UNITY BANCORP INC /NJ/
10-Ks and 10-Qs
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
March 31, 2020
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____.
Commission File Number
1-12431
Unity Bancorp, Inc.
(Exact name of registrant as specified in its charter)
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New Jersey
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22-3282551
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(State or other jurisdiction of incorporation or organization)
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(I.R.S. Employer Identification No.)
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64 Old Highway 22, Clinton, NJ
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08809
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(Address of principal executive offices)
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(Zip Code)
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Registrant’s telephone number, including area code
(908) 730-7630
Securities registered pursuant to Section 12(b) of the Exchange Act:
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Title of each class
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Trading Symbol(s)
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Name of each exchange on which registered
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Common stock
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UNTY
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NASDAQ
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Securities registered pursuant to Section 12(g) of the Exchange Act:
None
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934, as amended, during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:
Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act):
Large accelerated filer ☐ Accelerated filer ☒ Nonaccelerated filer ☐ Smaller reporting company ☒ Emerging Growth Company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act:
Yes ☐ No ☒
The number of shares outstanding of each of the registrant’s classes of common equity stock, as of April 30, 2020 common stock, no par value: 10,883,281 shares outstanding.
Table of Contents
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PART I
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CONSOLIDATED FINANCIAL INFORMATION
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Page #
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ITEM 1
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Consolidated Balance Sheets at March 31, 2020 and December 31, 2019
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Consolidated Statements of Income for the three months ended March 31, 2020 and 2019
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Consolidated Statements of Comprehensive Income for the three months ended March 31, 2020 and 2019
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Consolidated Statements of Changes in Shareholders' Equity for the three months ended March 31, 2020 and 2019
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Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019
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ITEM 2
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ITEM 3
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ITEM 4
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PART II
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ITEM 1
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ITEM 1A
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ITEM 2
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ITEM 3
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ITEM 4
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ITEM 5
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ITEM 6
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Exhibit 31.1
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Exhibit 31.2
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Exhibit 32.1
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PART I
CONSOLIDATED FINANCIAL INFORMATION
ITEM 1
Consolidated Financial Statements (Unaudited)
Unity Bancorp, Inc.
Consolidated Balance Sheets
(Unaudited)
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(In thousands)
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March 31, 2020
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December 31, 2019
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||||||
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ASSETS
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Cash and due from banks
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$
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20,377
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$
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21,106
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Federal funds sold and interest-bearing deposits
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158,618
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136,910
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Cash and cash equivalents
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178,995
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158,016
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Securities:
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Debt securities available for sale (amortized cost of $55,894 in 2020 and $63,883 in 2019)
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56,290
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64,275
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Equity securities with readily determinable fair values (amortized cost of $2,112 in 2020 and $2,218 in 2019)
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1,712
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2,289
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Total securities
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58,002
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66,564
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Loans:
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SBA loans held for sale
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10,726
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13,529
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SBA loans held for investment
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37,074
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35,767
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Commercial loans
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786,078
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765,032
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Residential mortgage loans
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456,072
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467,706
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Consumer loans
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149,695
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143,524
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Total loans
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1,439,645
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1,425,558
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Allowance for loan losses
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(17,376
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)
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(16,395
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)
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Net loans
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1,422,269
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1,409,163
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Premises and equipment, net
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21,046
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21,315
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Bank owned life insurance ("BOLI")
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26,379
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26,323
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Deferred tax assets
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6,305
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5,559
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Federal Home Loan Bank ("FHLB") stock
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9,054
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14,184
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Accrued interest receivable
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7,396
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6,984
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Other real estate owned ("OREO")
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1,523
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1,723
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Goodwill
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1,516
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1,516
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Prepaid expenses and other assets
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7,591
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7,595
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Total assets
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$
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1,740,076
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$
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1,718,942
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LIABILITIES AND SHAREHOLDERS' EQUITY
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Liabilities:
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Deposits:
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Noninterest-bearing demand
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$
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334,731
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$
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279,793
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Interest-bearing demand
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166,990
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176,335
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Savings
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388,213
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389,795
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Time, under $100,000
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278,776
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195,446
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Time, $100,000 to $250,000
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121,656
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126,192
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Time, $250,000 and over
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88,252
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82,553
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Total deposits
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1,378,618
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1,250,114
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Borrowed funds
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169,000
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283,000
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Subordinated debentures
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10,310
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10,310
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Accrued interest payable
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237
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455
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Accrued expenses and other liabilities
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17,606
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14,354
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Total liabilities
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1,575,771
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1,558,233
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Shareholders' equity:
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Common stock
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90,370
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90,113
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Retained earnings
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74,939
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70,442
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Treasury stock
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(172
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—
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Accumulated other comprehensive (loss) income
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(832
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154
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Total shareholders' equity
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164,305
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160,709
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Total liabilities and shareholders' equity
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$
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1,740,076
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$
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1,718,942
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COMMON SHARES AT PERIOD END
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Shares issued
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10,894
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10,881
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Shares outstanding
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10,883
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10,881
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Treasury shares
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11
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—
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The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.
3
Unity Bancorp, Inc.
Consolidated Statements of Income
(Unaudited)
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For the three months ended March 31,
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(In thousands, except per share amounts)
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2020
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2019
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INTEREST INCOME
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Federal funds sold and interest-bearing deposits
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$
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188
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$
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221
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FHLB stock
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109
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116
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Securities:
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Taxable
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511
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475
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Tax-exempt
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22
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29
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Total securities
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533
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504
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Loans:
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SBA loans
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985
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995
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Commercial loans
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9,933
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9,069
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Residential mortgage loans
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5,770
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5,560
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Consumer loans
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2,067
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2,035
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Total loans
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18,755
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17,659
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Total interest income
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19,585
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18,500
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INTEREST EXPENSE
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||||||||
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Interest-bearing demand deposits
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478
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409
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Savings deposits
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851
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1,119
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||||
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Time deposits
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2,447
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2,007
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||||
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Borrowed funds and subordinated debentures
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565
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749
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Total interest expense
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4,341
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4,284
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Net interest income
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15,244
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14,216
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||||
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Provision for loan losses
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1,500
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500
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Net interest income after provision for loan losses
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13,744
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13,716
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NONINTEREST INCOME
|
||||||||
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Branch fee income
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317
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368
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||||
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Service and loan fee income
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376
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442
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|
||||
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Gain on sale of SBA loans held for sale, net
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473
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316
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|
||||
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Gain on sale of mortgage loans, net
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1,051
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|
350
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|
||||
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BOLI income
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173
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151
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|
||||
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Net security (losses) gains
|
(170
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)
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100
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|
||||
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Other income
|
325
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|
295
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|
||||
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Total noninterest income
|
2,545
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|
2,022
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|
||||
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NONINTEREST EXPENSE
|
||||||||
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Compensation and benefits
|
5,439
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4,845
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||||
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Occupancy
|
624
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694
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||||
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Processing and communications
|
708
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716
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|
||||
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Furniture and equipment
|
655
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659
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||||
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Professional services
|
332
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288
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|
||||
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Loan collection and OREO expenses
|
186
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66
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|
||||
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Other loan expenses
|
89
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46
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|
||||
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Deposit insurance
|
88
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167
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|
||||
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Advertising
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290
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348
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||||
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Director fees
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200
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163
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Other expenses
|
712
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|
486
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||||
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Total noninterest expense
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9,323
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8,478
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|
||||
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Income before provision for income taxes
|
6,966
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|
7,260
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|
||||
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Provision for income taxes
|
1,598
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1,520
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|
||||
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Net income
|
$
|
5,368
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$
|
5,740
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|
||||||||
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Net income per common share - Basic
|
$
|
0.49
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$
|
0.53
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|
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Net income per common share - Diluted
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$
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0.49
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$
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0.52
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||||||||
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Weighted average common shares outstanding - Basic
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10,883
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10,801
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||||
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Weighted average common shares outstanding - Diluted
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11,037
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10,955
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The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.
4
Unity Bancorp, Inc.
Consolidated Statements of Comprehensive
Income
(Unaudited)
|
For the three months ended
|
||||||||||||||||||||||||
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March 31, 2020
|
March 31, 2019
|
|||||||||||||||||||||||
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(In thousands)
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Before tax amount
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Income tax expense (benefit)
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Net of tax amount
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Before tax amount
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Income tax expense (benefit)
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Net of tax amount
|
||||||||||||||||||
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Net income
|
$
|
6,966
|
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$
|
1,598
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$
|
5,368
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$
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7,260
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$
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1,520
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$
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5,740
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||||||
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Other comprehensive loss
|
||||||||||||||||||||||||
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Debt securities available for sale:
|
||||||||||||||||||||||||
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Unrealized holding (losses) gains on securities arising during the period
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(166
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)
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(35
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)
|
(131
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)
|
313
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73
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240
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|
||||||||||||
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Less: reclassification adjustment for (losses) gains on securities included in net income
|
(170
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)
|
(36
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)
|
(134
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)
|
100
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|
21
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79
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|
||||||||||||
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Total unrealized gains on debt securities available for sale
|
4
|
|
1
|
|
3
|
|
213
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|
52
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|
161
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|
||||||||||||
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Adjustments related to defined benefit plan:
|
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Amortization of prior service cost
|
21
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6
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|
15
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|
21
|
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(70
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)
|
91
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|
||||||||||||
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Total adjustments related to defined benefit plan
|
21
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|
6
|
|
15
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|
21
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(70
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)
|
91
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|
||||||||||||
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Net unrealized losses from cash flow hedges:
|
||||||||||||||||||||||||
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Unrealized holding losses on cash flow hedges arising during the period
|
(1,410
|
)
|
(406
|
)
|
(1,004
|
)
|
(408
|
)
|
(106
|
)
|
(302
|
)
|
||||||||||||
|
Total unrealized losses on cash flow hedges
|
(1,410
|
)
|
(406
|
)
|
(1,004
|
)
|
(408
|
)
|
(106
|
)
|
(302
|
)
|
||||||||||||
|
Total other comprehensive loss
|
(1,385
|
)
|
(399
|
)
|
(986
|
)
|
(174
|
)
|
(124
|
)
|
(50
|
)
|
||||||||||||
|
Total comprehensive income
|
$
|
5,581
|
|
$
|
1,199
|
|
$
|
4,382
|
|
$
|
7,086
|
|
$
|
1,396
|
|
$
|
5,690
|
|
||||||
The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.
5
Consolidated Statements of Changes in Shareholders’ Equity
For the
three months ended March 31,
2020
and
2019
(Unaudited)
|
Stock
|
Accumulated other
|
Total
|
|||||||||||||||||||||
|
(In thousands)
|
Shares
|
Amount
|
Retained earnings
|
comprehensive income (loss)
|
Treasury stock
|
shareholders' equity
|
|||||||||||||||||
|
Balance, December 31, 2019
|
10,881
|
|
$
|
90,113
|
|
$
|
70,442
|
|
$
|
154
|
|
$
|
—
|
|
$
|
160,709
|
|
||||||
|
Net income
|
—
|
|
—
|
|
5,368
|
|
—
|
|
—
|
|
5,368
|
|
|||||||||||
|
Other comprehensive loss, net of tax
|
—
|
|
—
|
|
—
|
|
(986
|
)
|
—
|
|
(986
|
)
|
|||||||||||
|
Dividends on common stock ($0.08 per share)
|
—
|
|
30
|
|
(871
|
)
|
—
|
|
—
|
|
(841
|
)
|
|||||||||||
|
Common stock issued and related tax effects (1)
|
13
|
|
227
|
|
—
|
|
—
|
|
—
|
|
227
|
|
|||||||||||
|
Acquisition of treasury stock, at cost
|
(11
|
)
|
(172
|
)
|
(172
|
)
|
|||||||||||||||||
|
Balance, March 31, 2020
|
10,883
|
|
$
|
90,198
|
|
$
|
74,939
|
|
$
|
(832
|
)
|
$
|
(172
|
)
|
$
|
164,305
|
|
||||||
|
Stock
|
Accumulated other
|
Total
|
|||||||||||||||||
|
(In thousands)
|
Shares
|
Amount
|
Retained earnings
|
comprehensive loss
|
shareholders' equity
|
||||||||||||||
|
Balance, December 31, 2018
|
10,780
|
|
$
|
88,484
|
|
$
|
50,161
|
|
$
|
(157
|
)
|
$
|
138,488
|
|
|||||
|
Net income
|
—
|
|
—
|
|
5,740
|
|
—
|
|
5,740
|
|
|||||||||
|
Other comprehensive loss, net of tax
|
—
|
|
—
|
|
—
|
|
(50
|
)
|
(50
|
)
|
|||||||||
|
Dividends on common stock ($0.07 per share)
|
—
|
|
26
|
|
(756
|
)
|
—
|
|
(730
|
)
|
|||||||||
|
Common stock issued and related tax effects (1)
|
42
|
|
269
|
|
—
|
|
—
|
|
269
|
|
|||||||||
|
Balance, March 31, 2019
|
10,822
|
|
$
|
88,779
|
|
$
|
55,145
|
|
$
|
(207
|
)
|
$
|
143,717
|
|
|||||
(1) Includes the issuance of common stock under employee benefit plans, which includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised.
The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.
6
Unity Bancorp, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
|
|
For the three months ended March 31,
|
|||||||
|
(In thousands)
|
2020
|
2019
|
||||||
|
OPERATING ACTIVITIES:
|
||||||||
|
Net income
|
$
|
5,368
|
|
$
|
5,740
|
|
||
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
||||||||
|
Provision for loan losses
|
1,500
|
|
500
|
|
||||
|
Net amortization of purchase premiums and discounts on securities
|
59
|
|
37
|
|
||||
|
Depreciation and amortization
|
317
|
|
121
|
|
||||
|
Deferred income tax (benefit) expense
|
(347
|
)
|
82
|
|
||||
|
Net security gains
|
(301
|
)
|
—
|
|
||||
|
Stock compensation expense
|
365
|
|
283
|
|
||||
|
Valuation writedowns on OREO
|
200
|
|
—
|
|
||||
|
Gain on sale of mortgage loans held for sale, net
|
(622
|
)
|
(258
|
)
|
||||
|
Gain on sale of SBA loans held for sale, net
|
(473
|
)
|
(316
|
)
|
||||
|
Origination of mortgage loans held for sale
|
(38,562
|
)
|
(19,431
|
)
|
||||
|
Origination of SBA loans held for sale
|
(2,595
|
)
|
(2,412
|
)
|
||||
|
Proceeds from sale of mortgage loans held for sale, net
|
39,184
|
|
19,689
|
|
||||
|
Proceeds from sale of SBA loans held for sale, net
|
5,850
|
|
6,511
|
|
||||
|
BOLI income
|
(173
|
)
|
(151
|
)
|
||||
|
Net change in other assets and liabilities
|
1,714
|
|
819
|
|
||||
|
Net cash provided by operating activities
|
11,484
|
|
11,214
|
|
||||
|
INVESTING ACTIVITIES
|
||||||||
|
Purchases of FHLB stock, at cost
|
(22,275
|
)
|
(20,295
|
)
|
||||
|
Maturities and principal payments on securities held to maturity
|
—
|
|
89
|
|
||||
|
Maturities and principal payments on debt securities available for sale
|
2,198
|
|
959
|
|
||||
|
Proceeds from sales of securities available for sale
|
6,029
|
|
—
|
|
||||
|
Proceeds from sales of equity securities
|
111
|
|
—
|
|
||||
|
Proceeds from redemption of FHLB stock
|
27,405
|
|
20,970
|
|
||||
|
Net increase in loans
|
(17,277
|
)
|
(12,541
|
)
|
||||
|
Proceeds from BOLI
|
117
|
|
—
|
|
||||
|
Purchases of premises and equipment
|
(166
|
)
|
(109
|
)
|
||||
|
Net cash used in investing activities
|
(3,858
|
)
|
(10,927
|
)
|
||||
|
FINANCING ACTIVITIES
|
||||||||
|
Net increase in deposits
|
128,504
|
|
18,899
|
|
||||
|
Proceeds from new borrowings
|
109,000
|
|
175,000
|
|
||||
|
Repayments of borrowings
|
(223,000
|
)
|
(190,000
|
)
|
||||
|
Proceeds from exercise of stock options
|
34
|
|
166
|
|
||||
|
Fair market value of shares withheld to cover employee tax liability
|
(172
|
)
|
—
|
|
||||
|
Dividends on common stock
|
(841
|
)
|
(730
|
)
|
||||
|
Purchase of treasury stock
|
(172
|
)
|
—
|
|
||||
|
Net cash provided by financing activities
|
13,353
|
|
3,335
|
|
||||
|
Increase in cash and cash equivalents
|
20,979
|
|
3,622
|
|
||||
|
Cash and cash equivalents, beginning of period
|
158,016
|
|
145,515
|
|
||||
|
Cash and cash equivalents, end of period
|
$
|
178,995
|
|
$
|
149,137
|
|
||
7
Unity Bancorp, Inc.
Consolidated Statements of Cash Flows
(Continued)
(Unaudited)
|
|
For the three months ended March 31,
|
|||||||
|
(In thousands)
|
2020
|
2019
|
||||||
|
SUPPLEMENTAL DISCLOSURES
|
||||||||
|
Cash:
|
||||||||
|
Interest paid
|
$
|
4,559
|
|
$
|
4,271
|
|
||
|
Income taxes paid
|
$
|
1,782
|
|
$
|
52
|
|
||
|
Noncash investing activities:
|
||||||||
|
Establishment of lease liability and right-of-use asset
|
$
|
—
|
|
$
|
2,765
|
|
||
|
Transfer of SBA loans held for sale to held to maturity
|
$
|
1,024
|
|
$
|
—
|
|
||
|
Capitalization of servicing rights
|
$
|
486
|
|
$
|
211
|
|
||
|
Transfer of loans to OREO
|
$
|
—
|
|
$
|
328
|
|
||
|
|
||||||||
|
The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.
|
||||||||
8
Unity Bancorp, Inc.
Notes to the Consolidated Financial Statements (Unaudited)
March 31, 2020
NOTE 1. Significant Accounting Policies
The accompanying Consolidated Financial Statements include the accounts of Unity Bancorp, Inc. (the "Parent Company") and its wholly-owned subsidiary, Unity Bank (the "Bank" or when consolidated with the Parent Company, the "Company"), and reflect all adjustments and disclosures which are generally routine and recurring in nature, and in the opinion of management, necessary for a fair presentation of interim results. The Bank has multiple subsidiaries used to hold part of its investment and loan portfolios and OREO properties. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior period amounts to conform to the current year presentation, with no impact on current earnings or shareholders’ equity. The financial information has been prepared in accordance with U.S. generally accepted accounting principles and has not been audited. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenues and expenses during the reporting periods. Actual results could differ from those estimates. Amounts requiring the use of significant estimates include the allowance for loan losses, valuation of deferred tax and servicing assets, the carrying value of loans held for sale and other real estate owned, the valuation of securities and the determination of other-than-temporary impairment for securities and fair value disclosures. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. The Company has evaluated subsequent events for potential recognition and/or disclosure through the date the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q were available to be issued. The markets served by the Company have been significantly impacted by COVID-19, which started during the first quarter of 2020. The Company continues to assess the financial impact of the COVID-19 pandemic.
The interim unaudited Consolidated Financial Statements included herein have been prepared in accordance with instructions for Form 10-Q and the rules and regulations of the Securities and Exchange Commission (“SEC”) and consist of normal recurring adjustments necessary for the fair presentation of interim results. The results of operations for the
three
months ended
March 31, 2020
are not necessarily indicative of the results which may be expected for the entire year. As used in this Form 10-Q, “we” and “us” and “our” refer to Unity Bancorp, Inc., and its consolidated subsidiary, Unity Bank, depending on the context. Certain information and financial disclosures required by U.S. generally accepted accounting principles have been condensed or omitted from interim reporting pursuant to SEC rules. Interim financial statements should be read in conjunction with the Company’s Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2019
.
Other-Than-Temporary Impairment
The Company has a process in place to identify securities that could potentially incur credit impairment that is other-than-temporary. This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation. This evaluation considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, the intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, our ability and intent to hold the security for a forecasted period of time that allows for the recovery in value.
Management assesses its intent to sell or whether it is more likely than not that it will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired with no intent to sell and no requirement to sell prior to recovery of its amortized cost basis, the amount of the impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income. For debt securities where management has the intent to sell, the amount of the impairment is reflected in earnings as realized losses.
9
The present value of expected future cash flows is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best estimate cash flows vary depending on the type of security. The asset-backed securities cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees. The corporate bond cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond specific facts and circumstances including timing, security interests and loss severity.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Loans
Loans Held for Sale
Loans held for sale represent the guaranteed portion of Small Business Administration (“SBA”) loans and are reflected at the lower of aggregate cost or market value. The Company originates loans to customers under an SBA program that historically has provided for SBA guarantees of up to 90 percent of each loan. The Company generally sells the guaranteed portion of its SBA loans to a third party and retains the servicing, holding the nonguaranteed portion in its portfolio. The net amount of loan origination fees on loans sold is included in the carrying value and in the gain or loss on the sale. When sales of SBA loans do occur, the premium received on the sale and the present value of future cash flows of the servicing assets are recognized in income. All criteria for sale accounting must be met in order for the loan sales to occur; see details under the “Transfers of Financial Assets” heading above.
Servicing assets represent the estimated fair value of retained servicing rights, net of servicing costs, at the time loans are sold. Servicing assets are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on stratifying the underlying financial assets by date of origination and term. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment, if temporary, would be reported as a valuation allowance.
Serviced loans sold to others are not included in the accompanying Consolidated Balance Sheets. Income and fees collected for loan servicing are credited to noninterest income when earned, net of amortization on the related servicing assets.
Loans Held to Maturity
Loans held to maturity are stated at the unpaid principal balance, net of unearned discounts and deferred loan origination fees and costs. In accordance with the level yield method, loan origination fees, net of direct loan origination costs, are deferred and recognized over the estimated life of the related loans as an adjustment to the loan yield. Interest is credited to operations primarily based upon the principal balance outstanding.
Loans are reported as past due when either interest or principal is unpaid in the following circumstances: fixed payment loans when the borrower is in arrears for two or more monthly payments; open end credit for two or more billing cycles; and single payment notes if interest or principal remains unpaid for 30 days or more.
Nonperforming loans consist of loans that are not accruing interest as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt (nonaccrual loans). When a loan is classified as nonaccrual, interest accruals are discontinued and all past due interest previously recognized as income is reversed and charged against current period earnings. Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income. Loans may be returned to an accrual status when the ability to collect is reasonably assured and when the loan is brought current as to principal and interest.
10
Loans are charged off when collection is sufficiently questionable and when the Company can no longer justify maintaining the loan as an asset on the balance sheet. Loans qualify for charge-off when, after thorough analysis, all possible sources of repayment are insufficient. These include: 1) potential future cash flows, 2) value of collateral, and/or 3) strength of co-makers and guarantors. All unsecured loans are charged off upon the establishment of the loan’s nonaccrual status. Additionally, all loans classified as a loss or that portion of the loan classified as a loss is charged off. All loan charge-offs are approved by the Board of Directors.
Troubled debt restructurings ("TDRs") occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. Interest income on accruing TDRs is credited to operations primarily based upon the principal amount outstanding, as stated in the paragraphs above.
The Company evaluates its loans for impairment. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company has defined impaired loans to be all TDRs and nonperforming loans individually evaluated for impairment. Impairment is evaluated in total for smaller-balance loans of a similar nature (consumer and residential mortgage loans), and on an individual basis for all other loans. Impairment of a loan is measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate, or as a practical expedient, based on a loan’s observable market price or the fair value of collateral, net of estimated costs to sell, if the loan is collateral-dependent. If the value of the impaired loan is less than the recorded investment in the loan, the Company establishes a valuation allowance, or adjusts existing valuation allowances, with a corresponding charge to the provision for loan losses.
For additional information on loans, see Note 8 to the Consolidated Financial Statements and the section titled "Loan Portfolio" under Item 2. Management's Discussion and Analysis.
