Bancorp, Inc. - Annual Report: 2019 (Form 10-K)



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

________________

FORM 10-K

_______________

(Mark One)



For the fiscal year ended December 31, 2019

OR

 



For the transition period from              to              

Commission File Number 51018

The Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (302) 385-5000





Securities registered pursuant to Section 12(b) of the Act:







Securities registered pursuant to Section 12(g) of the Act:





Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☐    No  ☒ 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(a) of the Act.    Yes  ☐    No  ☒ 

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 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  ☒    No  ☐ 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.    



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 Act).    Yes  ☐    No  ☒ 

The aggregate market value of the common shares of the registrant held by non-affiliates of the registrant, based upon the closing price of such shares on June 30, 2019 of $8.92 was approximately $455.7 million.

As of March 1, 2020, 57,400,556 shares of common stock, par value $1.00 per share, of the registrant were outstanding.



DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for registrant’s 2020 Annual Meeting of Shareholders are incorporated by reference in Part III of this Form 10-K.  

 

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FORWARD-LOOKING STATEMENTS



The Securities and Exchange Commission, or SEC, encourages companies to disclose forward-looking information so that investors can better understand a company’s future prospects and make informed investment decisions.  This report contains such “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act.



Words such as “anticipates,” “estimates,” “expects,” “projects,” “intends,” “plans,” “believes,” “should” and words and terms of similar substance used in connection with any discussion of future operating and financial performance identify forward-looking statements.  Unless we have indicated otherwise, or the context otherwise requires, references in this report to “we,” “us,” and “our” or similar terms, are to The Bancorp, Inc. and its subsidiaries.



We claim the protection of safe harbor for forward-looking statements provided in the Private Securities Litigation Reform Act of 1995.  These statements may be made directly in this report and they may also be incorporated by reference in this report to other documents filed with the SEC, and include, but are not limited to, statements about future financial and operating results and performance, statements about our plans, objectives, expectations and intentions with respect to future operations, products and services, and other statements that are not historical facts.  These forward-looking statements are based upon the current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are difficult to predict and generally beyond our control.  In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.  Actual results may differ materially from the anticipated results discussed in these forward-looking statements.



The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements: 



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We caution you not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.  All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.  Except to the extent required by applicable law or regulation, we undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

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PART I

Item 1. Business.  

Overview

We are a Delaware financial holding company and our primary subsidiary is The Bancorp Bank, which we wholly own and which we refer to as the Bank.  The vast majority of our revenue and income is generated through the Bank.  In our continuing operations, we have four primary lines of specialty lending: securities-backed lines of credit (SBLOC) and insurance policy cash value-backed lines of credit (IBLOC), leasing (direct lease financing), small business loans (SBL) and loans generated for sale into capital markets through commercial loan securitizations and other sales (CMBS).  SBL are comprised primarily of Small Business Administration (SBA) loans. SBLOCs and IBLOCs are loans which are generated through institutional banking affinity groups and are respectively collateralized by marketable securities and the cash value of insurance policies. SBLOCs are typically offered in conjunction with brokerage accounts and are offered nationally.  Vehicle fleet and other equipment leases are generated in a number of Atlantic Coast and other states.  SBL loans and commercial loans generated for sale are made nationally.  At December 31, 2019, SBLOC and IBLOC, leasing (direct lease financing), SBL and loans for sale in secondary markets respectively totaled $1.02 billion, $434.5 million, $572.6 million (including SBL loans held-for-sale) and $960.2 million (excluding SBL loans held-for-sale), respectively, and comprised approximately 34%, 14%, 19% and 32% of our loan portfolio and commercial loans held-for-sale.  Our investment portfolio amounted to $1.41 billion at December 31, 2019, representing a slight increase from the prior year. 

The majority of our deposits and non-interest income are generated in our payments business line which consists of consumer deposit accounts accessed by prepaid or debit cards, or issuing, automated clearing house, or ACH accounts and the collection of payments through credit card companies on behalf of merchants.  The issuing deposit accounts are comprised of debit and prepaid card accounts that are generated with the assistance of independent companies that market directly to end users.  Our issuing deposit account types are diverse and include: consumer and business debit, general purpose reloadable prepaid, pre-tax medical spending benefit, payroll, gift, government, corporate incentive, reward, business payment accounts and others.  Our ACH accounts facilitate  bill payments and our acquiring accounts provide clearing and settlement services for payments made to merchants which must be settled through associations such as Visa or MasterCard.  We also provide banking services to organizations with a pre-existing customer base tailored to support or complement the services provided by these organizations to their customers.  These services include loan and deposit accounts for investment advisory companies through our institutional banking department.  We typically provide these services under the name and through the facilities of each organization with whom we develop a relationship.  We refer to this, generally, as affinity banking.

Our main office is located at 409 Silverside Road, Wilmington, Delaware 19809 and our telephone number is (302) 385-5000.  Our web address is www.thebancorp.com.  We make available free of charge on our website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports and our proxy statements as soon as reasonably practicable after we file them with the SEC.  Investors are encouraged to access these reports and other information about our business on our website, www.thebancorp.com.  Information found on our website is not part of this Annual Report on Form 10-K.  We also will provide copies of our Annual Report on Form 10-K, free of charge, upon written request to our Investor Relations Department at our address for our principal executive offices, 409 Silverside Road, Wilmington, Delaware 19809.  Also posted on our website, and available in print upon request by any stockholder to our Investor Relations Department, are the charters of the standing committees of our Board of Directors and standards of conduct governing our directors, officers and employees.

Our Strategies 

Our principal strategies are to:



Fund our Loan and Investment Portfolio Growth with Stable Deposits and Generate Non-interest Income from Prepaid and Debit Card Accounts and Other Payment Processing. Our principal focus is to grow our specialty lending operations and investment portfolio, and fund these loans and investments through a variety of sources that provide stable deposits, which are lower cost compared to certain other types of funding.  Funding sources include prepaid and debit card accounts, institutional banking transaction accounts and card payment processing.  We derive the largest component of our deposits and non-interest income from our prepaid and debit card operations.       

 

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Develop Relationships with Affinity Groups to Gain Sponsored Access to their Membership, Client or Customer Bases to Market our Services.  We seek to develop relationships with organizations with established membership, client or customer bases. Through these affinity group relationships, we gain access to an organization’s members, clients and customers under the organization’s sponsorship.  We believe that by marketing targeted products and services to these constituencies through their pre-existing relationships with the organizations, we will continue to generate stable and lower cost deposits compared to certain other funding sources, generate fee income and, with respect to private label banking, lower our customer acquisition costs and build close customer relationships.



Use Our Existing Infrastructure as a Platform for Growth.  We have made significant investments in our banking infrastructure to support our growth.  We believe that this infrastructure can accommodate significant additional growth without proportionate increases in expense.  We believe that this infrastructure enables us to maximize efficiencies through economies of scale as we grow without adversely affecting our relationships with our customers.



Deposit Products and Services  



We offer a range of products and services to our affinity group clients and their customer bases through direct or private label banking strategies, including:

 



We also offer payment services such as ACH bill payment and other payment services.



Lending Activities



In the third quarter of 2014, we discontinued our Philadelphia-based commercial lending operations following our determination that those operations were inconsistent with our strategic focus on what we believe are lower risk and more granular and national lines of business.  We currently focus our lending activities upon four specialty lending segments:  SBLOC and IBLOC loans, vehicle fleet and other equipment leasing (direct lease financing), SBA loans and loans originated for sale into CMBS securitization capital markets.



SBLOC and IBLOC.  We make loans to individuals, trusts and entities which are secured by a pledge of marketable securities maintained in one or more accounts with respect to which we obtain a securities account control agreement.  The securities pledged may be either debt or equity securities or a combination thereof, but all such securities must be listed for trading on a national securities exchange or automated inter-dealer quotation system.  SBLOCs are typically payable on demand.  Most of our SBLOCs are drawn to meet a specific need of the borrower (such as for bridge financing of real estate) and are typically drawn for 12 to 18 months at a time.  Maximum SBLOC line amounts are calculated by applying a standard ‘advance rate’ calculation against the eligible security type depending on asset class:  typically up to 50% for equity securities and mutual fund securities and 80% for investment grade (Standard & Poor’s rating of BBB- or higher, or Moody’s rating of Baa3 or higher) municipal or corporate debt securities.  Borrowers generally must have a credit score of 660 or higher, although we may allow exceptions based upon a review of the borrower’s income, assets and other credit information.  Substantially all SBLOCs have full recourse to the borrower.  The underlying securities that act as collateral for our SBLOC commitments are monitored on a daily basis to confirm the composition of the client portfolio and its daily market value.  Although these accounts are closely monitored, severely falling markets or sudden drops in price with respect to individual pledged securities could result in the loan being under-collateralized and consequently in default and, upon sale of the collateral, could result in losses to the Bank.  We also make similar loans which are collateralized by the cash surrender value of insurance policies, or IBLOCs. Should a loan default, the primary risks for IBLOCs are if the insurance company issuing the policy were to become insolvent, or if that company would fail to recognize the Bank’s assignment of policy proceeds. To mitigate these risks, insurance company ratings are periodically evaluated for compliance with Bank standards.  Additionally, the Bank utilizes assignments of cash surrender value which legal counsel has concluded are enforceable.



