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 ended
December 31, 2019 and Part II, Item 1A - Risk Factors in our Quarterly Report on
Form 10-Q for the quarter ended March 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.
40--------------------------------------------------------------------------------
Table of Contents
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,
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, private banking, and consumer and other
lending. 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 nine months ended
•Net income totaled$4.3 million , or diluted earnings per share of$0.50 , for the three months endedSeptember 30, 2020 , compared to$5.1 million , or diluted earnings per share of$0.59 , for the same period in 2019. Net income totaled$10.9 million , or diluted earnings per share of$1.27 , for the nine months endedSeptember 30, 2020 , compared to$17.6 million , or diluted earnings per share of$2.01 , for the same period in 2019. •Annualized return on average assets and annualized return on average equity for the three months endedSeptember 30, 2020 measured 0.68% and 8.58%, respectively, compared to 0.97% and 10.68% for the same period in 2019. Annualized return on average assets and annualized return on average equity for the nine months endedSeptember 30, 2020 measured 0.62% and 7.49%, respectively, compared to 1.15% and 12.77% for the same period in 2019. •As ofSeptember 30, 2020 , the Corporation had$332.3 million in Paycheck Protection Program ("PPP") loans outstanding and deferred processing fee income from theSmall Business Administration ("SBA") outstanding of$6.9 million . The processing fee income is deferred and recognized over the contractual life of the loan, or accelerated at forgiveness. For the three and nine months endedSeptember 30, 2020 , the Corporation recognized$1.1 million and$2.0 million , respectively, in processing fee income through interest income. •Pre-tax, pre-provision adjusted earnings, which excludes certain one-time and discrete items, totaled$9.3 million for the three months endedSeptember 30, 2020 , up 23.0% from the same period in 2019. Pre-tax, pre-provision adjusted return on average assets was 1.47% for the three months endedSeptember 30, 2020 , compared to 1.45% for the same period in 2019. Pre-tax, pre-provision adjusted earnings totaled$26.7 million for the nine months endedSeptember 30, 2020 , up 20.6% from the same period in 2019. Pre-tax, pre-provision adjusted return on average assets was 1.51% for the nine months endedSeptember 30, 2020 , compared to 1.45% for the same period in 2019. •Period-end gross loans and leases receivable were$2.170 billion as ofSeptember 30, 2020 , up$455.7 million fromDecember 31, 2019 . Line of credit utilization was significantly impacted by PPP loan proceeds and was$217.6 million as ofSeptember 30, 2020 , down from$282.9 million atDecember 31, 2019 . Gross loans and leases receivable, excluding net PPP loans and lines of credit, were$1.627 billion as ofSeptember 30, 2020 , up 18.2% annualized, fromDecember 31, 2019 . •The allowance for loan and lease losses increased$11.3 million , or 57.9%, compared toDecember 31, 2019 due to a$5.8 million increase in the general reserve and a$5.5 million increase in specific reserves, primarily driven by the COVID-19 pandemic. The allowance for loan and lease losses increased to 1.41% of total loans, compared to 1.14% atDecember 31, 2019 . Excluding net PPP loans, the allowance for loan and lease losses increased to 1.67% of total loans as ofSeptember 30, 2020 . •Provision for loan and lease losses totaled$3.8 million for the three months endedSeptember 30, 2020 , compared to$1.3 million for the same period in 2019. Provision for loan and lease losses totaled$12.5 million for the nine months endedSeptember 30, 2020 , compared to$613,000 for the same period in 2019. •Robust liquidity position includes record in-market deposits of$1.667 billion , total deposits of$1.821 billion , and on-balance sheet liquidity of$556.1 million , defined as total short-term investments, unencumbered securities, and unencumbered pledged loans. In-market deposit balances were positively affected by PPP loan proceeds. 41 -------------------------------------------------------------------------------- Table of Contents •Net interest margin was 3.14% and 3.30% for the three and nine months endedSeptember 30, 2020 , respectively, compared to 3.40% and 3.57% for the three and nine months endedSeptember 30, 2019 , respectively. Adjusted net interest margin, which excludes certain one-time and discrete items, was 3.24% and 3.29% for the three and nine months endedSeptember 30, 2020 , respectively, compared to 3.24% and 3.30% for the three and nine months endedSeptember 30, 2019 , respectively. •Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization, totaled$1.5 million and$4.6 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to$1.1 million and$4.6 million for the three and nine months endedSeptember 30, 2019 , respectively. •Top line revenue, defined as net interest income plus non-interest income, totaled$26.0 million for the three months endedSeptember 30, 2020 , up 15.3% from the same period in 2019. Top line revenue totaled$74.7 million for the nine months endedSeptember 30, 2020 , up 10.5% from the same period in 2019. •Non-interest income totaled$7.4 million , or 28.5% of total revenue, for the three months endedSeptember 30, 2020 , surpassing the Corporation's goal of 25% for the sixth consecutive quarter. Non-interest income totaled$20.1 million , or 27.0% of total revenue, for the nine months endedSeptember 30, 2020 . •Non-interest expense was$16.8 million and$51.2 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to$14.7 million and$49.9 million for the three and nine months endedSeptember 30, 2019 , respectively. Operating expense, which excludes certain one-time and discrete items, totaled$16.7 million and$48.0 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to$15.0 million and$45.5 million for the three and nine months endedSeptember 30, 2019 , respectively. •The efficiency ratio improved to 64.16% and 64.29% for the three and nine months endedSeptember 30, 2020 , respectively, down from 66.41% and 67.29% for the three and nine months endedSeptember 30, 2019 , respectively. COVID-19 Update Paycheck Protection Program As ofSeptember 30, 2020 , the Corporation had$332.3 million in PPP loans outstanding and deferred processing fees outstanding of$6.9 million . The processing fees are deferred and recognized over the contractual life of the loan, or accelerated at forgiveness, as an adjustment of yield using the interest method. For the three and nine months endedSeptember 30, 2020 ,$1.1 million and$2.0 million , respectively, was recognized in interest income compared to no PPP loan processing fee income for the three and nine months endedSeptember 30, 2019 . 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. As ofOctober 20, 2020 , the Corporation had processed and submitted$97.9 million , or 29% of total gross PPP loans, to the SBA for forgiveness and clients have started to receive reimbursements. Liquidity Sources Management has reviewed all primary and secondary sources of liquidity in preparation for any unforeseen funding needs due to the COVID-19 pandemic and prioritized based on available capacity, term flexibility, and cost. As ofSeptember 30, 2020 , the Corporation had the following sources of liquidity, including the Corporation's ability to participate in theFederal Reserve's Paycheck Protection Program Liquidity Facility ("PPPLF"): (Unaudited) As of September 30, (in thousands) 2020 June 30, 2020 Short-term investments$ 23,500 $ 27,839 PPPLF availability 295,876 298,327