Allowance for Loan Losses and Reserve for Unfunded Loan Commitments
The allowance for loan losses is maintained at a level management considers adequate to provide for probable loan losses as of the balance sheet date. The allowance is increased by provisions charged to expense and is reduced by net charge-offs.
The level of the allowance is based on management’s evaluation of probable losses in the loan portfolio, after consideration of prevailing economic conditions in the Company’s market area, the volume and composition of the loan portfolio, and historical loan loss experience. The allowance for loan losses consists of specific reserves for individually impaired credits and TDRs, reserves for nonimpaired loans based on historical loss factors and reserves based on general economic factors and other qualitative risk factors such as changes in delinquency trends, industry concentrations or local/national economic trends. This risk assessment process is performed at least quarterly, and, as adjustments become necessary, they are realized in the periods in which they become known.
Although management attempts to maintain the allowance at a level deemed adequate to provide for probable losses, future additions to the allowance may be necessary based upon certain factors including changes in market conditions and underlying collateral values. In addition, various regulatory agencies periodically review the adequacy of the Company’s allowance for loan losses. These agencies may require the Company to make additional provisions based on their judgments about information available to them at the time of their examination.
The Company maintains an allowance for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the allowance are made through other expenses and applied to the allowance which is maintained in other liabilities.
For additional information on the allowance for loan losses and unfunded loan commitments, see Note 9 to the Consolidated Financial Statements and the sections titled "Asset Quality" and "Allowance for Loan Losses and Reserve for Unfunded Loan Commitments" under Item 2. Management's Discussion and Analysis.
11
Income Taxes
The Company accounts for income taxes according to the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates applicable to taxable income for the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Valuation reserves are established against certain deferred tax assets when it is more likely than not that the deferred tax assets will not be realized. Increases or decreases in the valuation reserve are charged or credited to the income tax provision.When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that ultimately would be sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. The evaluation of a tax position taken is considered by itself and not offset or aggregated with other positions. Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
Interest and penalties associated with unrecognized tax benefits would be recognized in income tax expense on the income statement.
NOTE 2. Litigation
The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. In the best judgment of management, based upon consultation with counsel, the consolidated financial position and results of operations of the Company will not be affected materially by the final outcome of any pending legal proceedings or other contingent liabilities and commitments.
NOTE 3. Net Income per Share
Basic net income per common share is calculated as net income divided by the weighted average common shares outstanding during the reporting period.
Diluted net income per common share is computed similarly to that of basic net income per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares, principally stock options, were issued during the reporting period utilizing the Treasury stock method.
The following is a reconciliation of the calculation of basic and diluted income per share:
|
For the three months ended March 31,
|
||||||||
|
(In thousands, except per share amounts)
|
2020
|
2019
|
||||||
|
Net income
|
$
|
5,368
|
|
$
|
5,740
|
|
||
|
Weighted average common shares outstanding - Basic
|
10,883
|
|
10,801
|
|
||||
|
Plus: Potential dilutive common stock equivalents
|
154
|
|
154
|
|
||||
|
Weighted average common shares outstanding - Diluted
|
11,037
|
|
10,955
|
|
||||
|
Net income per common share - Basic
|
$
|
0.49
|
|
$
|
0.53
|
|
||
|
Net income per common share - Diluted
|
0.49
|
|
0.52
|
|
||||
|
Stock options and common stock excluded from the income per share calculation as their effect would have been anti-dilutive
|
363
|
|
209
|
|
||||
12
NOTE 4. Income Taxes
The Company follows
FASB ASC Topic 740, “Income Taxes,”
which prescribes a threshold for the financial statement recognition of income taxes and provides criteria for the measurement of tax positions taken or expected to be taken in a tax return. ASC 740 also includes guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition of income taxes.
On July 1, 2018, New Jersey's Assembly Bill 4202 was signed into law. The bill, effective January 1, 2018, imposes a temporary surtax on corporations earning New Jersey allocated taxable income in excess of $1 million at a rate of 2.5 percent for tax years beginning on or after January 1, 2018, through December 31, 2019, and at 1.5 percent for tax years beginning on or after January 1, 2020, through December 31, 2021. In addition, New Jersey adopted mandatory unitary combined reporting for its Corporation Business Tax, which became effective for periods on or after January 1, 2019.
For the quarter ended
March 31, 2020
, the Company reported income tax expense of
$1.6 million
for an effective tax rate of
22.9
percent, compared to an income tax expense of
$1.5 million
and an effective tax rate of
20.9
percent for the prior year’s quarter. The Company did
not
recognize or accrue any interest or penalties related to income taxes during the
three months ended March 31,
2020
or
2019
. The Company did
not
have an accrual for uncertain tax positions as of
March 31, 2020
or
December 31, 2019
, as deductions taken and benefits accrued are based on widely understood administrative practices and procedures and are based on clear and unambiguous tax law. Tax returns for all years
2015
and thereafter are subject to future examination by tax authorities.
NOTE 5. Other Comprehensive Income (Loss)
The following tables show the changes in other comprehensive income (loss) for the three months ended
March 31,
2020
and
2019
, net of tax:
|
|
For the three months ended March 31, 2020
|
|||||||||||||||
|
(In thousands)
|
Net unrealized gains (losses) on securities
|
Adjustments related to defined benefit plan
|
Net unrealized gains (losses) from cash flow hedges
|
Accumulated other comprehensive income (loss)
|
||||||||||||
|
Balance, beginning of period (1)
|
$
|
316
|
|
$
|
(295
|
)
|
$
|
168
|
|
$
|
189
|
|
||||
|
Other comprehensive loss before reclassifications
|
(131
|
)
|
—
|
|
(1,004
|
)
|
(1,135
|
)
|
||||||||
|
Less amounts reclassified from accumulated other comprehensive loss
|
(134
|
)
|
(15
|
)
|
—
|
|
(149
|
)
|
||||||||
|
Period change
|
3
|
|
15
|
|
(1,004
|
)
|
(986
|
)
|
||||||||
|
Balance, end of period (1)
|
$
|
319
|
|
$
|
(280
|
)
|
$
|
(836
|
)
|
$
|
(797
|
)
|
||||
|
|
For the three months ended March 31, 2019
|
|||||||||||||||
|
(In thousands)
|
Net unrealized (losses) gains on securities
|
Adjustments related to defined benefit plan
|
Net unrealized gains (losses) from cash flow hedges
|
Accumulated other comprehensive loss
|
||||||||||||
|
Balance, beginning of period (1)
|
$
|
(721
|
)
|
$
|
(431
|
)
|
$
|
1,030
|
|
$
|
(122
|
)
|
||||
|
Other comprehensive income (loss) before reclassifications
|
240
|
|
—
|
|
(302
|
)
|
(62
|
)
|
||||||||
|
Less amounts reclassified from accumulated other comprehensive income (loss)
|
79
|
|
(91
|
)
|
—
|
|
(12
|
)
|
||||||||
|
Period change
|
161
|
|
91
|
|
(302
|
)
|
(50
|
)
|
||||||||
|
Balance, end of period (1)
|
$
|
(560
|
)
|
$
|
(340
|
)
|
$
|
728
|
|
$
|
(172
|
)
|
||||
13
(1) AOCI does not reflect the net reclassification of
$35 thousand
to Retained Earnings as a result of ASU 2016-01, "Financial
Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" & ASU
2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from
Accumulated Other Comprehensive Income".
NOTE 6. Fair Value
Fair Value Measurement
The Company follows
FASB ASC Topic 820, “Fair Value Measurement and Disclosures,”
which requires additional disclosures about the Company’s assets and liabilities that are measured at fair value. Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed as follows:
Level 1 Inputs
|
•
|
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
|
|
•
|
Generally, this includes debt and equity securities and derivative contracts that are traded in an active exchange market (i.e. New York Stock Exchange), as well as certain U.S. Treasury, U.S. Government and sponsored entity agency mortgage-backed securities that are highly liquid and are actively traded in over-the-counter markets.
|
Level 2 Inputs
|
•
|
Quoted prices for similar assets or liabilities in active markets.
|
|
•
|
Quoted prices for identical or similar assets or liabilities in inactive markets.
|
|
•
|
Inputs other than quoted prices that are observable, either directly or indirectly, for the term of the asset or liability (i.e., interest rates, yield curves, credit risks, prepayment speeds or volatilities) or “market corroborated inputs.”
|
|
•
|
Generally, this includes U.S. Government and sponsored entity mortgage-backed securities, corporate debt securities and derivative contracts.
|
Level 3 Inputs
|
•
|
Prices or valuation techniques that require inputs that are both unobservable (i.e. supported by little or no market activity) and that are significant to the fair value of the assets or liabilities.
|
|
•
|
These assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
|
Fair Value on a Recurring Basis
The following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis:
Debt Securities Available for Sale
The fair value of available for sale ("AFS") debt securities is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
14
As of
March 31, 2020
, the fair value of the Company's AFS debt securities portfolio was
$56.3 million
. Approximately
42 percent
of the portfolio was made up of residential mortgage-backed securities, which had a fair value of
$23.9 million
at
March 31, 2020
. Approximately
$23.6 million
of the residential mortgage-backed securities are guaranteed by the Government National Mortgage Association ("GNMA"), the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC"). The underlying loans for these securities are residential mortgages that are geographically dispersed throughout the United States.
All of the Company’s AFS debt securities were classified as Level 2 assets at
March 31, 2020
. The valuation of AFS debt securities using Level 2 inputs was primarily determined using the market approach, which uses quoted prices for similar assets or liabilities in active markets and all other relevant information. It includes model pricing, defined as valuing securities based upon their relationship with other benchmark securities.
Equity Securities with Readily Determinable Fair Values
The fair value of equity securities is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
As of
March 31, 2020
, the fair value of the Company's equity securities portfolio was
$1.7 million
.
All of the Company’s equity securities were classified as Level 2 assets at
March 31, 2020
. The valuation of equity securities using Level 2 inputs was primarily determined using the market approach, which uses quoted prices for similar assets or liabilities in active markets and all other relevant information.
There were no changes in the inputs or methodologies used to determine fair value during the period ended
March 31, 2020
, as compared to the periods ended
December 31, 2019
and
March 31, 2019
.
Loans Held for Sale
Fair Value for loans held for sale is derived from quoted market prices for similar loans, in which case they are characterized as Level 2 assets in the fair value hierarchy.
Interest Rate Swap Agreements
The fair value of interest rate swap agreements is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
The Company's derivative instruments are classified as Level 2 assets, as the readily observable market inputs to these models are validated to external sources, such as industry pricing services, or are corroborated through recent trades, dealer quotes, yield curves, implied volatility or other market-related data.
15
The tables below present the balances of assets and liabilities measured at fair value on a recurring basis as of
March 31, 2020
and
December 31, 2019
:
|
|
Fair Value Measurements at March 31, 2020 Using
|
|||||||||||||||
|
(In thousands)
|
Assets/Liabilities Measured at Fair Value
|
Quoted Prices in Active Markets for Identical Assets (Level 1)
|
Significant Other Observable Inputs (Level 2)
|
Significant Unobservable Inputs (Level 3)
|
||||||||||||
|
Measured on a recurring basis:
|
||||||||||||||||
|
Assets:
|
||||||||||||||||
|
Debt securities available for sale:
|
||||||||||||||||
|
U.S. Government sponsored entities
|
$
|
5,781
|
|
$
|
—
|
|
$
|
5,781
|
|
$
|
—
|
|
||||
|
State and political subdivisions
|
3,439
|
|
—
|
|
3,439
|
|
—
|
|
||||||||
|
Residential mortgage-backed securities
|
23,850
|
|
—
|
|
23,850
|
|
—
|
|
||||||||
|
Corporate and other securities
|
23,220
|
|
—
|
|
23,220
|
|
—
|
|
||||||||
|
Total debt securities available for sale
|
$
|
56,290
|
|
$
|
—
|
|
$
|
56,290
|
|
$
|
—
|
|
||||
|
|
||||||||||||||||
|
Equity securities with readily determinable fair values
|
1,712
|
|
—
|
|
1,712
|
|
—
|
|
||||||||
|
Total equity securities
|
$
|
1,712
|
|
$
|
—
|
|
$
|
1,712
|
|
$
|
—
|
|
||||
|
|
||||||||||||||||
|
Loans held for sale
|
11,658
|
|
—
|
|
11,658
|
|
—
|
|
||||||||
|
Total loans held for sale
|
$
|
11,658
|
|
—
|
|
$
|
11,658
|
|
—
|
|
||||||
|
Interest rate swap agreements
|
(1,173
|
)
|
—
|
|
(1,173
|
)
|
—
|
|
||||||||
|
Total swap agreements
|
$
|
(1,173
|
)
|
$
|
—
|
|
$
|
(1,173
|
)
|
$
|
—
|
|
||||
|
|
||||||||||||||||
|
|
Fair value Measurements at December 31, 2019 Using
|
|||||||||||||||
|
(In thousands)
|
Assets/Liabilities Measured at Fair Value
|
Quoted Prices in Active Markets for Identical Assets (Level 1)
|
Significant Other Observable Inputs (Level 2)
|
Significant Unobservable Inputs (Level 3)
|
||||||||||||
|
Measured on a recurring basis:
|
||||||||||||||||
|
Assets:
|
||||||||||||||||
|
Debt securities available for sale:
|
||||||||||||||||
|
U.S. Government sponsored entities
|
$
|
5,753
|
|
$
|
—
|
|
$
|
5,753
|
|
$
|
—
|
|
||||
|
State and political subdivisions
|
5,154
|
|
—
|
|
5,154
|
|
—
|
|
||||||||
|
Residential mortgage-backed securities
|
27,964
|
|
—
|
|
27,964
|
|
—
|
|
||||||||
|
Corporate and other securities
|
25,404
|
|
—
|
|
25,404
|
|
—
|
|
||||||||
|
Total debt securities available for sale
|
$
|
64,275
|
|
$
|
—
|
|
$
|
64,275
|
|
$
|
—
|
|
||||
|
|
||||||||||||||||
|
Equity securities with readily determinable fair values
|
2,289
|
|
—
|
|
2,289
|
|
—
|
|
||||||||
|
Total equity securities
|
$
|
2,289
|
|
$
|
—
|
|
$
|
2,289
|
|
$
|
—
|
|
||||
|
Loans held for sale
|
14,862
|
|
14,862
|
|
||||||||||||
|
Total loans held for sale
|
$
|
14,862
|
|
$
|
14,862
|
|
||||||||||
|
Interest rate swap agreements
|
238
|
|
—
|
|
238
|
|
—
|
|
||||||||
|
Total swap agreements
|
$
|
238
|
|
$
|
—
|
|
$
|
238
|
|
$
|
—
|
|
||||
16
Fair Value on a Nonrecurring Basis
The following tables present the assets and liabilities subject to fair value adjustments (impairment) on a non-recurring basis carried on the balance sheet by caption and by level within the hierarchy (as described above):
|
|
Fair Value Measurements at March 31, 2020 Using
|
|||||||||||||||||||
|
(In thousands)
|
Assets/Liabilities Measured at Fair Value
|
Quoted Prices in Active Markets for Identical Assets (Level 1)
|
Significant Other Observable Inputs (Level 2)
|
Significant Unobservable Inputs (Level 3)
|
Net Credit During Period
|
|||||||||||||||
|
Measured on a non-recurring basis:
|
||||||||||||||||||||
|
Financial assets:
|
||||||||||||||||||||
|
OREO
|
$
|
1,523
|
|
$
|
—
|
|
$
|
—
|
|
$
|
1,523
|
|
$
|
(200
|
)
|
|||||
|
Impaired collateral-dependent loans
|
2,323
|
|
—
|
|
—
|
|
2,323
|
|
(230
|
)
|
||||||||||
|
|
|
|
|
|
||||||||||||||||
|
|
Fair Value Measurements at December 31, 2019 Using
|
|||||||||||||||||||
|
(In thousands)
|
Assets/Liabilities Measured at Fair Value
|
Quoted Prices in Active Markets for Identical Assets (Level 1)
|
Significant Other Observable Inputs (Level 2)
|
Significant Unobservable Inputs (Level 3)
|
Net Credit During Period
|
|||||||||||||||
|
Financial assets:
|
||||||||||||||||||||
|
OREO
|
$
|
1,723
|
|
$
|
—
|
|
$
|
—
|
|
$
|
1,723
|
|
$
|
(231
|
)
|
|||||
|
Impaired collateral-dependent loans
|
1,925
|
|
—
|
|
—
|
|
1,925
|
|
(253
|
)
|
||||||||||
Certain assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following is a description of the valuation methodologies used for instruments measured at fair value on a nonrecurring basis:
Appraisal Policy
All appraisals must be performed in accordance with the Uniform Standards of Professional Appraisal Practice ("USPAP"). Appraisals are certified to the Company and performed by appraisers on the Company’s approved list of appraisers. Evaluations are completed by a person independent of Company management. The content of the appraisal depends on the complexity of the property. Appraisals are completed on a “retail value” and an “as is value.”
OREO
The fair value of OREO is determined using third party appraisals, which may be discounted based on management’s review and changes in market conditions (Level 3 Inputs).
Impaired Collateral-Dependent Loans
The fair value of impaired collateral-dependent loans is derived in accordance with
FASB ASC Topic 310, “Receivables.”
Fair value is determined based on the loan’s observable market price or the fair value of the collateral. Partially charged-off loans are measured for impairment based upon a third party appraisal for collateral-dependent loans. When an updated appraisal is received for a nonperforming loan, the value on the appraisal is discounted in the manner discussed above. If there is a deficiency in the value after the Company applies these discounts, management applies a specific reserve and the loan remains in nonaccrual status. The receipt of an updated appraisal would not qualify as a reason to put a loan back into accruing status. The Company removes loans from nonaccrual status generally when the borrower makes three months of contractual payments and demonstrates the ability to service the debt going forward. Charge-offs are determined based upon the loss that
17
management believes the Company will incur after evaluating collateral for impairment based upon the valuation methods described above and the ability of the borrower to pay any deficiency.
The valuation allowance for impaired loans is included in the allowance for loan losses in the consolidated balance sheets. At
March 31, 2020
, the valuation allowance for impaired loans was
$184 thousand
, a decrease of
$230 thousand
from
$414 thousand
at
December 31, 2019
.
Fair Value of Financial Instruments
FASB ASC Topic 825, “Financial Instruments,”
requires the disclosure of the estimated fair value of certain financial instruments, including those financial instruments for which the Company did not elect the fair value option. These estimated fair values as of
March 31, 2020
and
December 31, 2019
have been determined using available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data to develop estimates of fair value. The estimates presented are not necessarily indicative of amounts the Company could realize in a current market exchange. The use of alternative market assumptions and estimation methodologies could have had a material effect on these estimates of fair value. The methodology for estimating the fair value of financial assets and liabilities that are measured on a recurring or nonrecurring basis are discussed above. The following methods and assumptions were used to estimate the fair value of other financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents
For these short-term instruments, the carrying value is a reasonable estimate of fair value.
Securities
The fair value of securities is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
SBA Loans Held for Sale
The fair value of SBA loans held for sale is estimated by using a market approach that includes significant other observable inputs.
Loans
The fair value of loans is estimated by discounting the future cash flows using current market rates that reflect the interest rate risk inherent in the loan, except for previously discussed impaired loans.
FHLB Stock
Federal Home Loan Bank stock is carried at cost. Carrying value approximates fair value based on the redemption provisions of the issues.
Servicing Assets
Servicing assets do not trade in an active, open market with readily observable prices. The Company estimates the fair value of servicing assets using discounted cash flow models incorporating numerous assumptions from the perspective of a market participant including market discount rates and prepayment speeds.
Accrued Interest
The carrying amounts of accrued interest approximate fair value.
Deposit Liabilities
The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date (i.e. carrying value). The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using current market rates.
18
Borrowed Funds and Subordinated Debentures
The fair value of borrowings is estimated by discounting the projected future cash flows using current market rates.
Standby Letters of Credit
At
March 31, 2020
, the Bank had standby letters of credit outstanding of
$4.9 million
, compared to
$4.8 million
at
December 31, 2019
. The fair value of these commitments is nominal.
The table below presents the carrying amount and estimated fair values of the Company’s financial instruments presented as of
March 31, 2020
and
December 31, 2019
:
|
|
March 31, 2020
|
December 31, 2019
|
||||||||||||||||
|
(In thousands)
|
Fair value level
|
Carrying amount
|
Estimated fair value
|
Carrying amount
|
Estimated fair value
|
|||||||||||||
|
Financial assets:
|
||||||||||||||||||
|
Cash and cash equivalents
|
Level 1
|
$
|
178,995
|
|
$
|
178,995
|
|
$
|
158,016
|
|
$
|
158,016
|
|
|||||
|
Securities
|
Level 2
|
58,002
|
|
58,002
|
|
66,564
|
|
66,564
|
|
|||||||||
|
SBA loans held for sale
|
Level 2
|
10,726
|
|
11,658
|
|
13,529
|
|
14,862
|
|
|||||||||
|
Loans, net of allowance for loan losses (1)
|
Level 2
|
1,411,543
|
|
1,427,787
|
|
1,395,634
|
|
1,398,997
|
|
|||||||||
|
FHLB stock
|
Level 2
|
9,054
|
|
9,054
|
|
14,184
|
|
14,184
|
|
|||||||||
|
Servicing assets
|
Level 3
|
2,138
|
|
2,138
|
|
2,026
|
|
2,026
|
|
|||||||||
|
Accrued interest receivable
|
Level 2
|
7,396
|
|
7,396
|
|
6,984
|
|
6,984
|
|
|||||||||
|
OREO
|
Level 3
|
1,523
|
|
1,523
|
|
1,723
|
|
1,723
|
|
|||||||||
|
Financial liabilities:
|
||||||||||||||||||
|
Deposits
|
Level 2
|
1,378,618
|
|
1,385,200
|
|
1,250,114
|
|
1,252,082
|
|
|||||||||
|
Borrowed funds and subordinated debentures
|
Level 2
|
179,310
|
|
180,911
|
|
293,310
|
|
292,766
|
|
|||||||||
|
Accrued interest payable
|
Level 2
|
237
|
|
237
|
|
455
|
|
455
|
|
|||||||||
|
(1)
|
Includes collateral-dependent impaired loans that are considered Level 3 and reported separately in the tables under the “Fair Value on a Nonrecurring Basis” heading. Collateral-dependent impaired loans, net of specific reserves totaled
$2.3 million
and
$1.9 million
at
March 31, 2020
and
December 31, 2019
, respectively.
|
Limitations
Fair value estimates are made at a point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-statement of condition financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the effect of fair value estimates have not been considered in the above estimates.