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Leases.  We provide lease financing for commercial and government vehicle fleets and, to a lesser extent, provide lease financing for other equipment.  Our leases are either open-end or closed-end. An open-end lease is one in which, at the end of the lease term, the lessee must pay us the difference between the amount at which we sell the leased asset and the stated termination value. Termination value is a contractual value agreed to by the parties at the inception of a lease as to the value of the leased asset at the end of the lease term.  A closed-end lease is one for which no such payment is due on lease termination.  In a closed-end lease, the risk that the amount received on a sale of the leased asset will be less than the residual value is assumed by us, as lessor.  While we do not have specific underwriting criteria for our lease financing, we analyze information we obtain about the lessee, including financial statements and credit reports, to determine the lessee’s ability to perform its obligations.



SBL Loans.  SBL or small business loans consist primarily of SBA loans. We participate in two loan programs established by the SBA: the 7(a) Loan Guarantee Program and the 504 Fixed Asset Financing Program.  The 7(a) Loan Guarantee Program is designed to help small business borrowers start or expand their businesses by providing partial guarantees of loans made by banks and non-bank lending institutions for specific business purposes, including long or short term working capital; funds for the purchase of equipment, machinery, supplies and materials; funds for the purchase, construction or renovation of real estate; and funds to acquire, operate or expand an existing business or refinance existing debt, all under conditions established by the SBA.  The terms of the loans must come within parameters set by the SBA, including borrower eligibility, loan maturity, and maximum loan amount. 7(a) loans must be secured by all available business assets and personal real estate until the recovery value equals the loan amount or until all personal real estate of the borrower have been pledged.  Personal guarantees are required from all owners of 20% or more of the equity of the business, although lenders may also require personal guarantees of owners of less than 20%.  Loan guarantees can range up to 85% of loan principal for loans of up to $150,000 and 75% for loans in excess of that amount.



The SBA loan guaranty is typically paid to the lender after the liquidation of all collateral, but may be paid prior to liquidation of certain assets, mitigating the losses due to collateral deficiencies up to the percentage of the guarantee.  To maintain the guarantee, we must comply with applicable SBA regulations, and we risk loss of the guarantee should we fail to comply.  7(a) loan amounts are not limited to a percentage of estimated collateral value and are instead based on the business’s ability to repay the loan from its cash flow.  If the business generates inadequate cash flow to repay principal and interest and borrowers are otherwise unable to repay the loan, losses may result if related collateral is sold for less than the unguaranteed balance of the loan.  Because these loans are generally at variable rates, higher rate environments will increase required payments from borrowers, with increased payment default risk.  As a result of a wide variety of collateral with very specific uses, markets for resale of the collateral may be limited, which could adversely affect amounts realized upon sale.  The 7(a) program is funded through annual appropriations approved by Congress matching funding requirements for loans approved within the budget year.  Should those appropriations be reduced or cease, our ability to make 7(a) loans will be curtailed or terminated.



The 504 Fixed Asset Financing Program is designed to provide small businesses with financing for the purchase of fixed assets, including real estate and buildings; the purchase of improvements to real estate; the construction of new facilities or modernizing, renovating or converting existing facilities; the purchase of long-term machinery and equipment; and debt refinancing.  A 504 loan may not be used for working capital, trading asset purchases or investment in rental real estate.  In a 504 financing, the borrower must supply 10% of the financing amount, we provide 50% of the financing amount and a Certified Development Company, or CDC, provides 40% of the financing amount.  If the borrower has less than two years of operating history or if the assets being financed are considered “special purpose,” the funding percentages are 15%, 50% and 35%, respectively. If both conditions are met, the funding percentages are 20%, 50% and 30%, respectively.  We receive a first lien on the assets being financed and the CDC receives a second lien.  Personal guarantees of the principal owners of the business are required.  The funds for the CDC loans are raised through a monthly auction of bonds that are guaranteed by the U.S. government and, accordingly, if the government guarantees are curtailed or terminated, our ability to make 504 loans would be curtailed or terminated.  Certain basic loan terms, as with the 7(a) program, are established by the SBA, including borrower eligibility, maximum loan amount, maximum maturity date, interest rates and loan fees.  While real estate is appraised and values are established for other collateral, and the loan amount is limited to a percentage of cost of the assets being acquired by the borrower, such amounts may not be realized upon resale if the borrower defaults and the Bank forecloses on the collateral.



SBA 7(a) and 504 loans may include construction advances which are subject to risk inherent to construction projects, including environmental risks, engineering defects, contractor risk, and risk of project completion.  Delays in construction may also compromise the owner’s business plan and result in additional stresses on cash flow required to service the loan.  Higher than expected construction costs may also result, impacting repayment capability and collateral values. 



Additionally, the Bank makes SBA loans to franchisees of various business concepts, including loans to multiple franchisees with the same concept.  In making loans to franchisees, we consider franchisee failure rates for the specific franchise concept. 

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However, factors adversely affecting a specific type of franchisor or franchise concept, including in particular risks that a franchise concept loses popularity with consumers or encounters negative publicity about its products or services, could harm the value not only of a particular franchisee’s business but also of multiple loans to other franchisees with the same concept.



CMBS.  We originate loans for sale or securitization into secondary markets. These loans are collateralized by various types of commercial real estate, including but not limited to, multi-family, retail, office, apartments and hotels, and are not recourse to the borrower (except for carve-outs such as fraud) and, accordingly, depend on cash reserves and cash generated by the underlying properties for repayment.  The vast majority of these loans are variable rate and, as a result, higher market rates will result in higher payments and greater cash flow requirements, although all loans require an interest rate cap to mitigate that risk. Should cash flow and available cash reserves prove inadequate to cover debt service on these loans, repayment will primarily depend upon the sales price of the property.  Low occupancy or rental rates may negatively impact loan repayment.  Because these loans are being originated for sale, the underwriting and other criteria used are those which buyers in the capital markets indicate are most crucial when determining whether to buy the loans.  Such criteria include the loan-to-value ratio and debt yield (net operating income divided by first mortgage debt).  However, for the period during which we hold a loan prior to sale, property values may fall below appraised values and below the outstanding balance of the loan, which would reduce the price at which we could sell the loan.  While we historically have been able to sell loans into these markets, adverse market conditions may delay, or possibly preclude, expected sales into the secondary market or cause losses upon any resale.  To mitigate these risks, we establish guidelines for the maximum amounts of such loans we will hold on our balance sheet.



Affinity Group Banking Products and Services



Card Issuing Services.  We issue debit and prepaid cards to access diverse types of deposit accounts including: consumer and business debit, general purpose reloadable prepaid, pre-tax medical spending benefit, payroll, gift, government, corporate incentive, reward, business payment accounts and others. Our cards are offered to end users through our relationships with benefits administrators, third-party administrators, insurers, corporate incentive companies, rebate fulfillment organizations, payroll administrators, large retail chains, consumer service organizations and FinTech disruptors.  Our cards are network-branded through our agreements with Visa, MasterCard, and Discover.  The majority of fees we earn result from contractual fees paid by third-party sponsors, computed on a per transaction basis, and monthly service fees.  Additionally, we earn interchange fees paid through settlement associations such as Visa, which are also determined on a per transaction basis.  These accounts have demonstrated a history of stability and lower cost compared to certain other types of funding.  Our accounts are offered throughout the United States. For information relating to current constraints on our prepaid card programs resulting from consent orders we have entered into with federal banking authorities, see “Risk Factors-Risks Relating to Our Business-The entry into the Consent Orders and the supervisory letter from the Federal Reserve, have imposed certain restrictions and requirements on us and the Bank.”



Card Payment and ACH Processing.  We act as the depository institution for the processing of credit and debit card payments made to various businesses.  We also act as the bank sponsor and depository institution for independent service organizations that process such payments and for other companies, such as bill payment companies for which we process their ACH payments.  We have designed products that enable those organizations to more easily process electronic payments and to better manage their risk of loss. These accounts are a source of demand deposits and fee income.

Institutional Banking.  We have developed strategic relationships with limited-purpose trust companies, registered investment advisers, broker-dealers and other firms offering institutional banking services.  We provide customized, private label demand, money market and securities backed loan products to the client base of these groups.

Private Label Banking.  Through our private label banking strategy, we provide our affinity group partners with banking services that have been customized to the needs of their respective customers.  This allows these affinity groups to provide their members the affinity-branded banking services they desire.   Affinity group websites identify the Bank as the provider of these banking services.  We and the affinity group also may create products and services, or modify products and services already on our menu, that specifically relate to the needs and interests of the affinity group itself, or the affinity group’s members or customers.  Our private label banking services have been developed to include both deposit and lending-related products and services.

We pay fees to certain affinity groups based upon deposits and loans they generate. These fees vary, and certain fees increase as market interest rates increase, while other fee rates may be fixed.  These fees comprise substantially all of the interest expense on deposits in our consolidated statement of operations.

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Other Operations



Account Services.  Depending upon the type of account, account holders may access our products through the website of their affinity group, or through our website.  This access allows account holders to apply for loans, review account activity, enter transactions into an online account register, pay bills electronically, receive statements electronically and print statements.



Call Centers.  We have call center operations that serve as inbound customer support.  The call center provides account holders or potential account holders with assistance accessing the Bank’s products and services, and in resolving any problems that may arise in the servicing of accounts or other banking products.  A third-party servicer provides virtually all customer support, including institutional banking, for after hours and overflow support.  Located in Manila, Philippines, TELUS International currently operates 24 hours a day, seven days a week.  