Collateral value of unencumbered loans (FHLB borrowing availability)
107,456 178,587
Market value of unencumbered securities (Fed Discount Window and FHLB borrowing availability)
129,246 106,808
Total sources of liquidity $
556,078
In addition to the above primary sources of liquidity, as ofSeptember 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. 42 -------------------------------------------------------------------------------- Table of Contents Capital Strength The Corporation's capital ratios continued to exceed the highest required regulatory benchmark levels. •Total capital to risk-weighted assets atSeptember 30, 2020 , was 11.42%, tier 1 capital to risk-weighted assets was 9.09%, tier 1 leverage capital to adjusted average assets was 8.04%, and common equity tier 1 capital to risk-weighted assets was 8.64%. Tangible common equity to tangible assets was 7.29%. Excluding net PPP loans, tier 1 leverage capital to adjusted average assets and tangible common equity to tangible assets were 9.24% and 8.34%, respectively. •Management suspended the Corporation's stock repurchase program inMarch 2020 due to the uncertainty surrounding the COVID-19 pandemic. As ofMarch 16, 2020 , the Corporation had repurchased 141,137 shares of its common stock under its current authorization at a weighted average price of$24.62 per share, for a total value of$3.5 million . The Corporation has$1.5 million of buyback authority remaining. •As previously announced, during the third quarter of 2020, the Corporation's Board of Directors declared a regular quarterly dividend of$0.165 per share. The dividend was paid onAugust 13, 2020 to stockholders of record at the close of business onAugust 3, 2020 . Measured against third quarter 2020 diluted earnings per share of$0.50 , the dividend represents a 33.0% payout ratio. The Board of Directors routinely considers dividend declarations as part of its normal course of business. Deferral Requests The Corporation provided loan modifications deferring payments 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 ofSeptember 30, 2020 , the Corporation had deferred loans outstanding of$131.5 million , or 7.1% of gross loans and leases, excluding gross PPP loans, compared to$323.2 million , or 18.6% of gross loans and leases, excluding gross PPP loans, as ofJune 30, 2020 . As ofOctober 20, 2020 , 95% of clients whose first deferral concluded during the quarter resumed their scheduled payments. Management anticipates the loan modifications will continue through 2020 due to the remaining uncertainty surrounding the COVID-19 pandemic. The following tables represent a breakdown of the deferred loan balances by industry segment and collateral type: 43 -------------------------------------------------------------------------------- Table of Contents (Unaudited) As of (Dollars in thousands) September 30, 2020 June 30, 2020 Collateral Type % of Deferred % of Deferred of Total Non Real of Total Industries Description Balance Industry Real Estate Estate Balance
Industry
Real Estate and Rental and Leasing$ 67,214 7.7 %$ 67,214 $ -$ 147,584 18.8 % Accommodation and Food Services 26,884 25.3 % 26,884 - 52,468 52.7 % Manufacturing 17,807 9.6 % 10,506 7,301 34,214 17.5 % Health Care and Social Assistance 8,867 6.9 % 8,855 12 19,552 15.9 % Transportation and Warehousing 256 1.9 % - 256 19,402 21.3 % Retail Trade 6,781 14.7 % 6,781 - 14,851 29.7 % Information - - % - - 11,228 64.1 % Utilities - - % - - 7,129 96.4 % Construction 427 0.7 % 427 - 6,448 6.7 % Wholesale Trade 711 0.3 % 450 261 5,695 5.7 % Other Services (except Public Administration) 402 0.8 % 212 190 1,673 3.0 % Professional, Scientific, and Technical Services 364 0.4 % - 364 933 2.3 % Administrative and Support and Waste Management and Remediation Services 145 1.6 % - 145 831 9.9 % Finance and Insurance - - % - - 743 1.8 % Arts, Entertainment, and Recreation 1,350 7.9 % 1,350 - 300 1.7 % Agriculture, Forestry, Fishing and Hunting 261 0.8 % - 261 165 1.3 % Total deferred loan balances$ 131,469 $ 122,679 $ 8,790 $ 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 September 30, 2020 Category (Dollars in thousands) I II III IV Total Total deferred loan balances$ 69,984 $ 40,371 $ 20,045 $ 1,069 $ 131,469 % of Total 53.2 % 30.7 % 15.2 % 0.8 % 100.0 % As of June 30, 2020 Category (Dollars in thousands) I II III IV Total Total deferred loan balances$ 221,414 $ 66,554 $ 35,248 $ -$ 323,216 % of Total 68.5 % 20.6 % 10.9 % - % 100.0 % 44
--------------------------------------------------------------------------------
Table of Contents
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
September 30, 2020 June 30, 2020
Collateral Type
Real Estate and Rental and Leasing % Deferred of % Deferred of
Detail: Balance Sub-Industry Real Estate Non Real Estate Balance Sub-Industry
(Dollars in Thousands)
Office - Class A $ 7,922 4.8 % $ 7,922 $ - $ 23,204 15.3 %
Retail - Non-Credit Tenant -
Shopping Center 9,326 30.4 % 9,326 - 22,657 73.5 %
Office - Class B 5,738 10.2 % 5,738 - 17,652 32.1 %
1-4 Family 185 0.7 % 185 - 16,887 64.5 %
Multi-Family - Market Rent 26,888 12.1 % 26,888 - 16,174 8.5 %
Retail - Non-Credit Tenant - Strip
Center 4,944 26.3 % 4,944 - 11,389 59.7 %
Multi-Family - Student Housing 8,466 20.3 % 8,466 - 8,466 20.2 %
Retail - Non-Credit Tenant -
Restaurant 1,004 9.9 % 1,004 - 6,621 64.9 %
Retail - Other 986 7.1 % 986 - 6,110 13.9 %
Retail - Non-Credit-Tenant - Big
Box 1,755 31.2 % 1,755 - 5,629 100.0 %
Other - - % - - 12,795 5.6 %
Total Real Estate and Rental and
Leasing $ 67,214 $ 67,214 $ - $ 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
September 30, 2020 June 30, 2020
Collateral Type
Accommodation and Food Services % Deferred of % Deferred of
Detail: Balance Sub-Industry Real Estate Non Real Estate Balance Sub-Industry
(Dollars in Thousands)
Hotel - Flag $ 25,082 34.1 % $ 25,082 $ - $ 43,011 63.1 %
Hotel - No Flag - - % - - 1,862 46.0 %
Other 1,802 14.5 % 1,802 - 5,594 22.7 %
Retail - Restaurant/Bar - - % - - 2,001 13.0 %
Total Accommodation and Food
Service $ 26,884 $ 26,884 $ - $ 52,468 Exposure to
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
September 30, 2020 June 30, 2020
% Gross Loans % Gross Loans
Industries: Balance and Leases (1) Balance and Leases (1)
(Dollars in Thousands)
Retail (2) $ 75,261 4.1 % $ 70,028 4.0 %
Hospitality 78,786 4.3 % 73,502 4.2 %
Entertainment 7,758 0.4 % 16,675 1.0 %
Restaurants & food service 26,728 1.4 % 24,884 1.4 %
Total outstanding exposure $ 188,533 10.2 % $ 185,089 10.6 %
(1)Excluding net PPP loans.
(2)Includes $52.0 million and $51.7 million in loans secured by commercial real
estate as of September 30, 2020 and June 30, 2020 , respectively.