19
NOTE 7. Securities
This table provides the major components of debt securities available for sale ("AFS") and equity securities with readily determinable fair values ("equity securities") at amortized cost and estimated fair value at
March 31, 2020
and
December 31, 2019
:
|
|
March 31, 2020
|
December 31, 2019
|
||||||||||||||||||||||||||||||
|
(In thousands)
|
Amortized cost
|
Gross unrealized gains
|
Gross unrealized losses
|
Estimated fair value
|
Amortized cost
|
Gross unrealized gains
|
Gross unrealized losses
|
Estimated fair value
|
||||||||||||||||||||||||
|
Available for sale:
|
||||||||||||||||||||||||||||||||
|
U.S. Government sponsored entities
|
$
|
5,749
|
|
$
|
32
|
|
$
|
—
|
|
$
|
5,781
|
|
$
|
5,751
|
|
$
|
4
|
|
$
|
(2
|
)
|
$
|
5,753
|
|
||||||||
|
State and political subdivisions
|
3,581
|
|
7
|
|
(149
|
)
|
3,439
|
|
4,992
|
|
174
|
|
(12
|
)
|
5,154
|
|
||||||||||||||||
|
Residential mortgage-backed securities
|
23,293
|
|
639
|
|
(82
|
)
|
23,850
|
|
27,698
|
|
372
|
|
(106
|
)
|
27,964
|
|
||||||||||||||||
|
Corporate and other securities
|
23,271
|
|
235
|
|
(286
|
)
|
23,220
|
|
25,442
|
|
230
|
|
(268
|
)
|
25,404
|
|
||||||||||||||||
|
Total debt securities available for sale
|
$
|
55,894
|
|
$
|
913
|
|
$
|
(517
|
)
|
$
|
56,290
|
|
$
|
63,883
|
|
$
|
780
|
|
$
|
(388
|
)
|
$
|
64,275
|
|
||||||||
|
Equity securities:
|
||||||||||||||||||||||||||||||||
|
Total equity securities
|
$
|
2,112
|
|
$
|
—
|
|
$
|
(400
|
)
|
$
|
1,712
|
|
$
|
2,218
|
|
$
|
142
|
|
$
|
(71
|
)
|
$
|
2,289
|
|
||||||||
This table provides the remaining contractual maturities and yields of securities within the investment portfolios. The carrying value of securities at
March 31, 2020
is distributed by contractual maturity. Mortgage-backed securities and other securities, which may have principal prepayment provisions, are distributed based on contractual maturity. Expected maturities will differ materially from contractual maturities as a result of early prepayments and calls.
|
|
Within one year
|
After one through five years
|
After five through ten years
|
After ten years
|
Total carrying value
|
||||||||||||||||||||||||||||||
|
(In thousands, except percentages)
|
Amount
|
Yield
|
Amount
|
Yield
|
Amount
|
Yield
|
Amount
|
Yield
|
Amount
|
Yield
|
|||||||||||||||||||||||||
|
Available for sale at fair value:
|
|||||||||||||||||||||||||||||||||||
|
U.S. Government sponsored entities
|
$
|
3,776
|
|
1.61
|
%
|
$
|
2,005
|
|
2.16
|
%
|
$
|
—
|
|
—
|
%
|
$
|
—
|
|
—
|
%
|
$
|
5,781
|
|
1.80
|
%
|
||||||||||
|
State and political subdivisions
|
195
|
|
3.80
|
600
|
|
3.92
|
|
1,748
|
|
3.16
|
|
896
|
|
2.74
|
|
3,439
|
|
3.22
|
|
||||||||||||||||
|
Residential mortgage-backed securities
|
2
|
|
4.76
|
322
|
|
2.35
|
|
2,331
|
|
2.48
|
|
21,195
|
|
2.80
|
|
23,850
|
|
2.76
|
|
||||||||||||||||
|
Corporate and other securities
|
—
|
|
—
|
1,610
|
|
3.49
|
|
16,371
|
|
4.77
|
|
5,239
|
|
4.87
|
|
23,220
|
|
4.70
|
|
||||||||||||||||
|
Total debt securities available for sale
|
$
|
3,973
|
|
1.72
|
%
|
$
|
4,537
|
|
2.88
|
%
|
$
|
20,450
|
|
4.37
|
%
|
$
|
27,330
|
|
3.19
|
%
|
$
|
56,290
|
|
3.49
|
%
|
||||||||||
|
Equity Securities at fair value:
|
|||||||||||||||||||||||||||||||||||
|
Total equity securities
|
$
|
—
|
|
—
|
%
|
$
|
—
|
|
—
|
%
|
$
|
—
|
|
—
|
%
|
$
|
1,712
|
|
2.72
|
%
|
$
|
1,712
|
|
2.72
|
%
|
||||||||||
The fair value of securities with unrealized losses by length of time that the individual securities have been in a continuous unrealized loss position at
March 31, 2020
and
December 31, 2019
are as follows:
|
|
March 31, 2020
|
||||||||||||||||||||||||||
|
|
Less than 12 months
|
12 months and greater
|
Total
|
||||||||||||||||||||||||
|
(In thousands, except number in a loss position)
|
Total number in a loss position
|
Estimated fair value
|
Unrealized loss
|
Estimated fair value
|
Unrealized loss
|
Estimated fair value
|
Unrealized loss
|
||||||||||||||||||||
|
Available for sale:
|
|||||||||||||||||||||||||||
|
State and political subdivisions
|
3
|
|
$
|
1,246
|
|
$
|
(109
|
)
|
$
|
896
|
|
$
|
(40
|
)
|
$
|
2,142
|
|
$
|
(149
|
)
|
|||||||
|
Residential mortgage-backed securities
|
7
|
|
2,526
|
|
(12
|
)
|
3,042
|
|
(70
|
)
|
5,568
|
|
(82
|
)
|
|||||||||||||
|
Corporate and other securities
|
6
|
|
3,311
|
|
(55
|
)
|
3,758
|
|
(231
|
)
|
7,069
|
|
(286
|
)
|
|||||||||||||
|
Total temporarily impaired securities
|
16
|
|
$
|
7,083
|
|
$
|
(176
|
)
|
$
|
7,696
|
|
$
|
(341
|
)
|
$
|
14,779
|
|
$
|
(517
|
)
|
|||||||
20
|
|
December 31, 2019
|
||||||||||||||||||||||||||
|
|
Less than 12 months
|
12 months and greater
|
Total
|
||||||||||||||||||||||||
|
(In thousands, except number in a loss position)
|
Total number in a loss position
|
Estimated fair value
|
Unrealized loss
|
Estimated fair value
|
Unrealized loss
|
Estimated fair value
|
Unrealized loss
|
||||||||||||||||||||
|
Available for sale:
|
|||||||||||||||||||||||||||
|
U.S. Government sponsored entities
|
1
|
|
$
|
—
|
|
$
|
—
|
|
$
|
1,995
|
|
$
|
(2
|
)
|
$
|
1,995
|
|
$
|
(2
|
)
|
|||||||
|
State and political subdivisions
|
1
|
|
—
|
|
—
|
|
1,013
|
|
(12
|
)
|
1,013
|
|
(12
|
)
|
|||||||||||||
|
Residential mortgage-backed securities
|
10
|
|
3,707
|
|
(27
|
)
|
4,996
|
|
(79
|
)
|
8,703
|
|
(106
|
)
|
|||||||||||||
|
Corporate and other securities
|
6
|
|
3,366
|
|
(13
|
)
|
3,735
|
|
(255
|
)
|
7,101
|
|
(268
|
)
|
|||||||||||||
|
Total temporarily impaired securities
|
18
|
|
$
|
7,073
|
|
$
|
(40
|
)
|
$
|
11,739
|
|
$
|
(348
|
)
|
$
|
18,812
|
|
$
|
(388
|
)
|
|||||||
Unrealized Losses
The unrealized losses in each of the categories presented in the tables above are discussed in the paragraphs that follow:
U.S. government sponsored entities and state and political subdivision securities:
The unrealized losses on investments in these types of securities were caused by the increase in interest rate spreads or the increase in interest rates at the long end of the Treasury curve. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider these investments to be other-than temporarily impaired as of
March 31, 2020
or
December 31, 2019
.
Residential and commercial mortgage-backed securities:
The unrealized losses on investments in mortgage-backed securities were caused by increases in interest rate spreads or the increase in interest rates at the long end of the Treasury curve. The majority of contractual cash flows of these securities are guaranteed by the Federal National Mortgage Association (FNMA), the Government National Mortgage Association (GNMA) or the Federal Home Loan Mortgage Corporation (FHLMC). It is expected that the securities would not be settled at a price significantly less than the par value of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider these investments to be other-than-temporarily impaired as of
March 31, 2020
or
December 31, 2019
.
Corporate and other securities:
Included in this category are corporate and other debt securities. The unrealized losses on corporate and other debt securities were due to widening credit spreads. The Company evaluated the prospects of the issuers and forecasted a recovery period; and as a result determined it did not consider these investments to be other-than-temporarily impaired as of
March 31, 2020
or
December 31, 2019
. Because the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before recovery of its amortized cost basis, which may be at maturity, the Company did not consider these securities to be other-than-temporarily impaired as of
March 31, 2020
or
December 31, 2019
.
Realized Gains and Losses
Gross realized gains and losses on securities for the
three months ended March 31, 2020
and 2019 are detailed in the table below:
|
For the three months ended March 31,
|
||||||||
|
(In thousands)
|
2020
|
2019
|
||||||
|
Available for sale:
|
||||||||
|
Realized gains
|
$
|
296
|
|
$
|
—
|
|
||
|
Realized losses
|
—
|
|
—
|
|
||||
|
Total debt securities available for sale
|
296
|
|
—
|
|
||||
|
Net gains on sales of securities
|
$
|
296
|
|
$
|
—
|
|
||
21
The net realized gains are included in noninterest income in the Consolidated Statements of Income as net security gains. There were
$296 thousand
of gross realized gains during the three months ended March 31, 2020, compared to
no
gross realized gains during the same period a year ago. There were no gross realized losses for the three months ended March 31, 2020, or 2019.
|
•
|
The net gain during the first quarter of 2020 is attributed to the sale of
one
corporate bond with a book value of
$2.2 million
and resulting gains of
$61 thousand
,
three
mortgage-backed securities with a total book value of
$2.8 million
and resulting gains of
$57 thousand
,
one
tax-exempt municipal security with a book value of
$381 thousand
and resulting gains of
$27 thousand
,
one
taxable municipal security with a book value of
$456 thousand
and resulting gains of
$140 thousand
, and the call of
one
tax-exempt municipal security with a book value of
$485 thousand
and resulting gains of
$11 thousand
.
|
Equity Securities
Included in this category are Community Reinvestment Act ("CRA") investments and the Company's current other equity holdings of financial institutions. Equity securities are defined to include (a) preferred, common and other ownership interests in entities including partnerships, joint ventures and limited liability companies and (b) rights to acquire or dispose of ownership interest in entities at fixed or determinable prices.
The Company follows
ASU 2016-01,
"Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities,"
which aims to simplify accounting for financial instruments and to converge the guidance between U.S. GAAP and IFRS. ASU 2016-01 also includes guidance on how entities account for equity investments, present and disclose financial instruments, and measure the valuation allowance on deferred tax assets related to available-for-sale debt securities. The guidance in ASU 2016-01 requires an entity to disaggregate the net gains and losses on the equity investments recognized in the income statement during a reporting period into realized and unrealized gains and losses. As a result, equity securities are no longer carried at fair value through other comprehensive income ("OCI") or by applying the cost method to those equity securities that do not have readily determinable values. Equity securities are generally required to be measured at fair value with market value adjustments being reflected in net income. The Company adopted this standard as of January 1, 2018.
The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the
three
months ended
March 31, 2020
and 2019:
|
For the three months ended March 31,
|
||||||||
|
(In thousands)
|
2020
|
2019
|
||||||
|
Net (losses) gains recognized during the period on equity securities
|
$
|
(471
|
)
|
$
|
100
|
|
||
|
Net gains recognized during the period on equity securities sold during the period
|
5
|
|
—
|
|
||||
|
Unrealized (losses) gains recognized during the reporting period on equity securities still held at the reporting date
|
$
|
(466
|
)
|
$
|
100
|
|
||
Pledged Securities
Securities with a carrying value of
$3.5 million
and
$4.0 million
for
March 31, 2020
and
December 31, 2019
, respectively, were pledged to secure Government deposits, secure other borrowings and for other purposes required or permitted by law.
22
NOTE 8. Loans
The following table sets forth the classification of loans by class, including unearned fees, deferred costs and excluding the allowance for loan losses as of
March 31, 2020
and
December 31, 2019
:
|
(In thousands)
|
March 31, 2020
|
December 31, 2019
|
||||||
|
SBA loans held for investment
|
$
|
37,074
|
|
$
|
35,767
|
|
||
|
Commercial loans
|
|
|
||||||
|
SBA 504 loans
|
25,185
|
|
26,726
|
|
||||
|
Commercial other
|
120,029
|
|
112,014
|
|
||||
|
Commercial real estate
|
586,336
|
|
578,643
|
|
||||
|
Commercial real estate construction
|
54,528
|
|
47,649
|
|
||||
|
Residential mortgage loans
|
456,072
|
|
467,706
|
|
||||
|
Consumer loans
|
|
|
||||||
|
Home equity
|
75,240
|
|
69,589
|
|
||||
|
Consumer other
|
74,455
|
|
73,935
|
|
||||
|
Total loans held for investment
|
$
|
1,428,919
|
|
$
|
1,412,029
|
|
||
|
SBA loans held for sale
|
10,726
|
|
13,529
|
|
||||
|
Total loans
|
$
|
1,439,645
|
|
$
|
1,425,558
|
|
||
Loans are made to individuals as well as commercial entities. Specific loan terms vary as to interest rate, repayment, and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Credit risk tends to be geographically concentrated in that a majority of the loan customers are located in the markets serviced by the Bank. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type. A description of the Company's different loan segments follows:
SBA Loans:
SBA
7
(a) loans, on which the SBA has historically provided guarantees of up to
90 percent
of the principal balance, are considered a higher risk loan product for the Company than its other loan products. The guaranteed portion of the Company’s SBA loans is generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment. SBA loans are for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans are guaranteed by the businesses' major owners. SBA loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.
Commercial Loans:
Commercial credit is extended primarily to middle market and small business customers. Commercial loans are generally made in the Company’s market place for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. Loans will generally be guaranteed in full or for a meaningful amount by the businesses' major owners. Commercial loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided. Generally, the Company has a 50 percent loan to value ratio on SBA 504 program loans at origination.
Residential
Mortgage and Consumer Loans:
The Company originates mortgage and consumer loans including principally residential real estate and home equity lines and loans and consumer construction lines. The Company originates qualified mortgages which are generally sold in the secondary market and nonqualified mortgages which are generally held for investment. Each loan type is evaluated on debt to income, type of collateral and loan to collateral value, credit history and Company’s relationship with the borrower.
23
Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to credit administration policies and procedures. Due diligence on loans begins when we initiate contact regarding a loan with a borrower. Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval. The loan portfolio is then subject to on-going internal reviews for credit quality which in part is derived from ongoing collection and review of borrowers’ financial information, as well as independent credit reviews by an outside firm.
The Company's extension of credit is governed by the Credit Risk Policy which was established to control the quality of the Company's loans. This policy and the underlying procedures are reviewed and approved by the Board of Directors on a regular basis.
Credit Ratings
For SBA 7(a), SBA 504 and commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality. A loan’s internal risk rating is updated at least annually and more frequently if circumstances warrant a change in risk rating. The Company uses a 1 through 10 loan grading system that follows regulatory accepted definitions.
Pass:
Risk ratings of 1 through 6 are used for loans that are performing, as they meet, and are expected to continue to meet, all of the terms and conditions set forth in the original loan documentation, and are generally current on principal and interest payments. These performing loans are termed “Pass”.
Special Mention:
Criticized loans are assigned a risk rating of 7 and termed “Special Mention”, as the borrowers exhibit potential credit weaknesses or downward trends deserving management’s close attention. If not checked or corrected, these trends will weaken the Bank’s collateral and position. While potentially weak, these borrowers are currently marginally acceptable and no loss of interest or principal is anticipated. As a result, special mention assets do not expose an institution to sufficient risk to warrant adverse classification. Included in “Special Mention” could be turnaround situations, such as borrowers with deteriorating trends beyond one year, borrowers in startup or deteriorating industries, or borrowers with a poor market share in an average industry. "Special Mention" loans may include an element of asset quality, financial flexibility, or below average management. Management and ownership may have limited depth or experience. Regulatory agencies have agreed on a consistent definition of “Special Mention” as an asset with potential weaknesses which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. This definition is intended to ensure that the “Special Mention” category is not used to identify assets that have as their sole weakness credit data exceptions or collateral documentation exceptions that are not material to the repayment of the asset.
Substandard:
Classified loans are assigned a risk rating of an 8 or 9, depending upon the prospect for collection, and deemed “Substandard”. A risk rating of 8 is used for borrowers with well-defined weaknesses that jeopardize the orderly liquidation of debt. The loan is inadequately protected by the current paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified “Substandard”.
A risk rating of 9 is used for borrowers that have all the weaknesses inherent in a loan with a risk rating of 8, with the added characteristic that the weaknesses make collection of debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Serious problems exist to the point where partial loss of principal is likely. The possibility of loss is extremely high, but because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans’ classification as estimated losses is deferred until a more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures; capital injection; perfecting liens on additional collateral; and refinancing plans. Partial charge-offs are likely.
Loss:
Once a borrower is deemed incapable of repayment of unsecured debt, the risk rating becomes a 10, the loan is termed a “Loss”, and charged-off immediately. Loans to such borrowers are considered uncollectible and of such little value that continuance as active assets of the Bank is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these basically worthless assets even though partial recovery may be affected in the future.
24
For residential mortgage and consumer loans, management uses performing versus nonperforming as the best indicator of credit quality. Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. These credit quality indicators are updated on an ongoing basis, as a loan is placed on nonaccrual status as soon as management believes there is sufficient doubt as to the ultimate ability to collect interest on a loan.
At
March 31, 2020
, the Company owned
$1.5 million
in residential consumer properties that were included in OREO in the Consolidated Balance Sheets, compared to
$1.7 million
at
December 31, 2019
. Additionally, there were
$4.3 million
of residential consumer loans in the process of foreclosure at
March 31, 2020
, compared to
$3.6 million
at
December 31, 2019
.
The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of
March 31, 2020
:
|
|
March 31, 2020
|
|||||||||||||||
|
|
SBA, SBA 504 & Commercial loans - Internal risk ratings
|
|||||||||||||||
|
(In thousands)
|
Pass
|
Special mention
|
Substandard
|
Total
|
||||||||||||
|
SBA loans held for investment
|
$
|
35,994
|
|
$
|
—
|
|
$
|
1,080
|
|
$
|
37,074
|
|
||||
|
Commercial loans
|
|
|
|
|
||||||||||||
|
SBA 504 loans
|
23,374
|
|
1,779
|
|
32
|
|
25,185
|
|
||||||||
|
Commercial other
|
114,840
|
|
3,525
|
|
1,664
|
|
120,029
|
|
||||||||
|
Commercial real estate
|
584,044
|
|
749
|
|
1,543
|
|
586,336
|
|
||||||||
|
Commercial real estate construction
|
54,528
|
|
—
|
|
—
|
|
54,528
|
|
||||||||
|
Total commercial loans
|
776,786
|
|
6,053
|
|
3,239
|
|
786,078
|
|
||||||||
|
Total SBA, SBA 504 and commercial loans
|
$
|
812,780
|
|
$
|
6,053
|
|
$
|
4,319
|
|
$
|
823,152
|
|
||||
|
|
|
|
|
|
||||||||||||
|
|
Residential mortgage & Consumer loans - Performing/Nonperforming
|
|||||||||||||||
|
(In thousands)
|
|
Performing
|
Nonperforming
|
Total
|
||||||||||||
|
Residential mortgage loans
|
|
$
|
449,162
|
|
$
|
6,910
|
|
$
|
456,072
|
|
||||||
|
Consumer loans
|
|
|
|
|
||||||||||||
|
Home equity
|
|
74,735
|
|
505
|
|
75,240
|
|
|||||||||
|
Consumer other
|
|
74,455
|
|
—
|
|
74,455
|
|
|||||||||
|
Total consumer loans
|
|
149,190
|
|
505
|
|
149,695
|
|
|||||||||
|
Total residential mortgage and consumer loans
|
|
$
|
598,352
|
|
$
|
7,415
|
|
$
|
605,767
|
|
||||||
25
The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of
December 31, 2019
:
|
|
December 31, 2019
|
|||||||||||||||
|
|
SBA, SBA 504 & Commercial loans - Internal risk ratings
|
|||||||||||||||
|
(In thousands)
|
Pass
|
Special mention
|
Substandard
|
Total
|
||||||||||||
|
SBA loans held for investment
|
$
|
34,202
|
|
$
|
1,115
|
|
$
|
450
|
|
$
|
35,767
|
|
||||
|
Commercial loans
|
|
|
|
|
||||||||||||
|
SBA 504 loans
|
24,878
|
|
1,808
|
|
40
|
|
26,726
|
|
||||||||
|
Commercial other
|
107,220
|
|
3,361
|
|
1,433
|
|
112,014
|
|
||||||||
|
Commercial real estate
|
576,326
|
|
758
|
|
1,559
|
|
578,643
|
|
||||||||
|
Commercial real estate construction
|
47,649
|
|
—
|
|
—
|
|
47,649
|
|
||||||||
|
Total commercial loans
|
756,073
|
|
5,927
|
|
3,032
|
|
765,032
|
|
||||||||
|
Total SBA, SBA 504 and commercial loans
|
$
|
790,275
|
|
$
|
7,042
|
|
$
|
3,482
|
|
$
|
800,799
|
|
||||
|
|
|
|
|
|
||||||||||||
|
|
Residential mortgage & Consumer loans - Performing/Nonperforming
|
|||||||||||||||
|
(In thousands)
|
|
Performing
|
Nonperforming
|
Total
|
||||||||||||
|
Residential mortgage loans
|
|
$
|
463,770
|
|
$
|
3,936
|
|
$
|
467,706
|
|
||||||
|
Consumer loans
|
|
|
|
|
||||||||||||
|
Home equity
|
|
69,589
|
|
—
|
|
69,589
|
|
|||||||||
|
Consumer other
|
|
73,915
|
|
20
|
|
73,935
|
|
|||||||||
|
Total consumer loans
|
|
143,504
|
|
20
|
|
143,524
|
|
|||||||||
|
Total residential mortgage and consumer loans
|
|
$
|
607,274
|
|
$
|
3,956
|
|
$
|
611,230
|
|
||||||
Nonperforming and Past Due Loans
Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans and generally represent loans that are well collateralized and in the process of collection. The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.