Third-Party Service Providers.  To reduce operating costs and capitalize on the technical capabilities of selected vendors, we outsource certain bank operations and systems to third-party service providers, principally the following:

Because we outsource these operational functions to experienced third-party service providers that have the capacity to process a high volume of transactions, we believe we can more readily and cost-effectively respond to growth than if we sought to develop these capabilities internally.  Should any of our current relationships terminate, we believe we could maintain business continuity by securing the required services from an alternative source without material interruption of our operations.

Sales and Marketing

Affinity Group Banking.  Because of the national scope of our affinity group banking operation, we use a personal sales/targeted media advertising approach to market to existing and potential commercial affinity group organizations.  The affinity group organizations with which we have relationships perform marketing functions to the ultimate individual customers.  Our marketing program to affinity group organizations consists of:

Loan Administration Offices.  We maintain offices to market and administer our leasing programs in Crofton, Maryland, Kent, Washington, Charlotte, North Carolina, Raritan, New Jersey, Logan, Utah, Norristown, Pennsylvania and Orlando, Florida.  We maintain SBA loan offices in Chicago, Illinois and suburban Raleigh, North Carolina. We maintain an office in New York, New York for CMBS.

Technology



Primary System Architecture.  We provide financial products and services through a secure, tiered architecture using commercially available software and with third party providers whom we believe to be industry leaders.  We maintain a platform of

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several web technologies, databases, firewalls, and licensed and proprietary financial services software to support our unique client base.  User activity is distributed across our service offering, with internally developed software as well as third-party platforms and processors.  We also use third-party data processors.  The goal of our systems designs is to service our client requirements efficiently, which has been accomplished using data and service replication between internal data centers and cloud platforms for our critical applications.  The system’s flexible architecture is designed to meet current capacity needs and allow expansion for future demands.  In addition to built-in redundancies, we monitor our systems using automated internal tools, and use independent third parties to validate our controls.



 Security.  The Bancorp has an established Cyber Security Program that is mapped to the NIST Cyber Security Framework. The program is also fully compliant with the FFIEC Cyber Security framework and relevant ISO standards.  The Bancorp obtains annual PCI certification. Highlights of the program include:





Intellectual Property and Other Proprietary Rights

A significant portion of the core and internet banking systems and operations we use comes from third-party providers.  Where applicable, we rely principally upon trade secret and trademark law to protect our intellectual property.  We do not typically enter into intellectual property-related confidentiality agreements with our affinity group customers because we maintain control over the software used to create the sites and their banking functions rather than licensing them for customers to use.  Moreover, we believe that factors such as the relationships we develop with our affinity group and banking customers, the quality of our banking products, the level and reliability of the service we provide, and the customization of our products and services to meet the needs of our affinity groups are substantially more significant to our ability to succeed.

Competition

We compete with numerous banks and other financial institutions such as finance companies, leasing companies, credit unions, insurance companies, money market funds, investment firms and private lenders, as well as online lenders and other non-traditional competitors.  Our primary competitors in each of our business lines differ significantly from those in our other business lines principally because few financial institutions compete against us in all business segments in which we operate.  For prepaid and debit accounts, our largest source of funding and fee income, competitors include Meta Financial and for SBLOC, our largest lending portfolio, competitors include TriState Capital and Goldman Sachs.  For SBA loans our competitors include Live Oak Bank and for leasing our competitors include Enterprise.  Significant costs of entry include BSA and other regulatory costs which may impact competition for prepaid and debit card accounts.  We believe that our ability to compete successfully depends on a number of factors, including:

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If we experience difficulty in any of these areas, our competitive position could be materially adversely affected, which would affect our growth, our profitability and, possibly, our ability to continue operations.  With respect to our affinity group operations, we believe we can compete effectively as a result of our ability to customize our product offerings to the affinity group’s needs.  We believe that the costs of entry to offering prepaid and debit card accounts, especially compliance costs, are relatively high and somewhat prohibitive to new competitors.  We have competed successfully with institutions much larger than ourselves; however, many of our competitors have larger customer bases, greater name recognition, greater financial and other resources and longer operating histories which may impact our ability to compete.  Our future success will depend on our ability to compete effectively in a highly competitive market.



Regulation Under Banking Law  



Overview

We are regulated extensively under both federal and state banking law and related regulations.  We are a Delaware corporation and a financial holding company registered with the Board of Governors of the Federal Reserve System, or the Federal Reserve.  We are subject to supervision and regulation by the Federal Reserve and the Delaware Office of the State Bank Commissioner, or the Commissioner.  The Bank, as a state-chartered, nonmember depository institution, is supervised by the Commissioner, as well as the Federal Deposit Insurance Corporation, or FDIC. 

The Bank is subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amount of loans that may be made and the interest that may be charged, and limitations on the types of investments that may be made and the types of services that may be offered.  Various consumer laws and regulations also affect the Bank’s operations.  Any change in the regulatory requirements and policies by the Federal Reserve, the FDIC, the Commissioner, the United States Congress, or the states in which our customers reside could have a material adverse impact on us, the Bank and our operations.  We have entered into consent orders with the FDIC and have received a supervisory letter from the Federal Reserve which have imposed certain restrictions upon us and the Bank. See “Risk Factors-Risks Relating to Our Business-The entry into the Consent Orders, as amended, and a supervisory letter from the Federal Reserve have imposed certain restrictions and requirements on us and the Bank.”

Certain regulatory requirements applicable to us and the Bank are referred to below or elsewhere in this report.  The description of statutes and regulations is not intended to be a complete explanation of such statutes and regulations or their effects on the Bank or us and is qualified in its entirety by reference to the actual statutes and regulations.

Federal Regulation

As a financial holding company, we are subject to regular examination by the Federal Reserve and must file annual reports and provide any additional information that the Federal Reserve may request.  Under the Bank Holding Company Act of 1956, as amended, which we refer to as the BHCA, a financial holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank, or merge or consolidate with another financial holding company, without the prior approval of the Federal Reserve.

Permitted Activities.  The BHCA generally limits the activities of a financial holding company and its subsidiaries to that of banking, managing or controlling banks, or any other activity that is determined to be so closely related to banking or to managing or controlling banks that an exception is allowed for those activities.  These activities include, among other things, and subject to limitations, operating a mortgage company, finance company, credit card company or factoring company; performing data processing operations; the issuance and sale of consumer-type payment instruments; providing investment and financial advice; acting as an insurance agent for particular types of credit related insurance and providing specified securities brokerage services for customers.

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Change in Control.    The BHCA prohibits a company from acquiring control of a financial holding company without prior Federal Reserve approval.  Similarly, the Change in Bank Control Act, which we refer to as the CBCA, prohibits a person or group of persons from acquiring “control” of a financial holding company unless the Federal Reserve has been notified and has not objected to the transaction.  In general, under a rebuttable presumption established by the Federal Reserve, the acquisition of 10% or more of any class of voting securities of a financial holding company is presumed to be an acquisition of control of the holding company if: 

An acquisition of 25% or more of the outstanding shares of any class of voting securities of a financial holding company is conclusively deemed to be the acquisition of control.  In determining percentage ownership for a person, Federal Reserve policy is to count securities obtainable by that person through the exercise of options or warrants, even if the options or warrants have not then vested.

The Federal Reserve has revised its minority investment policy statement, under which, subject to the filing of certain commitments with the Federal Reserve, an investor can acquire up to one-third of our equity without being deemed to have engaged in a change in control, provided that no more than 15% of the investor’s equity is voting stock.  This revised policy statement also permits non-controlling passive investors to engage in interactions with our management without being considered as controlling our operations.

Regulatory Restrictions on Dividends.  It is the policy of the Federal Reserve that financial holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition.  The policy provides that financial holding companies should not maintain a level of cash dividends that undermines the financial holding company’s ability to serve as a source of strength to its banking subsidiaries.  See “Holding Company Liability,” below.  Federal Reserve policies also affect the ability of a financial holding company to pay in-kind dividends.

Various federal and state statutory provisions limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval.  The Bank is also subject to limitations under state law regarding the payment of dividends, including the requirement that dividends may be paid only out of net profits.  See “Delaware Regulation” below.  In addition to these explicit limitations, federal and state regulatory agencies are authorized to prohibit a banking subsidiary or financial holding company from engaging in unsafe or unsound banking practices.  Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.  In August 2015, we consented to the issuance of a consent order amendment pursuant to which the payment of dividends by the Bank to us would require prior FDIC approval, and received a Federal Reserve supervisory letter pursuant to which any payment of dividends by us would require prior approval from the Federal Reserve.  The requirement for Federal Reserve approval was lifted in fourth quarter 2019 at which time the supervisory letter was terminated.  See “Risk Factors-Risks Relating to Our Business-The entry into the Consent Orders has imposed certain restrictions and requirements on us and the Bank.”

Because we are a legal entity separate and distinct from the Bank, our right to participate in the distribution of assets of the Bank, or any other subsidiary, upon the Bank’s or the subsidiary’s liquidation or reorganization will be subject to the prior claims of the Bank’s or subsidiary’s creditors.  In the event of liquidation or other resolution of an insured depository institution, the claims of depositors and other general or subordinated creditors have priority of payment over the claims of holders of any obligation of the institution’s holding company or any of the holding company’s shareholders or creditors.

