SEVERN BANCORP The Company
The Company is a savings and loan holding company chartered as a corporation in the state ofMaryland in 1990. It conducts business primarily through four subsidiaries, the Bank, SBI, theTitle Company , and Hyatt Commercial. Hyatt Commercial conducts business as a commercial real estate brokerage and property management company. SBI holds mortgages that do not meet the underwriting criteria of the Bank and is the parent company ofCrownsville , which does business asAnnapolis Equity Group and acquires real estate for syndication and investment purposes.The Title Company engages in title work related to real estate transactions. The Bank has seven branches inAnne Arundel County, Maryland , which offer a full range of deposit products and originate mortgages in its primary market ofAnne Arundel County, Maryland and, to a lesser extent, in other parts ofMaryland ,Delaware , andVirginia .
Overview
The Company provides a wide range of personal and commercial banking services. Personal services include mortgage and consumer lending as well as deposit products such as personal Internet banking and online bill pay, checking accounts, individual retirement accounts, money market accounts, and savings and time deposit accounts. Commercial services include commercial secured and unsecured lending services as well as business Internet banking, corporate cash management services, and deposit services. The Company also provides ATMs, credit cards, debit cards, safe deposit boxes, and telephone banking, among other products and services. We have experienced a decreased level of profitability in our operations in 2019, primarily due to loan runoff and increased noninterest expenses. Less fourth quarter interest income was generated from lower volumes of interest-earning assets, particularly from significantly lower medical-use cannabis related deposits that earned overnight interest income during the first half of 2019. Also, loan interest income decreased from lower loan volumes, which was slightly offset by a reduction in interest expense from less reliance on borrowings. Our income before income taxes amounted to$11.6 million in 2019 and$11.5 million in 2018. In 2019, the Mid-Atlantic region in which we operate continued to experience improved regional economic performance. The national economy improved as well throughout the year. Consumer confidence has been bolstered by certain positive economic trends such as lower unemployment and increased housing metrics. These positive trends have enabled us to maintain strong levels of liquidity, capital, and credit quality, despite decreased profitability. The Company expects to experience similar stable market conditions during 2020. If interest rates increase, demand for borrowing may decrease and our interest rate spread could decrease. If interest rates decrease, demand for borrowing may increase, which could improve our interest rate spread, depending on other factors. We will continue to manage loan and deposit pricing against the risks of rising costs of our deposits and borrowings. Interest rates are outside of our control, so we must attempt to balance the pricing and duration of the loan portfolio against the risks of rising costs of our deposits and borrowings.
The continued success and attraction of
If the market and/or economy worsens, our business, financial condition, results of operations, access to funds, and the price of our stock could be materially and adversely impacted. Critical Accounting Policies Our accounting and financial reporting policies conform to accounting principles generally accepted in theU.S. ("GAAP") and general practice within the banking industry. Accordingly, preparation of the financial statements requires management to exercise significant judgment or discretion or make significant assumptions and estimates based on the information available that have, or could have, a material impact on the carrying value of certain assets or on income. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements 28
Table of Contents
and the reported amounts of income and expenses during the periods presented. The accounting policies we view as critical are those relating to the Allowance, the valuation of securities, the valuation of real estate acquired through foreclosure, and the valuation of deferred tax assets and liabilities. Significant accounting policies are discussed in detail in "Notes to Consolidated Financial Statements - Note 1 - Summary of Significant Account Policies" in this Annual Report on Form 10-K.
Results of Operations
Net Income
Net income decreased by$195,000 , or 2.3%, to$8.4 million for 2019, compared to$8.6 million for 2018. Basic and diluted income per share decreased to$0.66 and$0.65 , respectively, for 2019, compared to$0.68 and$0.67 , respectively, for 2018. We recognized an increase in net interest income and noninterest income compared to 2018. Noninterest expenses increased in 2019 compared to 2018 and we recorded a larger reversal of the provision for loan losses in 2019 compared to 2018. Net Interest Income Net interest income, which is interest earned net of interest expense, increased by$1.5 million , or 5.0%, to$30.5 million for 2019, compared to$29.1 million for 2018. The increase in net interest income was primarily due to an increase in the average balance of interest-earning assets, along with a decrease in the average volume of borrowings. Our net interest margin decreased from 3.66% in 2018 to 3.50% in 2019 and our net interest spread decreased from 3.29% in 2018 to 3.17% in 2019. Interest Income Interest income increased by$2.2 million , or 5.7%, to$39.8 million for 2019, compared to$37.7 million for 2018. Average interest-earning assets increased from$793.8 million in 2018 to$871.5 million in 2019. The yield on average assets decreased from 4.74% for 2018 to 4.57% in 2019 primarily as a result of decreasing interest rates in the latter part of 2019, mostly affecting interest on our other interest-earning assets by decreasing the average yield from 2.88% in 2018 to 1.87% in 2019. Average loans outstanding increased by$1.2 million in 2019 compared to 2018 due to increased originations, primarily in the commercial segment. Total loan originations, however, were significantly offset by loan runoff in 2019, which resulted in a lesser increase in average loans than would have occurred without the runoff. Average held-to-maturity ("HTM") securities decreased by$14.3 million in 2019 compared to 2018 due to maturities of securities and repayments from MBS. Average other interest-earning assets increased from$46.5 million in 2018 to$133.9 million in 2019. The increase was primarily due to increased short-term medical-use cannabis related funds that account holders relocated to investment opportunities outside of the Bank during the latter part of 2019.