26
The following tables set forth an aging analysis of past due and nonaccrual loans as of
March 31, 2020
and
December 31, 2019
:
|
|
March 31, 2020
|
|||||||||||||||||||||||||||
|
(In thousands)
|
30-59 days past due
|
60-89 days past due
|
90+ days and still accruing
|
Nonaccrual (1)
|
Total past due
|
Current
|
Total loans
|
|||||||||||||||||||||
|
SBA loans held for investment
|
$
|
131
|
|
$
|
154
|
|
$
|
—
|
|
$
|
1,627
|
|
$
|
1,912
|
|
$
|
35,162
|
|
$
|
37,074
|
|
|||||||
|
Commercial loans
|
|
|
|
|
|
|
|
|||||||||||||||||||||
|
SBA 504 loans
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
25,185
|
|
25,185
|
|
||||||||||||||
|
Commercial other
|
566
|
|
71
|
|
—
|
|
—
|
|
637
|
|
119,392
|
|
120,029
|
|
||||||||||||||
|
Commercial real estate
|
785
|
|
75
|
|
—
|
|
613
|
|
1,473
|
|
584,863
|
|
586,336
|
|
||||||||||||||
|
Commercial real estate construction
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
54,528
|
|
54,528
|
|
||||||||||||||
|
Residential mortgage loans
|
5,880
|
|
373
|
|
—
|
|
6,910
|
|
13,163
|
|
442,909
|
|
456,072
|
|
||||||||||||||
|
Consumer loans
|
|
|
|
|
|
|
|
|||||||||||||||||||||
|
Home equity
|
561
|
|
329
|
|
—
|
|
505
|
|
1,395
|
|
73,845
|
|
75,240
|
|
||||||||||||||
|
Consumer other
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
74,455
|
|
74,455
|
|
||||||||||||||
|
Total loans held for investment
|
$
|
7,923
|
|
$
|
1,002
|
|
$
|
—
|
|
$
|
9,655
|
|
$
|
18,580
|
|
$
|
1,410,339
|
|
$
|
1,428,919
|
|
|||||||
|
SBA loans held for sale
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
10,726
|
|
10,726
|
|
||||||||||||||
|
Total loans
|
$
|
7,923
|
|
$
|
1,002
|
|
$
|
—
|
|
$
|
9,655
|
|
$
|
18,580
|
|
$
|
1,421,065
|
|
$
|
1,439,645
|
|
|||||||
|
(1)
|
At
March 31, 2020
, nonaccrual loans included
$427
thousand of loans guaranteed by the SBA.
|
|
|
December 31, 2019
|
|||||||||||||||||||||||||||
|
(In thousands)
|
30-59 days past due
|
60-89 days past due
|
90+ days and still accruing
|
Nonaccrual (1)
|
Total past due
|
Current
|
Total loans
|
|||||||||||||||||||||
|
SBA loans held for investment
|
$
|
1,048
|
|
$
|
—
|
|
$
|
—
|
|
$
|
1,164
|
|
$
|
2,212
|
|
$
|
33,555
|
|
$
|
35,767
|
|
|||||||
|
Commercial loans
|
|
|
|
|
|
|
|
|||||||||||||||||||||
|
SBA 504 loans
|
—
|
|
1,808
|
|
—
|
|
—
|
|
1,808
|
|
24,918
|
|
26,726
|
|
||||||||||||||
|
Commercial other
|
71
|
|
—
|
|
—
|
|
316
|
|
387
|
|
111,627
|
|
112,014
|
|
||||||||||||||
|
Commercial real estate
|
215
|
|
—
|
|
—
|
|
213
|
|
428
|
|
578,215
|
|
578,643
|
|
||||||||||||||
|
Commercial real estate construction
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
47,649
|
|
47,649
|
|
||||||||||||||
|
Residential mortgage loans
|
4,383
|
|
1,676
|
|
930
|
|
3,936
|
|
10,925
|
|
456,781
|
|
467,706
|
|
||||||||||||||
|
Consumer loans
|
|
|
|
|
|
|
|
|||||||||||||||||||||
|
Home equity
|
1,446
|
|
178
|
|
—
|
|
—
|
|
1,624
|
|
67,965
|
|
69,589
|
|
||||||||||||||
|
Consumer other
|
—
|
|
113
|
|
—
|
|
20
|
|
133
|
|
73,802
|
|
73,935
|
|
||||||||||||||
|
Total loans held for investment
|
$
|
7,163
|
|
$
|
3,775
|
|
$
|
930
|
|
$
|
5,649
|
|
$
|
17,517
|
|
$
|
1,394,512
|
|
$
|
1,412,029
|
|
|||||||
|
SBA loans held for sale
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
13,529
|
|
13,529
|
|
||||||||||||||
|
Total loans
|
$
|
7,163
|
|
$
|
3,775
|
|
$
|
930
|
|
$
|
5,649
|
|
$
|
17,517
|
|
$
|
1,408,041
|
|
$
|
1,425,558
|
|
|||||||
|
(1)
|
At
December 31, 2019
, nonaccrual loans included
$59
thousand of loans guaranteed by the SBA.
|
Impaired Loans
The Company has defined impaired loans to be all nonperforming loans individually evaluated for impairment and TDRs. Management considers a loan impaired when, based on current information and events, it is determined that the Company will not be able to collect all amounts due according to the loan contract. Impairment is evaluated on an individual basis for SBA and commercial loans.
27
The following table provides detail on the Company’s impaired loans that are individually evaluated for impairment with the associated allowance amount, if applicable, as of
March 31, 2020
:
|
|
March 31, 2020
|
|||||||||||
|
(In thousands)
|
Unpaid principal balance
|
Recorded investment
|
Specific reserves
|
|||||||||
|
With no related allowance:
|
|
|
|
|||||||||
|
SBA loans held for investment (1)
|
$
|
1,221
|
|
$
|
1,062
|
|
$
|
—
|
|
|||
|
Commercial loans
|
|
|
|
|||||||||
|
Commercial other
|
500
|
|
—
|
|
—
|
|
||||||
|
Commercial real estate
|
913
|
|
613
|
|
—
|
|
||||||
|
Total commercial loans
|
1,413
|
|
613
|
|
—
|
|
||||||
|
Total impaired loans with no related allowance
|
2,634
|
|
1,675
|
|
—
|
|
||||||
|
|
|
|
|
|||||||||
|
With an allowance:
|
|
|
|
|||||||||
|
SBA loans held for investment (1)
|
163
|
|
138
|
|
138
|
|
||||||
|
Commercial loans
|
|
|
|
|||||||||
|
Commercial real estate
|
694
|
|
694
|
|
46
|
|
||||||
|
Total commercial loans
|
694
|
|
694
|
|
46
|
|
||||||
|
Total impaired loans with a related allowance
|
857
|
|
832
|
|
184
|
|
||||||
|
|
|
|
|
|||||||||
|
Total individually evaluated impaired loans:
|
|
|
|
|||||||||
|
SBA loans held for investment (1)
|
1,384
|
|
1,200
|
|
138
|
|
||||||
|
Commercial loans
|
|
|
|
|||||||||
|
Commercial other
|
500
|
|
—
|
|
—
|
|
||||||
|
Commercial real estate
|
1,607
|
|
1,307
|
|
46
|
|
||||||
|
Total commercial loans
|
2,107
|
|
1,307
|
|
46
|
|
||||||
|
Total individually evaluated impaired loans
|
$
|
3,491
|
|
$
|
2,507
|
|
$
|
184
|
|
|||
|
(1)
|
Balances are reduced by amount guaranteed by the SBA of
$427
thousand at
March 31, 2020
.
|
28
The following table provides detail on the Company’s impaired loans that are individually evaluated for impairment with the associated allowance amount, if applicable, as of
December 31, 2019
:
|
|
December 31, 2019
|
|||||||||||
|
(In thousands)
|
Unpaid principal balance
|
Recorded investment
|
Specific reserves
|
|||||||||
|
With no related allowance:
|
|
|
|
|||||||||
|
SBA loans held for investment (1)
|
$
|
1,224
|
|
$
|
1,064
|
|
$
|
—
|
|
|||
|
Commercial loans
|
|
|
|
|||||||||
|
Commercial real estate
|
213
|
|
213
|
|
—
|
|
||||||
|
Total commercial loans
|
213
|
|
213
|
|
—
|
|
||||||
|
Total impaired loans with no related allowance
|
1,437
|
|
1,277
|
|
—
|
|
||||||
|
|
|
|
|
|||||||||
|
With an allowance:
|
|
|
|
|||||||||
|
SBA loans held for investment (1)
|
157
|
|
41
|
|
41
|
|
||||||
|
Commercial loans
|
|
|
|
|||||||||
|
Commercial other
|
816
|
|
316
|
|
316
|
|
||||||
|
Commercial real estate
|
705
|
|
705
|
|
57
|
|
||||||
|
Total commercial loans
|
1,521
|
|
1,021
|
|
373
|
|
||||||
|
Total impaired loans with a related allowance
|
1,678
|
|
1,062
|
|
414
|
|
||||||
|
|
|
|
|
|||||||||
|
Total individually evaluated impaired loans:
|
|
|
|
|||||||||
|
SBA loans held for investment (1)
|
1,381
|
|
1,105
|
|
41
|
|
||||||
|
Commercial loans
|
|
|
|
|||||||||
|
Commercial other
|
816
|
|
316
|
|
316
|
|
||||||
|
Commercial real estate
|
918
|
|
918
|
|
57
|
|
||||||
|
Total commercial loans
|
1,734
|
|
1,234
|
|
373
|
|
||||||
|
Total individually evaluated impaired loans
|
$
|
3,115
|
|
$
|
2,339
|
|
$
|
414
|
|
|||
|
(1)
|
Balances are reduced by amount guaranteed by the SBA of
$59
thousand at
December 31, 2019
.
|
Impaired loans increased
$376 thousand
at
March 31, 2020
compared to
December 31, 2019
. The increase in impaired loans was primarily due to the addition of
one
commercial loan totaling
$913 thousand
, partially offset by paydowns on
two
commercial loans totaling
$529 thousand
.
29
The following table presents the average recorded investments in impaired loans and the related amount of interest recognized during the time period in which the loans were impaired for the
three
months ended
March 31, 2020
and
2019
. The average balances are calculated based on the month-end balances of impaired loans. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal under the cost recovery method, and therefore no interest income is recognized. The interest income recognized on impaired loans noted below represents primarily accruing TDRs and nominal amounts of income recognized on a cash basis for well-collateralized impaired loans.
|
|
For the three months ended March 31,
|
|||||||||||||||
|
|
2020
|
2019
|
||||||||||||||
|
(In thousands)
|
Average recorded investment
|
Interest income recognized on impaired loans
|
Average recorded investment
|
Interest income recognized on impaired loans
|
||||||||||||
|
SBA loans held for investment (1)
|
$
|
1,128
|
|
$
|
3
|
|
$
|
1,183
|
|
$
|
4
|
|
||||
|
Commercial loans
|
|
|
|
|
||||||||||||
|
SBA 504 loans
|
600
|
|
32
|
|
—
|
|
—
|
|
||||||||
|
Commercial other
|
5
|
|
10
|
|
7
|
|
—
|
|
||||||||
|
Commercial real estate
|
1,047
|
|
12
|
|
1,789
|
|
9
|
|
||||||||
|
Total
|
$
|
2,780
|
|
$
|
57
|
|
$
|
2,979
|
|
$
|
13
|
|
||||
|
(1)
|
Balances are reduced by the average amount guaranteed by the SBA of
$182 thousand
and
$100 thousand
for the three months ended
March 31, 2020
and
2019
, respectively.
|
TDRs
The Company's loan portfolio also includes certain loans that have been modified as TDRs. TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider, unless it results in a delay in payment that is insignificant. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs if the loan is collateral-dependent. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.
The Company had
one
performing TDR with a balance of
$694
thousand and
$705 thousand
as of
March 31, 2020
and
December 31, 2019
, respectively, which was included in the impaired loan numbers as of such dates. At
March 31, 2020
and
December 31, 2019
, there were specific reserves on the performing TDR of
$46 thousand
and
$57 thousand
, respectively. The loan remains in accrual status since it continues to perform in accordance with the restructured terms.
To date, the Company’s TDRs consisted of interest rate reductions, interest only periods, principal balance reductions, and maturity extensions. There were
no
loans modified during the
three
months ended
March 31, 2020
and
2019
that were deemed to be TDRs. There were
no
loans modified as a TDR within the previous 12 months that subsequently defaulted at some point during the
three
months ended
March 31, 2020
. In this case, the subsequent default is defined as 90 days past due or transferred to nonaccrual status.
NOTE
9. Allowance for Loan Losses and Reserve for Unfunded Loan Commitments
Allowance for Loan Losses
The Company has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. At a minimum, the adequacy of the allowance for loan losses is reviewed by management on a quarterly basis. For purposes of determining the allowance for loan losses, the Company has segmented the loans in its portfolio by loan type. Loans are segmented into the following pools: SBA 7(a), commercial, residential mortgages, and consumer loans. Certain portfolio segments are further broken down into classes based on the associated risks within those segments and the type of collateral underlying each loan. Commercial loans are divided into the following five classes: commercial real estate, commercial real estate construction, unsecured business line of credit, commercial other, and SBA 504. Consumer loans are divided into two classes as follows: home equity and other.
30
The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. The same standard methodology is used, regardless of loan type. Specific reserves are made to individual impaired loans and TDRs (see Note 1 for additional information on this term). The general reserve is set based upon a representative average historical net charge-off rate adjusted for the following environmental factors: delinquency and impairment trends, charge-off and recovery trends, changes in the volume of restructured loans, volume and loan term trends, changes in risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes. Within the five-year historical net charge-off rate, the Company weights the past three years more heavily as it believes it is more indicative of future charge-offs. All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate and high risk. Each environmental factor is evaluated separately for each class of loans and risk weighted based on its individual characteristics.
|
•
|
For SBA 7(a) and commercial loans, the estimate of loss based on pools of loans with similar characteristics is made through the use of a standardized loan grading system that is applied on an individual loan level and updated on a continuous basis. The loan grading system incorporates reviews of the financial performance of the borrower, including cash flow, debt-service coverage ratio, earnings power, debt level and equity position, in conjunction with an assessment of the borrower's industry and future prospects. It also incorporates analysis of the type of collateral and the relative loan to value ratio.
|
|
•
|
For residential mortgage and consumer loans, the estimate of loss is based on pools of loans with similar characteristics. Factors such as credit score, delinquency status and type of collateral are evaluated. Factors are updated frequently to capture the recent behavioral characteristics of the subject portfolios, as well as any changes in loss mitigation or credit origination strategies, and adjustments to the reserve factors are made as needed.
|
According to the Company’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable. All credits which are 90 days past due must be analyzed for the Company’s ability to collect on the credit. Once a loss is known to exist, the charge-off approval process is immediately expedited. This charge-off policy is followed for all loan types.
The allocated allowance is the total of identified specific and general reserves by loan category. The allocation is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of the portfolio.
The following tables detail the activity in the allowance for loan losses by portfolio segment for the
three months ended March 31, 2020
and
2019
:
|
|
For the three months ended March 31, 2020
|
|||||||||||||||||||
|
(In thousands)
|
SBA held for investment
|
Commercial
|
Residential
|
Consumer
|
Total
|
|||||||||||||||
|
Balance, beginning of period
|
$
|
1,079
|
|
$
|
9,722
|
|
$
|
4,254
|
|
$
|
1,340
|
|
$
|
16,395
|
|
|||||
|
Charge-offs
|
(25
|
)
|
(300
|
)
|
(200
|
)
|
—
|
|
(525
|
)
|
||||||||||
|
Recoveries
|
5
|
|
1
|
|
—
|
|
—
|
|
6
|
|
||||||||||
|
Net charge-offs
|
(20
|
)
|
(299
|
)
|
(200
|
)
|
—
|
|
(519
|
)
|
||||||||||
|
Provision for (credit to) loan losses charged to expense
|
(54
|
)
|
706
|
|
709
|
|
139
|
|
1,500
|
|
||||||||||
|
Balance, end of period
|
$
|
1,005
|
|
$
|
10,129
|
|
$
|
4,763
|
|
$
|
1,479
|
|
$
|
17,376
|
|
|||||
|
|
For the three months ended March 31, 2019
|
|||||||||||||||||||
|
(In thousands)
|
SBA held for investment
|
Commercial
|
Residential
|
Consumer
|
Total
|
|||||||||||||||
|
Balance, beginning of period
|
$
|
1,655
|
|
$
|
8,705
|
|
$
|
3,900
|
|
$
|
1,228
|
|
$
|
15,488
|
|
|||||
|
Charge-offs
|
(308
|
)
|
(1
|
)
|
—
|
|
(1
|
)
|
(310
|
)
|
||||||||||
|
Recoveries
|
1
|
|
5
|
|
—
|
|
—
|
|
6
|
|
||||||||||
|
Net (charge-offs) recoveries
|
(307
|
)
|
4
|
|
—
|
|
(1
|
)
|
(304
|
)
|
||||||||||
|
Provision for (credit to) loan losses charged to expense
|
330
|
|
84
|
|
116
|
|
(30
|
)
|
500
|
|
||||||||||
|
Balance, end of period
|
$
|
1,678
|
|
$
|
8,793
|
|
$
|
4,016
|
|
$
|
1,197
|
|
$
|
15,684
|
|
|||||
31
The following tables present loans and their related allowance for loan losses, by portfolio segment, as of
March 31, 2020
and
December 31, 2019
:
|
|
March 31, 2020
|
|||||||||||||||||||
|
(In thousands)
|
SBA held for investment
|
Commercial
|
Residential
|
Consumer
|
Total
|
|||||||||||||||
|
Allowance for loan losses ending balance:
|
||||||||||||||||||||
|
Individually evaluated for impairment
|
$
|
138
|
|
$
|
46
|
|
$
|
—
|
|
$
|
—
|
|
$
|
184
|
|
|||||
|
Collectively evaluated for impairment
|
867
|
|
10,083
|
|
4,763
|
|
1,479
|
|
17,192
|
|
||||||||||
|
Total
|
$
|
1,005
|
|
$
|
10,129
|
|
$
|
4,763
|
|
$
|
1,479
|
|
$
|
17,376
|
|
|||||
|
Loan ending balances:
|
||||||||||||||||||||
|
Individually evaluated for impairment
|
$
|
1,200
|
|
$
|
1,307
|
|
$
|
—
|
|
$
|
—
|
|
$
|
2,507
|
|
|||||
|
Collectively evaluated for impairment
|
30,497
|
|
784,770
|
|
456,072
|
|
149,695
|
|
1,421,034
|
|
||||||||||
|
Total
|
$
|
31,697
|
|
$
|
786,077
|
|
$
|
456,072
|
|
$
|
149,695
|
|
$
|
1,423,541
|
|
|||||
|
|
December 31, 2019
|
|||||||||||||||||||
|
(In thousands)
|
SBA held for investment
|
Commercial
|
Residential
|
Consumer
|
Total
|
|||||||||||||||
|
Allowance for loan losses ending balance:
|
||||||||||||||||||||
|
Individually evaluated for impairment
|
$
|
41
|
|
$
|
373
|
|
$
|
—
|
|
$
|
—
|
|
$
|
414
|
|
|||||
|
Collectively evaluated for impairment
|
1,038
|
|
9,349
|
|
4,254
|
|
1,340
|
|
15,981
|
|
||||||||||
|
Total
|
$
|
1,079
|
|
$
|
9,722
|
|
$
|
4,254
|
|
$
|
1,340
|
|
$
|
16,395
|
|
|||||
|
Loan ending balances:
|
||||||||||||||||||||
|
Individually evaluated for impairment
|
$
|
1,105
|
|
$
|
1,234
|
|
$
|
—
|
|
$
|
—
|
|
$
|
2,339
|
|
|||||
|
Collectively evaluated for impairment
|
34,662
|
|
763,798
|
|
467,706
|
|
143,524
|
|
1,409,690
|
|
||||||||||
|
Total
|
$
|
35,767
|
|
$
|
765,032
|
|
$
|
467,706
|
|
$
|
143,524
|
|
$
|
1,412,029
|
|
|||||
Changes in Methodology
The Company did not make any changes to its allowance for loan losses methodology in the current period.
Reserve for Unfunded Loan Commitments
In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the reserve are made through other expense and applied to the reserve which is classified as other liabilities. At
March 31, 2020
, a
$288 thousand
commitment reserve was reported on the balance sheet as an “other liability”, compared to a
$273 thousand
commitment reserve at
December 31, 2019
, due to a larger loan portfolio requiring a larger general reserve.
NOTE
10.
New
Accounting
Pronouncements
ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 was issued to replace the incurred loss impairment methodology in current GAAP with an expected credit loss methodology and requires consideration of a broader range of information to determine credit loss estimates. Financial assets measured at amortized cost will be presented at the net amount expected to be collected by using an allowance for credit losses. Purchased credit impaired loans will receive an allowance account at the acquisition date that represents a component of the purchase price allocation. Credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses, with such allowance limited to the amount by which fair value is below amortized cost. For public business entities, ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019.
32
In May 2019, FASB issued ASU 2019-05, "Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief." ASU 2019-05 was issued to address concerns with the adoption of ASU 2016-13. ASU 2019-05 gives entities the ability to irrevocable elect the fair value option in Subtopic 825-10 for certain existing financial assets upon transition to ASU 2016-03. Financial assets that are eligible for this fair value election are those that qualify under Subtopic 825-10 and are within the scope of Subtopic 326-10, "Financial Instruments - Credit Losses - Measured at Amortized Costs." An exception to this is held-to-maturity debt securities, which do not qualify for this transition election. The effective date for the amendment is the same as the effective date in ASU 2016-03. In November 2019, FASB issued ASU 2019-10, "Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates." ASU 2019-10 was issued to defer the effective dates for certain guidance in its Accounting Standard Codification ("ASC") for certain entities. The amendments in this update amend the mandatory effective dates for ASC 326, "Financial Instruments - Credit Losses", for entities eligible to be smaller reporting companies as defined by the SEC for fiscal years beginning after December 15, 2022, including interim reporting periods within that reporting period. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its consolidated financial statements.
In November 2019, FASB issued ASU 2019-11, "Codification Improvements to Topic 326, Financial Instruments - Credit Losses." ASU 2019-11 was issued to address issues raise by stakeholders during the implementation of ASU 2016-13. ASU 2019-11 provides transition relief when adjusting the effective interest rate for troubled debt restructurings ("TDRs") that exist as of the adoption date, extends the disclosure relief in ASU 2019-04 to disclose accrued interest receivable balances separately from the amortized cost basis to additional disclosures involving amortized cost basis, and provides clarification regarding application of the guidance in paragraph 326-20-35-6 for financial assets secured by collateral maintenance provisions that provides a practical expedient to measure the estimate of expected credit losses by comparing the amortized cost basis of a financial asset and the fair value of collateral securing the financial asset as of the reporting date. The effective date and transition requirements for the amendment are the same as the effective date and transition requirements in ASU 2016-13.
ASU 2017-04, "Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment." ASU 2017-04 was issued in an effort to simplify accounting in a new standard. The amendments in this update require that an entity perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. The amendment states that an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, but the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. For public business entities, ASU 2017-04 is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performing on testing dates after January 1, 2017. The Company adopted this standard as of January 1, 2020. The adoption of this ASU did not have an impact on the Company's consolidated financial statements since the fair values of our reporting units were not lower than their respective carrying amounts at the time of our goodwill impairment analysis.
ASU 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes." ASU 2019-12 removes the exception to the incremental approach for intraperiod tax allocation when there is a loss from continuing operations and income or a gain from other items and removes the exception to the interim period income tax accounting when a year-to-date loss exceeds the anticipated loss for the year. ASU 2019-12 also simplifies the accounting for income taxes by requiring that an entity recognize a franchise tax that is partially based on income as an income-based tax, that an entity evaluate when a step up in the tax basis of goodwill should be considered part of the business combination in which the book goodwill originally was recognized, and that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date. For public business entities, ASU 2019-12 is effective for interim and annual periods beginning after December 15, 2020.
ASU 2020-01, "Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 (a consensus of the Emerging Issues Task Force)." ASU 2020-01 clarifies that the observable price changes in orderly transactions that should be considered when applying the measurement alternative in accordance with ASC 321 include transactions that require it to either apply or discontinue the equity method of accounting under ASC 323. ASU 2020-01 also addresses questions about how to apply the guidance in Topic 815, “Derivatives and Hedging,” for certain forward contracts and purchased options to purchase securities that, upon settlement or exercise, would be accounted for under the equity method of accounting. The ASU clarifies that, for the purpose of applying ASC 815-10-15-141(a), an entity should not consider whether, upon the settlement of the forward contract or exercise of the purchased option, the underlying securities would be accounted for under the equity method in ASC 323 or the fair value option in accordance with the financial instruments guidance in Topic 825, “Financial Instruments.” For public business entities, ASU 2020-01 is effective for interim and annual periods beginning after December 15, 2020.
33
ASU 2020-03, "Codification Improvement to Financial Instruments." ASU 2020-03 clarifies that all entities are required to provide the fair value option disclosures in paragraphs 825-10-50-24 through 50-32 of the FASB’s Accounting Standards Codification (ASC). ASU 2020-03 also clarifies that the contractual term of a net investment in a lease determined in accordance with ASC 842, “Leases,” should be the contractual term used to measure expected credit losses under ASC 326, “Financial Instruments – Credit Losses.” ASU 2020-03 also addresses amendments to ASC 860-20, “Transfers and Servicing – Sales of Financial Assets,” clarify that when an entity regains control of financial assets sold, an allowance for credit losses should be recorded in accordance with ASC 326. The effective date and transition requirements for the amendment are the same as the effective date and transition requirements in deASU 2016-13.
ASU 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting." ASU 2020-04 provides temporary optional guidance intended to ease the burden of reference rate reform on financial reporting. The guidance provides optional expedients and exceptions for applying existing guidance to contract modifications, hedging relationships and other transactions that are expected to be affected by reference rate reform and meet certain scope guidance. ASU 2020-04 provides various optional expedients, including the following, for hedging relationships affected by reference rate reform, if certain criteria are met:
|
•
|
An entity can change certain critical terms of the hedging instrument or hedged item or transaction without having to dedesignate the relationship.
|
|
•
|
For fair value hedging relationships in which the designated interest rate is LIBOR or another rate that is expected to be discontinued, an entity may change the hedged risk to another permitted benchmark rate without dedesignating the relationship.
|
|
•
|
For cash flow hedging relationships in which the designated hedged risk is LIBOR or another rate that is expected to be discontinued, an entity may assert that the occurrence of the hedged forecasted transaction remains probable.
|
|
•
|
Certain qualifying conditions for the shortcut method and other methods that assume perfect effectiveness may be disregarded.
|
In addition, ASU 2020-04 permits an entity to make a one-time election to sell, transfer, or both sell and transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform and that were classified as held to maturity before January 1, 2020. ASU 2020-04 was effective upon its issuance on March 12, 2020. However, it cannot be applied to contract modifications that occur after December 31, 2022. With certain exceptions, the ASU also cannot be applied to hedging relationships entered into or evaluated after that date.