Holding Company Liability.  Under Federal Reserve policy, a financial holding company is expected to act as a source of financial strength to each of its banking subsidiaries and commit resources to their support.  The Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, codified this policy as a statutory requirement.  Under this requirement, we are expected to commit resources to support the Bank, including at times when we may not be in a financial position to provide such resources.  As discussed below under “Prompt Corrective Action,” a financial holding company in certain circumstances could be required to guarantee the capital plan of an undercapitalized banking subsidiary.

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In the event of a financial holding company’s bankruptcy under Chapter 11 of the U.S. Bankruptcy Code, the trustee will be deemed to have assumed, and is required to cure immediately, any deficit under any commitment by the debtor holding company to any of the federal banking agencies to maintain the capital of an insured depository institution, and any claim for breach of such obligation will generally have priority over most other unsecured claims.

Capital Adequacy. The Federal Reserve and the FDIC have issued standards for measuring capital adequacy for financial holding companies and banks.  These standards are designed to provide risk-based capital guidelines and to incorporate a consistent framework.  The risk-based guidelines are used by the agencies in their examination and supervisory process, as well as in the analysis of any applications.  As discussed below under “Prompt Corrective Action,” a failure to meet minimum capital requirements could subject us or the Bank to a variety of enforcement remedies available to federal regulatory authorities, including, in the most severe cases, termination of deposit insurance by the FDIC and placing the Bank into conservatorship or receivership.

In general, these risk-related standards require banks and financial holding companies to maintain capital based on “risk-adjusted” assets so that the categories of assets with potentially higher credit risk will require more capital backing than categories with lower credit risk.  In addition, banks and financial holding companies are required to maintain capital to support off-balance sheet activities such as loan commitments. 

As a result of the Dodd-Frank Act, our financial holding company status depends upon our maintaining our status as “well capitalized” and “well managed” under applicable Federal Reserve regulations.  If a financial holding company ceases to meet these requirements, the Federal Reserve may impose corrective capital and/or managerial requirements on the financial holding company and place limitations on its ability to conduct the broader financial activities permissible for financial holding companies.  In addition, the Federal Reserve may require divestiture of the holding company’s depository institution if the deficiencies persist. 

The standards classify total capital for this risk-based measure into two tiers, referred to as Tier 1 and Tier 2.  Tier 1 capital consists of common shareholders’ equity, certain non-cumulative perpetual preferred stock, and minority interests in equity accounts of consolidated subsidiaries, less certain adjustments.  Tier 2 capital consists of the allowance for loan and lease losses (within certain limits), perpetual preferred stock not included in Tier 1, hybrid capital instruments, term subordinate debt, and intermediate-term preferred stock, less certain adjustments.  Together, these two categories of capital comprise a bank’s or financial holding company’s “qualifying total capital.” However, capital that qualifies as Tier 2 capital is limited in amount to 100% of Tier 1 capital in testing compliance with the total risk-based capital minimum standards.  Banks and financial holding companies must have a minimum ratio of 8% of qualifying total capital to total risk-weighted assets, and a minimum ratio of 4% of qualifying Tier 1 capital to total risk-weighted assets.  At December 31, 2019, we and the Bank had total capital to risk-adjusted assets ratios of 19.45% and 19.11%, respectively, and Tier 1 capital to risk-adjusted assets ratios of 19.04% and 18.71%, respectively.

In addition, the Federal Reserve and the FDIC have established minimum leverage ratio guidelines.  The principal objective of these guidelines is to constrain the maximum degree to which a financial institution can leverage its equity capital base.  It is intended to be used as a supplement to the risk-based capital guidelines.  These guidelines provide for a minimum ratio of Tier 1 capital to adjusted average total assets of 3% for financial holding companies that meet certain specified criteria, including those having the highest regulatory rating.  Other financial institutions generally must maintain a leverage ratio of at least 3% plus 100 to 200 basis points.  The guidelines also provide that financial institutions experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above minimum supervisory levels, without significant reliance on intangible assets.  Furthermore, the banking agencies have indicated that they may consider other indicia of capital strength in evaluating proposals for expansion or new activities.  At December 31, 2019, we and the Bank had leverage ratios of 9.63% and 9.46%, respectively. 

The federal banking agencies’ standards provide that concentration of credit risk and certain risks arising from non-traditional activities, as well as an institution’s ability to manage these risks, are important factors to be taken into account by them in assessing a financial institution’s overall capital adequacy.  The risk-based capital standards also provide for the consideration of interest rate risk in the agency’s determination of a financial institution’s capital adequacy.  The standards require financial institutions to effectively measure and monitor their interest rate risk and to maintain capital adequate for that risk.  These standards can be expected to be amended from time to time.

The Dodd-Frank Act includes certain related provisions which are often referred to as the “Collins Amendment.”  These provisions are intended to subject bank holding companies to the same capital requirements as their bank subsidiaries and to eliminate

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or significantly reduce the use of hybrid capital instruments, especially trust preferred securities, as regulatory capital.  Under the Collins Amendment, trust preferred securities issued by a company, such as our company, with total consolidated assets of less than $15 billion before May 19, 2010 and treated as regulatory capital are grandfathered, but any such securities issued later are not eligible as regulatory capital.  The federal banking regulators issued final rules setting minimum risk-based and leverage capital requirements for holding companies and banks on a consolidated basis that are no less stringent than the generally applicable requirements in effect for depository institutions under the prompt corrective action regulations discussed below and other components of the Collins Amendment.  



Basel III Capital Rules.  In July 2013, our primary federal regulator, the Federal Reserve, and the Bank’s primary federal regulator, the FDIC, approved final rules, which we refer to as the New Capital Rules, establishing a new comprehensive capital framework for U.S. banking organizations.  The New Capital Rules generally implement the Basel Committee on Banking Supervision’s December 2010 final capital framework referred to as “Basel III” for strengthening international capital standards.  The New Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including us and the Bank, as compared to the current U.S. general risk-based capital rules.  The New Capital Rules revise the definitions and the components of regulatory capital, as well as address other issues affecting the numerator in banking institutions’ regulatory capital ratios.  The New Capital Rules also address asset risk-weights and other matters affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing general risk-weighting approach, which was derived from the Basel Committee’s 1988 “Basel I” capital accords, with a more risk-sensitive approach based, in part, on the “standardized approach” in the Basel Committee’s 2004 “Basel II” capital accords.  In addition, the New Capital Rules implement certain provisions of the Dodd-Frank Act, including the requirements of Section 939A to remove references to credit ratings from the federal agencies’ rules.  The New Capital Rules became effective for us and the Bank on January 1, 2015, subject to phase-in periods for certain of their components and other provisions.

Among other matters, the New Capital Rules: (i) introduce a new capital measure called “Common Equity Tier 1,” or CET1 and related regulatory capital ratio of CET1 to risk-weighted assets; (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements; (iii) mandate that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions from and adjustments to capital as compared to existing regulations.  Under the New Capital Rules, for most banking organizations, the most common form of Additional Tier 1 capital is non-cumulative perpetual preferred stock and the most common form of Tier 2 capital is subordinated notes and a portion of the allocation for loan and lease losses, in each case, subject to the New Capital Rules’ specific requirements.



Minimum capital ratios in effect at December 31, 2019 were as follows:





The New Capital Rules also introduce a new “capital conservation buffer”, composed entirely of CET1, on top of these minimum risk-weighted asset ratios.  The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.  Thus, when fully phased-in on January 1, 2019, we and the Bank were required to maintain such additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios of (i) CET1 to risk-weighted assets of at least 7%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5%, and (iii) Total capital to risk-weighted assets of at least 10.5%.



The New Capital Rules provide for a number of deductions from and adjustments to CET1.  These include, for example, the requirement that deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1.



In addition, under the current general risk-based capital rules, the effects of accumulated other comprehensive income or loss, or AOCI, items included in shareholders’ equity (for example, marks-to-market of securities held in the available-for-sale portfolio)

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under U.S. GAAP are reversed for the purposes of determining regulatory capital ratios.  Pursuant to the New Capital Rules, the effects of certain AOCI items are not excluded; however, non-advanced approaches banking organizations, including us and the Bank, may make a one-time permanent election to continue to exclude these items.  This election had to be made concurrently with the first filing of certain of our and the Bank’s periodic regulatory reports in the beginning of 2015.  We and the Bank made this election in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of our securities portfolio.  The New Capital Rules also preclude certain hybrid securities, such as trust preferred securities, from inclusion in bank holding companies’ Tier 1 capital, subject to grandfathering in the case of bank holding companies, such as us, that had less than $15 billion in total consolidated assets as of December 31, 2009.  Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and are being phased-in over a 4-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter).  The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and increased by 0.625% on each subsequent January 1, until it reached 2.5% on January 1, 2019.



With respect to the Bank, the New Capital Rules revise the “prompt corrective action” or PCA, regulations adopted pursuant to Section 38 of the Federal Deposit Insurance Act, by: (i) introducing a CET1 ratio requirement at each PCA category (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 capital ratio for well-capitalized status being 8% (as compared to the current 6%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3% leverage ratio and still be adequately capitalized.  The New Capital Rules do not change the total risk-based capital requirement for any PCA category.



The New Capital Rules prescribe a new standardized approach for risk weightings that expand the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset classes. 