Interest Expense
Interest expense increased by$700,000 , or 8.1%, to$9.3 million for 2019, compared to$8.6 million for 2018. The increase was primarily due to the increased average rate paid on our deposit accounts due to an increased interest rate environment in the first half of 2019. The average rate paid on deposits increased from 1.19% in 2018 to 1.25% in 2019. The average rate paid on CDs increased from 1.74% in 2018 to 2.38% in 2019. The increase in interest expense related to deposit accounts was slightly offset by a decrease in interest expense related to borrowings. Average borrowings decreased$36.8 million in 2019 compared to 2018. We paid off$38.5 million in long-term FHLB advances and commercial loans in 2019. 29 Table of Contents The following table sets forth, for the years indicated, information regarding the average balances of interest-earning assets and interest-bearing liabilities and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities. 2019 2018 2017 Average Yield/ Average Yield/ Average Yield/ Balance Interest (2) Rate Balance Interest (2) Rate Balance Interest (2) Rate ASSETS (dollars in thousands) Loans (1)$ 676,622 $ 35,639 5.27 %
4.88 %
Loans held for sale ("LHFS") 10,962 562 5.13 % 5,598 234 4.18 % 3,550 152 4.28 %
Available-for-sale ("AFS")
securities 11,392 202 1.77 % 11,795 208 1.76 % 5,164 92 1.78 %
HTM securities 35,584 728 2.05 % 49,867 988 1.98 % 61,514 1,141 1.85 %
Other interest-earning assets
(3) 133,935 2,499 1.87 % 46,470 1,338 2.88 % 48,276 472 0.98 %
Restricted stock investments, at
cost 3,038 180 5.92 % 4,612 249 5.40 % 4,750 225 4.74 %
Total interest-earning assets 871,533 39,810 4.57 % 793,760 37,660 4.74 % 741,092 32,224 4.35 %
Allowance (8,042) (8,179) (8,589)
Cash and other
noninterest-earning assets 44,512 43,055 59,867
Total assets $ 908,003 39,810 $ 828,636 37,660 $ 792,370 32,224
LIABILITIES AND STOCKHOLDERS'
EQUITY
Interest-bearing deposits:
Checking and savings $ 386,206 2,517 0.65 % $ 255,665 1,794 0.70 % $ 286,738 713 0.25 %
CDs 203,165 4,833 2.38 % 224,222 3,894 1.74 % 215,924 3,324 1.54 %
Total interest-bearing deposits 589,371 7,350 1.25 % 479,887 5,688 1.19 % 502,662 4,037 0.80 %
Borrowings 74,949 1,953 2.61 % 111,788 2,915 2.61 % 115,574 3,593 3.11 %
Total interest-bearing
liabilities 664,320 9,303 1.40 % 591,675 8,603 1.45 % 618,236 7,630 1.23 %
Noninterest-bearing deposits 135,027 139,467 83,693
Other noninterest-bearing
liabilities 6,039 2,283 2,599
Stockholders' equity 102,617 95,211 87,842
Total liabilities and
stockholders' equity $ 908,003 9,303 $ 828,636 8,603 $ 792,370 7,630
Net interest income/net interest
spread $ 30,507 3.17 % $ 29,057 3.29 % $ 24,594 3.12 %
Net interest margin 3.50 % 3.66 % 3.32 %
--------------------------------------------------------------------------------
(1) Nonaccrual loans are included in average loans. (2) There are no tax equivalency adjustments.
(3) Other interest-earning assets include interest-earning deposits, federal
funds sold, and certificates of deposit held for investment.
The "Rate/Volume Analysis" below indicates the changes in our net interest income as a result of changes in volume and rates. We maintain an asset and liability management policy designed to provide a proper balance between rate-sensitive assets and rate-sensitive liabilities to attempt to optimize interest margins while providing adequate liquidity for our
30Table of Contents
anticipated needs. Changes in interest income and interest expense that result
from variances in both volume and rates have been allocated to rate and volume
changes in proportion to the absolute dollar amounts of the change in each.
2019 vs. 2018 2018 vs. 2017
Due to Variances in Due to Variances in
Rate Volume Total Rate Volume Total
Interest earned on: (dollars in thousands)
Loans $ 934 $ 62 $ 996 $ 1,599 $ 2,902 $ 4,501
LHFS 63 265 328 (4) 86 82
AFS securities - (6) (6) (1) 117 116
HTM Securities 32 (292) (260) 74 (227) (153)
Other interest-earning assets (611) 1,772 1,161 884 (18) 866
Restricted stock investments, at cost 23 (92) (69) 31 (7) 24
Total interest income 441 1,709 2,150 2,583 2,853 5,436
Interest paid on:
Interest-bearing deposits:
Checking and savings (136) 859 723 1,152 (71) 1,081
CDs 1,332 (393) 939 438 132 570
Total interest-bearing deposits 1,196 466 1,662 1,590 61 1,651
Borrowings (2) (960) (962) (563) (115) (678)
Total interest expense 1,194 (494) 700 1,027 (54) 973
Net interest income $ (753) $ 2,203 $ 1,450 $ 1,556 $ 2,907 $ 4,463
Provision for Loan Losses
Our loan portfolio is subject to varying degrees of credit risk and an Allowance
is maintained to absorb losses inherent in our loan portfolio. Credit risk
includes, but is not limited to, the potential for borrower default and the
failure of collateral to be worth what we determined it was worth at the time of
the origination of the loan. We monitor loan delinquencies at least monthly. All
loans that are delinquent and all loans within the various categories of our
portfolio as a group are evaluated. Management, with the advice and
recommendation of the Company's Board of Directors, estimates an Allowance to be
set aside for loan losses. Included in determining the calculation are such
factors as historical losses for each loan portfolio, current market value of
the loan's underlying collateral, inherent risk contained within the portfolio
after considering the state of the general economy, economic trends,
consideration of particular risks inherent in different kinds of lending, and
consideration of known information that may affect loan collectability. As a
result of our Allowance analysis, for the years ended December 31, 2019 and
2018, we determined that provision reversals of $500,000 and $300,000 ,
respectively, were appropriate.
See additional information about the provision for loan losses under "Credit Risk Management and the Allowance" later in this Item.
Noninterest Income
Total noninterest income increased by$1.8 million , or 21.8%, to$10.3 million for 2019 compared to$8.4 million for 2018, primarily due to increased mortgage-banking revenue, increased real estate commissions, increased deposit service charges, and increased title company revenue. Mortgage-banking revenue increased$1.2 million , or 46.3%, to$3.7 million for 2019 compared to$2.6 million for 2018. This increase was the result of an increase in mortgage-banking activity in 2019, with an increase of originations from$100.8 million in 2018 to$171.8 million in 2019. Real estate commissions by Hyatt Commercial increased by$127,000 , or 7.4%, to$1.8 million for 2019 compared to$1.7 million for 2018. The increase was due to an increase in commercial sales activity in 2019. Deposit service charges increased$637,000 , or 41.0%, to$2.2 million in 2019, compared to$1.6 million in 2018 due primarily to on-boarding and monthly service fees charged to medical-use cannabis customers. Title company revenue increased$81,000 from$1.0 million in 2018 to$1.1 million in 2019 due to increased loan closings. 31 Table of Contents Noninterest Expense Total noninterest expense increased$3.4 million , or 13.0%, to$29.7 million for 2019, compared to$26.2 million for 2018, primarily due to increases in compensation and related expenses, occupancy costs, professional fees, and data processing and licensing and software costs. Compensation and related expenses increased by$1.9 million , or 10.8%, to$19.7 million for 2019, compared to$17.8 million for 2018. This increase was primarily due to annual salary increases, increased commissions, and bonuses. Net occupancy costs increased by$148,000 , or 9.5%, to$1.7 million for 2019 compared to$1.6 million for 2018, primarily due to additional properties. We opened ourCrofton branch in 2019. Professional fees increased by$649,000 , or 130.3%, to$1.1 million in 2019 compared to$498,000 in 2018, primarily due to increased external audit fees and additional consulting fees. Data processing fees and licensing and software expense increased$410,000 and$350,000 , respectively, in 2019 compared to 2018 due to additional efficiency and security enhancements to our core and related systems, as well as the implementation of a new customer relationship management ("CRM") system. Income Tax Provision We recognized a$3.2 million provision for income taxes on income before income taxes of$11.6 million for an effective tax rate of 27.9% during 2019 compared to a provision for income taxes of$3.0 million on income before taxes of$11.5 million for an effective tax rate of 25.8% in 2018. The increase in the effective tax rate from 2018 to 2019 was a function of changes in our permanent differences between recorded tax expense and taxes payable.