NOTE
11. Derivative Financial Instruments and Hedging Activities
Derivative Financial Instruments
The Company has derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments, and the value of the derivatives are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Such difference, which represents the fair value of the derivative instrument, is reflected on the Company’s balance sheet as other assets or other liabilities.
The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to any derivative agreement. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and does not expect any counterparties to fail their obligations. The Company deals only with primary dealers.
Derivative instruments are generally either negotiated OTC contracts or standardized contracts executed on a recognized exchange. Negotiated OTC derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise prices and maturity.
Risk Management Policies – Hedging Instruments
The primary focus of the Company’s asset/liability management program is to monitor the sensitivity of the Company’s net portfolio value and net income under varying interest rate scenarios to take steps to control its risks. On a quarterly basis, the Company evaluates the effectiveness of entering into any derivative agreement by measuring the cost of such an agreement in relation to the reduction in net portfolio value and net income volatility within an assumed range of interest rates.
Interest Rate Risk Management – Cash Flow Hedging Instruments
34
The Company has variable rate debt as a source of funds for use in the Company’s lending and investment activities and for other general business purposes. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases. Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore hedges its variable-rate interest payments. To meet this objective, management enters into interest rate swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments during the contract period.
At
March 31, 2020
, the Company had interest rate swaps with a notional amount of
$100.0 million
, compared to a notional amount of
$60.0 million
at
December 31, 2019
, which were designated as cash flow hedging instruments. During the three months ended March 31, 2020, the Company entered into
two
new swap agreements with notional values of
$20.0 million
each. A summary of the Company’s outstanding interest rate swap agreements used to hedge variable rate debt at
March 31, 2020
and
December 31, 2019
, respectively is as follows:
|
(In thousands, except percentages and years)
|
March 31, 2020
|
December 31, 2019
|
||||||
|
Notional amount
|
$
|
100,000
|
|
$
|
60,000
|
|
||
|
Fair value
|
$
|
(1,173
|
)
|
$
|
238
|
|
||
|
Weighted average pay rate
|
1.19
|
%
|
|
1.42
|
%
|
|||
|
Weighted average receive rate
|
1.51
|
%
|
|
2.19
|
%
|
|||
|
Weighted average maturity in years
|
2.58
|
|
1.25
|
|
||||
|
Number of contracts
|
6
|
|
4
|
|
||||
During the
three
months ended
March 31, 2020
, the Company received variable rate London Interbank Offered Rate ("LIBOR") payments from and paid fixed rates in accordance with its interest rate swap agreements. At
March 31, 2020
, the unrealized loss relating to interest rate swaps was recorded as a derivative liability, whereas at
December 31, 2019
, the unrealized gain relating to interest rate swaps was recorded as a derivative asset. Changes in the fair value of the interest rate swaps designated as hedging instruments of the variability of cash flows associated with long-term debt are reported in other comprehensive income. The following table presents the net losses recorded in other comprehensive income and the consolidated financial statements relating to the cash flow derivative instruments at
March 31, 2020
and
2019
, respectively:
|
For the three months ended March 31,
|
||||||
|
(In thousands)
|
2020
|
2019
|
||||
|
Unrealized losses relating to interest rate swaps
|
(1,410
|
)
|
(381
|
)
|
||
NOTE 12. Employee Benefit Plans
Stock Option Plans
The Company has incentive and nonqualified option plans, which allow for the grant of options to officers, employees and members of the Board of Directors. Grants under the Company's incentive and nonqualified option plans generally vest over
3 years
and must be exercised within
10 years
of the date of grant. Transactions under the Company’s stock option plans for the
three months ended
March 31, 2020
are summarized in the following table:
|
Shares
|
Weighted average exercise price
|
Weighted average remaining contractual life in years
|
Aggregate intrinsic value
|
||||||||||
|
Outstanding at December 31, 2019
|
614,311
|
|
$
|
14.78
|
|
6.9
|
$
|
4,783,402
|
|
||||
|
Options granted
|
101,000
|
|
20.39
|
|
|
|
|||||||
|
Options exercised
|
(5,500
|
)
|
6.23
|
|
|
|
|||||||
|
Options forfeited
|
—
|
|
—
|
|
|
|
|||||||
|
Options expired
|
—
|
|
—
|
|
|
|
|||||||
|
Outstanding at March 31, 2020
|
709,811
|
|
$
|
15.65
|
|
7.1
|
$
|
926,893
|
|
||||
|
Exercisable at March 31, 2020
|
436,981
|
|
$
|
12.55
|
|
5.8
|
$
|
926,893
|
|
||||
35
On April 25, 2019, The Company adopted the 2019 Equity Compensation Plan providing for grants of up to
500,000
shares to be allocated between incentive and non-qualified stock options, restricted stock awards, performance units and deferred stock. The Plan replaced all previously approved and established equity plans then currently in effect. As of
March 31, 2020
,
142,000
options and
30,900
shares of restricted stock have been awarded from the plan leaving
327,100
shares available for future grants.
The fair values of the options granted during the
three
months ended
March 31, 2020
and
2019
were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
|
|
For the three months ended March 31,
|
|||||||
|
|
2020
|
2019
|
||||||
|
Number of options granted
|
101,000
|
|
55,000
|
|
||||
|
Weighted average exercise price
|
$
|
20.39
|
|
$
|
20.61
|
|
||
|
Weighted average fair value of options
|
$
|
5.54
|
|
$
|
6.21
|
|
||
|
Expected life in years (1)
|
8.66
|
|
8.23
|
|
||||
|
Expected volatility (2)
|
27.13
|
%
|
27.08
|
%
|
||||
|
Risk-free interest rate (3)
|
1.55
|
%
|
2.55
|
%
|
||||
|
Dividend yield (4)
|
1.61
|
%
|
1.36
|
%
|
||||
(1) The expected life of the options was estimated based on historical employee behavior and represents the period of time that options granted are expected to be outstanding.
(2) The expected volatility of the Company’s stock price was based on the historical volatility over the period commensurate with the expected life of the options.
(3) The risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of the options on the date of grant.
(4) The expected dividend yield is the projected annual yield based on the grant date stock price.
Upon exercise, the Company issues shares from its authorized but unissued common stock to satisfy the options. The following table presents information about options exercised during the
three
months ended
March 31, 2020
and
2019
:
|
For the three months ended March 31,
|
||||||||
|
2020
|
2019
|
|||||||
|
Number of options exercised
|
5,500
|
|
20,434
|
|
||||
|
Total intrinsic value of options exercised
|
$
|
86,241
|
|
$
|
240,403
|
|
||
|
Cash received from options exercised
|
$
|
34,265
|
|
$
|
165,943
|
|
||
|
Tax deduction realized from options
|
$
|
25,264
|
|
$
|
72,325
|
|
||
The following table summarizes information about stock options outstanding and exercisable at
March 31, 2020
:
|
Options outstanding
|
Options exercisable
|
||||||||||||||||
|
Range of exercise prices
|
Options outstanding
|
Weighted average remaining contractual life (in years)
|
Weighted average exercise price
|
Options exercisable
|
Weighted average exercise price
|
||||||||||||
|
$0.00 - $6.00
|
59,011
|
|
2.4
|
$
|
5.60
|
|
59,011
|
|
$
|
5.60
|
|
||||||
|
$6.01 - $12.00
|
190,767
|
|
5.0
|
8.73
|
|
190,767
|
|
8.73
|
|
||||||||
|
$12.01 - $18.00
|
102,533
|
|
7.9
|
15.94
|
|
67,533
|
|
15.78
|
|
||||||||
|
$18.01 - $24.00
|
357,500
|
|
8.8
|
20.91
|
|
119,670
|
|
20.26
|
|
||||||||
|
Total
|
709,811
|
|
7.1
|
$
|
15.65
|
|
436,981
|
|
$
|
12.55
|
|
||||||
36
Financial Accounting Standards Board Accounting Standards Codification
("FASB ASC") Topic 718, “Compensation - Stock Compensation,”
requires an entity to recognize the fair value of equity awards as compensation expense over the period during which an employee is required to provide service in exchange for such an award (vesting period). Compensation expense related to stock options and the related income tax benefit for the
three
months ended
March 31, 2020
and
2019
are detailed in the following table:
|
|
For the three months ended March 31,
|
|||||||
|
|
2020
|
2019
|
||||||
|
Compensation expense
|
$
|
192,489
|
|
$
|
136,356
|
|
||
|
Income tax benefit
|
$
|
55,629
|
|
$
|
39,407
|
|
||
As of
March 31, 2020
, unrecognized compensation costs related to nonvested share-based compensation arrangements granted under the Company’s stock option plans totaled approximately
$1.5 million
. That cost is expected to be recognized over a weighted average period of
2.2
years.
Restricted Stock Awards
Restricted stock is issued under the stock bonus program to reward employees and directors and to retain them by distributing stock over a period of time. Restricted stock awards granted to date vest over a period of 4 years and are recognized as compensation to the recipient over the vesting period. The awards are recorded at fair market value at the time of grant and amortized into salary expense on a straight line basis over the vesting period. The following table summarizes nonvested restricted stock activity for the
three months ended March 31,
2020
:
|
Shares
|
Average grant date fair value
|
||||||
|
Nonvested restricted stock at December 31, 2019
|
108,740
|
|
$
|
19.18
|
|
||
|
Granted
|
15,000
|
|
16.63
|
|
|||
|
Cancelled
|
—
|
|
—
|
|
|||
|
Vested
|
(33,718
|
)
|
17.08
|
|
|||
|
Nonvested restricted stock at March 31, 2020
|
90,022
|
|
$
|
19.54
|
|
||
Restricted stock awards granted during the
three
months ended
March 31, 2020
and
2019
were as follows:
|
|
For the three months ended March 31,
|
|||||||
|
|
2020
|
2019
|
||||||
|
Number of shares granted
|
15,000
|
|
30,150
|
|
||||
|
Average grant date fair value
|
$
|
16.63
|
|
$
|
20.65
|
|
||
Compensation expense related to restricted stock for the
three
months ended
March 31, 2020
and
2019
is detailed in the following table:
|
|
For the three months ended March 31,
|
|||||||
|
|
2020
|
2019
|
||||||
|
Compensation expense
|
$
|
172,905
|
|
$
|
146,288
|
|
||
|
Income tax benefit
|
$
|
49,969
|
|
$
|
42,277
|
|
||
As of
March 31, 2020
, there was approximately
$1.6 million
of unrecognized compensation cost related to nonvested restricted stock awards granted under the Company’s stock incentive plans. That cost is expected to be recognized over a weighted average period of
2.7
years.
401(k) Savings Plan
The Bank has a 401(k) savings plan covering substantially all employees. Under the Plan, an employee can contribute up to
80 percent
of their salary on a tax deferred basis. The Bank may also make discretionary contributions to the Plan. The Bank contributed
$185 thousand
and
$146 thousand
to the Plan during the
three months ended March 31, 2020
and
2019
, respectively.
37
Deferred Fee Plan
The Company has a deferred fee plan for Directors and executive management. Directors of the Company have the option to elect to defer up to
100 percent
of their respective retainer and Board of Director fees, and each member of executive management has the option to elect to defer up to
100 percent
of their year end cash bonuses. Director and executive deferred fees totaled
$491 thousand
and
$312 thousand
during the
three months ended March 31, 2020
and
2019
, respectively. The interest paid on the deferred balances totaled
$28 thousand
and
$23 thousand
during the
three months ended March 31, 2020
and
2019
, respectively. The fees distributed on the deferred balances totaled
$2 thousand
in 2020 and
$3 thousand
in 2019.
Benefit Plans
In addition to the 401(k) savings plan which covers substantially all employees, in 2015 the Company established an unfunded supplemental defined benefit plan to provide additional retirement benefits for the President and Chief Executive Officer (“CEO”) and certain key executives.
On June 4, 2015, the Company approved the Supplemental Executive Retirement Plan (“SERP”) pursuant to which the President and CEO is entitled to receive certain supplemental nonqualified retirement benefits. On September 27, 2018 the Company approved a change in calculation of the Retirement Benefit payable under the SERP so that the Retirement Benefit shall be an amount equal to sixty percent (
60%
) of the average of Executive's base salary for the thirty-six (
36
) months immediately preceding executive's separation from service after age 66, adjusted annually thereafter by two percent (
2%
). The total benefit is to be made payable in
fifteen
annual installments. The future payments are estimated to total
$6.6 million
. A discount rate of four percent (
4%
) was used to calculate the present value of the benefit obligation.
The President and CEO commenced vesting in this retirement benefit on January 1, 2014, and vests an additional three percent (
3%
) each year until fully vested on January 1, 2024. In the event that the President and CEO’s separation from service from the Company were to occur prior to full vesting, the President and CEO would be entitled to and shall be paid the vested portion of the retirement benefit calculated as of the date of separation from service. Notwithstanding the foregoing, upon a Change in Control, and provided that within
6 months
following the Change in Control the President and CEO is involuntarily terminated for reasons other than “cause” or the President and CEO resigns for “good reason,” as such is defined in the SERP, or the President and CEO voluntarily terminates his employment after being offered continued employment in a position that is not a “Comparable Position,” as such is also defined in the SERP, the President and CEO shall become one hundred percent (
100%
) vested in the full retirement benefit.
No contributions or payments have been made during the
three months ended March 31,
2020
. The following table summarizes the components of the net periodic pension cost of the defined benefit plan recognized during the
three months ended March 31,
2020
and
2019
:
|
For the three months ended March 31,
|
||||||||
|
(In thousands)
|
2020
|
2019
|
||||||
|
Service cost
|
$
|
31
|
|
$
|
47
|
|
||
|
Interest cost
|
37
|
|
29
|
|
||||
|
Amortization of prior service cost
|
21
|
|
21
|
|
||||
|
Net periodic benefit cost
|
$
|
89
|
|
$
|
97
|
|
||
The following table summarizes the changes in benefit obligations of the defined benefit plan during the
three months ended
March 31, 2020
and
2019
:
|
For the three months ended March 31,
|
||||||||
|
(In thousands)
|
2020
|
2019
|
||||||
|
Benefit obligation, beginning of year
|
$
|
3,571
|
|
$
|
2,747
|
|
||
|
Service cost
|
31
|
|
47
|
|
||||
|
Interest cost
|
37
|
|
29
|
|
||||
|
Benefit obligation, end of period
|
$
|
3,639
|
|
$
|
2,823
|
|
||
On October 22, 2015, the Company entered into an Executive Incentive Retirement Plan (the “Plan”) with certain key executive officers other than the President and CEO. The Plan has an effective date of January 1, 2015.
38
The Plan is an unfunded, nonqualified deferred compensation plan. For any Plan Year, a guaranteed annual Deferral Award percentage of seven and one half percent (
7.5%
) of the participant’s annual base salary will be credited to each Participant’s Deferred Benefit Account. A discretionary annual Deferral Award equal to seven and one half percent (
7.5%
) of the participant’s annual base salary may be credited to the Participant’s account in addition to the guaranteed Deferral Award, if the Bank exceeds the benchmarks set forth in the Annual Executive Bonus Matrix. The total Deferral Award shall never exceed fifteen percent (
15%
) of the participant's base salary for any given Plan Year. Each Participant shall be one hundred percent (
100%
) vested in all Deferral Awards as of the date they are awarded.
As of
March 31, 2020
, the Company had total year to date expenses of
$24 thousand
related to the Plan. The Plan is reflected on the Company’s balance sheet as accrued expenses.
Certain members of management are also enrolled in a split-dollar life insurance plan with a post retirement death benefit of
$250 thousand
. Total expenses related to this plan were
$1 thousand
for the
three months ended March 31,
2020
and
2019
.
NOTE
13. Regulatory Capital
A significant measure of the strength of a financial institution is its capital base. Federal regulators have classified and defined capital into the following components: (1) tier 1 capital, which includes tangible shareholders' equity for common stock, qualifying preferred stock and certain qualifying hybrid instruments, and (2) tier 2 capital, which includes a portion of the allowance for loan losses, subject to limitations, certain qualifying long-term debt, preferred stock and hybrid instruments, which do not qualify for tier 1 capital. The Bank is currently subject to various regulatory capital requirements administered by the FDIC.
On September 17, 2019, the federal banking agencies issued a final rule providing simplified capital requirements for certain community banking organizations (banks and holding companies) with less than $10 billion in total consolidated assets, implementing provisions of The Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”). Under the proposal, a qualifying community banking organization would be eligible to elect the community bank leverage ratio framework, or continue to measure capital under the existing Basel III requirements set forth in the New Rules. The new rule takes effect January 1, 2020, and qualifying community banking organizations may elect to opt into the new community bank leverage ratio (“CBLR”) in their call report for the first quarter of 2020.
A qualifying community banking organization (“QCBO”) is defined as a bank, a savings association, a bank holding company or a savings and loan holding company with:
|
•
|
A leverage capital ratio of greater than 9.0%;
|
|
•
|
Total consolidated assets of less than $10.0 billion;
|
|
•
|
Total off-balance sheet exposures (excluding derivatives other than credit derivatives and unconditionally cancelable commitments) of 25% or less of total consolidated assets; and
|
|
•
|
Total trading assets and trading liabilities of 5% or less of total consolidated assets.
|
A QCBO opting into the CBLR must maintain a CBLR of 9.0%, subject to a two quarter grace period to come back into compliance, provided that the QCBO maintains a leverage ratio of more than 8.0% during the grace period. A QCBO failing to satisfy these requirements must comply with the existing Basel III requirements as implemented by the banking regulators.
The numerator of the CBLR is Tier 1 capital, as calculated under present rules. The denominator of the CBLR is the QCBO’s average assets, calculated in accordance with the QCBO’s Call Report instructions and less assets deducted from Tier 1 capital.
The Bank has opted into the CBLR, and will therefore not be required to comply with the Basel III capital requirements. As of March 31, 2020, the Bank’s CBLR was 10.16%, and the Company’s CBLR was 10.56%.
39
For comparison purposes only, we set forth below what the capital ratios for the Bank and the Company were, and would have been, under the Basel III requirements:
|
|
At March 31, 2020
|
Required for capital adequacy purposes effective
|
To be well-capitalized under prompt corrective action regulations
|
||||||||||
|
Company
|
Bank
|
January 1, 2019
|
Bank
|
||||||||||
|
Leverage ratio
|
|
10.56
|
%
|
|
10.16
|
%
|
4.00
|
%
|
5.00
|
%
|
|||
|
CET1
|
11.67
|
%
|
11.91
|
%
|
7.00
|
%
|
(1
|
)
|
6.50
|
%
|
|||
|
Tier I risk-based capital ratio
|
|
12.39
|
%
|
|
11.91
|
%
|
|
8.50
|
%
|
(1
|
)
|
8.00
|
%
|
|
Total risk-based capital ratio
|
|
13.15
|
%
|
|
12.70
|
%
|
|
10.50
|
%
|
(1
|
)
|
10.00
|
%
|
|
|
At December 31, 2019
|
Required for capital
adequacy purposes effective |
To be well-capitalized under prompt corrective action regulations
|
|||||||||||
|
Company
|
Bank
|
January 1, 2019
|
Bank
|
|||||||||||
|
Leverage ratio
|
|
10.59
|
%
|
|
10.15
|
%
|
4.000
|
%
|
5.00
|
%
|
||||
|
CET1
|
11.59
|
%
|
11.81
|
%
|
7.000
|
%
|
(1
|
)
|
6.50
|
%
|
||||
|
Tier I risk-based capital ratio
|
|
12.32
|
%
|
|
11.81
|
%
|
|
8.500
|
%
|
(1
|
)
|
8.00
|
%
|
|
|
Total risk-based capital ratio
|
|
13.06
|
%
|
|
12.58
|
%
|
|
10.500
|
%
|
(1
|
)
|
10.00
|
%
|
|
|
(1) Includes 2.5% capital conservation buffer.
|
||||||||||||||
NOTE
14. Leases
The Company follows
ASU 2016-02, "Leases (Topic 842),"
which revised certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. ASU 2016-02 requires that a lessee recognize the assets and liabilities on its balance sheet that arise from all leases with a term greater than 12 months. The core principle requires the lessee to recognize a liability to make lease payments and a "right-of-use" asset.
Operating leases in which the Bank is the lessee are recorded as right-of-use ("ROU") assets and lease liabilities and are included in Prepaid expenses and other assets and Accrued expenses and other liabilities, respectively, on the Bank's Consolidated Balance Sheets. The Bank does not currently have any finance leases in which it is the lessee.
Operating lease ROU assets represent the Bank's right to use an underlying asset during the lease term and operating lease liabilities represent its obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate. The incremental borrowing rate was calculated for each lease by taking a variable rate FHLB ARC product (based on Libor plus a spread) and then swapping it to a fixed rate borrowing by adding a fixed mid swap rate for the desired term. The borrowing rate for each lease is unique based on the lease term. Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded in Occupancy expense in the Consolidated Statements of Income.
The Bank's leases relate primarily to bank branches, office space and equipment with remaining lease terms of generally
1
to
10
years. Certain lease arrangements contain extension options which typically range from
1
to
5
years at the then fair market rental rates. As these extension options are not generally considered reasonably certain of exercise, they are not included in the lease term.
Certain real estate leases have lease payments that adjust based on annual changes in the Consumer Price Index ("CPI"). The leases that are dependent upon CPI are initially measured using the index or rate at the commencement date and are included in the measurement of the lease liability.
Operating lease ROU assets totaled
$2.7 million
at
March 31, 2020
, compared to
$2.8 million
at
December 31, 2019
. As of
March 31, 2020
, operating lease liabilities totaled
$2.7 million
, compared to
$2.8 million
at
December 31, 2019
.
40
The table below summarizes our net lease cost:
|
For the three months ended March 31,
|
||||||||
|
(In thousands)
|
2020
|
2019
|
||||||
|
Operating lease cost
|
$
|
148
|
|
$
|
150
|
|
||
|
Net lease cost
|
$
|
148
|
|
$
|
150
|
|
||
The table below summarizes the cash and non-cash activities associated with our leases:
|
For the three months ended March 31,
|
||||||||
|
(In thousands)
|
2020
|
2019
|
||||||
|
Cash paid for amounts included in the measurement of lease liabilities:
|
||||||||
|
Operating cash flows from operating leases
|
$
|
141
|
|
$
|
142
|
|
||
|
ROU assets obtained in exchange for new operating lease liabilities
|
$
|
—
|
|
$
|
2,765
|
|
||
The table below summarizes other information related to our operating leases:
|
(In thousands, except percentages and years)
|
March 31, 2020
|
December 31, 2019
|
||||||
|
Weighted average remaining lease term in years
|
6.57
|
|
6.76
|
|
||||
|
Weighted average discount rate
|
5.48
|
%
|
5.47
|
%
|
||||
|
Operating lease right-of-use assets
|
$
|
2,667
|
|
$
|
2,792
|
|
||
The table below summarizes the maturity of remaining lease liabilities:
|
(In thousands)
|
March 31, 2020
|
|||
|
2020 (excluding the three months ended March 31, 2020)
|
$
|
416
|
|
|
|
2021
|
528
|
|
||
|
2022
|
477
|
|
||
|
2023
|
410
|
|
||
|
2024
|
361
|
|
||
|
2025 and thereafter
|
1,036
|
|
||
|
Total lease payments
|
$
|
3,228
|
|
|
|
Less: Interest
|
(526
|
)
|
||
|
Present value of lease liabilities
|
$
|
2,702
|
|
|
As of
March 31, 2020
, the Corporation had not entered into any material leases that have not yet commenced.