We believe that we and the Bank will continue to be able to meet targeted capital ratios. Actual ratios are shown in the following paragraph.



Prompt Corrective Action.  Federal banking agencies must take prompt supervisory and regulatory actions against undercapitalized depository institutions pursuant to the Prompt Corrective Action provisions of the Federal Deposit Insurance Act.  Depository institutions are assigned one of five capital categories—“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”—and are subjected to differential regulation corresponding to the capital category within which the institution falls.  Under certain circumstances, a well-capitalized, adequately capitalized or undercapitalized institution may be treated as if the institution were in the next lower capital category.  As we describe in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources,” an institution is deemed to be well capitalized if it has a total risk-based capital ratio of at least 10.00%, a Tier 1 risk-based capital ratio of at least 6.50% and a leverage ratio of at least 5.00%.  An institution is adequately capitalized if it has a total risk-based capital ratio of at least 8.00%, a Tier 1 risk-based capital ratio of at least 4.50% and a leverage ratio of at least 4.00%.  At December 31, 2019, our total risk-based capital ratio was 19.45%, our Tier 1 risk-based capital ratio was 19.04% and our leverage ratio was 9.63% while the Bank’s ratios were 19.11%, 18.71% and 9.46%, respectively and, accordingly, both we and the Bank were “well capitalized” within the meaning of the regulations.  A depository institution is generally prohibited from making capital distributions (including paying dividends) or paying management fees to a holding company if the institution would thereafter be undercapitalized.  Adequately capitalized institutions cannot accept, renew or roll over brokered deposits except with a waiver from the FDIC, and are subject to restrictions on the interest rates that can be paid on such deposits.  Undercapitalized institutions may not accept, renew, or roll over brokered deposits.  The majority of the Bank’s deposits are classified as brokered, because related accounts, primarily prepaid and debit card deposit accounts, are obtained with the assistance of third parties.  On December 12, 2019, the FDIC issued a proposed notice of regulatory change which, if adopted, could result in the reclassification of the majority of our deposits to non-brokered, see “Insurance of Deposit Accounts” below.

Bank regulatory agencies are permitted or, in certain cases, required to take action with respect to institutions falling within one of the three undercapitalized categories.  Depending on the level of an institution’s capital, the agency’s corrective powers include, among other things:

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A banking institution that is undercapitalized must submit a capital restoration plan.  This plan will not be accepted unless, among other things, the banking institution’s holding company guarantees the plan up to an agreed-upon amount.  Any guarantee by a depository institution’s holding company is entitled to a priority of payment in bankruptcy.  Failure to implement a capital plan, or failure to have a capital restoration plan accepted, may result in a conservatorship or receivership.

As noted above, the New Capital Rules became effective as of January 1, 2015, with the first measurement date as of March 31, 2015 subject to phased implementation in certain respects, and revised the PCA regulations.  We are in compliance with these rules.

Insurance of Deposit Accounts.  The Bank’s deposits are insured to the maximum extent permitted by the Deposit Insurance Fund or DIF.  Upon enactment of the Emergency Economic Stabilization Act of 2008 on October 3, 2008, federal deposit insurance coverage levels under the DIF temporarily increased from $100,000 to $250,000 per deposit category, per depositor, per institution, through December 31, 2009.  On May 20, 2009, the Helping Families Save Their Homes Act extended the temporary increase through December 31, 2012.  The Dodd-Frank Act permanently increases the maximum amount of deposit insurance to $250,000 per deposit category, per depositor, per institution retroactive to January 1, 2008.  The Dodd-Frank Act provided unlimited deposit insurance coverage on non-interest bearing transaction accounts through December 31, 2012.  Due to the expiration of this unlimited deposit insurance on December 31, 2012, beginning January 1, 2013 deposits held in non-interest bearing transaction accounts are aggregated with any interest bearing deposits the owner may hold in the same ownership category, and the combined total is insured up to at least $250,000. 

As the insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions.  The FDIC also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the DIF.  The FDIC also has the authority to initiate enforcement actions against banks.

The FDIC has implemented a risk-based assessment system under which FDIC-insured depository institutions pay annual premiums at rates based on their risk classification.  A bank’s risk classification is based on its capital levels and the level of supervisory concern the bank poses to the regulators.  Institutions assigned to higher risk classifications (that is, institutions that pose a greater risk of loss to the DIF) pay assessments at higher rates than institutions that pose a lower risk.  A decrease in the Bank’s capital ratios or the occurrence of events that have an adverse effect on a bank’s asset quality, management, earnings, liquidity or sensitivity to market risk could result in a substantial increase in deposit insurance premiums paid by the Bank, which would adversely affect earnings.  In addition, the FDIC can impose special assessments in certain instances.  The range of assessments in the risk-based system is a function of the reserve ratio in the DIF.  Each insured institution is assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors.  An institution’s assessment rate depends upon the category to which it is assigned.  Unlike the other categories, Risk Category I contains further risk differentiation based on the FDIC’s analysis of financial ratios, examination component ratings and other information.  Assessment rates are determined by the FDIC and, including potential adjustments to reflect an institution’s risk profile, currently range from five to nine basis points for the healthiest institutions (Risk Category I) to 35 basis points of assessable liabilities for the riskiest (Risk Category IV).  Rates may be increased an additional ten basis points depending on the amount of brokered deposits utilized.  The above rates apply to institutions with assets under $10 billion.  Other rates apply for larger or “highly complex” institutions.  The FDIC may adjust rates uniformly from one quarter to the next, except that no single adjustment can exceed three basis points.  At December 31, 2019, the Bank’s DIF assessment rate was 19 basis points.  A reduction in the assessment rate will depend on future FDIC evaluations of the Bank. In December 2014, the FDIC issued new guidance which reclassified the Bank’s prepaid card deposits and most other deposits as brokered deposits because such deposits are obtained with the assistance of third parties.  The reclassification resulted in a 10 basis point increase in our assessment rate which is reflected in the increased FDIC insurance expense in subsequent periods. On December 12, 2019, the FDIC issued a notice for a proposed regulatory change, which would reclassify certain brokered deposits obtained with the assistance of third parties as non-brokered. The proposal requires an application to the FDIC, and if the proposal is adopted, we intend to apply for the classification change. If the classification change is approved, our FDIC insurance expense could decrease depending on other

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factors. However, there can be no assurance that the proposed regulation will be adopted, or that our application will be approved and that FDIC insurance expense will decrease.



Pursuant to the Dodd-Frank Act, the FDIC has established 2.0% as the designated reserve ratio (DRR), that is, the ratio of the DIF to insured deposits of the total industry.  The FDIC has adopted a plan under which it will meet the statutory minimum DRR of 1.35% by September 30, 2020, the deadline imposed by the Dodd-Frank Act.  The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets of less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%.  The FDIC issued a final rule regarding this offset on March 25, 2016.  Accordingly, the Bank received an assessment credit for the portion of its assessment that offset the impact of the increase from 1.15% to 1.35%. 



Loans-to-One Borrower.  Generally, a bank may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus.  An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by specified collateral, generally readily marketable collateral (which is defined to include certain financial instruments and bullion) and real estate.  At December 31, 2019, the Bank’s limit on loans-to-one borrower was $71.7 million ($119.5 million for secured loans).    



Transactions with Affiliates and other Related Parties.  There are various legal restrictions on the extent to which a financial holding company and its non-bank subsidiaries can borrow or otherwise obtain credit from banking subsidiaries or engage in other transactions with or involving those banking subsidiaries.  The Bank’s authority to engage in transactions with related parties or “affiliates” (that is, any entity that controls, is controlled by or is under common control with an institution, including us and our non-bank subsidiaries) is limited by Sections 23A and 23B of the Federal Reserve Act and Regulation W promulgated thereunder.  Section 23A restricts the aggregate amount of covered transactions with any individual affiliate to 10% of the Bank’s capital and surplus.  At December 31, 2019, we were not indebted to the Bank.  The aggregate amount of covered transactions with all affiliates is limited to 20% of the Bank’s capital and surplus.  Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in Section 23A and the purchase of low quality assets from affiliates are generally prohibited.  Section 23B generally provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies.



The Dodd-Frank Act generally enhances the restrictions on transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered credit transactions must be satisfied.  Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivatives transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions.  Restrictions are also placed on certain assets sales to and from an insider to an institution including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.

The Bank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve.  Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital.  In addition, extensions of credit in excess of certain limits must be approved by the Bank’s board of directors.  At December 31, 2019 and 2018, loans to these related parties included in assets held-for-sale amounted to $2.3 million and $2.0 million.

Standards for Safety and Soundness.  The Federal Deposit Insurance Act requires each federal banking agency to prescribe for all insured depository institutions standards relating to, among other things, internal controls, information and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, fees, benefits and such other operational and managerial standards as the agency deems appropriate.  The federal banking agencies have adopted final regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness to implement these safety and soundness standards.  The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired.  If the appropriate federal banking agency determines that an

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institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard.

Privacy.  Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party.  Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.  The Bank has adopted privacy standards that we believe will satisfy regulatory scrutiny, and communicates its privacy practices to its customers through privacy disclosures designed in a manner consistent with recommended model forms.