45--------------------------------------------------------------------------------
Table of Contents
As ofSeptember 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 15.3% for the three months endedSeptember 30, 2020 compared to the same period in the prior year primarily due to an increase in average loans and lease, increase in fees in lieu of interest, and increase in commercial loan interest rate swap fee income, partially offset by net interest margin compression. Top line revenue increased 10.5% for the nine months endedSeptember 30, 2020 compared to the same period in the prior year primarily due to an increase in average loans and leases, increase in commercial loan interest rate swap fee income, and increase in gains on the sale of SBA loans, partially offset by net interest margin compression. The components of top line revenue were as follows: For the Nine Months Ended For the Three Months Ended September 30, September 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change (Dollars in Thousands)
Net interest income$ 18,621 $ 16,776 $ 1,845 11.0 %$ 54,558 $ 51,382 $ 3,176 6.2 % Non-interest income 7,408 5,792 1,616 27.9 20,141 16,234 3,907 24.1 Top line revenue$ 26,029 $ 22,568 $ 3,461 15.3$ 74,699 $ 67,616 $ 7,083 10.5
Annualized Return on Average Assets and Annualized Return on Average Equity
ROAA for the three months endedSeptember 30, 2020 decreased to 0.68% compared to 0.97% for the three months endedSeptember 30, 2019 . ROAA for the nine months endedSeptember 30, 2020 decreased to 0.62% compared to 1.15% for the nine months endedSeptember 30, 2019 . The decrease in ROAA in both periods of comparison 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, increase in gains on the sale of SBA loans, and net interest income improvement mainly due to an increase in average loans and leases. 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 endedSeptember 30, 2020 was 8.58% compared to 10.68% for the three months endedSeptember 30, 2019 . ROAE for the nine months endedSeptember 30, 2020 was 7.49% compared to 12.77% for the nine months endedSeptember 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 and Pre-Tax, Pre-Provision Adjusted Earnings Efficiency ratio is a non-GAAP measure representing non-interest expense excluding the effects of the SBA recourse provision or benefit, impairment of tax credit investments, net gains or 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 net gains or losses on securities, if any. Pre-tax, pre-provision adjusted earnings is defined as operating revenue less operating expense. In the judgment of the Corporation's management, the adjustments made to non-interest expense and non-interest income allow investors and analysts to better assess the Corporation's operating expenses in relation to its core operating revenue by removing the volatility that is associated with certain one-time items and other discrete items. 46
--------------------------------------------------------------------------------
Table of Contents
The efficiency ratio was 64.16% and 64.29% for the three and nine months endedSeptember 30, 2020 compared to 66.41% and 67.29% for the three and nine months endedSeptember 30, 2019 . Operating revenue growth outpaced the change in operating expense for the three and nine months endedSeptember 30, 2020 , resulting in positive operating leverage. Results for the three and nine months endedSeptember 30, 2020 have benefited from PPP interest income, PPP loan processing fee recognition, and below average business development related expenses due to the COVID-19 pandemic. For the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 , operating revenue increased 15.3% while operating expense increased 11.4%. Similarly, for the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 , operating revenue increased 10.5% while operating expense increased 5.6%. 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 and pre-tax, pre-provision adjusted earnings allow 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 Nine Months Ended
For the Three Months Ended September 30, September 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
(Dollars in Thousands)
Total non-interest
expense $ 16,758 $ 14,716 $ 2,042 13.9 % $ 51,245 $ 49,922 $ 1,323 2.7 %
Less:
Net (gain) loss on foreclosed properties (121) 262 (383) NM 329 241 88 36.5 Amortization of other intangible assets 9 11 (2) (18.2) 27 33 (6) (18.2) SBA recourse provision (benefit) 57 (427) 484 NM 53 167 (114) (68.3) Tax credit investment impairment (recovery) 113 (120) 233 NM 2,066 3,982 (1,916) (48.1) Loss on early extinguishment of debt - - - NM 744 - 744 NM Total operating expense$ 16,700 $ 14,990 $ 1,710 11.4$ 48,026 $ 45,499 $ 2,527 5.6 Net interest income 18,621 16,776 1,845 11.0$ 54,558 $ 51,382 $ 3,176 6.2 Total non-interest income 7,408 5,792 1,616 27.9 20,141 16,234 3,907 24.1 Less: Net loss on sale of securities - (4)
4 NM (4) (5)
1 (20.0)
Total operating revenue $ 26,029 $ 22,572 $ 3,457 15.3 $ 74,703 $ 67,621 $ 7,082 10.5
Pre-tax, pre-provision
adjusted earnings $ 9,329 $ 7,582 $ 1,747 23.0 $ 26,677 $ 22,122 $ 4,555 20.6
Efficiency ratio 64.16 % 66.41 % 64.29 % 67.29 %
NM = Not Meaningful
Net Interest Income
47--------------------------------------------------------------------------------
Table of Contents
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 nine months endedSeptember 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 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 Increase (Decrease) for the Three Months Nine Months Ended September Ended September 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)$ (3,728) $ 1,500 $ (2,228) $ (8,438) $ 2,738 $ (5,700) Commercial and industrial loans(1) (4,148) 3,584 (564) (9,812) 8,138 (1,674) Direct financing leases(1) (23) (35) (58) (86) (120) (206) Consumer and other loans(1) (48) 81 33 (132) 181 49 Total loans and leases receivable (7,947) 5,130 (2,817) (18,468) 10,937
(7,531)
Mortgage-related securities (228) 1 (227) (495) 279
(216)
Other investment securities (11) 48 37 (7) 21 14 FHLB and FRB Stock 13 63 76 87 143 230 Short-term investments (154) (77) (231) (569) 53
(516)
Total net change in income on interest-earning assets (8,327) 5,165 (3,162) (19,452) 11,433
(8,019)
Interest-bearing liabilities Transaction accounts (1,167) 507 (660) (2,736) 1,154
(1,582)
Money market accounts (2,541) 2 (2,539) (6,342) 666
(5,676)
Certificates of deposit (232) (238) (470) (461) (614) (1,075) Wholesale deposits (458) (256) (714) (353) (1,711) (2,064) Total deposits (4,398) 15 (4,383) (9,892) (505) (10,397) FHLB advances (2,067) 1,750 (317) (1,695) 1,264 (431) Federal reserve PPP lending facility - 26 26 - 44 44 Other borrowings (260) (73) (333) (356) (58) (414) Junior subordinated notes - - - 2 1 3 Total net change in expense on interest-bearing liabilities (6,725) 1,718 (5,007) (11,941) 746
(11,195)
Net change in net interest income$ (1,602) $ 3,447 $ 1,845 $ (7,511) $ 10,687
(1)The average balances of loans and leases include non-accrual loans and leases and loans held for sale.
