, December 31,
2020 2019 2019
(In Thousands)
Impaired loans and leases with no
impairment reserves required $ 10,742 $ 7,184 $ 7,312
Impaired loans and leases with
impairment reserves required 13,402 16,525 13,441
Total impaired loans and leases 24,144 23,709 20,753
Less: Impairment reserve (included in
allowance for loan and lease losses) 5,924 4,711 3,365
Net impaired loans and leases $ 18,220 $ 18,998 $ 17,388
Average impaired loans and leases $ 23,847 $ 24,252 $ 24,090
Foregone interest income attributable
to impaired loans and leases $ 1,114 $ 718 $ 2,693
Less: Interest income recognized on
impaired loans and leases 458 668 793
Net foregone interest income on
impaired loans and leases $ 656 $ 50 $ 1,900
Non-performing assets also include foreclosed properties. A summary of foreclosed properties activity is as follows:
As of and for the
Year Ended December
As of and for the Six Months Ended June 30, 31,
2020 2019 2019
(In Thousands)
Balance at the beginning of the period $ 2,919 $ 2,547 $ 2,547
Transfer of loans and leases to
foreclosed properties 80 - 596
Proceeds from sale of foreclosed
properties (1,160 ) - -
Net loss on sale of foreclosed
properties (54 ) - -
Impairment adjustments (396 ) - (224 )
Balance at the end of the period $ 1,389 $ 2,547 $ 2,919
Allowance for Loan and Lease Losses The allowance for loan and lease losses increased$7.9 million , or 40.7%, from$19.5 million as ofDecember 31, 2019 to$27.5 million as ofJune 30, 2020 . The allowance for loan and lease losses as a percentage of gross loans and leases also increased from 1.14% as ofDecember 31, 2019 to 1.33% as ofJune 30, 2020 . The allowance for loan and lease losses as a percentage of gross loans and leases, excluding PPP loans, was 1.58% as ofJune 30, 2020 . The increase in allowance for loan and lease losses as a percent of gross loans and leases was principally driven by COVID-19 and the economic impact it could have on the Corporation's loan portfolio. For the six months endedJune 30, 2020 , the increase in the allowance for loan and lease losses was in large part due to an increase in several qualitative factors after careful evaluation by management. Most notably, a$4.3 million increase was due to the economic conditions caused by the pandemic, including the increase in the unemployment rate, and an additional$953,000 stemmed from the other qualitative factors, such as management's ongoing review and grading of the loan and lease portfolios, consideration of delinquency experience, and the level of loans and leases subject to more frequent review by management. Additionally, an increase in specific reserves of$2.1 million was driven by deterioration of two existing legacy SBA impaired relationships. There have been no substantive changes to our methodology for estimating the appropriate level of allowance for loan and lease loss reserves from what was previously outlined in our most recent Annual Report on Form 10-K. Please refer to the section titled COVID-19 Update for additional information. 59
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During the six months endedJune 30, 2020 , we recorded net charge-offs on impaired loans and leases of$707,000 , comprised of$948,000 of charge-offs and$241,000 of recoveries. During the six months endedJune 30, 2019 , we recorded net recoveries on impaired loans and leases of approximately$130,000 , comprised of$63,000 of charge-offs and$193,000 of recoveries. We will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed, in particular as it relates to our commercial clients impacted by the COVID-19 pandemic. Loans and leases with previously established specific reserves may ultimately result in a charge-off under a variety of scenarios. Based upon the application of our methodology for estimating the appropriate level of allowance for loan and lease loss reserves, which includes actively monitoring the asset quality and inherent risks within the loan and lease portfolio, management concluded that an allowance for loan and lease losses of$27.5 million , or 1.58% of total loans and leases excluding PPP loans, was appropriate as ofJune 30, 2020 . Given ongoing complexities with current workout situations, including those related to the COVID-19 pandemic, further charge-offs and increased provisions for loan and lease losses may be recorded if additional facts and circumstances lead us to a different conclusion. As ofJune 30, 2020 andDecember 31, 2019 , our allowance for loan and lease losses to total non-accrual loans and leases was 113.98% and 94.70%, respectively. Impaired loans and leases exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease. However, the measurement of impairment on loans and leases may not always result in a specific reserve included in the allowance for loan and lease losses. As part of the underwriting process, as well as our ongoing monitoring efforts, we try to ensure that we have sufficient collateral to protect our interest in the related loan or lease. As a result of this practice, a significant portion of our outstanding balance of non-performing loans or leases either does not require additional specific reserves or requires only a minimal amount of required specific reserve, as we believe the loans and leases are adequately collateralized as of the measurement period. In addition, management is proactive in recording charge-offs to bring loans to their net realizable value in situations where it is determined with certainty that we will not recover the entire amount of our principal. This practice may lead to a lower allowance for loan and lease losses to non-accrual loans and leases ratio as compared to our peers or industry expectations. As asset quality strengthens, our allowance for loan and lease losses is measured more through general characteristics, including historical loss experience, of our portfolio rather than through specific identification and we would therefore expect this ratio to rise. Conversely, if we identify further impaired loans or leases, this ratio could fall if the impaired loans are adequately collateralized and therefore require no specific or general reserve. Given our business practices and evaluation of our existing loan and lease portfolio, we believe this coverage ratio is appropriate for the probable losses inherent in our loan and lease portfolio as ofJune 30, 2020 . 