Financial Condition
Total assets decreased$147.3 million , or 15.1%, to$826.9 million atDecember 31, 2019 compared to$974.2 million atDecember 31, 2018 . Cash and cash equivalents decreased by$100.1 million , or 53.2%, to$88.2 million atDecember 31, 2019 compared to$188.3 million atDecember 31, 2018 , primarily due to the decrease in deposits noted below. LHFS increased$1.2 million , or 12.6%, to$10.9 million atDecember 31, 2019 compared to$9.7 million atDecember 31, 2018 . This increase was due to an increased volume of originations from$100.8 million in 2018 to$171.8 million in 2019. Loans decreased$36.7 million , or 5.4%, to$645.7 million atDecember 31, 2019 compared to$682.3 million atDecember 31, 2018 due to significant loan runoff, which offset increased origination activity in 2019. Real estate acquired through foreclosure increased$850,000 , or 55.3%, to$2.4 million atDecember 31, 2019 compared to$1.5 million atDecember 31, 2018 . This increase was due to the addition of four properties. Total securities decreased$12.0 million , or 23.6%, due to maturities and MBS repayments. Total deposits decreased$118.5 million , or 15.2%, to$661.0 million atDecember 31, 2019 compared to$779.5 million atDecember 31, 2018 . Long-term borrowings decreased by$38.5 million , or 52.4%, to$35.0 million atDecember 31, 2019 compared to$73.5 million atDecember 31, 2018 as we paid off FHLB advances and a commercial note payable.
Securities
We utilize the securities portfolio as part of our overall asset/liability management practices to enhance interest revenue while providing necessary liquidity for the funding of loan growth or deposit withdrawals. We continually monitor the credit risk associated with investments and diversify the risk in the securities portfolios. We held$12.9 million and$12.0 million in securities classified as AFS as ofDecember 31, 2019 and 2018, respectively. We held$26.0 million and$38.9 million in securities classified as HTM as ofDecember 31, 2019 and 2018, respectively. Changes in current market conditions, such as interest rates and the economic uncertainties in the mortgage, housing, and banking industries impact the securities market. Quarterly, we review each security in our AFS portfolio to determine the nature of any decline in value and evaluate if any impairment should be classified as other-than-temporary impairment ("OTTI"). Such evaluations resulted in the determination that no OTTI charges were required during 2019 or 2018. All of the AFS and HTM securities that were impaired as ofDecember 31, 2019 were so due to declines in fair values resulting from changes in interest rates or increased credit/liquidity spreads compared to the time they were purchased. We have the intent to hold these securities to maturity and it is more likely than not that we will not be required to sell the securities before recovery of value. As such, management considers the impairments to be temporary. 32
Table of Contents
Our securities portfolio composition is as follows at
AFS HTM
2019 2018 2017 2019 2018 2017
(dollars in thousands)
U.S. Treasury securities $ - $ 1,981 $ - $ 994 $ 1,991 $ 4,994
U.S. government agency notes 5,019 9,997 10,119 4,986 11,992 19,004
MBS 7,887 - - 19,980 24,929 30,305
$ 12,906 $ 11,978 $ 10,119 $ 25,960 $ 38,912 $ 54,303
The amortized cost, estimated fair values, and weighted average yields of debt
securities at December 31, 2019 , by contractual maturity, are shown below.
Actual maturities may differ from contractual maturities because issuers have
the right to call or prepay obligations.
Weighted
Amortized Unrealized Estimated Average
Cost Gains Losses Fair Value Yield
AFS Securities: (dollars in thousands)
U.S. government agency notes:
Due within one year $ 5,017 $ 2 $ - $ 5,019 2.23 %
MBS:
Due after ten years 7,951 - 64 7,887 2.90 %
$ 12,968 $ 2 $ 64 $ 12,906 2.64 %
HTM Securities:
U.S. Treasury securities:
Due within one year $ 994 $ 14 $ - $ 1,008 2.63 %
US government agency notes:
Due within one year 3,007 - 5 3,002 1.80 %
Due after one to five years 1,979 100 - 2,079 2.81 %
MBS:
Due after one to five years 1,430 10 2 1,438 2.15 %
Due after five to ten years 7,114 51 3 7,162 2.77 %
Due after ten years 11,436 53 20 11,469 2.86 %
$ 25,960 $ 228 $ 30 $ 26,158 2.66 %
Weighted yields are based on amortized cost. MBS are assigned to maturity categories based on their final maturity.
We did not hold any securities with an aggregate book value and market value in excess of 10% of stockholders' equity.
LHFS
We originate residential mortgage loans for sale on the secondary market.
At
When we sell mortgage loans we make certain representations to the purchaser
related to loan ownership, loan compliance and legality, and accurate
documentation, among other things. If a loan is found to be out of compliance
with any of the representations subsequent to the date of purchase, we may be
required to repurchase the loan or indemnify the purchaser for losses related to
the loan, depending on the agreement with the purchaser. In addition other
factors may cause us to be required to repurchase or "make-whole" a loan
previously sold.
The most common reason for a loan repurchase is due to a documentation error or
disagreement with an investor, or on rare occasions for fraud. Repurchase
requests are negotiated with each investor at the time we are notified of the
demand and an appropriate reserve is taken at that time. We did not repurchase
any loans during 2019 or 2018. We do not expect
33Table of Contents
increases in repurchases or related losses to be a growing trend nor do we see it having a significant impact on our financial results.
Loans
Our loan portfolio is expected to produce higher yields than investment securities and other interest-earning assets; the absolute volume and mix of loans and the volume and mix of loans as a percentage of total interest-earning assets is an important determinant of our net interest margin.
The following table sets forth the composition of our loan portfolio net of
unearned loan fees as of
2019 2018 2017 2016 2015
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
(dollars in thousands)
Residential Mortgage $ 268,152 41.5 % $ 274,759 40.3 % $ 285,819 42.8 % $ 257,659 42.2 % $ 283,211 47.4 %
Commercial 43,127 6.7 % 35,884 5.2 % 37,356 5.6 % 46,468 7.6 % 29,484 4.9 %
Commercial real estate 228,012 35.3 % 242,693 35.6 % 235,129 35.2 % 195,710 32.1 % 174,912 29.2 %
ADC 92,822 14.4 % 114,540 16.8 % 93,060 13.9 % 90,102 14.8 % 85,054 14.2 %
Home equity/2nds 12,031 1.9 % 13,386 2.0 % 15,703 2.3 % 19,129 3.1 % 24,529 4.1 %
Consumer 1,541 0.2 % 1,087 0.1 % 1,084 0.2 % 1,210 0.2 % 1,224 0.2 %
$ 645,685 100.0 % $ 682,349 100.0 % $ 668,151 100.0 % $ 610,278 100.0 % $ 598,414 100.0 %
Loans decreased by $36.7 million , or 5.4%, to $645.7 million at
December 31, 2019 compared to $682.3 million at December 31, 2018 . This decrease
was primarily due to decreased residential mortgage, commercial real estate, and
ADC loan demand, as well as significant runoff in 2019 in those loan segments.