Fair and Accurate Credit Transactions Act of 2003. The Fair and Accurate Credit Transactions Act of 2003, known as the FACT Act, provides consumers with the ability to restrict companies from using certain information obtained from affiliates to make marketing solicitations.  In general, a person is prohibited from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and had a reasonable opportunity to opt out of such solicitations.  The rule permits opt-out notices to be given by any affiliate that has a pre-existing business relationship with the consumer and permits a joint notice from two or more affiliates.  Moreover, such notice would not be applicable if the company using the information has a pre-existing business relationship with the consumer.  This notice may be combined with other required disclosures, including notices required under other applicable privacy provisions.



Section 315 of the FACT Act requires each financial institution or creditor to develop and implement a written Identity Theft Prevention Program to detect, prevent and mitigate identity theft in connection with the opening of certain accounts or certain existing accounts.  In accordance with this rule, the Bank was required to adopt “reasonable policies and procedures” to:



Bank Secrecy Act: Anti-Money Laundering and Related Regulations.  The Bank Secrecy Act, which we refer to as BSA, requires the Bank to implement a risk-based compliance program in order to protect the Bank from being used as a conduit for financial or other illicit crimes including but not limited to money laundering and terrorist financing.  These rules are administered by the Financial Crimes Enforcement Network, a bureau of the U.S. Treasury Department, which we refer to as FinCEN.  Under the law, the Bank must have a board-approved written BSA-Anti-Money Laundering, which we refer to as AML, program which must contain the following key requirements: (1) appointing responsible persons to manage the program, including a BSA Officer; (2) ongoing training of all appropriate Bank staff and management on BSA-AML compliance; (3) developing a system of internal controls (including appropriate policies, procedures and processes); and (4) requiring independent testing to ensure effective implementation of the program and appropriate compliance.  Under BSA regulations, the Bank is subject to various reporting requirements such as currency transaction reporting (CTR) for all cash transactions initiated by or on behalf of a customer which, when aggregated, exceed $10,000 per day.  The Bank is also required to monitor customer activity and transactions and file a suspicious activity report, or SAR, when suspicious activity is observed and the applicable dollar threshold for the observed suspicious activity is met.  The BSA also contains numerous recordkeeping requirements.  For a description of a consent order with the FDIC under the BSA that imposes certain requirements on the Bank, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Recent Developments” and “Risk Factors-Risks Relating to Our Business-The entry into the Consent Orders and a supervisory letter from the Federal Reserve have imposed certain restrictions and requirements on us and the Bank.”

On July 26, 2011, FinCEN issued a final rule expanding the reach of BSA-AML related compliance to certain defined “providers” and “sellers” of “prepaid access” either outside of, or minimally regulated under the BSA.  The final rule became effective on September 27, 2011 and imposed expanded affirmative BSA-AML compliance obligations on providers and sellers of prepaid access.  The Bank has evaluated the impact of these rules on its operations and its third-party relationships, and has established internal processes accordingly. 

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On May 11, 2016, FinCEN issued a final rule related to Customer Due Diligence (CDD) under the Bank Secrecy Act for banks and other covered financial institutions, which we refer to as the “CDD Rule”.  The CDD Rule became effective on July 11, 2016, and imposes a new requirement that the Bank identify and verify the identity of the natural persons who are beneficial owners of legal entity customers.  Financial institutions were required to be in full compliance by May 11, 2018.  As a covered institution, the Bank is required to maintain written compliance procedures that are “reasonably designed to identify and verify the beneficial owners of legal entity customers,” except for those specifically excluded from the definition of “legal entity customer.” As required, the Bank adopted procedures related to the identification and verification of a beneficial owner at the time a new account is opened. 

USA PATRIOT Act. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, which we refer to as the USA PATRIOT Act, amended, in part, the BSA, by, in pertinent part, criminalizing the financing of terrorism and augmenting the existing BSA framework by strengthening customer identification procedures, requiring financial institutions to have due diligence procedures, including enhanced due diligence procedures and, most significantly, improving information sharing between financial institutions and the U.S. government. 

Under the USA PATRIOT Act, FinCEN can send bank regulatory agencies lists of the names of persons suspected of involvement in terrorist activities or money laundering.  The Bank must search its records for any relationships or transactions with persons on those lists.  If the Bank finds any relationships or transactions, it must report specific information to FinCEN and implement other internal compliance procedures in accordance with the Bank’s BSA-AML compliance procedures. 

Office of Foreign Assets Control Regulations for the Financial Community.  The Office of Foreign Assets Control, which we refer to as OFAC, is a division of the U.S. Treasury Department, and administers and enforces economic and trade sanctions based on U.S. foreign policy and national security goals against targeted foreign countries, terrorists, international narcotics traffickers, and those engaged in activities related to the proliferation of weapons of mass destruction.  OFAC functions under the President’s wartime and national emergency powers, as well as under authority granted by specific legislation, to impose controls on transactions and freeze assets under U.S. jurisdiction.  In addition, many of the sanctions are based on United Nations and other international mandates, and typically involve close cooperation with allied governments.  OFAC maintains lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, as well as sanctions programs for certain countries.  If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list or is otherwise asked to facilitate a transaction prohibited under a government sanctions program, the Bank must freeze or block such account or reject a transaction, and perform additional procedures as required by OFAC regulations.  The Bank filters its customer base and transactional activity against OFAC-issued lists.  The Bank performs these checks utilizing purpose directed software, which is updated each time a modification is made to the lists provided by OFAC and other agencies.

Unfair or Deceptive or Abusive Acts or Practices.  Section 5 of the Federal Trade Commission Act prohibits all persons, including financial institutions, from engaging in any unfair or deceptive acts or practices in or affecting commerce.  The Dodd-Frank Act codifies this prohibition, and expands it even further by prohibiting “abusive” practices as well.  These prohibitions, which we refer to as UDAAP, apply in all areas of the Bank, including marketing and advertising practices, product features, terms and conditions, operational practices, and the conduct of third parties with whom the Bank may partner or on whom the Bank may rely in bringing Bank products and services to consumers.

Other Consumer Protection-Related Laws and Regulations.  The Bank is subject to a wide range of consumer protection laws and regulations which may have an enterprise-wide impact or may principally govern its lending or deposit operations.  To the extent the Bank engages third-party service providers in any aspect of its products and services, these third parties may also be subject to compliance with applicable law, and must therefore be subject to Bank oversight.

The Bank’s loan operations are also subject to federal consumer protection laws applicable to credit transactions, including:

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In addition, interest and other charges collected or contracted for by the Bank will be subject to state usury laws and federal laws concerning interest rates.



The deposit operations of the Bank are subject to various consumer protection laws including but not limited to:





Final Prepaid Account Rule Amending Regulation E and Regulation Z.  On April 1, 2019, a final rule issued by the CFPB went into effect related to prepaid accounts and the applicability of provisions of Regulation E and Regulation Z, respectively, which we call the Final Prepaid Rule.



The Final Prepaid Rule includes a significant number of changes to the regulatory framework for prepaid products, some of which include: (a) establishing a definition of “prepaid account” within Regulation E that includes reloadable and non-reloadable physical cards, as well as codes or other devices, and focuses on how the product is issued and used; (b) modifying Regulation E to require that short form and long form disclosures be provided to a consumer prior to a consumer agreeing to acquire a prepaid account with certain exceptions and with specified forms that, if used, would provide a safe harbor for financial institutions; (c) extending to prepaid accounts the periodic transaction history and statement requirements of Regulation E currently applicable to payroll and Federal government benefit accounts; (d) extending the error resolution and limited liability provisions of Regulation E currently applicable to payroll cards to registered network branded prepaid cards; (e) requiring financial institutions to post prepaid account agreements to the issuers’ websites and to submit them to the CFPB; (f) extending Regulation Z’s credit card rules and disclosure requirements to prepaid accounts that provide overdraft protection and other credit features; (g) requiring an issuer to obtain a prepaid account holder’s consent prior to adding overdraft services or other credit features and prohibiting the issuer from adding overdraft services or other credit features for at least 30 calendar days after a consumer registers the prepaid account; and (h) prohibiting the application of different terms and conditions, such as charging different fees, to a prepaid account depending on whether the consumer elects to link the prepaid account to overdraft services or other credit features. The Bank has evaluated the impact of the Final Prepaid Rule on its operations and its third-party relationships, and has established internal processes accordingly.  



Community Reinvestment Act.    Under the Community Reinvestment Act of 1977, which we refer to as the CRA, a federally-insured institution has a continuing and affirmative obligation to help meet the credit needs of its community, including low-and moderate-income neighborhoods, consistent with the safe and sound operation of the institution.  The bank shall delineate one or more

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assessment areas within which the FDIC evaluates the bank's record of helping to meet the credit needs of its community.  The CRA further requires that a record be kept of whether a financial institution meets its community’s credit needs, which record will be taken into account when evaluating applications for, among other things, domestic branches and mergers and acquisitions.  The regulations promulgated pursuant to the CRA contain three evaluation tests which are part of the traditional CRA evaluation:





As an alternative to the traditional evaluation tests summarized above, the CRA permits a financial institution to develop its own strategic plan setting forth specific goals for CRA compliance and related performance ratings.  If approved by its regulator, a financial institution may operate under its strategic plan and CRA ratings will be applied based on an institution’s performance under its approved strategic plan.