48
--------------------------------------------------------------------------------
Table of Contents
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 nine months endedSeptember 30, 2020 and 2019. The average balances are derived from average daily balances. For the Three Months Ended September 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)$ 1,282,132 $ 12,340 3.85 %$ 1,153,591 $ 14,568 5.05 % Commercial and industrial loans(1) 791,909 8,133 4.11 517,043 8,697 6.73 Direct financing leases(1) 26,129 258 3.95 29,600 316 4.27 Consumer and other loans(1) 39,269 374 3.81 31,195 341 4.37 Total loans and leases receivable(1) 2,139,439 21,105 3.95 1,731,429 23,922 5.53 Mortgage-related securities(2) 167,326 833 1.99 167,113 1,060 2.54 Other investment securities(3) 34,004 171 2.01 24,755 134 2.17 FHLB and FRB stock 12,835 161 5.02 7,692 85 4.42 Short-term investments 21,287 6 0.11 40,707 237 2.33 Total interest-earning assets 2,374,891 22,276 3.75 1,971,696 25,438 5.16 Non-interest-earning assets 165,844 121,589 Total assets$ 2,540,735 $ 2,093,285 Interest-bearing liabilities Transaction accounts$ 445,687 259 0.23$ 217,870 919 1.69 Money market accounts 642,881 318 0.20 642,385 2,857 1.78 Certificates of deposit 110,891 513 1.85 154,095 983 2.55 Wholesale deposits 160,067 533 1.33 211,528 1,247 2.36 Total interest-bearing deposits 1,359,526 1,623 0.48 1,225,878 6,006 1.96 FHLB advances 379,915 1,356 1.43 307,060 1,673 2.18 Federal reserve PPPLF 29,605 26 0.35 - - - Other borrowings 24,403 370 6.06 27,545 703 10.21 Junior subordinated notes 10,056 280 11.14 10,041 280 11.15 Total interest-bearing liabilities 1,803,505 3,655 0.81 1,570,524 8,662 2.21 Non-interest-bearing demand deposit accounts 445,245 283,675 Other non-interest-bearing liabilities 91,810 48,688 Total liabilities 2,340,560 1,902,887 Stockholders' equity 200,175 190,398 Total liabilities and stockholders' equity$ 2,540,735 $ 2,093,285 Net interest income$ 18,621 $ 16,776 Interest rate spread 2.94 % 2.95 % Net interest-earning assets$ 571,386 $ 401,172 Net interest margin 3.14 % 3.40 % Average interest-earning assets to average interest-bearing liabilities 131.68 % 125.54 % Return on average assets(4) 0.68 0.97 Return on average equity(4) 8.58 10.68 Average equity to average assets 7.88 9.10 Non-interest expense to average assets(4) 2.64 2.81 (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. 49
--------------------------------------------------------------------------------
Table of Contents
For the Nine Months Ended September 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) $ 1,209,810 $ 38,312 4.22 % $ 1,135,596 $ 44,012 5.17 %
Commercial and industrial loans(1) 678,650 24,338 4.78 492,247 26,012 7.04
Direct financing leases(1) 27,065 761 3.75 31,143 967 4.14
Consumer and other loans(1) 37,260 1,091 3.90 31,391 1,042 4.43
Total loans and leases receivable(1) 1,952,785 64,502 4.40 1,690,377 72,033 5.68
Mortgage-related securities(2) 173,985 2,806 2.15 158,407 3,022 2.54
Other investment securities(3) 29,177 456 2.08 27,849 442 2.12
FHLB and FRB stock 10,558 491 6.20 7,210 261 4.83
Short-term investments 39,293 153 0.52 36,139 669 2.47
Total interest-earning assets 2,205,798 68,408 4.13 1,919,982 76,427 5.31
Non-interest-earning assets 151,994 109,395
Total assets $ 2,357,792 $ 2,029,377
Interest-bearing liabilities
Transaction accounts $ 362,326 1,197 0.44 $ 222,513 2,779 1.66
Money market accounts 649,999 2,555 0.52 597,487 8,231 1.84
Certificates of deposit 122,781 1,890 2.05 159,390 2,965 2.48
Wholesale deposits 132,811 2,021 2.03 243,254 4,085 2.24
Total interest-bearing deposits 1,267,917 7,663 0.81 1,222,644 18,060 1.97
FHLB advances 371,738 4,198 1.51 280,538 4,629 2.20
Federal reserve PPPLF 16,855 44 0.35 - - -
Other borrowings 24,490 1,110 6.04 25,497 1,524 7.97
Junior subordinated notes 10,052 835 11.07 10,038 832 11.05
Total interest-bearing liabilities 1,691,052 13,850 1.09 1,538,717 25,045 2.17
Non-interest-bearing demand deposit accounts 392,455 265,121
Other non-interest-bearing liabilities 80,270 42,276
Total liabilities 2,163,777 1,846,114
Stockholders' equity 194,015 183,263
Total liabilities and stockholders' equity $ 2,357,792 $ 2,029,377
Net interest income $ 54,558 $ 51,382
Interest rate spread 3.04 % 3.14 %
Net interest-earning assets $ 514,746 $ 381,265
Net interest margin 3.30 % 3.57 %
Average interest-earning assets to average
interest-bearing liabilities 130.44 % 124.78 %
Return on average assets(4) 0.62 1.15
Return on average equity(4) 7.49 12.77
Average equity to average assets 8.23 9.03
Non-interest expense to average assets 2.90 3.28
(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.
50--------------------------------------------------------------------------------
Table of Contents
Comparison of Net Interest Income for the Three and Nine Months Ended September
30, 2020 and 2019
Net interest income increased $1.8 million , or 11.0%, during the three months
ended September 30, 2020 compared to the three months ended September 30, 2019 .
The increase in net interest income reflected an increase in average gross loans
and leases and an increase in fees collected in lieu of interest, partially
offset by adjusted net interest margin compression. Fees in lieu of interest,
which can vary from quarter to quarter, totaled $1.5 million for the three
months ended September 30, 2020 , compared to $1.1 million for the same period in
2019. Excluding fees in lieu of interest, interest income from PPP loans, and
interest expense from Federal Reserve PPPLF advances, net interest income
increased $617,000 , or 3.9%. Average gross loans and leases for the three months
ended September 30, 2020 increased $408.0 million , or 23.6%, compared to the
three months ended September 30, 2019 . Excluding net PPP loans and lines of
credit, average gross loans and leases for the three months ended September 30,
2020 increased $179.2 million , or 12.6%, compared to the three months ended
September 30, 2019 . Net interest income for the nine months ended September 30,
2020 increased $3.2 million , or 6.2%, compared to the nine months ended
September 30, 2019 . The increase in net interest income for the nine months
ended September 30, 2020 was principally due to an increase in average gross
loans and leases, including interest income received from PPP loans, partially
offset by a reduction in fees collected in lieu of interest and net interest
margin compression. Fees in lieu of interest totaled $4.6 million for both the
nine months ended September 30, 2020 and September 30, 2019 . Excluding fees in
lieu of interest, interest income from PPP loans and interest expense from
Federal Reserve PPPLF advances, net interest income for the nine months ended
September 30, 2020 increased $1.8 million , or 3.9%. Average gross loans and
leases for the nine months ended September 30, 2020 increased $262.4 million , or
15.5%, compared to the nine months ended September 30, 2019 . Excluding net PPP
loans and lines of credit, average gross loans and leases for the nine months
ended September 30, 2020 increased $71.6 million , or 7.0% annualized, compared
to the nine months ended September 30, 2019 .
The yield on average loans and leases for the three and nine months ended
September 30, 2020 declined to 3.95% and 4.40%, respectively, compared to 5.53%
and 5.68% for the three and nine months ended September 30, 2019 , respectively.
Excluding the impact of fees collected in lieu of interest and PPP loan interest
income, the yield on average loans and leases excluding net PPP loans for the
three and nine months ended September 30, 2020 was 4.13% and 4.43%,
respectively, compared to 5.27% and 5.31% for the three and nine months ended,
September 30, 2019 , respectively. Similarly, the yield on average
interest-earning assets for the three and nine months ended September 30, 2020
measured 3.75% and 4.13%, respectively, compared to 5.16% and 5.31% for the
three and nine months ended September 30, 2019 , respectively. Excluding fees
collected in lieu of interest and PPP loan interest income, the yield on average
interest-earning assets excluding net PPP loans for the three and nine months
ended September 30, 2020 was 3.89% and 4.13%, respectively, compared to 4.94%
and 4.98% for the three and nine months ended September 30, 2019 . The decline in
yields for the three and nine months ended September 30, 2020 compared to the
three and nine months ended September 30, 2019 was primarily due to the decrease
in LIBOR and Prime and related impact on variable-rate loans, in addition to the
renewal of fixed-rate loans and reinvestment of security cash flows at
historically low interest rates.