Commercial loans increased 20.2% as we increased our focus on commercial lending
in 2019.
Approximately 53% of our loans had adjustable rates as of December 31, 2019 . Our
variable-rate loans adjust to the current interest rate environment, whereas
fixed rates do not allow this flexibility. If interest rates were to increase in
the future, our interest earned on the variable-rate loans would improve, and if
rates were to fall, the interest we earn on such loans would decline, thus
impacting our interest income. Some variable-rate loans have rate floors and/or
ceilings which may delay and/or limit changes in interest income in a period of
changing rates. See our discussion in "Interest Rate Sensitivity" later in this
Item for more information on interest rate fluctuations.
The following table sets forth the maturity distribution for our loan portfolio
at December 31, 2019 . Some of our loans may be renewed or repaid prior to
maturity. Therefore, the following table should not be used as a forecast of our
future cash collections.
Maturing
In one year or less After 1 through 5 years After 5 years
Fixed Variable Fixed Variable Fixed Variable Total
(dollars in thousands)
Residential Mortgage $ 22,306 $ 11,031 $
25,736
3,490 16,661 8,097 2,812 5,616 6,451 43,127 Commercial real estate
9,005 12,766 52,116 7,709 71,230 75,186 228,012 ADC
34,889 19,569 5,480 17,376 1,398 14,110 92,822
Home equity/2nds 263 - 389 - 203 11,176 12,031
Consumer - - 672 23 846 - 1,541
$ 69,953 $ 60,027 $ 92,490 $ 33,498 $ 142,299 $ 247,418 $ 645,685
$ 129,980 $ 125,988 $ 389,717
34
Table of Contents
Credit Risk Management and the Allowance
Credit risk is the risk of loss arising from the inability of a borrower to meet
his or her obligations and entails both general risks, which are inherent in the
process of lending, and risks specific to individual borrowers. Our credit risk
is mitigated through portfolio diversification, which limits exposure to any
single customer, industry, or collateral type.
We manage credit risk by evaluating the risk profile of the borrower, repayment
sources, the nature of the underlying collateral, and other support given
current events, conditions, and expectations. We attempt to manage the risk
characteristics of our loan portfolio through various control processes, such as
credit evaluation of borrowers, establishment of lending limits, and application
of lending procedures, including the holding of adequate collateral and the
maintenance of compensating balances. However, we seek to rely primarily on the
cash flow of our borrowers as the principal source of repayment. Although credit
policies and evaluation processes are designed to minimize our risk, management
recognizes that loan losses will occur and the amount of these losses will
fluctuate depending on the risk characteristics of our loan portfolio, as well
as general and regional economic conditions.
Management has an established methodology to determine the adequacy of the
Allowance that assesses the risks and losses inherent in the loan portfolio. Our
Allowance methodology employs management's assessment as to the level of future
losses on existing loans based on our internal review of the loan portfolio,
including an analysis of the borrowers' current financial position, and the
consideration of current and anticipated economic conditions and their potential
effects on specific borrowers and/or lines of business. In determining our
ability to collect certain loans, we also consider the fair value of any
underlying collateral. In addition, we evaluate credit risk concentrations,
including trends in large dollar exposures to related borrowers, industry and
geographic concentrations, and economic and environmental factors. Our risk
management practices are designed to ensure timely identification of changes in
loan risk profiles; however, undetected losses may inherently exist within the
loan portfolio. The assessment aspects involved in analyzing the quality of
individual loans and assessing collateral values can also contribute to
undetected, but probable, losses. For more detailed information about our
Allowance methodology and risk rating system, see Note 3 to the Consolidated
Financial Statements.
35
Table of Contents
The following table summarizes the activity in our Allowance by portfolio
segment as of and for the years ended
2019 2018 2017 2016 2015
(dollars in thousands)
Allowance, beginning of year $ 8,044 $ 8,055 $ 8,969 $ 8,758 $ 9,435
Charge-offs:
Residential mortgage (20) (534) (726) (151) (454)
Commercial - - - (17) (154)
Commercial real estate (537) (38) - (178) (80)
ADC - (34) - (72) -
Home equity/2nds - - (98) (50) (834)
Consumer (14) - (2) - -
Total charge-offs (571) (606) (826) (468) (1,522)
Recoveries:
Residential mortgage 14 228 375 324 629
Commercial - - - 54 284
Commercial real estate 130 424 157 23 -
ADC 5 - - 157 49
Home equity/2nds 11 243 30 421 163
Consumer 5 - - 50 -
Total recoveries 165 895 562 1,029 1,125
Net (charge-offs) recoveries (406) 289 (264) 561 (397)
Reversal of provision for loan losses (500) (300) (650) (350) (280)
Allowance, end of year $ 7,138 $ 8,044 $ 8,055 $ 8,969 $ 8,758
Loans:
Year-end balance $ 645,685 $ 682,349 $ 668,151 $ 610,278 $ 598,414
Average balance during year 676,622 675,418 617,838 604,356 624,087
Allowance as a percentage of
year-end loan balance 1.11 % 1.18 % 1.21 % 1.47 % 1.46 %
Percent of average loans:
Reversal of provision for loan losses 0.07 % 0.04 % 0.11 % 0.06 % 0.04 %
Net (charge-offs) recoveries (0.06) % 0.04 % (0.04) % 0.09 % (0.06) %
The following tables summarize our allocation of the Allowance by loan segment
as of December 31 :
2019 2018 2017
Percent Percent Percent
of Loans of Loans of Loans
Percent to Total Percent to Total Percent to Total
Amount of Total Loans Amount of Total Loans Amount of Total Loans
(dollars in thousands)
Residential mortgage $ 2,264 31.7 % 41.5 % $ 2,224 27.6 % 40.3 % $ 3,099 38.5 % 42.8 %
Commercial 1,421 19.9 % 6.7 % 2,736 34.0 % 5.2 % 527 6.5 % 5.6 %
Commercial real estate 984 13.8 % 35.3 % 457 5.7 % 35.6 % 2,805 34.8 % 35.2 % ADC
2,286 32.0 % 14.4 % 2,239 27.8 % 16.8 % 1,236 15.4 % 13.9 % Home equity/2nds
134 1.9 % 1.9 % 222 2.8 % 2.0 % 386 4.8 % 2.3 % Consumer
- - % 0.2 % 1 - % 0.1 % 2 - 0.2 %
Unallocated 49 0.7 % - % 165 2.1 % - % - - - %
Total $ 7,138 100.0 % 100.0 % $ 8,044 100.0 % 100.0 % $ 8,055 100.0 % 100.0 %
36
Table of Contents
2016 2015
Percent Percent
of Loans of Loans
Percent to Total Percent to Total
Amount of Total Loans Amount of Total Loans
(dollars in thousands)