The Bank operates its CRA program under an FDIC-approved CRA Strategic Plan.  The Bank now operates under an approved plan for the period of January 1, 2020 through December 31, 2020. On July 3, 2019, the Bank received its 2018 CRA Performance Evaluation which was completed on November 11, 2018.  The Bank was assigned a “Satisfactory” CRA rating.  The Bank continues to closely monitor its performance in alignment with its CRA Strategic Plan to meet the specified lending, service and investment requirements contained therein.



On January 9, 2020, the FDIC and the Comptroller of the Currency issued a joint notice of proposed rulemaking to strengthen the CRA regulations by clarifying which activities qualify for CRA credit, updating where activities count for CRA credit, creating a more transparent and objective method for measuring CRA performance, and providing for more transparent, consistent, and timely CRA-related data collection, recordkeeping, and reporting.  The Bank is evaluating the impact of these proposed rules on the Bank and its Strategic Plan. 



Enforcement.  Under the Federal Deposit Insurance Act, the FDIC has the authority to bring actions against a bank and all affiliated parties, including stockholders, attorneys, appraisers and accountants, who knowingly or recklessly participate in wrongful actions likely to have an adverse effect on the bank.  Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors, to institution of receivership or conservatorship proceedings, or termination of deposit insurance.  Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases.  Federal law also establishes criminal penalties for certain violations.



Federal Reserve System. Federal Reserve regulations require banks to maintain non-interest bearing reserves against their transaction accounts (primarily demand deposits and regular checking accounts).  For 2019, Federal Reserve regulations generally required that reserves be maintained against aggregate transaction accounts as follows: for accounts aggregating $110.6 million or less (subject to adjustment by the Federal Reserve), the reserve requirement is 3%; and, for accounts aggregating greater than $110.6 million, the reserve requirement is 10% (subject to adjustment by the Federal Reserve to between 8% and 14%).  The first $16.0 million of otherwise reservable balances (subject to adjustments by the Federal Reserve) are exempt from the reserve requirements.  At December 31, 2019, the Bank met these requirements by maintaining $314.7 million in cash and balances at the Federal Reserve.



The Dodd-Frank Act.  On July 21, 2010, the Dodd-Frank Act was signed into law.  The Dodd-Frank Act (as amended) implements far-reaching changes across the financial regulatory landscape, including provisions that, among other things, will (or have already):



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Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years.  Specific rulemaking intended to implement provisions of the Dodd-Frank Act is underway and is addressed elsewhere in this section as applicable.  It is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations may impact us.  However, compliance with these new laws and regulations may increase our costs, limit our ability to pursue attractive business opportunities, cause us to modify our strategies and business operations and increase our capital requirements and constraints, any of which may have a material adverse impact on our business, financial condition, liquidity or results of operations.  We cannot predict whether, or in what form, any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.



Economic Growth, Regulator Relief, and Consumer Protection Act of 2018.  On May 24, 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”) was signed into law, which amended provisions of the Dodd-Frank Act and was intended to ease regulatory burden and refine the rules, particularly with respect to smaller-sized institutions such as the Company. EGRRCPA’s highlights include, among other things: (i) exempts banks with less than $10 billion in assets from the ability-to-repay requirements for certain qualified residential mortgage loans held in portfolio; (ii) waives certain appraisal requirements for certain transactions valued at less than $400,000 in rural areas; (iii) clarifies that, subject to various conditions, reciprocal deposits of another depository institution obtained using a deposit broker through a deposit placement network for purposes of obtaining

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maximum deposit insurance would not be considered brokered deposits subject to the FDIC’s brokered-deposit regulations; (iv) raises eligibility for the 18-month exam cycle from $1 billion to banks with $3 billion in assets; and (v) simplifies capital calculations by requiring regulators to establish for institutions under $10 billion in assets a community bank leverage ratio (tangible equity to average consolidated assets) at a percentage not less than 8% and not greater than 10% that such institutions may elect to replace the general applicable risk-based capital requirements for determining well capitalized status.



Volcker Rule Adoption.  On December 10, 2013, five financial regulatory agencies, including our primary federal regulators the Federal Reserve and the FDIC, adopted final rules (the “Final Volcker Rules”) implementing the Volcker Rule embodied in Section 13 of the Bank Holding Company Act, which was added by Section 619 of the Dodd-Frank Act.  The Final Volcker Rules prohibit banking entities from (1) engaging in short-term proprietary trading for their own accounts, and (2) having certain ownership interests in and relationships with hedge funds or private equity funds (“covered funds”).  The Final Volcker Rules also require each regulated entity to establish an internal compliance program that is consistent with the extent to which it engages in activities covered by the Final Volcker Rules, which must include (for the largest entities) making regular reports about those activities to regulators.  Smaller banks and community banks, including the Bank, are afforded some relief under the Final Volcker Rules.  Smaller banks, including the Bank, that are engaged only in exempted proprietary trading, such as trading in U.S. government, agency, state and municipal obligations, are exempt from compliance program requirements.  Moreover, even if a community or small bank engages in proprietary trading or covered fund activities under the Final Volcker Rules, they need only incorporate references to the Volcker Rule into their existing policies and procedures.  The Final Rules became effective April 1, 2014, but the conformance period was extended from its statutory end date of July 21, 2014 until July 21, 2017.  This did not have a material impact on our operations. 



Consumer Protections for Remittance Transfers.  On February 7, 2012, the CFPB published a final rule to implement Section 1073 of the Dodd-Frank Act.  The final rule creates a comprehensive set of consumer protections for remittance transfers sent by consumers in the United States to parties in foreign countries.  The final rule, among other things, mandates certain disclosures and consumer cancellation rights for foreign remittances covered by the rule.



Federal Regulatory Guidance on Incentive Compensation.  On June 21, 2010, federal banking regulators released final guidance on sound incentive compensation policies for banking organizations.  This guidance, which covers all employees that have the ability to materially affect the risk profile of an organization either individually or as part of a group, is based upon  key principles including: (1) incentive compensation arrangements at a banking organization should provide employees incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risk; (2) these arrangements should be compatible with effective controls and risk-management; and (3) these arrangements should be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.  The final guidance seeks to address the safety and soundness risks of incentive compensation practices to ultimately be sure that compensation practices are not structured in a manner to give employees incentives to take imprudent risks.  Federal regulators intend to actively monitor the actions being taken by banking organizations with respect to incentive compensation arrangements and will review and update their guidance as appropriate to incorporate best practices that emerge.



The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations such as ours that are not considered “large, complex banking organizations.”  These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements.  The findings of the supervisory initiatives will be included in reports of examination.  Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions.  Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management controls or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.



In February 2011, the Federal Reserve, the Office of Comptroller of the Currency and the FDIC approved a joint proposed rulemaking to implement Section 956 of the Dodd-Frank Act, which prohibits incentive-based compensation arrangements that encourage inappropriate risk-taking by covered financial institutions and that are deemed to be excessive, or that may lead to material losses. 

Effect of Governmental Monetary Policies.   The commercial banking business is affected not only by general economic conditions but also by both U.S. fiscal policy and the monetary policies of the Federal Reserve.  Some of the instruments of fiscal and monetary policy available to the Federal Reserve include changes in the discount rate on member bank borrowings, the fluctuating availability of borrowings at the “discount window,” open market operations, the imposition of and changes in reserve requirements against member banks’ deposits and assets of foreign branches, the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates, and the placing of limits on interest rates that member banks may pay on time and savings

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deposits.  Such policies influence to a significant extent the overall growth of bank loans, investments, and deposits and the interest rates charged on loans or paid on time and savings deposits (see “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations”).  We cannot predict the nature of future fiscal and monetary policies and the effect of such policies on the future business and our earnings.



Delaware Law and Regulation and Other State Laws and Regulations



General. As a Delaware financial holding company, we are subject to the supervision of and periodic examination by the Delaware Office of the State Bank Commissioner and must comply with the reporting requirements of the Delaware Office of the State Bank Commissioner.  The Bank, as a banking corporation chartered under Delaware law, is subject to comprehensive regulation by the Delaware Office of the State Bank Commissioner, including regulation of the conduct of its internal affairs, the extent and exercise of its banking powers, the issuance of capital notes or debentures, any mergers, consolidations or conversions, its lending and investment practices and its revolving and closed-end credit practices.  The Bank also is subject to periodic examination by the Delaware Office of the State Bank Commissioner and must comply with the reporting requirements of the Delaware Office of the State Bank Commissioner.  The Delaware Office of the State Bank Commissioner has the power to issue cease and desist orders prohibiting unsafe and unsound practices in the conduct of a banking business.

 

Limitation on Dividends.  Under Delaware banking law, the Bank’s directors may declare dividends on common or preferred stock of so much of its net profits as they judge expedient; but the Bank must, before the declaration of a dividend on common stock from net profits, carry 50% of its net profits of the preceding period for which the dividend is paid to its surplus fund until its surplus fund amounts to 50% of its capital stock and thereafter must carry 25% of its net profits for the preceding period for which the dividend is paid to its surplus fund until its surplus fund amounts to 100% of its capital stock.  The Bank’s payment of dividends is also governed by federal banking laws and regulations promulgated by the FDIC, and by an amendment to the 2014 Consent Order with the FDIC which provides that any payment of dividends by the Bank must receive prior approval from the FDIC.



Other State Laws and Regulations.  The Bank is governed by other state laws and regulations in connection with some of its business and operational practices.  This includes, for example, complying with state laws governing abandoned or unclaimed property, state and local licensing requirements and other state-based rules which direct how the Bank may conduct its activities.