ITEM 2
Management's
Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of financial condition and results of operations should be read in conjunction with the
2019
consolidated audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended
December 31, 2019
. When necessary, reclassifications have been made to prior period data throughout the following discussion and analysis for purposes of comparability. This Quarterly Report on Form 10-Q contains certain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which may be identified by the use of such words as “believe”, “expect”, “anticipate”, “should”, “planned”, “estimated” and “potential”. Examples of forward looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of Unity Bancorp, Inc. that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, in addition to those items contained in the Company’s Annual Report on Form 10-K under Item IA-Risk Factors, as updated by our subsequent Quarterly Reports on Form 10-Q, the following: changes in general, economic, and market conditions, legislative and regulatory conditions, the development of an interest rate environment that adversely affects Unity Bancorp, Inc.’s interest rate spread or other income anticipated from operations and investments and the impact of the COVID-19 pandemic on our employees, operations and customers.
Overview
Unity Bancorp, Inc. (the “Parent Company”) is a bank holding company incorporated in New Jersey and registered under the Bank Holding Company Act of 1956, as amended. Its wholly-owned subsidiary, Unity Bank (the “Bank” or, when consolidated with the Parent Company, the “Company”) is chartered by the New Jersey Department of Banking and Insurance and commenced operations on September 13, 1991. The Bank provides a full range of commercial and retail banking services through the Internet and its nineteen branch offices located in Bergen, Hunterdon, Middlesex, Somerset, Union and Warren counties in New Jersey, and Northampton County in Pennsylvania. These services include the acceptance of demand, savings, and time deposits and the extension of consumer, real estate, Small Business Administration ("SBA") and other commercial credits. The Bank has multiple subsidiaries used to hold part of its investment and loan portfolios and OREO properties.
The Company has two other wholly-owned subsidiaries: Unity (NJ) Statutory Trust II and Unity Risk Management, Inc. On July 24, 2006, the Trust issued $10.0 million of trust preferred securities to investors. These floating rate securities are treated as subordinated debentures on the Company’s financial statements. However, they qualify as Tier I Capital for regulatory capital compliance purposes, subject to certain limitations. Unity Risk Management, Inc. is the Company's captive insurance company that insures risks to the Bank not covered by the traditional commercial insurance market. The Company does not consolidate the accounts and related activity of Unity (NJ) Statutory Trust II, but it does consolidate the accounts of Unity Risk Management, Inc.
Impact of COVID-19
The Central and Northern New Jersey and Eastern Pennsylvania markets served by the Registrant have been significantly impacted by the Coronavirus ("COVID-19") epidemic. By Executive Order, the Governor of the State of New Jersey has ordered all non-essential businesses to close, and has banned large scale gatherings. The Commonwealth of Pennsylvania has enacted similar restrictions, at least in some counties. As a result, the Company does not expect that its results of operations for at least the first and second quarters of 2020 will track with the Company's historical performance.
41
The Company has and is taking steps to protect the health and safety of its employees and to work with its customers experiencing economic consequences from the epidemic. The Bank has closed its branch lobbies and is servicing clients through its drive through facilities, through ATM’s or by appointment. Approximately 75% of non-branch personnel are currently working remotely. The Bank is working with its loan customers to provide short term payment deferrals and to waive certain fees. These accommodations are likely to have a negative impact on the Company’s results of operations during the duration of the epidemic, and, depending on how quickly the businesses of our customers rebound after the emergency, could lead to an increase in nonperforming assets.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed into law. The CARES Act provides assistance to small businesses through the establishment of the Paycheck Protection Program ("PPP"). The PPP provides small businesses with funds to pay up to 8 weeks of payroll costs, including benefits. The funds are provided in the form of loans that will be fully forgiven when used for payroll costs, interest on mortgages, rent, and utilities. The payments on these loans will be deferred for six months. Forgiveness of the PPP loans is based on the employer maintaining or quickly rehiring employees and maintaining salary levels. Most small businesses with 500 or fewer employees are eligible. Applications for the PPP loans started on April 3, 2020. As an existing SBA 7(a) lender, the Company has opted to participate in the program. The Company currently has 450 approved applications with estimated funding of $90.0 million.
Earnings Summary
Net income totaled
$5.4 million
, or
$0.49
per diluted share for the quarter ended
March 31, 2020
, compared to
$5.7 million
, or
$0.52
per diluted share for the same period a year ago. Return on average assets and average common equity for the quarter were
1.32
percent and
13.23
percent, respectively, compared to
1.55
percent and
16.52
percent for the same period a year ago.
First
quarter highlights include:
|
•
|
Net interest income increased 7.23 percent compared to the prior year’s quarter due to loan growth.
|
|
•
|
Net interest margin equaled 3.92 percent this quarter compared to 4.06 percent in the prior years' quarter. Due to recent significant interest rate cuts by the Federal Reserve Board in response to COVID-19, modest net interest margin contractions are expected in 2020.
|
|
•
|
The provision for loan losses was $1.5 million for the quarter ended March 31, 2020 an increase of $1.0 million from the prior year's quarter due to the increased risk of loan defaults as a result of COVID-19. Many of the Company's customers have been required to close pursuant to government restrictions on non-essential businesses, and we expect they will suffer significant cash flow losses. Due to the uncertainty of COVID-19, the Company anticipates an elevated provision until businesses have reopened and deferral periods have expired.
|
|
•
|
Noninterest income increased 25.8 percent compared to the prior year's quarter primarily due to increased gains on mortgage loan sales, partially offset by amortization on our equity securities.
|
|
•
|
Noninterest expense increased 10.0 percent compared to the prior year's quarter due to increased compensation accruals, severance payouts and increased consulting expenses for Bank Secrecy Act/Anti-Money Laundering remediation.
|
|
•
|
The effective tax rate was 22.9 percent compared to 20.9 percent in the prior year's quarter.
|
The Company's quarterly performance ratios may be found in the table below.
|
|
For the three months ended March 31,
|
|||||||
|
|
2020
|
2019
|
||||||
|
Net income per common share - Basic (1)
|
$
|
0.49
|
|
$
|
0.53
|
|
||
|
Net income per common share - Diluted (2)
|
$
|
0.49
|
|
$
|
0.52
|
|
||
|
Return on average assets
|
1.32
|
%
|
1.55
|
%
|
||||
|
Return on average equity (3)
|
13.23
|
%
|
16.52
|
%
|
||||
|
Efficiency ratio (4)
|
51.92
|
%
|
52.53
|
%
|
||||
(1) Defined as net income divided by weighted average shares outstanding.
(2) Defined as net income divided by the sum of the weighted average shares and the potential dilutive impact of the exercise
of outstanding options.
(3) Defined as net income divided by average shareholders' equity.
(4) The efficiency ratio is a non-GAAP measure of operational performance. It is defined as noninterest expense divided by the
42
sum of net interest income plus noninterest income less any gains or losses on securities.
Net Interest Income
The primary source of the Company’s operating income is net interest income, which is the difference between interest and dividends earned on earning assets and fees earned on loans, and interest paid on interest-bearing liabilities. Earning assets include loans to individuals and businesses, investment securities, interest-earning deposits and federal funds sold. Interest-bearing liabilities include interest-bearing demand, savings and time deposits, FHLB advances and other borrowings. Net interest income is determined by the difference between the yields earned on earning assets and the rates paid on interest-bearing liabilities (“net interest spread”) and the relative amounts of earning assets and interest-bearing liabilities. The Company’s net interest spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand, deposit flows and general levels of nonperforming assets.
COVID-19 has adversely affected, and will continue to adversely affect economic activity globally, nationally and locally. Following the COVID-19 outbreak, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time. Additionally, the Federal Open Market Committee reduced the target federal funds rate by 50 basis points to 1.00% to 1.25%. This rate was further reduced to 0% to 0.25% on March 16, 2020. These reductions in interest rates and other effects of the COVID-19 outbreak may adversely affect the Company's financial condition and results of operations.
During the quarter ended
March 31, 2020
, tax-equivalent net interest income amounted to $15.2 million, an increase of $1.0 million or 7.2 percent when compared to the same period in
2019
. The net interest margin decreased 14 basis points to 3.92 percent for the quarter ended
March 31, 2020
, compared to 4.06 percent for the same period in
2019
. The net interest spread was 3.53 percent for the
first
quarter of
2020
, a 15 basis point decrease compared to the same period in
2019
.
43
During the quarter ended
March 31, 2020
, tax-equivalent interest income was $19.6 million, an increase of $1.1 million or 5.9 percent when compared to the same period in the prior year. This increase was mainly driven by the increase in the balance of average loans, partially offset by a decrease in the yield on loans and the rates on federal funds sold and interest-bearing deposits.
|
•
|
Of the $1.1 million net increase in interest income on a tax-equivalent basis, $1.7 million of the increase was due to increased average earning assets, partially offset by a $629 thousand decrease to yields on the earning assets.
|
|
•
|
The average volume of interest-earning assets increased $143.1 million to $1.6 billion for the
first
quarter of
2020
compared to $1.4 billion for the same period in
2019
. This was due primarily to a $111.3 million increase in average loans, primarily commercial, residential mortgage and consumer loans, a $31.1 million increase in federal funds sold and interest-bearing deposits and a $703 thousand increase in investment securities.
|
|
•
|
The yield on total interest-earning assets decreased 24 basis points to 5.04 percent for the three months ended
March 31, 2020
when compared to the same period in
2019
. The yield on the loan portfolio decreased 16 basis points to 5.29 percent.
|
Total interest expense was $4.3 million for the three months ended
March 31, 2020
, an increase of $57 thousand or 1.3 percent compared to the same period in
2019
. This increase was driven by the increased volume on interest-bearing deposits, partially offset by the decreased rates on borrowed funds and subordinated debentures and decreased rates on interest-bearing deposits compared to a year ago:
|
•
|
Of the $57 thousand increase in interest expense, $368 thousand was due to an increase in the volume of average interest-bearing liabilities, partially offset by a $311 thousand decrease on the rates on interest-bearing liabilities.
|
|
•
|
Interest-bearing liabilities averaged $1.2 billion for the
first
quarter of
2020
, an increase of $69 thousand or 6.3 percent compared to the prior year’s quarter. The increase in interest-bearing liabilities was due to a $73 thousand increase in interest-bearing deposits, primarily time and interest-bearing demand deposits, partially offset by a $4 thousand decrease in borrowed funds and subordinated debentures.
|
|
•
|
The average cost of total interest-bearing liabilities decreased 9 basis points to 1.51 percent. The cost of interest-bearing deposits decreased 3 basis points to 1.48 percent for the
first
quarter of
2020
and the cost of borrowed funds and subordinated debentures decreased 52 basis points to 1.73 percent.
|
The following table reflects the components of net interest income, setting forth for the periods presented herein: (1) average assets, liabilities and shareholders’ equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) net interest spread, and (5) net interest income/margin on average earning assets. Rates/Yields are computed on a fully tax-equivalent basis, assuming a federal income tax rate of 21 percent in 2020 and 2019.
44
Consolidated Average Balance Sheets
(Dollar amounts in thousands, interest amounts and interest rates/yields on a fully tax-equivalent basis)
|
For the three months ended
|
|||||||||||||||||||||||
|
March 31, 2020
|
March 31, 2019
|
||||||||||||||||||||||
|
Average Balance
|
Interest
|
Rate/Yield
|
Average Balance
|
Interest
|
Rate/Yield
|
||||||||||||||||||
|
ASSETS
|
|||||||||||||||||||||||
|
Interest-earning assets:
|
|||||||||||||||||||||||
|
Federal funds sold and interest-bearing deposits
|
$
|
69,076
|
|
$
|
188
|
|
1.09
|
|
%
|
$
|
38,066
|
|
$
|
221
|
|
2.35
|
|
%
|
|||||
|
FHLB stock
|
6,883
|
|
109
|
|
6.37
|
|
6,951
|
|
116
|
|
6.77
|
|
|||||||||||
|
Securities:
|
|||||||||||||||||||||||
|
Taxable
|
60,363
|
|
511
|
|
3.40
|
|
58,735
|
|
475
|
|
3.28
|
|
|||||||||||
|
Tax-exempt
|
3,783
|
|
31
|
|
3.30
|
|
4,588
|
|
36
|
|
3.18
|
|
|||||||||||
|
Total securities (A)
|
64,146
|
|
542
|
|
3.40
|
|
63,323
|
|
511
|
|
3.27
|
|
|||||||||||
|
Loans:
|
|||||||||||||||||||||||
|
SBA loans
|
50,528
|
|
985
|
|
7.84
|
|
50,015
|
|
995
|
|
8.07
|
|
|||||||||||
|
Commercial loans
|
769,497
|
|
9,933
|
|
5.19
|
|
697,856
|
|
9,069
|
|
5.27
|
|
|||||||||||
|
Residential mortgage loans
|
462,748
|
|
5,770
|
|
5.02
|
|
439,904
|
|
5,560
|
|
5.13
|
|
|||||||||||
|
Consumer loans
|
142,284
|
|
2,067
|
|
5.84
|
|
125,987
|
|
2,035
|
|
6.55
|
|
|||||||||||
|
Total loans (B)
|
1,425,057
|
|
18,755
|
|
5.29
|
|
1,313,762
|
|
17,659
|
|
5.45
|
|
|||||||||||
|
Total interest-earning assets
|
$
|
1,565,162
|
|
$
|
19,594
|
|
5.04
|
|
%
|
$
|
1,422,102
|
|
$
|
18,507
|
|
5.28
|
|
%
|
|||||
|
|
|||||||||||||||||||||||
|
Noninterest-earning assets:
|
|||||||||||||||||||||||
|
Cash and due from banks
|
21,942
|
|
26,105
|
|
|||||||||||||||||||
|
Allowance for loan losses
|
(16,698
|
)
|
(15,753
|
)
|
|||||||||||||||||||
|
Other assets
|
70,381
|
|
70,586
|
|
|||||||||||||||||||
|
Total noninterest-earning assets
|
75,625
|
|
80,938
|
|
|||||||||||||||||||
|
Total assets
|
$
|
1,640,787
|
|
$
|
1,503,040
|
|
|||||||||||||||||
|
|
|||||||||||||||||||||||
|
LIABILITIES AND SHAREHOLDERS' EQUITY
|
|||||||||||||||||||||||
|
Interest-bearing liabilities:
|
|||||||||||||||||||||||
|
Total interest-bearing demand deposits
|
$
|
193,016
|
|
$
|
478
|
|
1.00
|
|
%
|
$
|
182,080
|
|
$
|
409
|
|
0.91
|
|
%
|
|||||
|
Total savings deposits
|
394,082
|
|
851
|
|
0.87
|
|
397,209
|
|
1,119
|
|
1.14
|
|
|||||||||||
|
Total time deposits
|
435,705
|
|
2,447
|
|
2.26
|
|
370,990
|
|
2,007
|
|
2.19
|
|
|||||||||||
|
Total interest-bearing deposits
|
1,022,803
|
|
3,776
|
|
1.48
|
|
950,279
|
|
3,535
|
|
1.51
|
|
|||||||||||
|
Borrowed funds and subordinated debentures
|
131,057
|
|
565
|
|
1.73
|
|
134,877
|
|
749
|
|
2.25
|
|
|||||||||||
|
Total interest-bearing liabilities
|
$
|
1,153,860
|
|
$
|
4,341
|
|
1.51
|
|
%
|
$
|
1,085,156
|
|
$
|
4,284
|
|
1.60
|
|
%
|
|||||
|
|
|||||||||||||||||||||||
|
Noninterest-bearing liabilities:
|
|||||||||||||||||||||||
|
Noninterest-bearing demand deposits
|
307,683
|
|
262,664
|
|
|||||||||||||||||||
|
Other liabilities
|
16,101
|
|
14,327
|
|
|||||||||||||||||||
|
Total noninterest-bearing liabilities
|
323,784
|
|
276,991
|
|
|||||||||||||||||||
|
Total shareholders' equity
|
163,143
|
|
140,893
|
|
|||||||||||||||||||
|
Total liabilities and shareholders' equity
|
$
|
1,640,787
|
|
$
|
1,503,040
|
|
|||||||||||||||||
|
|
|||||||||||||||||||||||
|
Net interest spread
|
$
|
15,253
|
|
3.53
|
|
%
|
$
|
14,223
|
|
3.68
|
|
%
|
|||||||||||
|
Tax-equivalent basis adjustment
|
(9
|
)
|
(7
|
)
|
|||||||||||||||||||
|
Net interest income
|
$
|
15,244
|
|
$
|
14,216
|
|
|||||||||||||||||
|
Net interest margin
|
3.92
|
|
%
|
4.06
|
|
%
|
|||||||||||||||||
|
(A)
|
Yields related to securities exempt from federal and state income taxes are stated on a fully tax-equivalent basis. They are reduced by the nondeductible portion of interest expense, assuming a federal tax rate of 21 percent in 2020 and 2019, as well as all applicable state rates.
|
|
(B)
|
The loan averages are stated net of unearned income, and the averages include loans on which the accrual of interest has been discontinued.
|
45
The rate volume table below presents an analysis of the impact on interest income and expense resulting from changes in average volume and rates over the periods presented. Changes that are not due to volume or rate variances have been allocated proportionally to both, based on their relative absolute values. Amounts have been computed on a tax-equivalent basis, assuming a federal income tax rate of 21 percent in 2020 and 2019.
|
For the three months ended March 31, 2020 versus March 31, 2019
|
||||||||||||
|
Increase (decrease) due to change in:
|
||||||||||||
|
(In thousands on a tax-equivalent basis)
|
Volume
|
Rate
|
Net
|
|||||||||
|
Interest income:
|
||||||||||||
|
Federal funds sold and interest-bearing deposits
|
$
|
124
|
|
$
|
(157
|
)
|
$
|
(33
|
)
|
|||
|
FHLB stock
|
(1
|
)
|
(6
|
)
|
(7
|
)
|
||||||
|
Securities
|
9
|
|
22
|
|
31
|
|
||||||
|
Loans
|
1,585
|
|
(489
|
)
|
1,096
|
|
||||||
|
Total interest income
|
$
|
1,717
|
|
$
|
(630
|
)
|
$
|
1,087
|
|
|||
|
Interest expense:
|
||||||||||||
|
Demand deposits
|
$
|
26
|
|
$
|
43
|
|
$
|
69
|
|
|||
|
Savings deposits
|
(9
|
)
|
(259
|
)
|
(268
|
)
|
||||||
|
Time deposits
|
371
|
|
69
|
|
440
|
|
||||||
|
Total interest-bearing deposits
|
388
|
|
(147
|
)
|
241
|
|
||||||
|
Borrowed funds and subordinated debentures
|
(20
|
)
|
(164
|
)
|
(184
|
)
|
||||||
|
Total interest expense
|
368
|
|
(311
|
)
|
57
|
|
||||||
|
Net interest income - fully tax-equivalent
|
$
|
1,348
|
|
$
|
(318
|
)
|
$
|
1,030
|
|
|||
|
Decrease in tax-equivalent adjustment
|
(2
|
)
|
||||||||||
|
Net interest income
|
$
|
1,028
|
|
|||||||||
Provision for Loan Losses
The provision for loan losses totaled $1.5 million for the
three months ended March 31, 2020
, compared to $500 thousand for the three months ended March 31, 2019. The $1.0 million increase in provision to loan losses was to cover inherent losses stemming from the ongoing coronavirus pandemic. It is likely we will incur elevated provisions until we can better access the impact of the pandemic on the economy of our market area and our customers.
Each period’s loan loss provision is the result of management’s analysis of the loan portfolio and reflects changes in the size and composition of the portfolio, the level of net charge-offs, delinquencies, current economic conditions and other internal and external factors impacting the risk within the loan portfolio. Additional information may be found under the captions “Financial Condition - Asset Quality” and “Financial Condition - Allowance for Loan Losses and Reserve for Unfunded Loan Commitments.” The current provision is considered appropriate under management’s assessment of the adequacy of the allowance for loan losses.
Noninterest Income
The following table shows the components of noninterest income for the
three
months ended
March 31, 2020
and
2019
:
|
|
For the three months ended March 31,
|
|||||||
|
(In thousands)
|
2020
|
2019
|
||||||
|
Branch fee income
|
$
|
317
|
|
$
|
368
|
|
||
|
Service and loan fee income
|
376
|
|
442
|
|
||||
|
Gain on sale of SBA loans held for sale, net
|
473
|
|
316
|
|
||||
|
Gain on sale of mortgage loans, net
|
1,051
|
|
350
|
|
||||
|
BOLI income
|
173
|
|
151
|
|
||||
|
Net security (losses) gains
|
(170
|
)
|
100
|
|
||||
|
Other income
|
325
|
|
295
|
|
||||
|
Total noninterest income
|
$
|
2,545
|
|
$
|
2,022
|
|
||
46
For the
three months ended March 31, 2020
, noninterest income increased $523 thousand to
$2.5 million
, compared to the same period last year. Quarterly noninterest income increased primarily due to increased gains on mortgage loan sales, partially offset by amortization on our equity securities.
Changes in our noninterest income for the
three
months ended
March 31, 2020
vs.
2019
reflect:
|
•
|
Branch fee income decreased $51 thousand for the three months ended March 31, 2020 when compared to the same period in the prior year, primarily due to decreased overdraft fee income.
|
|
•
|
Service and loan fee income decreased $66 thousand primarily due to lower loan prepayment penalties. As we are waiving fees for customers during the COVID-19 epidemic, we expect our fee income to continue to decline during the emergency.
|
|
•
|
SBA loan sales during the first quarter of 2020 totaled $5.4 million with a net gain of $473 thousand, compared to $6.2 million in sales with a net gain of $316 thousand in the prior year's quarter due to higher premiums on the sales.
|
|
•
|
During the quarter, $38.6 million in residential mortgage loans were sold at a gain of $1.1 million, compared to $19.4 million in loans sold at a gain of $350 thousand during the prior year's quarter. Residential mortgage loans are sold as a tool to manage liquidity needs within the Bank.
|
|
•
|
Bank owned life insurance ("BOLI") income increased $22 thousand for the three months ended March 31, 2020 when compared to the same period in the prior year.
|
|
•
|
Net security losses totaled $170 thousand during the first quarter of 2020 compared to gains of $100 thousand in the prior year's quarter. There were approximately $471 thousand in losses which resulted from a decrease in the market value of equity securities, compared to an increase of $100 thousand in the prior year's quarter. Gains on sales of securities totaled $301 thousand for the three months ended March 31, 2020, compared to no gains in the same period a year ago.
|
|
•
|
Other income increased in the quarterly period primarily due to increased Visa check card interchange fees.
|
Noninterest Expense
The following table presents a breakdown of noninterest expense for the
three months ended March 31,
2020
and
2019
:
|
For the three months ended March 31,
|
||||||||
|
(In thousands)
|
2020
|
2019
|
||||||
|
Compensation and benefits
|
$
|
5,439
|
|
$
|
4,845
|
|
||
|
Occupancy
|
624
|
|
694
|
|
||||
|
Processing and communications
|
708
|
|
716
|
|
||||
|
Furniture and equipment
|
655
|
|
659
|
|
||||
|
Professional services
|
332
|
|
288
|
|
||||
|
Loan collection and OREO expenses
|
186
|
|
66
|
|
||||
|
Other loan expenses
|
89
|
|
46
|
|
||||
|
Deposit insurance
|
88
|
|
167
|
|
||||
|
Advertising
|
290
|
|
348
|
|
||||
|
Director fees
|
200
|
|
163
|
|
||||
|
Other expenses
|
712
|
|
486
|
|
||||
|
Total noninterest expense
|
$
|
9,323
|
|
$
|
8,478
|
|
||
Noninterest expense increased $845 thousand to
$9.3 million
for the three months ended
March 31, 2020
.