60
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A summary of the activity in the allowance for loan and lease losses follows:
As of and for the Three Months Ended June 30, As of and for the Six Months Ended June 30,
2020 2019 2020 2019
(Dollars in Thousands)
Allowance at beginning of
period $ 22,748 $ 20,449 $ 19,520 $ 20,425
Charge-offs:
Commercial real estate:
Commercial real estate -
owner occupied (27 ) - (27 ) -
Commercial real estate -
non-owner occupied - - - -
Construction and land
development - - - -
Multi-family - - - -
1-4 family - - - -
Commercial and industrial (729 ) (13 ) (854 ) (61 )
Direct financing leases (55 ) - (55 ) -
Consumer and other:
Home equity and second
mortgages - - - -
Other (6 ) (2 ) (12 ) (2 )
Total charge-offs (817 ) (15 ) (948 ) (63 )
Recoveries:
Commercial real estate:
Commercial real estate -
owner occupied - - 1 1
Commercial real estate -
non-owner occupied 2 71 2 72
Construction and land
development - - - -
Multi-family - - - -
1-4 family - - - -
Commercial and industrial 62 73 238 92
Direct financing leases - - - -
Consumer and other:
Home equity and second
mortgages - 25 - 26
Other - - - 2
Total recoveries 64 169 241 193
Net (charge-offs) recoveries (753 ) 154 (707 ) 130
Provision for loan and lease
losses 5,469 (784 ) 8,651 (736 )
Allowance at end of period $ 27,464 $ 19,819 $ 27,464 $ 19,819
Annualized net charge-offs
(recoveries) as a percent of
average gross loans and
leases 0.15 % (0.04 )% 0.08 % (0.02 )%
Annualized net charge-offs
(recoveries) as a percent of
average gross loans and
leases, excluding average
PPP loans 0.17 % (0.04 )% 0.08 % (0.02 )%
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Liquidity and Capital Resources
The Corporation expects to meet its liquidity needs through existing cash on
hand, established cash flow sources, its third party senior line of credit, and
dividends received from the Bank. While the Bank is subject to certain generally
applicable regulatory limitations regarding its ability to pay dividends to the
Corporation, we do not believe that the Corporation will be adversely affected
by these dividend limitations. The Corporation's principal liquidity
requirements at June 30, 2020 were the interest payments due on subordinated and
junior subordinated notes. On July 24, 2020 , the Bank's Board of Directors
declared a dividend in the aggregate amount of $2.0 million bringing
year-to-date dividend declarations to $10.5 million . The capital ratios of the
Corporation and its subsidiary continue to meet all applicable regulatory
capital adequacy requirements. The Corporation's and the Bank's respective
Boards of Directors and management teams adhere to the appropriate regulatory
guidelines on decisions which affect their capital positions, including but not
limited to, decisions relating to the payment of dividends and increasing
indebtedness.
The Bank maintains liquidity by obtaining funds from several sources. The Bank's
primary source of funds are principal and interest payments on loans receivable
and mortgage-related securities, deposits, and other borrowings, such as federal
funds, FHLB advances, Federal Reserve Discount Window advances, and Federal
Reserve PPPLF advances. The scheduled payments of loans and mortgage-related
securities are generally a predictable source of funds. Deposit flows and loan
prepayments, however, are greatly influenced by general interest rates, economic
conditions, and competition. Please refer to the section titled COVID-19 Update
for additional information on the Bank's primary and secondary sources of
available liquidity the during the COVID-19 pandemic.
On-balance sheet liquidity is a critical element to maintaining adequate
liquidity to meet our cash and collateral obligations. We define our on-balance
sheet liquidity as the total of our short-term investments, our unencumbered
securities available-for-sale, and our unencumbered pledged loans. As of
June 30, 2020 and December 31, 2019 , our immediate on-balance sheet liquidity
was $611.6 million and $438.2 million , respectively. At June 30, 2020 and
December 31, 2019 , the Bank had $27.3 million and $44.4 million on deposit with
the FRB recorded in short-term investments, respectively. Any excess funds not
used for loan funding or satisfying other cash obligations were maintained as
part of our on-balance sheet liquidity in our interest-bearing accounts with the
FRB, as we value the safety and soundness provided by the FRB. We plan to
utilize excess liquidity to fund loan and lease portfolio growth, pay down
maturing debt, allow run off of maturing wholesale certificates of deposit, or
invest in securities to maintain adequate liquidity at an improved margin.