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
nine months ended September 30, 2020 decreased to 0.27% and 0.49%, respectively,
down from 1.47% and 1.50%, for the three and nine months ended September 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
200 basis points from September 2019 to September 2020 . For the three and nine
months ended September 30, 2020 compared to the three and nine months ended
September 30, 2019 , the average target federal funds rate decreased 205 basis
points and 180 basis points, respectively. Similarly, the average rate paid on
total interest-bearing liabilities for the three and nine months ended
September 30, 2020 decreased to 0.81% and 1.09%, respectively, compared to 2.21%
and 2.17% for the three and nine months ended September 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.
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 September 30,
2020 increased $72.9 million to $379.9 million at an average rate paid of 1.43%,
compared to $307.1 million at an average rate paid of 2.18% for the three months
ended September 30, 2019 . Average FHLB advances for the nine months ended
September 30, 2020 increased $91.2 million to $371.7 million at an average rate
paid of 1.51%, compared to $280.5 million at an average rate paid of 2.20% for
the nine months ended September 30, 2019 . As of September 30, 2020 , the weighted
average original maturity of our FHLB term advances was 5.1 years, compared to
5.2 years as of September 30, 2019 . Average wholesale deposits, consisting
of brokered certificates of deposit and deposits gathered from internet listing
services, for the three months ended September 30, 2020 decreased $51.5
million to $160.1 million at an average rate paid of 1.33%, compared to $211.5
million at an average rate paid of 2.36%. Average wholesale deposits for the
nine months ended September 30, 2020 decreased $110.4 million to $132.8 million
at an
51
--------------------------------------------------------------------------------
Table of Contents
average rate paid of 2.03%, compared to $243.3 million at an average rate paid
of 2.24% for the nine months ended September 30, 2019 . As the existing wholesale
deposit portfolio matured lower cost FHLB advances were used, when needed, to
fund loan growth and manage interest rate risk by match funding long-term
fixed-rate loans. As of September 30, 2020 , the weighted average original
maturity of our wholesale deposits was 4.3 years, compared to 5.5 years as of
September 30, 2019 .
The average rate paid on total bank funding for the three and nine months
ended September 30, 2020 decreased to 0.54% and 0.78%, respectively, compared to
1.69% and 1.71% for the three and nine months ended September 30, 2019 . Total
bank funding is defined as total deposits plus FHLB advances and Federal Reserve
PPPLF advances.
Net interest margin decreased 26 basis points to 3.14% for the three
months ended September 30, 2020 compared to 3.40% for the three months ended
September 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, PPP loan interest income, Federal Reserve interest income, FHLB
dividends, and interest expense from Federal Reserve PPPLF advances, net
interest margin measured 3.24% for the third quarter of 2020, compared to 3.24%
in the third quarter of 2019. Net interest margin decreased 27 basis points to
3.30% for the nine months ended September 30, 2020 compared to 3.57% for the
nine months ended September 30, 2019 . The decrease was primarily due to the
decrease in average yield on loans and leases receivable partially offset by a
decrease in the average rate paid on in-market deposits and wholesale funding.
Excluding fees collected in lieu of interest, PPP loan interest income, Federal
Reserve interest income, FHLB dividends, and interest expense from Federal
Reserve PPPLF advances, net interest margin measured 3.29% and 3.30% for the
nine months ended September 30, 2020 and September 30, 2019 , respectively.
Management believes its success in growing in-market deposits, disciplined
loan pricing, and increased production in existing higher-yielding specialty
finance lines of business will allow the Corporation to achieve a net interest
margin of at least 3.50%, on average, over the long-term. 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 and U.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 lease losses increased $11.3 million ,
or 57.9%, compared to December 31, 2019 . The provision for loan and lease losses
totaled $3.8 million and $12.5 million for the three and nine months ended
September 30, 2020 , respectively, compared to $1.3 million and $613,000 for the
three and nine months ended September 30, 2019 , respectively. For the nine
months ended September 30, 2020 , the increase in the allowance for loan and
lease losses was in large part due to an increase in specific reserves on
impaired loans, in addition to several qualitative factors after careful
evaluation by management. Most notably, an increase in specific reserves of $5.5
million was driven by deterioration of two existing legacy SBA impaired
relationships and one relationship in the hospitality industry. Additionally, a
$4.7 million increase was due to the economic conditions caused by the pandemic,
including the increase in the unemployment rate, 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.
52--------------------------------------------------------------------------------
Table of Contents
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:
As of
September 30, June 30, September 30,
2020 2020 2019
(In Thousands)
Performing loans:
Off-balance sheet loans $ 26,017 $ 28,843 $ 40,288
On-balance sheet loans 15,175 16,554 21,814
Gross loans 41,192 45,397 62,102
Non-performing loans:
Off-balance sheet loans 2,574 1,640 7,287
On-balance sheet loans 9,561 9,725 14,663
Gross loans 12,135 11,365 21,950
Total loans:
Off-balance sheet loans 28,591 30,483 47,575
On-balance sheet loans 24,736 26,279 36,477
Gross loans $ 53,327 $ 56,762 $ 84,052
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 Nine Months Ended September
30, 2020 and 2019Non-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 endedSeptember 30, 2020 non-interest income increased by$1.6 million , or 27.9%, to$7.4 million from$5.8 million for the same period in 2019. For the nine months endedSeptember 30, 2020 non-interest income increased$3.9 million , or 24.1%, to$20.1 million from$16.2 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 28.5% and 27.0% of total revenues for the three and nine months endedSeptember 30, 2020 , respectively, compared to 25.7% and 24.0% for the three and nine months endedSeptember 30, 2019 , respectively. Management believes the expected gradual expansion of its SBA lending program, fees from commercial loan interest rate swap activity with commercial borrowers, and the geographic expansion of its private wealth management division will allow the Corporation to sustain a strategic target of 25% over the long-term. 53
--------------------------------------------------------------------------------
Table of Contents
The components of non-interest income were as follows:
For the Nine Months Ended
For the Three Months Ended September 30, September 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
(Dollars in Thousands)
Private wealth management
service fees $ 2,167 $ 2,060 $ 107 5.2 % $ 6,402 $ 6,125 $ 277 4.5 %
Gain on sale of SBA loans 760 454 306 67.4 1,598 993 605 60.9
Service charges on
deposits 881 795 86 10.8 2,527 2,314 213 9.2
Loan fees 478 439 39 8.9 1,414 1,316 98 7.4
Increase in cash
surrender value of
bank-owned life insurance 365 305 60 19.7 1,037 894 143 16.0
Net loss on sale of
securities - (4) 4 NM (4) (5) 1 (20.0)
Commercial loan swap fees 2,446 374 2,072 NM 5,782 1,898 3,884 NM
Other non-interest income 311 1,369 (1,058) (77.3) 1,385 2,699 (1,314) (48.7)
Total non-interest income $ 7,408 $ 5,792 $ 1,616 27.9 $ 20,141 $ 16,234 $ 3,907 24.1
Fee income ratio(1) 28.5 % 25.7 % 27.0 % 24.0 %