Changes in noninterest expense for the
three months ended March 31,
2020
versus
2019
reflect:
|
•
|
Compensation and benefits expense, the largest component of noninterest expense, increased $594 thousand for the three months ended March 31,
2020
, when compared to 2019 primarily due to increased salary expenses and commissions paid to employees.
|
|
•
|
Occupancy expense decreased $70 thousand for the three months ended March 31,
2020
, compared to the same period a year ago, primarily due to decreased repairs and maintenance.
|
|
•
|
Processing and communications expenses decreased $8 thousand in
2020
when compared to 2019.
|
47
|
•
|
Furniture and equipment expense remained relatively flat during the first quarter of 2019 when compared to the same period a year ago.
|
|
•
|
Professional service fees increased $44 thousand for the three months ended March 30,
2020
, primarily due to higher consulting expenses.
|
|
•
|
Loan collection and OREO costs increased $120 thousand compared to the prior year's quarter primarily due to increased property tax expenses on OREO properties.
|
|
•
|
Other loan expenses, which consist of expenses such as appraisals, filings and credit reports, increased $43 thousand for the three months ended
March 31, 2020
, compared to the prior year's quarter.
|
|
•
|
Deposit insurance expense decreased $79 thousand for the three months ended
March 31, 2020
, due to an FDIC assessment credit during the second half of 2019. Expenses are expected to rise in future quarters.
|
|
•
|
Advertising expense decreased $58 thousand compared to the prior year's quarter primarily due to decreased expenses related to marketing events.
|
|
•
|
Director fees increased $37 thousand for the three months ended March 31, 2020.
|
|
•
|
Other expenses increased $226 thousand during the first quarter of 2019 when compared to the same period a year ago primarily due to severance payouts.
|
Income Tax Expense
For the quarter ended
March 31, 2020
, the Company reported income tax expense of
$1.6 million
for an effective tax rate of
22.9 percent
, compared to income tax expense of
$1.5 million
and an effective tax rate of
20.9 percent
for the prior year’s quarter.
On July 1, 2018, New Jersey's Assembly Bill 4202 was signed into law. The bill, effective January 1, 2018, imposed a temporary surtax on corporations earning New Jersey allocated income in excess of $1 million at a rate of 2.5% for tax years beginning on or after January 1, 2018 through December 31, 2019, and at a rate of 1.5% for years beginning on or after January 1, 2020, through December 31, 2021. In addition, New Jersey adopted mandatory unitary combined reporting for its Corporation Business Tax, which became effective for periods on or after January 1, 2019.
For additional information on income taxes, see Note 4 to the Consolidated Financial Statements.
Financial Condition at
March 31, 2020
Total assets increased
$21.1 million
or
1.2
percent, to
$1.7 billion
at
March 31, 2020
, when compared to year end
2019
. This increase was primarily due to an increase of
$21.0 million
in cash and cash equivalents and
$13.1 million
in net loans, with strong commercial and consumer loan growth, partially offset by a decrease of
$8.6 million
in investments.
Total deposits increased
$128.5 million
, primarily due to increases of
$84.5 million
in time deposits and
$54.9 million
in noninterest-bearing demand deposits, partially offset by decreases of
$9.3 million
in interest-bearing demand deposits and
$1.6 million
in savings deposits. Borrowed funds decreased
$114.0 million
due to a reduction in overnight borrowings.
Total shareholders’ equity increased
$3.6 million
over year end
2019
, primarily due to earnings and an increase in common stock, partially offset by accumulated other comprehensive loss and dividends paid during the
three months ended March 31, 2020
.
These fluctuations are discussed in further detail in the paragraphs that follow.
Securities Portfolio
The Company’s securities portfolio consists of AFS and equity investments. The investment securities portfolio is maintained for asset-liability management purposes, as well as for liquidity and earnings purposes.
AFS debt securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. AFS debt securities consist primarily of obligations of U.S. Government sponsored entities, obligations of state and political subdivisions, mortgage-backed securities, and corporate and other securities.
AFS debt securities totaled
$56.3 million
at
March 31, 2020
, a decrease of $8.0 million or 12.4 percent, compared to
$64.3 million
at
December 31, 2019
. This net decrease was the result of:
|
•
|
$6.0 million from the sale of three mortgage-backed securities, one corporate bond and two municipal bonds,
|
|
•
|
$1.9 million in principal payments, maturities and called bonds, and
|
|
•
|
$59 thousand in net amortization, partially offset by
|
|
•
|
$4 thousand of appreciation in the market value of the portfolio. At
March 31, 2020
, the portfolio had a net unrealized loss of $395 thousand compared to a net unrealized loss of $391 thousand at
December 31, 2019
. These net unrealized losses are reflected net of tax in shareholder's equity as accumulated other comprehensive income.
|
The weighted average life of AFS debt securities, adjusted for prepayments, amounted to 4.7 years and 4.9 years at
March 31, 2020
and
December 31, 2019
, respectively.
48
Equity securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. Equity securities consist of Community Reinvestment Act ("CRA") investments and the equity holdings of financial institutions.
Equity securities totaled
$1.7 million
at
March 31, 2020
, a decrease of $577 thousand or 25.2%, compared to
$2.3 million
at
December 31, 2019
. This net decrease was the result of:
|
•
|
$466 thousand in market value adjustments throughout the year, and
|
|
•
|
$111 thousand in sales net of realized gains from the sale of one community bank holding.
|
The average balance of taxable securities amounted to $60.2 million for the
three months ended March 31,
2020
, compared to $58.7 million for the same period in
2019
. The average yield earned on taxable securities increased 13 basis points, to 3.41 percent for the
three months ended March 31,
2020
, from 3.28 percent for the same period in the prior year. The average balance of tax-exempt securities amounted to $3.8 million for the
three months ended March 31,
2020
, compared to $4.6 million for the same period in
2019
. The average yield earned on tax-exempt securities increased 12 basis points, to 3.30 percent for the
three
months ended
March 31, 2020
, from 3.18 percent for the same period in
2019
.
Securities with a carrying value of $3.5 million and $4.0 million at
March 31, 2020
and
December 31, 2019
, respectively, were pledged to secure Government deposits, secure other borrowings, collateralize hedging instruments and for other purposes required or permitted by law.
Approximately 59 percent of the total investment portfolio had a fixed rate of interest at
March 31, 2020
.
See Note 7 to the accompanying Consolidated Financial Statements for more information regarding Securities.
Loan Portfolio
The loan portfolio, which represents the Company’s largest asset group, is a significant source of both interest and fee income. The portfolio consists of SBA, commercial, residential mortgage and consumer loans. Each of these segments is subject to differing levels of credit and interest rate risk.
Total loans increased $14.1 million or 1.0 percent to
$1.4 billion
at
March 31, 2020
, compared to year end
2019
. Commercial and consumer loans increased $21.0 million and $6.2 million, respectively, partially offset by a decrease of $11.6 million and $1.5 million in residential mortgage and SBA loans, respectively.
The following table sets forth the classification of loans by major category, including unearned fees and deferred costs and excluding the allowance for loan losses as of
March 31, 2020
and
December 31, 2019
:
|
March 31, 2020
|
December 31, 2019
|
|||||||||||||
|
(In thousands, except percentages)
|
Amount
|
% of total
|
Amount
|
% of total
|
||||||||||
|
SBA loans held for investment
|
$
|
37,074
|
|
2.6
|
%
|
$
|
35,767
|
|
2.5
|
%
|
||||
|
Commercial loans
|
786,078
|
|
54.6
|
|
765,032
|
|
53.7
|
|
||||||
|
Residential mortgage loans
|
456,072
|
|
31.7
|
|
467,706
|
|
32.8
|
|
||||||
|
Consumer loans
|
149,695
|
|
10.4
|
|
143,524
|
|
10.1
|
|
||||||
|
Total loans held for investment
|
1,428,919
|
|
99.3
|
|
1,412,029
|
|
99.1
|
|
||||||
|
SBA loans held for sale
|
10,726
|
|
0.7
|
|
13,529
|
|
0.9
|
|
||||||
|
Total loans
|
$
|
1,439,645
|
|
100.0
|
%
|
$
|
1,425,558
|
|
100.0
|
%
|
||||
Average loans increased $111.3 million or 8.5 percent to $1.4 billion for the
three months ended
March 31, 2020
from $1.3 billion for the same period in
2019
. The increase in average loans was due to increases in commercial, residential mortgage, consumer and SBA loans. The yield on the overall loan portfolio decreased 16 basis points to 5.29 percent for the
three months ended
March 31, 2020
when compared to the same period in the prior year.
49
SBA 7(a) loans, on which the SBA historically has provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. These loans are made for the purposes of providing working capital or financing the purchase of equipment, inventory or commercial real estate. Generally, an SBA 7(a) loan has a deficiency in its credit profile that would not allow the borrower to qualify for a traditional commercial loan, which is why the SBA provides the guarantee. The deficiency may be a higher loan to value (“LTV”) ratio, lower debt service coverage (“DSC”) ratio or weak personal financial guarantees. In addition, many SBA 7(a) loans are for start up businesses where there is no history or financial information. Finally, many SBA borrowers do not have an ongoing and continuous banking relationship with the Bank, but merely work with the Bank on a single transaction. The guaranteed portion of the Company’s SBA loans are generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment.
SBA 7(a) loans held for sale, carried at the lower of cost or market, amounted to
$10.7 million
at
March 31, 2020
, a decrease of $2.8 million from
$13.5 million
at
December 31, 2019
. SBA 7(a) loans held to maturity amounted to
$37.1 million
at
March 31, 2020
, an increase of $1.3 million from
$35.8 million
at
December 31, 2019
. The yield on SBA loans, which are generally floating and adjust quarterly to the Prime rate, was 7.84 percent for the
three months ended
March 31, 2020
, compared to 8.07 percent in the prior year.
The guarantee rates on SBA 7(a) loans range from 50 percent to 90 percent, with the majority of the portfolio having a guarantee rate of 75 percent at origination. The guarantee rates are determined by the SBA and can vary from year to year depending on government funding and the goals of the SBA program. The carrying value of SBA loans held for sale represents the guaranteed portion to be sold into the secondary market. The carrying value of SBA loans held to maturity represents the unguaranteed portion, which is the Company's portion of SBA loans originated, reduced by the guaranteed portion that is sold into the secondary market. Approximately $94.8 million and $93.6 million in SBA loans were sold but serviced by the Company at
March 31, 2020
and
December 31, 2019
, respectively, and are not included on the Company’s balance sheet. There is no relationship or correlation between the guarantee percentages and the level of charge-offs and recoveries on the Company’s SBA 7(a) loans. Charge-offs taken on SBA 7(a) loans effect the unguaranteed portion of the loan. SBA loans are underwritten to the same credit standards irrespective of the guarantee percentage.
Commercial loans are generally made in the Company’s marketplace for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. These loans amounted to
$786.1 million
at
March 31, 2020
, an increase of $21.0 million from year end
2019
. The yield on commercial loans was 5.19 percent for the
three months ended
March 31, 2020
, compared to 5.27 percent for the same period in
2019
. The SBA 504 program, which consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property, is included in the Commercial loan portfolio. Generally, the Company has a 50 percent LTV ratio on SBA 504 program loans at origination.
Residential mortgage loans consist of loans secured by 1 to 4 family residential properties. These loans amounted to
$456.1 million
at
March 31, 2020
, a decrease of $11.6 million from year end
2019
. Sales of mortgage loans totaled $38.6 million for the
three months ended
March 31, 2020
. Approximately $9.8 million of the loans sold were from portfolio, with the remainder consisting of new production. The yield on residential mortgages was 5.02 percent for the
three months ended
March 31, 2020
, compared to 5.13 percent in the
2019
period. Residential mortgage loans maintained in portfolio are generally to individuals that do not qualify for conventional financing. In extending credit to this category of borrowers, the Bank considers other mitigating factors such as credit history, equity and liquid reserves of the borrower. As a result, the residential mortgage loan portfolio of the Bank includes adjustable rate mortgages with rates that exceed the rates on conventional fixed-rate mortgage loan products but which are not considered high priced mortgages.
Consumer loans consist of home equity loans, construction loans and loans for the purpose of financing the purchase of consumer goods, home improvements, and other personal needs, and are generally secured by the personal property being purchased. These loans amounted to
$149.7 million
, an increase of $6.2 million from year end
2019
. The yield on consumer loans was 5.84 percent for the
three months ended
March 31, 2020
, compared to 6.55 percent for the same period in
2019
.
There are no concentrations of loans to any borrowers or group of borrowers exceeding 10 percent of the total loan portfolio and no foreign loans in the portfolio.
In the normal course of business, the Company may originate loan products whose terms could give rise to additional credit risk. Interest-only loans, loans with high LTV or debt service ratios, construction loans with payments made from interest reserves and multiple loans supported by the same collateral (e.g. home equity loans) are examples of such products. However, these products are not material to the Company’s financial position and are closely managed via credit controls that mitigate
50
their additional inherent risk. Management does not believe that these products create a concentration of credit risk in the Company’s loan portfolio. The Company does not have any option adjustable rate mortgage loans.
The majority of the Company’s loans are secured by real estate. Declines in the market values of real estate in the Company’s trade area impact the value of the collateral securing its loans. This could lead to greater losses in the event of defaults on loans secured by real estate. At
March 31, 2020
and
December 31, 2019
, approximately 94 percent of the Company’s loan portfolio was secured by real estate.
TDRs
TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.
At
March 31, 2020
, there was one loan totaling
$694 thousand
that was classified as a TDR and deemed impaired, compared to one such loan totaling
$705 thousand
at
December 31, 2019
. The TDR was a commercial real estate loan which was modified in 2017 to reduce the principal balance. The loan remains in accrual status since it continues to perform in accordance with the restructured terms. Restructured loans that are placed in nonaccrual status may be removed after six months of contractual payments and the borrower showing the ability to service the debt going forward.
Asset Quality
Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to strict credit administration policies and procedures. Due diligence on loans begins when we initiate contact regarding a loan with a borrower. Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval. The loan portfolio is then subject to on-going internal reviews for credit quality, as well as independent credit reviews by an outside firm.
The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. In some cases, these factors have also resulted in significant impairment to the value of loan collateral. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.
Nonperforming assets consist of nonperforming loans and OREO. Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being delinquent for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. When a loan is classified as nonaccrual, interest accruals discontinue and all past due interest previously recognized as income is reversed and charged against current period income. Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal, until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans. Loans past due 90 days or more and still accruing generally represent loans that are well secured and in process of collection.
51
The following table sets forth information concerning nonperforming assets and loans past due 90 days or more and still accruing interest at each of the periods presented:
|
(In thousands, except percentages)
|
March 31, 2020
|
December 31, 2019
|
March 31, 2019
|
|||||||||
|
Nonperforming by category:
|
||||||||||||
|
SBA loans held for investment (1)
|
$
|
1,627
|
|
$
|
1,164
|
|
$
|
814
|
|
|||
|
Commercial loans
|
613
|
|
529
|
|
1,046
|
|
||||||
|
Residential mortgage loans
|
6,910
|
|
3,936
|
|
5,243
|
|
||||||
|
Consumer loans
|
505
|
|
20
|
|
171
|
|
||||||
|
Total nonperforming loans
|
$
|
9,655
|
|
$
|
5,649
|
|
$
|
7,274
|
|
|||
|
OREO
|
1,523
|
|
1,723
|
|
273
|
|
||||||
|
Total nonperforming assets
|
$
|
11,178
|
|
$
|
7,372
|
|
$
|
7,547
|
|
|||
|
Past due 90 days or more and still accruing interest:
|
||||||||||||
|
Commercial loans
|
$
|
—
|
|
$
|
—
|
|
$
|
39
|
|
|||
|
Residential mortgage loans
|
—
|
|
930
|
|
—
|
|
||||||
|
Total past due 90 days or more and still accruing interest
|
$
|
—
|
|
$
|
930
|
|
$
|
39
|
|
|||
|
Nonperforming loans to total loans
|
0.67
|
%
|
0.40
|
%
|
0.55
|
%
|
||||||
|
Nonperforming loans and TDRs to total loans (2)
|
0.72
|
|
0.45
|
|
0.61
|
|
||||||
|
Nonperforming assets to total loans and OREO
|
0.78
|
|
0.52
|
|
0.57
|
|
||||||
|
Nonperforming assets to total assets
|
0.64
|
|
0.43
|
|
0.47
|
|
||||||
|
(1) Guaranteed SBA loans included above
|
$
|
427
|
|
$
|
59
|
|
$
|
68
|
|
|||
|
(2) Performing TDRs
|
694
|
|
705
|
|
738
|
|
||||||
Nonperforming loans were $9.7 million at
March 31, 2020
, a $4.1 million increase from $5.6 million at year end
2019
and a $2.4 million increase from $7.3 million at
March 31, 2019
. Since year end
2019
, nonperforming loans in the residential, consumer, SBA and commercial loan segments increased. Included in nonperforming loans at
March 31, 2020
are approximately $427 thousand of loans guaranteed by the SBA, compared to $59 thousand at
December 31, 2019
, and $68 thousand at
March 31, 2019
, respectively. In addition, there were no loans past due 90 days or more and still accruing interest at
March 31, 2020
, compared to $930 thousand at
December 31, 2019
.
OREO properties totaled $1.5 million at
March 31, 2020
, a decrease of $200 thousand from $1.7 million at
December 31, 2019
and an increase of $1.3 million at
March 31, 2019
. During the
three months ended
March 31, 2020
, the Company charged off $200 thousand to one OREO property.
The Company also monitors potential problem loans. Potential problem loans are those loans where information about possible credit problems of borrowers causes management to have doubts as to the ability of such borrowers to comply with loan repayment terms. These loans are not included in nonperforming loans as they continue to perform. Potential problem loans totaled $5.5 million at
March 31, 2020
, a decrease of $1.9 million when compared to year end
2019
. The decrease is due to the deletion of 7 loans totaling $2.7 million, partially offset by the addition of 5 loans totaling $1.0 million.
See Note 8 to the accompanying Consolidated Financial Statements for more information regarding Asset Quality.
Allowance for Loan Losses and
Reserve for
Unfunded Loan Commitments
Management reviews the level of the allowance for loan losses on a quarterly basis. The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. Specific reserves are made to individual impaired loans, which have been defined to include all nonperforming loans and TDRs. The general reserve is set based upon a representative average historical net charge-off rate adjusted for certain environmental factors such as: delinquency and impairment trends, charge-off and recovery trends, volume and loan term trends, risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes.
52
When calculating the five-year historical net charge-off rate, the Company weights the past three years more heavily. The Company believes using this approach is more indicative of future charge-offs. All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate, and high risk. The factors are evaluated separately for each type of loan. For example, commercial loans are broken down further into commercial and industrial loans, commercial mortgages, construction loans, etc. Each type of loan is risk weighted for each environmental factor based on its individual characteristics.
According to the Company’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable. All credits which are 90 days past due must be analyzed for the Company's ability to collect on the credit. Once a loss is known to exist, the charge-off approval process is immediately expedited.
The allowance for loan losses totaled $17.4 million at
March 31, 2020
, compared to $16.4 million at
December 31, 2019
, and $15.7 million at
March 31, 2019
, with a resulting allowance to total loan ratio of 1.21 percent at
March 31, 2020
, 1.15 percent at
December 31, 2019
, and 1.19 percent at
March 31, 2019
. Net charge-offs amounted to $519 thousand for the
three months ended
March 31, 2020
, compared to $304 thousand for the same period in
2019
. Net charge-offs to average loan ratios are shown in the table below for each major loan category.
|
|
For the three months ended March 31,
|
|||||||
|
(In thousands, except percentages)
|
2020
|
2019
|
||||||
|
Balance, beginning of period
|
$
|
16,395
|
|
$
|
15,488
|
|
||
|
Provision for loan losses charged to expense
|
1,500
|
|
500
|
|
||||
|
Less: Chargeoffs
|
||||||||
|
SBA loans held for investment
|
25
|
|
308
|
|
||||
|
Commercial loans
|
300
|
|
1
|
|
||||
|
Residential mortgage loans
|
200
|
|
—
|
|
||||
|
Consumer loans
|
—
|
|
1
|
|
||||
|
Total chargeoffs
|
525
|
|
310
|
|
||||
|
Add: Recoveries
|
||||||||
|
SBA loans held for investment
|
5
|
|
1
|
|
||||
|
Commercial loans
|
1
|
|
5
|
|
||||
|
Total recoveries
|
6
|
|
6
|
|
||||
|
Net charge-offs
|
519
|
|
304
|
|
||||
|
Balance, end of period
|
$
|
17,376
|
|
$
|
15,684
|
|
||
|
Selected loan quality ratios:
|
||||||||
|
Net chargeoffs to average loans:
|
||||||||
|
SBA loans held for investment
|
0.16
|
%
|
2.49
|
%
|
||||
|
Commercial loans
|
0.16
|
|
—
|
|
||||
|
Residential mortgage loans
|
0.17
|
|
—
|
|
||||
|
Total loans
|
0.15
|
|
0.09
|
|
||||
|
Allowance to total loans
|
1.21
|
|
1.19
|
|
||||
|
Allowance to nonperforming loans
|
179.97
|
%
|
215.62
|
%
|
||||
In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the reserve are made through other expense and applied to the reserve which is maintained in other liabilities. At
March 31, 2020
, a $288 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $273 thousand commitment reserve at
December 31, 2019
.
See Note 9 to the accompanying Consolidated Financial Statements for more information regarding the Allowance for Loan Losses and Reserve for Unfunded Loan Commitments.
Deposits
Deposits, which include noninterest-bearing demand deposits, interest-bearing demand deposits, savings deposits and time deposits, are the primary source of the Company’s funds. The Company offers a variety of products designed to attract and retain customers, with primary focus on building and expanding relationships. The Company continues to focus on establishing a comprehensive relationship with business borrowers, seeking deposits as well as lending relationships.
Total deposits increased $128.5 million to $1.4 billion at
March 31, 2020
, from year-end 2019. This increase in deposits was due to increases of $84.5 million in time deposits and $54.9 million in noninterest-bearing demand deposits, partially offset by a decrease of $9.3 million in interest-bearing demand deposits and $1.6 million in savings deposits. The increase in time deposits is attributable to a combination of retail and broker generated time deposits. The decrease in interest-bearing demand deposits was primarily due to seasonal outflows of municipal deposits.
The Company’s deposit composition at
March 31, 2020
, consisted of 35.4 percent time deposits, 28.2 percent savings deposits, 24.3 percent noninterest-bearing demand deposits and 12.1 percent interest-bearing demand deposits.
Borrowed Funds and Subordinated Debentures
Borrowed funds consist primarily of adjustable and fixed rate advances from the Federal Home Loan Bank of New York. These borrowings are used as a source of liquidity or to fund asset growth not supported by deposit generation. Residential mortgages and commercial loans collateralize the borrowings from the FHLB.