Residential mortgage$ 3,833 42.7 % 42.2 %$ 4,188 47.8 % 47.4 % Commercial 478 5.3 % 7.6 % 291 3.3 % 4.9 % Commercial real estate 2,535 28.3 % 32.1 % 2,792 31.9 % 29.2 % ADC 1,390 15.5 % 14.8 % 956 10.9 % 14.2 % Home equity/2nds 728 8.1 % 3.1 % 528 6.1 % 4.1 % Consumer 5 0.1 % 0.2 % 3 - % 0.2 % Total$ 8,969 100.0 % 100.0 %$ 8,758 100.0 % 100.0 % Based upon management's evaluation, provisions are made to maintain the Allowance as a best estimate of inherent losses within the portfolio. The Allowance totaled$7.1 million atDecember 31, 2019 and$8.0 million atDecember 31, 2018 . Any changes in the Allowance from period to period reflect management's ongoing application of its methodologies to establish the Allowance, which, for the year endedDecember 31, 2019 , resulted in a reversal of the provision for loan losses of$500,000 , compared to a similar such reversal of$300,000 for the year endedDecember 31, 2018 . AtDecember 31, 2018 , due to a reevaluation of its qualitative factors, the Company changed its estimates of the Allowance relative to historical loss experience within specific loan portfolio segments in order to better align its qualitative factors with historical losses experienced over a longer period of time, relative to those specific loan segments. The result of this change in estimate did not result in a material increase in the Allowance compared to the year endedDecember 31, 2017 , however there were material changes to the Allowance between loan segments. Due to the change in accounting estimate, Allowance allocated to commercial loans and ADC loans increased approximately$2.2 and$1.1 million , respectively, while Allowance allocated to residential mortgage loans and commercial real estate loans decreased$600,000 and$2.7 million , respectively, as ofDecember 31, 2018 . This change in accounting estimate had no impact on earnings or diluted earnings per share. This change in estimate did not have any impact on the current period provision for loan losses, rather, it resulted in re-allocation of existing Allowances between loan classifications. During 2019 we recorded net charge-offs of$406,000 compared to net recoveries of$289,000 during 2018. During 2019, net charge-offs as compared to average loans outstanding amounted to 0.06% compared to net recoveries as compared to average loans outstanding of 0.04% during 2018. The Allowance as a percentage of outstanding loans decreased from 1.18% as ofDecember 31, 2018 to 1.11% as ofDecember 31, 2019 , reflecting the improvement in our overall asset quality. Although management uses available information to establish the appropriate level of the Allowance, future additions or reductions to the Allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. As a result, our Allowance may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our Allowance and related methodology. Such agencies may require us to recognize adjustments to the Allowance based on their judgments about information available to them at the time of their examination. Management believes the Allowance is adequate as ofDecember 31, 2019 and is sufficient to address the credit losses inherent in the current loan portfolio.
Nonperforming Assets ("NPAs")
Given the volatility of the real estate market, it is very important for us to
have current appraisals on our NPAs. In general, we obtain appraisals on NPAs on
an annual basis. As part of our asset monitoring activities, we maintain a Loss
Mitigation Committee that meets once a month. During these Loss Mitigation
Committee meetings, all NPAs and loan delinquencies are reviewed. We also
produce an NPA report which is distributed monthly to senior management and is
also discussed and reviewed at the Loss Mitigation Committee meetings. This
report contains all relevant data on the NPAs, including the latest appraised
value and valuation date. Accordingly, these reports identify which assets will
require an updated appraisal. As a result, we have not experienced any internal
delays in identifying which loans/credits require appraisals.
37Table of Contents
With respect to the ordering process of the appraisals, we have not experienced any delays in turnaround time nor has this been an issue over the past three years. Furthermore, we have not had any delays in turnaround time or variances thereof in our specific loan operating markets.
NPAs, expressed as a percentage of total assets, totaled 0.8% atDecember 31, 2019 and 0.6% atDecember 31, 2018 . The ratio of the Allowance to nonperforming loans was 168.3% atDecember 31, 2019 and 172.8% atDecember 31, 2018 . The decrease in this ratio fromDecember 31, 2018 toDecember 31, 2019 was primarily a reflection of the decrease in the Allowance. The ratio of nonperforming loans to total loans was 0.7% at bothDecember 31, 2019 and 2018. The distribution of our NPAs is illustrated in the following table as ofDecember 31 : 2019 2018 2017 2016 2015 Nonaccrual Loans: (dollars in thousands) Residential mortgage$ 3,766 $ 2,580 $ 3,891 $ 3,580 $ 3,191 Commercial - 430 78 151 483 Commercial real estate 237 660 159 2,938 2,681 ADC 89 558 314 269 521 Home equity/2nds 150 428 1,268 2,914 2,098 4,242 4,656 5,710 9,852 8,974 Real Estate Acquired Through Foreclosure: Residential mortgage 1,377 1,366 - 206 1,381 Commercial - - - - 37 Commercial real estate 452 - 187 528 - ADC 558 171 216 239 326 2,387 1,537 403 973 1,744 Total Nonperforming Assets$ 6,629 $ 6,193 $ 6,113 $ 10,825 $ 10,718 Nonaccrual loans amounted to$4.2 million atDecember 31, 2019 and$4.7 million atDecember 31, 2018 . Significant activity in nonaccrual loans during 2019 included additions of$2.3 million , transfers to real estate acquired through foreclosure of$1.3 million , returns to accrual status of$172,000 , and pay-offs/sales of$1.1 million .
Real estate acquired through foreclosure increased
The activity in our real estate acquired through foreclosure was as follows as
of and for the years ended
2019 2018 2017 2016 2015
(dollars in thousands)
Balance at beginning of year $ 1,537 $ 403 $ 973 $ 1,744 $ 1,947
Real estate acquired in satisfaction of loans 1,342 1,366 703 1,575 2,234
Write-downs and losses on real estate
acquired through foreclosure (259) (61) (103) (176) (9)
Proceeds from sales of real estate acquired
through foreclosure (233) (171) (1,170) (2,170) (2,428)
Balance at end of year $ 2,387 $ 1,537 $ 403 $ 973 $ 1,744 There were no loans greater than 90 days past due and still accruing at
Troubled Debt Restructured Loans ("TDRs")
In situations where, for economic or legal reasons related to a borrower's financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a TDR.