(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 increased$107,000 , or 5.2%, and$277,000 , or 4.5% for the three and nine months endedSeptember 30, 2020 , respectively, compared to the three and nine months endedSeptember 30, 2019 . The increase for the three and nine month comparison periods was mainly driven by an increase in equity market values and growth in assets under management attributable to new client relationships. As ofSeptember 30, 2020 , trust assets under management and administration totaled$2.018 billion , increasing$125.3 million , or 6.6%, compared to$1.892 billion as ofDecember 31, 2019 and$217.0 million , or 12.1%, compared to$1.801 billion as ofSeptember 30, 2019 . Commercial loan interest rate swap fee income was$2.4 million and$5.8 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to$374,000 and$1.9 million for the three and nine months endedSeptember 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$306,000 , or 67.4%, and$605,000 , or 60.9%, for the three and nine months endedSeptember 30, 2020 , respectively, compared to the three and nine months endedSeptember 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$12.0 million , or 390.20%, to$15.0 million compared toSeptember 30, 2019 . Other non-interest income for the three and nine months endedSeptember 30, 2020 totaled$311,000 and$1.4 million , respectively, compared to$1.4 million and$2.7 million , respectively, for three and nine months endedSeptember 30, 2019 . The decrease for both the three and nine month periods of comparison was primarily due to above average returns from the Corporation's investments in mezzanine funds and a gain on sale of a state tax credit in the prior year periods. The decrease for the nine months ended was also impacted by gains recognized on end-of-term buyout agreements related to the Company's equipment finance business line. 54
--------------------------------------------------------------------------------
Table of Contents Comparison of Non-Interest Expense for the Three and Nine Months Ended September
30, 2020 and 2019Non-Interest Expense
The components of non-interest expense were as follows:
For the Nine Months Ended
For the Three Months Ended September 30, September 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
(Dollars in Thousands)
Compensation $ 11,857 $ 10,324 $ 1,533 14.8 % $ 33,705 $ 30,991 $ 2,714 8.8 %
Occupancy 570 580 (10) (1.7) 1,696 1,730 (34) (2.0)
Professional fees 943 751 192 25.6 2,621 2,745 (124) (4.5)
Data processing 679 654 25 3.8 2,066 1,923 143 7.4
Marketing 356 548 (192) (35.0) 1,169 1,611 (442) (27.4)
Equipment 310 277 33 11.9 905 938 (33) (3.5)
Computer software 1,017 859 158 18.4 2,873 2,485 388 15.6
FDIC insurance 312 1 311 NM 760 595 165 27.7
Collateral liquidation
costs 45 110 (65) (59.1) 281 108 173 NM
Net (gain) loss on
foreclosed properties (121) 262 (383) NM 329 241 88 36.5
Tax credit investment
impairment (recovery) 113 (120) 233 NM 2,066 3,982 (1,916) (48.1)
SBA recourse provision
(benefit) 57 (427) 484 NM 53 167 (114) (68.3)
Loss on early
extinguishment of debt - - - NM 744 - 744 NM
Other non-interest
expense 620 897 (277) (30.9) 1,977 2,406 (429) (17.8)
Total non-interest
expense $ 16,758 $ 14,716 $ 2,042 13.9 $ 51,245 $ 49,922 $ 1,323 2.7
Total operating
expense(1) $ 16,700 $ 14,990 $ 1,710 11.4 $ 48,026 $ 45,499 $ 2,527 5.6
Full-time equivalent employees 300 281 300 281 (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 endedSeptember 30, 2020 increased by$2.0 million , or 13.9%, to$16.8 million compared to$14.7 million for the same period in 2019. Non-interest expense for the nine months endedSeptember 30, 2020 increased by$1.3 million , or 2.7%, to$51.2 million compared to$49.9 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$1.7 million , or 11.4%, to$16.7 million for the three months endedSeptember 30, 2020 compared to$15.0 million for the same period in 2019. Operating expense increased$2.5 million , or 5.6%, to$48.0 million compared to$45.5 million for the same period in 2019. The increase in operating expense for the three month period was primarily due to an increase in compensation, professional fees, computer software, andFDIC insurance, partially offset by a decrease in marketing. The increase in operating expense for the nine month period was primarily due to an increase in compensation and computer software expense, partially offset by a decrease in general business-related expenses due to the Corporation's adherence to COVID-19 restrictions. Compensation expense for the three months endedSeptember 30, 2020 was$11.9 million , an increase of$1.5 million , or 14.8%, compared to the three months endedSeptember 30, 2019 . Compensation expense for the nine months endedSeptember 30, 2020 was$33.7 million , an increase of$2.7 million , or 8.8%, compared to the nine months endedSeptember 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 295 for the quarter endedSeptember 30, 2020 compared to 274 for the quarter endedSeptember 30, 2019 . Professional fee expense for the three months endedSeptember 30, 2020 increased by$192,000 , or 25.6%, to$943,000 compared to$751,000 for the same period in 2019. Professional fee expense for the nine months endedSeptember 30, 2020 decreased by$124,000 , or 4.5%, to$2.6 million compared to$2.7 million for the same period in 2019. The 55 -------------------------------------------------------------------------------- Table of Contents increase in the three months ended was mainly due to additional consulting expense related to annual loan review which had previously been sourced in-house and reported as compensation expense. The decrease for the nine months endedSeptember 30, 2020 was primarily driven by a reduced need to utilize external recruitment services. Computer software expense increased$158,000 to$1.0 million for the three monthsSeptember 30, 2020 compared to$859,000 for the three months endedSeptember 30, 2019 , and increased$388,000 to$2.9 million for the nine months endedSeptember 30, 2020 compared to$2.5 million for the nine months endedSeptember 30, 2019 . The increase in computer software expense in both periods of comparison is mainly due to investments made in our small ticket vendor finance and floorplan financing lines of business.FDIC insurance expense for the three months endedSeptember 30, 2020 was$312,000 , an increase of$311,000 compared to the three months endedSeptember 30, 2019 .FDIC insurance expense for the nine months endedSeptember 30, 2020 was$760,000 , an increase of$165,000 , compared to the nine months endedSeptember 30, 2019 .FDIC insurance expense for the three and nine months endedSeptember 30, 2019 benefited from an assessment credit because as the Deposit Insurance Fund Ratio reached 1.40%, as ofJune 30, 2019 which exceeded the required minimum ratio of 1.35%, theFDIC was required to distribute assessment credits to small banks for their portion of their assessments that contributed to the growth in the reserve ratio. The Corporation received a credit of$315,000 in the third quarter of 2019. Marketing expense for the three months endedSeptember 30, 2020 decreased by$192,000 , or 35.0%, to$356,000 compared to$548,000 in the same period in 2019. Marketing expense for the nine months endedSeptember 30, 2020 decreased by$442,000 to$1.2 million compared to$1.6 million for the same period in 2019. During 2020, the Corporation's adherence to COVID-19 restrictions resulted in a reduction in marketing expenses, such as meals and entertainment, and advertisement expense. No historic tax credits or related impairment were recognized for the three months endedSeptember 30, 2020 andSeptember 30, 2019 . Tax credit investment impairment expense was$2.1 million for the nine months endedSeptember 30, 2020 , compared to$4.0 million for the nine months endedSeptember 30, 2019 . 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$2.5 million in tax credits during the quarter. During the nine months endedSeptember 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 provision was$57,000 and$53,000 for the three and nine months endedSeptember 30, 2020 , respectively, compared to recourse benefit of$427,000 for the three months endedSeptember 30, 2019 and a recourse provision of$167,000 for the nine months endedSeptember 30, 2019 . 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$1.1 million , or 1.4% of total sold SBA loans outstanding, atSeptember 30, 2020 , compared to$1.3 million , or 1.8%, atDecember 31, 2019 , and$1.6 million , or 2.2%, atSeptember 30, 2019 . Income Taxes Income tax expense totaled$73,000 for the nine months endedSeptember 30, 2020 compared to an income tax benefit of$475,000 for the nine months endedSeptember 30, 2019 . The income tax expense for the nine months endedSeptember 30, 2020 reflects a benefit from 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 nine months endedSeptember 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 nine months endedSeptember 30, 2020 , excluding the discrete items, was 19.33%. 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. 56