Borrowed funds and subordinated debentures totaled
$179.3 million
and
$293.3 million
at
March 31, 2020
and
December 31, 2019
, respectively, and are broken down in the following table:
|
(In thousands)
|
March 31, 2020
|
December 31, 2019
|
||||||
|
FHLB borrowings:
|
||||||||
|
Fixed rate advances
|
$
|
40,000
|
|
$
|
40,000
|
|
||
|
Adjustable rate advances
|
50,000
|
|
50,000
|
|
||||
|
Overnight advances
|
79,000
|
|
193,000
|
|
||||
|
Subordinated debentures
|
10,310
|
|
10,310
|
|
||||
|
Total borrowed funds and subordinated debentures
|
$
|
179,310
|
|
$
|
293,310
|
|
||
The $114.0 million decrease in total borrowed funds and subordinated debentures was due to a $114.0 million decrease in FHLB overnight advances. The following transactions impacted borrowed funds and subordinated debentures:
FHLB Borrowings
At March 31, 2020 and December 31, 2019, the Company had $40 million in fixed rate advances. The terms of this transaction are as follows:
|
•
|
A $40.0 million FHLB borrowing with a maturity date August 22, 2024, at a fixed rate of 1.810%
|
53
At
March 31, 2020
and
December 31, 2019
, the
$50.0 million
FHLB adjustable rate ("ARC") advances consisted of two $20.0 million and one $10.0 million advances. These ARC advances roll over every six months. The Company has opted to use swap instruments to control the uncertainty from variable rate instruments. Each ARC advance has a swap instrument which modifies the borrowing to a 5 year fixed rate borrowing. The term of these transactions are as follows:
|
•
|
A $20.0 million ARC FHLB borrowing with a maturity date of June 9, 2020, at a rate of 3 month LIBOR plus 0.025%. The swap instrument modifies the borrowing to a 5 year fixed rate borrowing at 1.755% and matures on December 7, 2021.
|
|
•
|
A $20.0 million ARC FHLB borrowing with a maturity date of July 6, 2020, at a rate of 1 month LIBOR plus 0.195%. The swap instrument modifies the borrowing to a 5 year fixed rate borrowing at 1.243% that matures July 5, 2021.
|
|
•
|
A $10.0 million ARC FHLB borrowing with a maturity date of August 18, 2020, at a rate of 3 month LIBOR plus 0.190%. The swap instrument modifies the borrowing to a 5 year fixed rate borrowing at 1.293% that matures on February 16, 2021.
|
At
March 31, 2020
, there were FHLB overnight borrowings of
$79.0 million
at a rate of 0.400%, compared to
$193.0 million
at a rate of 1.810% at
December 31, 2019
.
In March 2020, the FHLB issued a $12.0 million municipal deposit letter of credit in the name of Unity Bank naming the NJ Department of Banking and Insurance as beneficiary, to secure municipal deposits as required under New Jersey law.
At
March 31, 2020
, the Company had $347.2 million of additional credit available at the FHLB. Pledging additional collateral in the form of 1 to 4 family residential mortgages, commercial loans and investment securities can increase the line with the FHLB.
Subordinated Debentures
On July 24, 2006, Unity (NJ) Statutory trust II, a statutory business trust and wholly-owned subsidiary of Unity Bancorp, Inc., issued $10.0 million of floating rate capital trust pass through securities to investors due on July 24, 2036. The subordinated debentures are redeemable in whole or part, prior to maturity but after July 24, 2011. The floating interest rate on the subordinated debentures is three-month LIBOR plus 159 basis points and reprices quarterly. The floating interest rate was 2.785% at
March 31, 2020
and 3.518% at
December 31, 2019
. At March 31, 2020 and December 31, 2019, the subordinated debentures had a swap instrument which modified the borrowing to a 3 year fixed rate at 3.435%.
Interest Rate Sensitivity
The principal objectives of the asset and liability management function are to establish prudent risk management guidelines, evaluate and control the level of interest-rate risk in balance sheet accounts, determine the level of appropriate risk given the business focus, operating environment, capital, and liquidity requirements, and actively manage risk within the Board approved guidelines. The Company seeks to reduce the vulnerability of operations to changes in interest rates, and actions in this regard are taken under the guidance of the Asset/Liability Management Committee (“ALCO”) of the Board of Directors. The ALCO reviews the maturities and re-pricing of loans, investments, deposits and borrowings, cash flow needs, current market conditions, and interest rate levels.
The Company utilizes Modified Duration of Equity and Economic Value of Portfolio Equity (“EVPE”) models to measure the impact of longer-term asset and liability mismatches beyond two years. The modified duration of equity measures the potential price risk of equity to changes in interest rates. A longer modified duration of equity indicates a greater degree of risk to rising interest rates. Because of balance sheet optionality, an EVPE analysis is also used to dynamically model the present value of asset and liability cash flows with rate shocks of 200 basis points. The economic value of equity is likely to be different as interest rates change. Results falling outside prescribed ranges require action by the ALCO. The Company’s variance in the economic value of equity, as a percentage of assets with rate shocks of 200 basis points at
March 31, 2020
, is a decline of 0.20 percent in a rising-rate environment and a decrease of 1.35 percent in a falling-rate environment. The variances in the EVPE at
March 31, 2020
are within the Board-approved guidelines of +/- 3.00 percent. In a falling rate environment with a rate shock of 200 basis points, benchmark interest rates are assumed to have floors of 0.00%. At
December 31, 2019
, the economic value of equity as a percentage of assets with rate shocks of 200 basis points was a decline of 0.21 percent in a rising-rate environment and an decrease of 0.22 percent in a falling-rate environment.
Liquidity
Consolidated
Bank Liquidity
Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A bank’s liquidity reflects its ability to meet loan demand, to accommodate possible outflows in deposits and to take advantage of interest rate opportunities in the marketplace. Our liquidity is monitored by management and the Board of Directors through a Risk Management Committee, which reviews historical funding requirements, our current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments. Our goal is to maintain sufficient asset-based liquidity to cover potential funding requirements in order to minimize our dependence on volatile and potentially unstable funding markets.
The principal sources of funds at the Bank are deposits, scheduled amortization and prepayments of investment and loan principal, sales and maturities of investment securities, additional borrowings and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit inflows and outflows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Consolidated Statement of Cash Flows provides detail on the Company’s sources and uses of cash, as well as an indication of the Company’s ability to maintain an adequate level of liquidity. At
March 31, 2020
, the balance of cash and cash equivalents was
$179.0
million, an increase of
$21.0
million from
December 31, 2019
. A discussion of the cash provided by and used in operating, investing and financing activities follows.
Operating activities provided
$11.5
million and
$11.2
million of net cash for the
three months ended
March 31, 2020
and
2019
, respectively. The primary sources of funds were net income from operations and adjustments to net income, such as the proceeds from the sale of mortgage and SBA loans held for sale, partially offset by originations of mortgage and SBA loans held for sale.
Investing activities used
$3.9
million and
$10.9
million in net cash for the
three months ended
March 31, 2020
and
2019
, respectively. Cash was primarily used to purchase FHLB stock and fund new loans, partially offset by proceeds from redemption of FHLB stock and proceeds from the sales of securities available for sale.
|
•
|
Securities.
The Consolidated Bank’s available for sale investment portfolio amounted to $56.3 million and $64.3 million at
March 31, 2020
and
December 31, 2019
, respectively. This excludes the Parent Company’s securities discussed under the heading “Parent Company Liquidity” below. Projected cash flows from securities over the next twelve months are $14.3 million.
|
|
•
|
Loans.
The SBA loans held for sale portfolio amounted to $10.7 million and $13.5 million at
March 31, 2020
and
December 31, 2019
, respectively. Sales of these loans provide an additional source of liquidity for the Company.
|
|
•
|
Outstanding Commitments.
The Company was committed to advance approximately $288.3 million to its borrowers as of
March 31, 2020
, compared to $272.8 million at
December 31, 2019
. At
March 31, 2020
, $131.1 million of these commitments expire within one year, compared to $119.2 million at
December 31, 2019
. The Company had $4.9 million and $4.8 million in standby letters of credit at
March 31, 2020
and
December 31, 2019
, respectively, which are included in the commitments amount noted above. The estimated fair value of these guarantees is not significant. The Company believes it has the necessary liquidity to honor all commitments. Many of these commitments will expire and never be funded.
|
54
Financing activities provided
$13.4
million and
$3.3
million in net cash for the three months ended March 31, 2020 and 2019, respectively, primarily due to an increase in the Company's deposits and proceeds from new borrowings, partially offset by repayments of borrowings.
|
•
|
Deposits.
As of
March 31, 2020
, deposits included $125.9 million of Government deposits, as compared to $123.3 million at year end
2019
. These deposits are generally short in duration and are very sensitive to price competition. The Company believes that the current level of these types of deposits is appropriate. Included in the portfolio were $99.7 million of deposits from ten municipalities with account balances in excess of $5.0 million. The withdrawal of these deposits, in whole or in part, would not create a liquidity shortfall for the Company.
|
|
•
|
Borrowed Funds.
Total FHLB borrowings amounted to $169.0 million and $283.0 million as of
March 31, 2020
and
December 31, 2019
, respectively. As a member of the Federal Home Loan Bank of New York, the Company can borrow additional funds based on the market value of collateral pledged. At
March 31, 2020
, pledging provided an additional $347.2 million in borrowing potential from the FHLB. In addition, the Company can pledge additional collateral in the form of 1 to 4 family residential mortgages, commercial loans or investment securities to increase this line with the FHLB.
|
Parent Company Liquidity
The Parent Company’s cash needs are funded by dividends paid and rental payments on corporate headquarters by the Bank. Other than its investment in the Bank, Unity Risk Management, Inc. and Unity Statutory Trust II, the Parent Company does not actively engage in other transactions or business. Only expenses specifically for the benefit of the Parent Company are paid using its cash, which typically includes the payment of operating expenses, cash dividends on common stock and payments on trust preferred debt.
At
March 31, 2020
, the Parent Company had $2.1 million in cash and cash equivalents and $764 thousand in investment securities valued at fair market value, compared to $2.3 million and $1.4 million at
December 31, 2019
.
Regulatory Capital
Federal regulators have classified and defined capital into the following components: (1) tier 1 capital, which includes tangible shareholders’ equity for common stock, qualifying preferred stock and certain qualifying hybrid instruments, and (2) tier 2 capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt, preferred stock and hybrid instruments which do not qualify as tier 1 capital.
On September 17, 2019, the federal banking agencies issued a final rule providing simplified capital requirements for certain community banking organizations (banks and holding companies) with less than $10 billion in total consolidated assets, implementing provisions of The Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”). Under the proposal, a qualifying community banking organization would be eligible to elect the community bank leverage ratio framework, or continue to measure capital under the existing Basel III requirements set forth in the New Rules. The new rule takes effect January 1, 2020, and qualifying community banking organizations may elect to opt into the new community bank leverage ratio (“CBLR”) in their call report for the first quarter of 2020.
A qualifying community banking organization (“QCBO”) is defined as a bank, a savings association, a bank holding company or a savings and loan holding company with:
|
•
|
A leverage capital ratio of greater than 9.0%;
|
|
•
|
Total consolidated assets of less than $10.0 billion;
|
|
•
|
Total off-balance sheet exposures (excluding derivatives other than credit derivatives and unconditionally cancelable commitments) of 25% or less of total consolidated assets; and
|
|
•
|
Total trading assets and trading liabilities of 5% or less of total consolidated assets.
|
A QCBO opting into the CBLR must maintain a CBLR of 9.0%, subject to a two quarter grace period to come back into compliance, provided that the QCBO maintains a leverage ratio of more than 8.0% during the grace period. A QCBO failing to satisfy these requirements must comply with the existing Basel III requirements as implemented by the banking regulators.
The numerator of the CBLR is Tier 1 capital, as calculated under present rules. The denominator of the CBLR is the QCBO’s average assets, calculated in accordance with the QCBO’s Call Report instructions and less assets deducted from Tier 1 capital.
The Bank has opted into the CBLR, and will therefore not be required to comply with the Basel III capital requirements. As of March 31, 2020, the Bank’s CBLR was 10.16%, and the Company’s CBLR was 10.56%.
55
For comparison purposes only, we set forth below what the capital ratios for the Bank and the Company were, and would have been, under the Basel III requirements:
|
|
At March 31, 2020
|
Required for capital adequacy purposes effective
|
To be well-capitalized under prompt corrective action regulations
|
||||||||||
|
Company
|
Bank
|
January 1, 2019
|
Bank
|
||||||||||
|
Leverage ratio
|
|
10.56
|
%
|
|
10.16
|
%
|
4.000
|
%
|
5.00
|
%
|
|||
|
CET1
|
11.67
|
%
|
11.91
|
%
|
7.000
|
%
|
(1
|
)
|
6.50
|
%
|
|||
|
Tier I risk-based capital ratio
|
|
12.39
|
%
|
|
11.91
|
%
|
|
8.500
|
%
|
(1
|
)
|
8.00
|
%
|
|
Total risk-based capital ratio
|
|
13.15
|
%
|
|
12.70
|
%
|
|
10.500
|
%
|
(1
|
)
|
10.00
|
%
|
|
|
At December 31, 2019
|
Required for capital
adequacy purposes effective |
To be well-capitalized under prompt corrective action regulations
|
||||||||||
|
Company
|
Bank
|
January 1, 2019
|
Bank
|
||||||||||
|
Leverage ratio
|
|
10.59
|
%
|
|
10.15
|
%
|
4.000
|
%
|
5.00
|
%
|
|||
|
CET1
|
11.59
|
%
|
11.81
|
%
|
7.000
|
%
|
(1
|
)
|
6.50
|
%
|
|||
|
Tier I risk-based capital ratio
|
|
12.32
|
%
|
|
11.81
|
%
|
|
8.500
|
%
|
(1
|
)
|
8.00
|
%
|
|
Total risk-based capital ratio
|
|
13.06
|
%
|
|
12.58
|
%
|
|
10.500
|
%
|
(1
|
)
|
10.00
|
%
|
|
(1) Includes 2.5% capital conservation buffer.
|
|||||||||||||
For additional information on regulatory capital, see Note 13 to the Consolidated Financial Statements.
Shareholders’ Equity
Shareholders’ equity increased $3.6 million to
$164.3
million at
March 31, 2020
compared to
$160.7
million at
December 31, 2019
, primarily due to net income of $5.4 million. Other items impacting shareholders’ equity included $986 thousand in accumulated other comprehensive loss net of tax, $841 thousand in dividends paid on common stock, $227 thousand from the issuance of common stock under employee benefit plans, and $172 thousand in treasury stock purchased at cost. The issuance of common stock under employee benefit plans includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised.
Repurchase Plan
On July 16, 2019, the Company authorized the repurchase of up to 525 thousand shares, or approximately 5 percent of its outstanding common stock. The amount and timing of purchases is dependent upon a number of factors, including the price and availability of the Company’s shares, general market conditions and competing alternate uses of funds. The new plan replaces the Company's prior share repurchase program. 10,540 shares were repurchased at an average price of $16.24 during the
three
months ended
March 31, 2020
, leaving 514 thousand shares available for repurchase. No shares were repurchased for the same period in
2019
. Although the Company has suspended its stock repurchase plan during the COVID-19 epidemic, it expects to resume repurchases, depending on the market conditions, as the Company obtains better clarity on the impact of COVID-19 on the company, its customers and the communities it serves, and the Company's capital needs.
Impact of Inflation and Changing Prices
The financial statements and notes thereto, presented elsewhere herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the operations. Unlike most industrial companies, nearly all the Company’s assets and liabilities are monetary. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
ITEM 3
Quantitative and Qualitative Disclosures about Market Risk
During the
three months ended March 31,
2020
, there have been no significant changes in the Company's assessment of market risk as reported in Item 6 of the Company's Annual Report on Form 10-K for the year ended
December 31, 2019
. (See Interest Rate Sensitivity in Management's Discussion and Analysis herein.)
56
ITEM 4
Controls and Procedures
|
a)
|
The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures as of
March 31, 2020
. Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective for recording, processing, summarizing and reporting the information the Company is required to disclose in the reports it files under the Securities Exchange Act of 1934, within the time periods specified in the SEC's rules and forms.
|
|
b)
|
No significant change in the Company’s internal control over financial reporting has occurred during the quarterly period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s controls over financial reporting.
|
57
PART II
OTHER INFORMATION
ITEM 1
Legal Proceedings
From time to time, the Company is subject to other legal proceedings and claims in the ordinary course of business. The Company currently is not aware of any such legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse effect on the business, financial condition, or the results of the operation of the Company.
ITEM 1A
Risk Factors
Information regarding this item as of
March 31, 2020
appears under the heading, “Risk Factors” within the Company’s Form 10-K for the year ended
December 31, 2019
, as supplemented by the Company's subsequent quarterly reports on Form 10-Q and as set forth below:
Pandemic events could have a material adverse effect on our operations and our financial condition.
The outbreak of disease on a regional, national or global level, such as the spread of the COVID-19 coronavirus, could have a material adverse effect on commerce, which may, in turn impact our lines of business.
Our operations are significantly affected by the general economic conditions of New Jersey and the specific local markets in which we operate. The Central and Northern New Jersey and Eastern Pennsylvania markets served by the Registrant have been significantly impact by the Coronavirus epidemic. Our entire real estate portfolio consists primarily of loans secured by properties located in Bergen, Hunterdon, Middlesex, Somerset, Union and Warren counties in New Jersey, and Northampton County in Pennsylvania. A decline in the economies of these counties in which we operate, which we consider to be our primary market area, could have a material adverse effect on our business, financial condition, results of operations, and prospects.
The coronavirus outbreak may also have an adverse effect on our customers directly or indirectly. These effects could include disruptions or restrictions in our customers’ supply chains or employee productivity, closures of customers' facilities, decreases in demand for customers' products and services or in other economic activities. Their businesses may be adversely affected by quarantines and travel restrictions in countries most affected by COVID-19. In addition, entire industries such as agriculture, may be adversely impacted due to lower exports caused by reduced economic activity in the affected countries. If our customers are adversely affected, or if the virus leads to a widespread health crisis that impacts U.S. economic growth, our condition and results of operations could be adversely affected, despite having no direct operations in China.
Such events could also affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans and/or result in loss of revenue. A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse. Many of the loans in our portfolio are secured by real estate. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively affect the borrower’s ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various other factors, including changes in general or regional economic conditions and governmental rules or policies. If we are required to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely affected. Adverse changes in the regional and general economy could reduce our growth rate, impair our ability to collect loans and generally have a negative effect on our financial condition and results of operations.
The Company and its bank subsidiary are likely to become subject to regulatory enforcement orders requiring improvement in compliance functions and remedial actions.
In recent years, a combination of financial reform legislation and heightened scrutiny by banking regulators have significantly increased expectations regarding what constitutes an effective risk and compliance management infrastructure. In February 2020, Unity Bank received communication from the Federal Deposit Insurance Corporation (the "FDIC") seeking Unity's agreement to stipulate to the entry of a consent order (the “Order”). Under the terms of the proposed Order, Unity is required to, among other things, increase board supervision of Unity’s BSA/AML program, review and improve its written BSA/AML compliance program, review and improve its BSA risk assessment, review and improve its system of internal controls to assure and monitor compliance with the BSA, provide for independent testing of its BSA compliance, provide additional resources and training to staff to ensure BSA compliance, review its compliance with Office of Foreign Assets Control regulations, retain a firm acceptable to the FDIC and the New Jersey Department of Banking and Insurance ("NJDOBI") to undertake a review of all accounts and transaction
58
activity to determine that appropriate reporting was undertaken, establish a board oversight committee consisting of independent directors and provide quarterly reporting to the FDIC and NJDOBI.
Although Unity has not yet entered into the Order, we have begun to take steps toward the improvement of our BSA/AML program, including:
|
•
|
Established an Independent Board Compliance Committee to oversee BSA/AML enhancements,
|
|
•
|
Additional investment into processes and Financial Crime Risk Management system upgrades to strengthen anti-money laundering controls,
|
|
•
|
Continued emphasis on education, training and the importance of compliance for all associates,
|
|
•
|
The search of a highly experienced BSA/AML professional to oversee these efforts has commenced; and
|
|
•
|
Contracted with a specialized third-party vendor to evaluate, propose additional enhancements and to conduct independent tests to validate the Bank's BSA/AML policy and procedures.
|
The Company has evaluated the impact of the pending Order, and anticipates costs of remediation and look-back to be approximately $1.5 million. Compliance with the proposed order, if it is issued, or any other remedial action taken by our regulators, could adversely impact our results of operation due to the costs incurred to comply with the order or other remedial action and remedy any weaknesses cited, the diversion of management attention to complying with the order or other remedial action, rather than growing the Company's business, and the inability of the Company to grow, enter new lines of business or acquire other entities, to the extent regulatory approval is required, while the order or other enforcement action is in effect.
ITEM 2
Unregistered Sales of Equity Securities and Use of Proceeds - None
ITEM 3
Defaults upon Senior Securities - None
ITEM 4
Mine Safety Disclosures - N/A
ITEM 5
Other Information - None
59
ITEM 6
Exhibits
|
(a) Exhibits |
Description
|
|
|
By-laws of Unity Bancorp as amended. Incorporated by reference from Exhibit 3.1 of current report on Form 8-K filed February 24, 2017
|
||
|
Form of Indemnification Agreement entered into on January 23, 2020 by and among the Registrant, Unity Bank and each of their respective Directors (1)
|
||
|
Form of Amendment Agreement with respect to the Amended and Restated Employment Agreement dated as of June 4, 2015 with James A. Hughes (2)
|
||
|
Form of Amendment Agreement with respect to the Retention Agreement with each John Kauchak and Janice Bolomey (2)
|
||
|
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002
|
||
|
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002
|
||
|
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Rule 13a-14(b) or Rule 15d-14(b) and 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|
||
|
(1)
|
Incorporated by reference to Exhibit 10.1 to Current Report of Form 8-K filed January 28, 2020
|
|
|
(2)
|
Incorporated by reference to Exhibits 10.1 and 10.2 to Current Report on Form 8-K filed February 6, 2020
|
|
60
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
UNITY BANCORP, INC.
|
|
|
|
|
|
|
Dated:
|
May 5, 2020
|
/s/ Laureen S. Cook
|
|
|
Laureen S. Cook
|
|
|
|
Senior Vice President and Interim Principal Accounting and Financial Officer
|
|
61
EXHIBIT INDEX
QUARTERLY REPORT ON FORM 10-Q
|
Exhibit No.
|
Description
|
|
Form of Indemnification Agreement entered into on January 23, 2020 by and among the Registrant, Unity Bank and each of their respective Directors (1)
|
|
|
Amendment Agreement with respect to the Amended and Restated Employment Agreement dated as of June 4, 2015 with James A. Hughes (2)
|
|
|
Form of Amendment Agreement with respect to the Retention Agreement with each John Kauchak and Janice Bolomey (2)
|
|
|
Exhibit 31.1-Certification of James A. Hughes. Required by Rule 13a-14(a) or Rule 15d-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002
|
|
|
Exhibit 31.2-Certification of Laureen S. Cook. Required by Rule 13a-14(a) or Rule 15d-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002
|
|
|
Exhibit 32.1-Certification of James A. Hughes and Laureen S. Cook. Required by Rule 13a-14(b) or Rule 15d-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
|
|
|
101.INS
|
XBRL Instance Document
|
|
101.SCH
|
XBRL Taxonomy Extension Schema Document
|
|
101.CAL
|
XBRL Taxonomy Extension Calculation Linkbase Document
|
|
101.LAB
|
XBRL Taxonomy Extension Label Linkbase Document
|
|
101.PRE
|
XBRL Taxonomy Extension Presentation Linkbase Document
|
|
101.DEF
|
XBRL Taxonomy Extension Definitions Linkbase Document
|
|
(1)
|
Incorporated by reference to Exhibit 10.1 to Current Report of Form 8-K filed January 28, 2020
|
|
(2)
|
Incorporated by reference to Exhibits 10.1 and 10.2 to Current Report on Form 8-K filed February 6, 2020
|
62
TABLE OF CONTENTS
Part IItem 1 Consolidated Financial Statements (unaudited)Note 1. Significant Accounting PoliciesNote 2. LitigationNote 3. Net Income Per ShareNote 4. Income TaxesNote 5. Other Comprehensive Income (loss)Note 6. Fair ValueNote 7. SecuritiesNote 8. LoansNote 9. Allowance For Loan Losses and Reserve For Unfunded Loan CommitmentsNote 10. New Accounting PronouncementsNote 11. Derivative Financial Instruments and Hedging ActivitiesNote 12. Employee Benefit PlansNote 13. Regulatory CapitalNote 14. LeasesItem 2 Management's Discussion and Analysis Of Financial Condition and Results Of OperationsItem 3 Quantitative and Qualitative Disclosures About Market RiskItem 4 Controls and ProceduresPart II Other InformationPart IIItem 1 Legal ProceedingsItem 1A Risk FactorsItem 2 Unregistered Sales Of Equity Securities and Use Of Proceeds - NoneItem 3 Defaults Upon Senior Securities - NoneItem 4 Mine Safety Disclosures - N/aItem 5 Other Information - NoneItem 6 Exhibits