38Table of Contents
The composition of our TDRs is illustrated in the following table as ofDecember 31 : 2019 2018 2017 2016 2015 Residential mortgage: (dollars in thousands) Nonaccrual$ 85 $ 446 $ 736 $ 2,137 $ 1,071
<90 days past due/current 7,675 9,469 11,631 15,648 20,831
Commercial:
Nonaccrual - - - - -
<90 days past due/current - - - - 103
Commercial real estate:
Nonaccrual - - 78 249 252<90 days past due/current 984 1,019 1,862 1,914 2,464
ADC:
Nonaccrual - - 6 6 6
<90 days past due/current 130 134 137 170 978
Home equity/2nds:
Nonaccrual - - - - -
<90 days past due/current - - - 238 -
Consumer:
Nonaccrual - - - - -
<90 days past due/current 69 76 84 96 10
Totals:
Nonaccrual 85 446 820 2,392 1,329
<90 days past due/current 8,858 10,698 13,714 18,066 24,386
$ 8,943 $ 11,144 $ 14,534 $ 20,458 $ 25,715 See additional information on TDRs in Note 3 to the Consolidated Financial Statements.
Deposits
Deposits were$661.0 million atDecember 31, 2019 and$779.5 million atDecember 31, 2018 . During the year endedDecember 31, 2019 , we experienced decreases in all categories of deposit accounts due primarily to competition. In 2019 we saw runoff of short-term medical-use cannabis related funds (funds that have not actually been used in the medical-use cannabis industry yet) that account holders relocated to investment opportunities outside of the Bank. Management was aware of the short-term nature of certain medical-use cannabis related deposits and offset those funds by maintaining short-term liquidity to meet any deposit outflows.
The deposit breakdown is as follows as of
2019 2018 2017 2016 2015
(dollars in thousands)
NOW $ 83,612 $ 106,508 $ 63,616 $ 63,137 $ 56,096
Money market 162,621 203,351 103,649 66,356 47,690
Savings 61,514 75,692 98,717 110,492 111,992
CDs 230,401 247,351 263,413 273,816 277,778Total interest-bearing deposits 538,148 632,902 529,395 513,801 493,556
Noninterest-bearing deposits 122,901 146,604 72,833 58,145 30,215 Total deposits$ 661,049 $ 779,506 $ 602,228 $ 571,946 $ 523,771 39 Table of Contents The following table provides the maturities of CDs in amounts of$100,000 or more atDecember 31 : 2019 2018 Maturing in: (dollars in thousands) 3 months or less$ 13,137 $ 26,910 Over 3 months through 6 months 21,019 23,330 Over 6 months through 12 months 37,331 27,160 Over 12 months 56,805 66,352$ 128,292 $ 143,752 Borrowings
Our borrowings consist of advances from the FHLB and a term loan from a commercial bank.
The FHLB advances are available under a specific collateral pledge and security agreement, which requires that we maintain collateral for all of our borrowings equal to 30% of total assets. Our advances from the FHLB may be in the form of short-term or long-term obligations. Short-term advances have maturities for one year or less and may contain prepayment penalties. Long-term borrowings through the FHLB have original maturities up to 20 years and generally contain prepayment penalties. AtDecember 31, 2019 , our total available credit line with the FHLB was$246.7 million . The Bank, from time to time, utilizes the line of credit when interest rates are more favorable than obtaining deposits from the public. Our outstanding FHLB advance balance atDecember 31, 2019 andDecember 31, 2018 was$35.0 million and$70.0 million , respectively. OnSeptember 30, 2016 , we entered into a loan agreement with a commercial bank whereby we borrowed$3.5 million for a term of 8 years. The unsecured note bore interest at a fixed rate of 4.25% for the first 36 months then converted to a floating rate of the Wall Street Journal Prime plus 50 basis points for the remaining five years. Repayment terms were monthly interest only payments for the first 36 months, then quarterly principal payments of$175,000 plus interest. During the fourth quarter of 2019, we repaid the loan without penalty. 40 Table of Contents Certain information regarding our borrowings is as follows as ofDecember 31 : 2019 2018 2017 Amount outstanding at year-end: (dollars in thousands) FHLB advances$ 35,000 $ 70,000 $ 85,000 Commercial note payable - 3,500 3,500
Weighted-average interest rate at year-end:
FHLB advances 1.92 % 2.27 %
2.40 %
Commercial note payable - % 4.25 %
4.25 %
Maximum outstanding at any month-end:
FHLB advances$ 70,000 $ 96,000 $ 169,950 Commercial note payable 3,500 3,500 3,500 Average outstanding: FHLB advances$ 50,897 $ 87,669 $ 91,456 Commercial note payable 3,433 3,500 3,500
Weighted-average interest rate during the year:
FHLB advances 1.74 % 2.17 % 3.03 % Commercial note payable 4.20 % 5.04 % 5.04 %
The following table sets forth information concerning the interest rates and
maturity dates of the advances from the FHLB as of
Principal
Amount (in thousands) Rate Maturity
$
25,000 1.75% to 1.92% 2020
10,000 2.19% 2022
$
35,000
Subordinated Debentures
As of December 31, 2019 and 2018, the Company had outstanding $20.6 million in
principal amount of Junior Subordinated Debt Securities , due in 2035 (the "2035
Debentures"). The 2035 Debentures were issued pursuant to an Indenture dated as
of December 17, 2004 (the "2035 Indenture") between the Company and Wells Fargo
Bank, National Association as Trustee. The 2035 Debentures pay interest
quarterly at a floating rate of interest of 3month LIBOR plus 200 basis points
and mature on January 7, 2035 . Payments of principal, interest, premium, and
other amounts under the 2035 Debentures are subordinated and junior in right of
payment to the prior payment in full of all senior indebtedness of the Company,
as defined in the 2035 Indenture. The 2035 Debentures became redeemable, in
whole or in part, by the Company on January 7, 2010 .
The 2035 Debentures were issued and sold to Severn Capital Trust I (the
"Trust"), of which 100% of the common equity is owned by the Company. The Trust
was formed for the purpose of issuing corporation-obligated mandatorily
redeemable Capital Securities ("Capital Securities") to third-party investors
and using the proceeds from the sale of such Capital Securities to purchase the
2035 Debentures. The 2035 Debentures held by the Trust are the sole assets of
the Trust. Distributions on the Capital Securities issued by the Trust are
payable quarterly at a rate per annum equal to the interest rate being earned by
the Trust on the 2035 Debentures. The Capital Securities are subject to
mandatory redemption, in whole or in part, upon repayment of the 2035
Debentures. We have entered into an agreement which, taken collectively, fully
and unconditionally guarantees the Capital Securities subject to the terms of
the guarantee.