--------------------------------------------------------------------------------
Table of Contents
Financial ConditionGeneral
Total assets increased by$505.1 million , or 24.1%, to$2.602 billion as ofSeptember 30, 2020 compared to$2.097 billion atDecember 31, 2019 . The increase in total assets was primarily driven by PPP loan growth and commercial real estate ("CRE") loan growth, partially offset by a decrease in short-term investments. Short-Term Investments Short-term investments decreased by$27.5 million , or 53.9%, to$23.5 million atSeptember 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 ofSeptember 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 often provide an attractive yield in comparison to other short-term alternatives. 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. Securities Total securities, including available-for-sale and held-to-maturity, increased by$2.3 million , or 1.1%, to$208.2 million atSeptember 30, 2020 compared to$205.8 million atDecember 31, 2019 . During the nine months endedSeptember 30, 2020 , due to declining interest rates, we recognized unrealized gains of$3.9 million before income taxes through other comprehensive income, compared to gains of$3.3 million for the same period in 2019. As ofSeptember 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 3.8 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 ofSeptember 30, 2020 . Loans and Leases Receivable Loans and leases receivable, net of allowance for loan and lease losses, increased by$444.4 million to$2.139 billion atSeptember 30, 2020 from$1.695 billion atDecember 31, 2019 which was driven by the aforementioned PPP loan and CRE loan growth, partially offset by a reduction in commercial and industrial ("C&I") loans. Loans and leases receivable, net of allowance for loan and lease losses and excluding net PPP loans, increased by$118.9 million , or 7.0%, to$1.814 billion atSeptember 30, 2020 fromDecember 31, 2019 . Total CRE increased$172.4 million to$1.327 billion , up from$1.154 billion atDecember 31, 2019 . Multifamily, commercial real estate non-owner occupied, and construction loans were the largest contributors to CRE loan growth as ofSeptember 30, 2020 , increasing$70.3 million ,$49.1 million , and$33.7 million , respectively, fromDecember 31, 2019 . Importantly, management has elevated its underwriting standards during the pandemic to ensure business owners and guarantors have robust liquidity, operating performance, and collateral positions. Despite these higher standards, the Corporation has been able to grow loans and deepen banking relationships. C&I loans increased$286.9 million to$790.3 million from$503.4 million atDecember 31, 2019 . Excluding net PPP loans, C&I loans decreased$38.5 million to$464.9 million from$503.4 million atDecember 31, 2019 primarily due to a$31.2 million decrease in asset-based loans and$4.0 million decrease in accounts receivable financing. Specialty finance products have historically experienced counter cyclical growth, growing during times of economic stress and uncertainty. As such, management expects asset-based loans and accounts receivable financing volume to increase during the remainder of 2020 and throughout 2021. 57
--------------------------------------------------------------------------------
Table of Contents
There continues to be a concentration in CRE loans which represented 71.6% and 67.3% of our total loans, excluding net PPP loans, as ofSeptember 30, 2020 andDecember 31, 2019 , respectively. As ofSeptember 30, 2020 , 18.1% 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. Management believes our ongoing investment in C&I loan production will allow C&I loan growth to keep pace with CRE growth over the long-term, ultimately stabilizing the concentration in CRE loans. As mentioned above, excluding net PPP loans, our C&I portfolio decreased$38.5 million , or 7.7%, to$464.9 million atSeptember 30, 2020 from$503.4 million atDecember 31, 2019 . Line of credit usage was$217.6 million as ofSeptember 30, 2020 , down from$282.9 million atDecember 31, 2019 , as line of credit usage significantly declined due to PPP loan proceeds. We will continue to actively pursue 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$15.4 million , or 74.9%, to$36.1 million atSeptember 30, 2020 , compared to$20.6 million atDecember 31, 2019 . The increase in non-accrual loans was principally due to the impairment of three previously identified relationships in the hospitality, wholesale food distributor, and commercial industries during the nine months endedSeptember 30, 2020 with balances outstanding of$5.8 million ,$4.3 million , and$5.0 million , respectively. In addition, an impaired legacy SBA loan of$3.6 million was repurchased. The Corporation's non-accrual loans as a percentage of total gross loans and leases measured 1.66% and 1.20% atSeptember 30, 2020 andDecember 31, 2019 , respectively. Non-accrual loans as a percentage of total gross loans and leases, excluding net PPP loans, was 1.95% atSeptember 30, 2020 . Please refer to the sections titled COVID-19 Update and Asset Quality for additional information on credit quality. Deposits As ofSeptember 30, 2020 , deposits increased by$291.0 million , or 19.0%, to$1.821 billion from$1.530 billion atDecember 31, 2019 primarily due to a$369.5 million increase in transaction accounts, partially offset by a$37.5 million decrease in money market accounts. Transaction account balances increased primarily due to the influx of PPP loan proceeds. Management attributes the transition from money market accounts to reciprocal transaction accounts with fullFDIC insurance to our clients' preferences for safety and soundness 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$1.528 billion for the nine months endedSeptember 30, 2020 , compared to$1.271 billion for the year endedDecember 31, 2019 . FHLB Advances and Other Borrowings As ofSeptember 30, 2020 , FHLB advances and other borrowings increased by$164.1 million , or 51.4%, to$483.5 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, as needed, to match-fund fixed rate loans and mitigate interest rate risk. 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
58
--------------------------------------------------------------------------------
Table of Contents
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 of September 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. 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.
Asset Quality
Impaired Assets
Total impaired assets consisted of the following at
September 30, December 31,
2020 2019
(Dollars in Thousands)
Non-accrual loans and leases
Commercial real estate:
Commercial real estate - owner occupied $ 7,941 $ 4,032
Commercial real estate - non-owner occupied 5,813 -
Land development 890 1,526
Construction - -
Multi-family - -
1-4 family 333 333
Total non-accrual commercial real estate 14,977 5,891
Commercial and industrial 20,693 14,575
Direct financing leases, net 351 -
Consumer and other:
Home equity and second mortgages - -
Other 29 147
Total non-accrual consumer and other loans 29 147
Total non-accrual loans and leases 36,050 20,613
Foreclosed properties, net 613 2,919
Total non-performing assets 36,663 23,532
Performing troubled debt restructurings 47 140
Total impaired assets Total non-accrual loans and leases to gross loans and leases 1.66 % 1.20 %
Total non-performing assets to gross loans and leases plus foreclosed properties, net
1.68 1.37
Total non-performing assets to total assets 1.41 1.12
Allowance for loan and lease losses to gross loans and leases 1.41 1.14
Allowance for loan and lease losses to non-accrual loans and leases
85.48 94.70
59--------------------------------------------------------------------------------
Table of Contents
Net PPP loans outstanding as ofSeptember 30, 2020 , were$325.5 million . There were no PPP loans outstanding as ofDecember 31, 2019 . The following asset quality ratios exclude net PPP loans as they are fully guaranteed by the SBA: September 30, December 31, 2020 2019 Total non-accrual loans and leases to gross loans and leases 1.95 % 1.20 %
Total non-performing assets to gross loans and leases plus foreclosed properties, net
1.98 1.37
Total non-performing assets to total assets 1.61 1.12
Allowance for loan and lease losses to gross loans and leases 1.67 1.14
As of September 30, 2020 and December 31, 2019 , $15.4 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.