We had $530.4 million of outstanding wholesale funds at June 30, 2020 , compared
to $446.5 million of wholesale funds as of December 31, 2019 , which
represented 24.7% and 24.5%, respectively, of ending balance total bank funding.
Wholesale funds include FHLB advances, Federal Reserve PPPLF advances, brokered
certificates of deposit, and deposits gathered from internet listing services.
Total bank funding is defined as total deposits plus FHLB advances and Federal
Reserve PPPLF advances. We are committed to raising in-market deposits while
utilizing wholesale funds to mitigate interest rate risk. Wholesale funds
continue to be an efficient and cost effective source of funding for the Bank
and allows it to gather funds across a larger geographic base at price levels
and maturities that are more attractive than local time deposits when required
to raise a similar level of in-market deposits within a short time period.
Access to such deposits and borrowings allows us the flexibility to refrain from
pursuing single service deposit relationships in markets that have experienced
unfavorable pricing levels. In addition, the administrative costs associated
with wholesale funds are considerably lower than those that would be incurred to
administer a similar level of local deposits with a similar maturity structure.
During the time frames necessary to accumulate wholesale funds in an orderly
manner, we will use short-term FHLB advances to meet our temporary funding
needs. The short-term FHLB advances will typically have terms of one week to one
month to cover the overall expected funding demands.
Period-end in-market deposits increased $241.7 million to $1.621 billion at
June 30, 2020 from $1.379 billion at December 31, 2019 as in-market deposit
balances were primarily inflated due to PPP loan proceeds. Our in-market
relationships remain stable; however, deposit balances associated with those
relationships will fluctuate. We expect to establish new client relationships
and continue marketing efforts aimed at increasing the balances in existing
clients' deposit accounts. Nonetheless, we will continue to use wholesale funds
in specific maturity periods, typically three to five years, needed to
effectively mitigate the interest rate risk measured through our asset/liability
management process or in shorter time periods if in-market deposit balances
decline. In order to provide for ongoing liquidity and funding, all of our
wholesale funds are certificates of deposit which do not allow for withdrawal at
the option of the depositor before the stated maturity (with the exception of
deposits accumulated through the internet listing service which have the same
early withdrawal privileges and fees as do our other in-market deposits) and
FHLB advances with contractual maturity terms and no call provisions. The Bank
limits the percentage of wholesale funds to total bank funds in accordance with
liquidity policies approved by its Board. The Bank was in compliance with its
policy limits as of June 30, 2020 and December 31, 2019 .
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The Bank was able to access the wholesale funding market as needed at rates and terms comparable to market standards during the six month period endedJune 30, 2020 . In the event that there is a disruption in the availability of wholesale funds at maturity, the Bank has managed the maturity structure, in compliance with our approved liquidity policy, so at least one year of maturities could be funded through on-balance sheet liquidity. These potential funding sources include deposits maintained at the FRB or Federal Reserve Discount Window utilizing currently unencumbered securities and acceptable loans as collateral. As ofJune 30, 2020 , the available liquidity was in excess of the stated policy minimum. We believe the Bank will also have access to the unused federal funds lines, cash flows from borrower repayments, and cash flows from security maturities. The Bank also has the ability to raise local market deposits by offering attractive rates to generate the level required to fulfill its liquidity needs. The Bank is required by federal regulation to maintain sufficient liquidity to ensure safe and sound operations. We believe that the Bank has sufficient liquidity to match the balance of net withdrawable deposits and short-term borrowings in light of present economic conditions and deposit flows. During the six months endedJune 30, 2020 , operating activities resulted in a net cash inflow of$2.1 million , which included net income and provision for loan and lease losses of$6.6 million and$8.7 million , respectively, partially offset by a net increase in loans originated for sale. Net cash used in investing activities for the six months endedJune 30, 2020 was approximately$347.4 million which consisted of cash outflows to fund net loan growth and the purchase of$8.0 million in additional bank-owned life insurance, partially offset by a net reduction in securities. Net cash provided by financing activities resulted in a net cash inflow of$320.6 million for the six months endedJune 30, 2020 primarily due to a net increase in FHLB advances, an increase in Federal Reserve PPPLF advances, and a net increase in deposits. Please refer to the Consolidated Statements of Cash Flows included in PART I., Item 1 for further details regarding significant sources of cash flow for the Corporation. Contractual Obligations and Off-Balance Sheet Arrangements As ofJune 30, 2020 , there were no material changes to our contractual obligations and off-balance sheet arrangements disclosed in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . We continue to believe that we have adequate capital and liquidity available from various sources to fund projected contractual obligations and commitments.
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