Under the terms of the 2035 Debentures, we are permitted to defer the payment of
interest on the 2035 Debentures for up to 20 consecutive quarterly periods,
provided that no event of default has occurred and is continuing. As of
41
Table of Contents
Capital Resources
Total stockholders' equity increased
Series A Preferred Stock
OnNovember 15, 2008 , the Company completed a private placement offering consisting of a total of 70 units, at an offering price of$100,000 per unit, for gross proceeds of$7.0 million . Each unit consisted of 6,250 shares of the Company's Series A 8.0% Non-Cumulative Convertible Preferred Stock. OnMarch 13, 2018 , the Company notified holders of its Series A preferred stock that the Company had exercised its option to convert all 437,500 outstanding shares of Series A preferred stock for 437,500 shares of common stock. The Company converted the Series A preferred stock onApril 2, 2018 and as of that date, the Series A preferred stock was no longer deemed outstanding and all rights with respect to such stock ceased and terminated.
Capital Adequacy
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary, actions by the regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. As of bothDecember 31, 2019 and 2018, the Bank exceeded all capital adequacy requirements to which it is subject and met the qualifications to be considered "well-capitalized." See details of our capital ratios in Note 10 to the Consolidated Financial Statements.
Off-Balance Sheet Arrangements and Derivatives
We enter into off-balance sheet arrangements in the normal course of business. These arrangements consist primarily of commitments to extend credit, lines of credit, and letters of credit. In addition, we have certain operating lease obligations.
Credit Commitments
Credit commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party. Our exposure to credit loss in the event of nonperformance by the borrower is the contract amount of the commitment. Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. We are not aware of any accounting loss we would incur by funding our commitments.
See more detailed information on credit commitments below under "Liquidity."
Derivatives
We maintain and account for derivatives, in the form of interest-rate lock
commitments ("IRLCs"), mandatory forward contracts, and best effort forward
contracts, in accordance with the Financial Accounting Standards Board ("FASB")
guidance on accounting for derivative instruments and hedging activities. We
recognize gains and losses on IRLCs, mandatory forward contracts, and best
effort forward contracts on the loan pipeline through mortgage-banking revenue
in the Consolidated Statements of Income.
42Table of Contents
IRLCs on mortgage loans that we intend to sell in the secondary market are considered derivatives. We are exposed to price risk from the time a mortgage loan closes until the time the loan is sold. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 14 days to 60 days. For these IRLCs, we attempt to protect the Bank from changes in interest rates through the use of best efforts and mandatory forward contracts.
Information pertaining to the carrying amounts of our derivative financial
instruments follows as of
2019 2018
Notional Estimated Notional Estimated
Amount Fair Value Amount Fair Value
(dollars in thousands)
Asset - IRLCs $ 7,645 $ 179 $ 3,710 $ 100
Asset - mandatory forward contracts 7,645 23 - -
Asset - best effort forward contracts 10,591 23 3,710 -
Liability - mandatory forward contracts - - 9,363 16
Contractual Obligations
We have certain obligations to make future payments under contract. At
December 31, 2019 , the aggregate contractual obligations and commitments were:
Less than After 1-3 After 3-5 After
Total one Year Years Years 5 Years
(dollars in thousands)
CDs $ 230,401 $ 126,156 $ 91,588 $ 12,657 $ -
Borrowings 35,000 25,000 10,000 - -
Subordinated debentures 20,619 - - - 20,619
Annual rental commitments under noncancelable
leases 3,170 357 694 547 1,572
$ 289,190 $ 151,513 $ 102,282 $ 13,204 $ 22,191
Liquidity
Liquidity describes our ability to meet financial obligations, including lending
commitments and contingencies, which arise during the normal course of business.
Liquidity is primarily needed to meet the borrowing and deposit withdrawal
requirements of our customers, to fund our mortgage-banking operations, as well
as to meet current and planned expenditures. These cash requirements are met on
a daily basis through the inflow of deposit funds, the maintenance of short-term
overnight investments, maturities and calls in our securities portfolio, and
available lines of credit with the FHLB, which requires pledged collateral.
Fluctuations in deposit and short-term borrowing balances may be influenced by
the interest rates paid, general consumer confidence, and the overall economic
environment. There can be no assurances that deposit withdrawals and loan
fundings will not exceed all available sources of liquidity on a short-term
basis. Such a situation would have an adverse effect on our ability to originate
new loans and maintain reasonable loan and deposit interest rates, which would
negatively impact earnings.
Our principal sources of liquidity are loan repayments, maturing investments,
sales of AFS securities, deposits, borrowed funds, and proceeds from loans sold
on the secondary market. The levels of such sources are dependent on the Bank's
operating, financing, and investing activities at any given time. We consider
core deposits stable funding sources and include all deposits, except CDs of
$100,000 or more. The Bank's experience has been that a substantial portion of
CDs renew at time of maturity and remain on deposit with the Bank. CDs scheduled
to mature within one year amounted to $126.2 million at December 31, 2019 .
Additionally, loan payments, maturities, deposit growth, and earnings contribute
to our flow of funds.
In addition to our ability to generate deposits, we have external sources of
funds, which may be drawn upon when desired. The primary source of external
liquidity is an available line of credit with the FHLB. Our credit availability
under the FHLB's credit availability program was $246.7 million at
December 31, 2019 , of which $35.0 million was outstanding.
43Table of Contents
The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit (collectively "commitments"), which totaled$113.5 million atDecember 31, 2019 . Historically, many of the commitments expire without being fully drawn; therefore, the total commitment amounts do not necessarily represent future cash requirements. As ofDecember 31, 2019 , we had$16.9 million in unadvanced commitments for home equity lines of credit,$701,000 outstanding in mortgage loan commitments,$79.4 million outstanding in unadvanced construction commitments, and commitments under lines of credit for$16.5 million , which we expect to fund from the sources of liquidity described above. Standby letters of credit amounted to$3.3 million atDecember 31, 2019 . Customer withdrawals are also a principal use of liquidity, but are generally mitigated by growth in customer funding sources, such as deposits and short-term borrowings. In addition to the foregoing, the payment of dividends is a use of cash, but is not expected to have a material effect on liquidity. As ofDecember 31, 2019 , we had no material commitments for capital expenditures. Our ability to acquire deposits or borrow could be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. AtDecember 31, 2019 , management considered the Company's liquidity level to be sufficient for the purposes of meeting our cash flow requirements. We are not aware of any undisclosed known trends, demands, commitments, or uncertainties that are reasonably likely to result in material changes in our liquidity. We anticipate that our primary sources of liquidity over the next twelve months will be from loan repayments, maturing investments, deposit growth, and borrowed funds. We believe that these sources of liquidity will be sufficient for us to meet our liquidity needs over the next twelve months.
Interest Rate Sensitivity
Interest rate sensitivity is an important factor in the management of the
composition and maturity configurations of our interest-earning assets and our
funding sources. The primary objective of our asset/liability management is to
ensure the steady growth of our primary earnings component, net interest income.