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 $13.1 million , or 55.8%, to $36.7 million at September 30, 2020 from
$23.5 million at December 31, 2019 . The increase in non-accrual loans was
principally due to the impairment of three previously identified relationships
in the hospitality, wholesale food distributor, and commercial industries during
the nine months ended September 30, 2020 with balances outstanding of $5.8
million , $4.3 million , and $5.0 million , respectively. In addition, an impaired
legacy SBA loan of $3.6 million was repurchased.
We also monitor early stage delinquencies to assist in the identification of
potential future problems. As of September 30, 2020 , 99.90% of the loan and
lease portfolio, excluding non-accrual loans and leases, was in a current
payment status, compared to 99.76% at December 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.
60--------------------------------------------------------------------------------
Table of Contents
The following represents additional information regarding our impaired loans
and leases:
As of and for the Nine Months Ended As of and for the
September 30, Year Ended December 31,
2020 2019 2019
(In Thousands)
Impaired loans and leases with no impairment
reserves required $ 15,557 $ 9,320 $ 7,312
Impaired loans and leases with impairment
reserves required 20,540 13,615 13,441
Total impaired loans and leases 36,097 22,935 20,753
Less: Impairment reserve (included in allowance
for loan and lease losses) 8,898 4,319 3,365
Net impaired loans and leases $ 27,199 $ 18,616 $ 17,388
Average impaired loans and leases $ 24,899 $ 24,835 $ 24,090
Foregone interest income attributable to
impaired loans and leases $ 2,049 $ 2,113 $ 2,693
Less: Interest income recognized on impaired
loans and leases 467 783 793
Net foregone interest income on impaired loans
and leases $ 1,582 Non-performing assets also include foreclosed properties. A summary of foreclosed properties activity is as follows:
As of and for the Nine Months Ended As of and for the
September 30, Year Ended December 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 80 596 596
Proceeds from sale of foreclosed
properties (2,057) - -
Net loss on sale of foreclosed properties 34 - -
Impairment adjustments (363) (241) (224)
Balance at the end of the period $ 613 $
2,902
Allowance for Loan and Lease Losses
The allowance for loan and lease losses increased$11.3 million , or 57.9%, from$19.5 million as ofDecember 31, 2019 to$30.8 million as ofSeptember 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 1.41% as ofSeptember 30, 2020 . The allowance for loan and lease losses as a percentage of gross loans and leases, excluding net PPP loans, was 1.67% as ofSeptember 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 nine months endedSeptember 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$4.7 million increase was due to the economic conditions caused by the pandemic, including the increase in the unemployment rate, 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$5.5 million was driven by deterioration of two existing legacy SBA impaired relationships and one relationship in the hospitality industry. 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. 61
--------------------------------------------------------------------------------
Table of Contents
During the nine months endedSeptember 30, 2020 , we recorded net charge-offs on impaired loans and leases of$1.2 million , comprised of$1.5 million of charge-offs and$264,000 of recoveries. During the nine months endedSeptember 30, 2019 , we recorded net charge-offs on impaired loans and leases of approximately$868,000 , comprised of$1.2 million of charge-offs and$294,000 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$30.8 million , or 1.67% of total loans and leases excluding net PPP loans, was appropriate as ofSeptember 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 ofSeptember 30, 2020 andDecember 31, 2019 , our allowance for loan and lease losses to total non-accrual loans and leases was 85.48% 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 ofSeptember 30, 2020 . 62
--------------------------------------------------------------------------------
Table of Contents
A summary of the activity in the allowance for loan and lease losses follows:
As of and for the Three Months Ended As of and for the Nine Months
September 30, Ended September 30,
2020 2019 2020 2019
(Dollars in Thousands)
Allowance at beginning of period $ 27,464 $ 19,819 $ 19,520 $ 20,425
Charge-offs:
Commercial real estate:
Commercial real estate - owner occupied - - (27) -
Commercial real estate - non-owner
occupied - - - -
Construction and land development - - - -
Multi-family - - - -
1-4 family - - - -
Commercial and industrial (505) (1,097) (1,358) (1,158)
Direct financing leases - - (56) -
Consumer and other:
Home equity and second mortgages - (2) - (2)
Other - - (13) (2)
Total charge-offs (505) (1,099) (1,454) (1,162)
Recoveries:
Commercial real estate:
Commercial real estate - owner occupied - - 1 1
Commercial real estate - non-owner
occupied - 1 2 73
Construction and land development - - - -
Multi-family - - - -
1-4 family - - - -
Commercial and industrial 21 99 259 191
Direct financing leases - - - -
Consumer and other:
Home equity and second mortgages - - - 26
Other 2 1 2 3
Total recoveries 23 101 264 294
Net (charge-offs) recoveries (482) (998) (1,190) (868)
Provision for loan and lease losses 3,835 1,349 12,487 613
Allowance at end of period $ 30,817 $ 20,170 $ 30,817 $ 20,170
Annualized net charge-offs (recoveries)
as a percent of average gross loans and
leases 0.09 % 0.23 % 0.08 % 0.07 %
Annualized net charge-offs (recoveries)
as a percent of average gross loans and
leases, excluding average net PPP loans 0.11 % 0.23 % 0.09 % 0.07 %
63--------------------------------------------------------------------------------
Table of Contents
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 September 30, 2020 were the interest payments due on
subordinated and junior subordinated notes. On October 23, 2020 , the Bank's
Board of Directors declared a dividend in the aggregate amount of $1.5
million bringing year-to-date dividend declarations to $12.0 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
September 30, 2020 and December 31, 2019 , our immediate on-balance sheet
liquidity was $556.1 million and $438.2 million , respectively. At September 30,
2020 and December 31, 2019 , the Bank had $22.8 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 $613.2 million of outstanding wholesale funds at September 30, 2020 ,
compared to $446.5 million of wholesale funds as of December 31, 2019 , which
represented 26.9% 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 $288.3 million to $1.667 billion at
September 30, 2020 from $1.379 billion at December 31, 2019 as in-market deposit
balances increased 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 September 30, 2020 and December 31, 2019 .
64--------------------------------------------------------------------------------
Table of Contents
The Bank was able to access the wholesale funding market as needed at rates and terms comparable to market standards during the nine month period endedSeptember 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 orFederal Reserve Discount Window utilizing currently unencumbered securities and acceptable loans as collateral. As ofSeptember 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 nine months endedSeptember 30, 2020 , operating activities resulted in a net cash inflow of$5.4 million , which included net income and provision for loan and lease losses of$10.9 million and$12.5 million , respectively, partially offset by a net increase in loans originated for sale. Net cash used in investing activities for the nine months endedSeptember 30, 2020 was approximately$470.1 million which consisted of cash outflows to fund net loan growth and the purchase of$8.0 million in additional bank-owned life insurance and$13.4 million of FHLB stock, partially offset by a net reduction in securities. Net cash provided by financing activities resulted in a net cash inflow of$449.3 million for the nine months endedSeptember 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 ofSeptember 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.
© Edgar Online, source