Our net interest income can fluctuate with significant interest rate movements.
We may attempt to structure the statement of financial condition so that
repricing opportunities exist for both assets and liabilities in roughly
equivalent amounts at approximately the same time intervals. However, imbalances
in these repricing opportunities at any point in time may be appropriate to
mitigate risks from fee income subject to interest rate risk, such as
mortgage-banking activities.
The measurement of our interest rate sensitivity, or "gap," is one of the
techniques used in asset/liability management. Interest sensitive gap is the
dollar difference between our assets and liabilities which are subject to
interest rate pricing within a given time period, including both floating-rate
or adjustable-rate instruments and instruments which are approaching maturity.
More assets repricing or maturing than liabilities over a given time period is
considered asset-sensitive and is reflected as a positive gap, and more
liabilities repricing or maturing than assets over a given time period is
considered liability-sensitive and is reflected as negative gap. An
asset-sensitive position (i.e., a positive gap) will generally enhance earnings
in a rising interest rate environment and will negatively impact earnings in a
falling interest rate environment, while a liability-sensitive position (i.e., a
negative gap) will generally enhance earnings in a falling interest rate
environment and negatively impact earnings in a rising interest rate
environment. Fluctuations in interest rates are not predictable or controllable.
Our management and our board of directors oversee the asset/liability management
function and meet periodically to monitor and manage the statement of financial
condition, control interest rate exposure, and evaluate pricing strategies. We
evaluate the asset mix of the statement of financial condition continually in
terms of several variables: yield, credit quality, funding sources, and
liquidity. Our management of the liability mix of the statement of financial
condition focuses on expanding our various funding sources and promotion of
deposit products with desirable repricing or maturity characteristics.
In theory, we can diminish interest rate risk through maintaining a nominal
level of interest rate sensitivity. In practice, this is made difficult by a
number of factors including cyclical variation in loan demand, different impacts
on our interest-
44
Table of Contents
sensitive assets and liabilities when interest rates change, and the
availability of our funding sources. Accordingly, we strive to manage the
interest rate sensitivity gap by adjusting the maturity of and establishing
rates on the interest-earning asset portfolio and certain interest-bearing
liabilities commensurate with our expectations relative to market interest
rates. Additionally, we may employ the use of off-balance sheet instruments,
such as interest rate swaps or caps, to manage our exposure to interest rate
movements. Generally, we attempt to maintain a balance between rate-sensitive
assets and liabilities that is appropriate to minimize our overall interest rate
risk, not just our net interest margin.
Our interest rate sensitivity position as of December 31, 2019 is presented in
the following table. Our assets and liabilities are scheduled based on maturity
or repricing data except for core deposits which are based on internal core
deposit analyses. These assumptions are validated periodically by management.
The difference between our rate-sensitive assets and rate-sensitive liabilities,
or the interest rate sensitivity gap, is shown at the bottom of the table. As
of December 31, 2019 , we had a one-year cumulative negative gap of $111.4
million .
180 days 181 days - One-five
or less one year years > 5 years Total
(dollars in thousands)
Interest-bearing deposits (1) $ 95,733 $ - $ - $ - $ 95,733
Securities 6,570 3,562 7,570 21,164 38,866
Restricted stock investments 2,431 - - - 2,431
LHFS 10,910 - - - 10,910
Loans 149,497 73,720 304,576 110,754 638,547
$ 265,141 $ 77,282 $ 312,146 $ 131,918 $ 786,487
Savings $ 24,606 $ 18,454 $ 18,454 $ - $ 61,514
NOWs 63,564 20,048 - - 83,612
Money market 137,228 18,138 7,255 - 162,621
CDs 60,800 65,356 104,245 - 230,401
Borrowings - 25,000 10,000 - 35,000
Subordinated debentures 20,619 - - - 20,619
$ 306,817 $ 146,996 $ 139,954 $ - $ 593,767
Period $ (41,676) $ (69,714) $ 172,192 $ 131,918
% of Assets (5.04) % (8.43) % 20.82 % 15.95 %
Cumulative $ (41,676) $ (111,390) $ 60,802 $ 192,720
% of Assets (5.04) % (13.47) % 7.35 % 23.30 %
Cumulative assets to liabilities 86.42 % 75.45 % 110.24 % 132.46 %
--------------------------------------------------------------------------------
(1) Includes CDs held for investment
While we monitor interest rate sensitivity gap reports, we primarily test our
interest rate sensitivity through the deployment of simulation analysis. We use
earnings simulation models to estimate what effect specific interest rate
changes would have on our net interest income. Simulation analysis provides us
with a more rigorous and dynamic measure of interest sensitivity. Changes in
prepayments have been included where changes in behavior patterns are assumed to
be significant to the simulation, particularly mortgage-related assets. Call
features on certain securities and borrowings are based on their call
probability in view of the projected rate change, and pricing features such as
interest rate floors are incorporated. We attempt to structure our asset and
liability management strategies to mitigate the impact on net interest income by
changes in market interest rates. However, there can be no assurance that we
will be able to manage interest rate risk so as to avoid significant adverse
effects on net interest income. We use the PROFITstar® model to monitor our
exposure to interest rate risk, which calculates changes in the economic value
of equity ("EVE").
45
Table of Contents
At
Change in Rates Amount $ Change % Change
(dollars in thousands
+400 bp $ 145,951 $ 648 0.45 %
+300 bp 149,554 4,251 2.93 %
+200 bp 152,214 6,911 4.76 %
+100 bp 151,187 5,884 4.05 %
0 bp 145,303
(100) bp 128,886 (16,417) (11.30) %
(200) bp 101,144 (44,159) (30.39) %
The preceding income simulation analysis does not represent a forecast of actual
results and should not be relied upon as being indicative of expected operating
results. These hypothetical estimates are based upon numerous assumptions, which
are subject to change, including: the nature and timing of interest rate levels
including the yield curve shape, prepayments on loans and securities, deposit
decay rates, pricing decisions on loans and deposits, reinvestment/replacement
of asset and liability cash flows, and others. Also, as market conditions vary,
prepayment/refinancing levels, the varying impact of interest rate changes on
caps and floors embedded in adjustable-rate loans, early withdrawal of deposits,
changes in product preferences, and other internal/external variables will
likely deviate from those assumed.
Inflation
The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with GAAP and practices within the banking industry which require the measurement of financial condition and operating results in terms of historical dollars, without considering the changes in the relative purchasing power of money over time due to inflation. As a financial institution, virtually all of our assets and liabilities are monetary in nature and interest rates have a more significant impact on our performance than the effects of general levels of inflation. A prolonged period of inflation could cause interest rates, wages, and other costs to increase and could adversely affect our results of operations unless mitigated by increases in our revenues correspondingly. However, we believe that the impact of inflation on our operations was not material for 2019 or 2018.
Subsequent Event
On
© Edgar Online, source