Employees

As of December 31, 2019, we had 612 full-time employees and believe our relationships with our employees to be good. Our employees are not employed under a collective bargaining agreement.

Item 1A. Risk Factors

Risks Relating to Our Business

Our business may be affected materially by various risks and uncertainties.  Any of the risks described below or elsewhere in this Annual Report on Form 10-K or our other SEC filings, as well as other risks we have not identified, may have a material negative impact on our financial condition and operating results. 

The Bank’s allowance for loan losses may not be adequate to cover actual losses.



Like all financial institutions, the Bank maintains an allowance for loan losses to provide for probable losses inherent in its loan portfolio.  At December 31, 2019, the ratios of the allowance for loan losses to total loans and to non-performing loans were, respectively, 0.56% and 113.0%.  The Bank’s allowance for loan losses may not be adequate to cover actual loan losses and future provisions for loan losses could materially and adversely affect the Bank’s operating results.  The Bank’s allowance for loan losses is determined by management after analyzing historical loan losses, current trends in delinquencies and charge-offs, plans for problem loan resolution, changes in the size and composition of the loan portfolio and industry information.  Also included in management’s estimates for loan losses are considerations with respect to the impact of economic events, the outcome of which are uncertain.  The determination by management of the allowance for loan losses involves a high degree of subjectivity and requires management to estimate current and future credit risk based on both qualitative and quantitative facts, each of which is subject to significant change.  The amount of future loan losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond the Bank’s control, and these loan losses may exceed current estimates.  Bank regulatory agencies, as an

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integral part of their examination process, review the Bank’s loans and allowance for loan losses.  Although we believe that the Bank’s allowance for loan losses is adequate to provide for probable losses and that the methodology used by the Bank to determine the amount of both the allowance and provision is effective, we cannot assure you that we will not need to increase the Bank’s allowance for loan losses, change our methodology for determining our allowance and provision for loan losses or that our regulators will not require us to increase this allowance.  Any of these occurrences could materially reduce our earnings and profitability and could result in our sustaining losses.  For more information about risks which are specific to the different types of loans we make and which could impact the allowance for loan losses, see Item 1,” Business –Lending Activities.”



Recent changes to the FASB accounting standards will result in a significant change to our recognition of credit losses and may materially impact our financial condition or results of operations.



In June 2016, the FASB issued an update to Accounting Standards Update (ASU or Update) 2016-13 – “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”.  The Update changes the accounting for credit losses on loans and debt securities. For loans and held-to-maturity debt securities, the Update requires a current expected credit loss (CECL) approach to determine the allowance for credit losses.  CECL requires loss estimates for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts.  Also, the Update eliminates the existing guidance for purchased credit impaired loans, but requires an allowance for purchased financial assets with more than insignificant deterioration since origination.  In addition, the Update modifies the other-than-temporary impairment model for available-for-sale debt securities to require an allowance for credit impairment instead of a direct write-down, which allows for reversal of credit impairments in future periods based on improvements in credit.  The CECL model will materially impact how we determine our allowance for loan and lease losses and may require us to significantly increase our allowance for loan and lease losses.  Furthermore, our allowance for loan and lease losses may experience more fluctuations, some of which may be significant. Were we required to significantly increase our allowance for loan and lease losses, it may negatively impact our business, earnings, financial condition and results of operations.  We expect that the transition to the CECL model will result in an increase in the allowance for credit losses given the change to estimated losses over the contractual life of the asset adjusted for expected prepayments, an additional allowance for the uninsured portion of SBA loan commitments and the potential addition of an allowance for debt securities. The amount of the increase will be impacted by the portfolio composition and credit quality at the adoption date as well as economic conditions and forecasts at that time. If we are required to materially increase our level of allowance for loan and lease losses for any reason, such increase could adversely affect our business, financial condition and results of operations.  The guidance is effective in first quarter 2020 with a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption.



The Bank may suffer losses in its loan portfolio despite its underwriting practices.



The Bank seeks to mitigate the risks inherent in its loan portfolio by adhering to specific underwriting practices.  These practices vary depending on the facts and circumstances of each loan.  For other than SBLOC and IBLOC loans, these practices may include analysis of a borrower’s prior credit history, financial statements, tax returns and cash flow projections, valuation of certain types of collateral based on reports of independent appraisers and verification of liquid assets.  For SBLOC loans, a primary element of the credit decision is the market value of the borrower’s brokerage account, which is reduced by the varying collateral percentages against which the Company is willing to lend, resulting in excess collateral. Rapid excessive movements in the market value of brokerage accounts might not be sufficiently offset by the excess collateral and losses could result. For example, we typically lend against 50% of the value of equity securities.  For IBLOC, the credit decision is primarily based upon the cash value of insurance policies which may ultimately be dependent upon the insurer for repayment.  Although the Bank believes that its underwriting criteria are appropriate for the various kinds of loans it makes, the Bank may incur losses on loans that meet its underwriting criteria, and these losses may exceed the amounts set aside as reserves in the Bank’s allowance for loan losses.  In addition, only certain SBA loans are 75% guaranteed by the U.S. government, and even for those, we still assume credit risk on the remaining 25%.  These borrowers, which include new start-ups, may have a higher probability of failure which may result in higher losses on such loans.  If the level of non-performing assets increases, interest income will be reduced.  If we experience loan defaults in excess of amounts that we have included in our allowance for loan losses, we will have to increase the provision for loan losses which will reduce our income and might cause us to incur losses.  At the time loans are classified as troubled debt restructurings, losses are recognized if the fair value of collateral is less than the loan balance. For more information about the risks which are specific to the different types of loans we make and which could impact loan losses, see Item 1,” Business –Lending Activities.”



An inconsistent recovery from an extended period of weak economic and slow growth conditions in the U.S. economy have had, and may continue to have, significant adverse effects on our assets and operating results.



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Since the end of the recession in 2009, the United States economy has been subject to low rates of growth in general and, in particular localities, recession-like conditions have occurred.  As a result, the financial system in the United States, including credit markets and markets for real estate and real-estate related assets, have periodically been subject to weakness.  These weaknesses have episodically resulted in declines in the availability of credit, reduction in the values of real estate and real estate-related assets, the reduction of markets for those assets and impairment of the ability of certain borrowers to repay their obligations.  As a result of these conditions, we increased our provision for loan losses, and experienced increases in the amount of loans charged off and non-performing assets in our Philadelphia-based commercial loan portfolio which is now reflected in discontinued operations.  Rated investment securities, generally considered to be less risky than loans, have in recent economic periods, in certain instances, experienced greater than expected losses, which could recur.  A continuation of weak economic conditions could further harm our financial condition and results of operations. 



We are subject to extensive government regulation and supervision.



We and our subsidiary, The Bancorp Bank, are subject to extensive federal and state regulation and supervision.  Banking regulations are primarily intended to protect customers, depositors’ funds, the federal deposit insurance funds and the banking system as a whole, not stockholders.  These regulations affect the Bank’s lending practices, capital structure and requirements, investment activities, dividend policy, product offerings, expansionary strategies and growth, among other things.  The legal and regulatory landscape is frequently changing as Congress and the regulatory agencies having jurisdiction over our operations adopt or amend laws, or change interpretation of existing statutes, regulations or policies.  These changes could affect the Company and the Bank in substantial and unpredictable ways.  Additionally, while we have policies and procedures designed to prevent violations of the extensive federal and state regulations that we are subject to, there can be no assurance that such violations will not occur.  Failure to comply with these statutes, regulations or policies could result in sanctions against us or the Bank by regulatory agencies, civil money penalties, criminal penalties, reputational damage, and a downgrade in the Bank’s ratings for capital adequacy, asset quality, management, earnings, liquidity and market sensitivity, any of which alone or in combination could have a material adverse effect on our financial condition and results of operations.



The entry into the Consent Orders has imposed certain restrictions and requirements upon us and the Bank.



The Bank entered into a Stipulation and Consent to the Issuance of a Consent Order effective August 7, 2012, which we refer to as the 2012 Consent Order.  The Bank took this action without admitting or denying any charges of unsafe or unsound banking practices or violations of law or regulation.  Under the 2012 Consent Order, the Bank agreed to increase its supervision of third-party relationships, develop new written compliance and related internal audit compliance programs, develop a new third-party risk management program and screen new third-party relationships as provided in the 2012 Consent Order.  As part of the 2012 Consent Order, the Bank agreed to pay a civil money penalty in the amount of $172,000, which was paid in 2012.  The 2012 Consent Order was amended and restated in 2015 as noted below.



On June 5, 2014, the Bank entered into a Stipulation and Consent to the Issuance of a Consent Order with the FDIC, which we refer to as the 2014 Consent Order.  The Bank took this action without admitting or denying any charges of unsafe or unsound banking practices or violations of law or regulation relating to the Bank’s BSA compliance program.  The 2014 Consent Order requires the Bank to take certain affirmative actions to comply with its BSA obligations.  Satisfaction of the requirements of the 2014 Consent Order is subject to the review of the FDIC and the Delaware State Bank Commissioner.  The Bank has and expects to continue to expend significant management and financial resources to address the Bank’s BSA compliance program.  Expenses associated with the required look back review were significant in 2015 and 2016.  The look back review was completed in the third quarter of 2016.



The 2014 Consent Order restricts the Bank from signing and boarding new independent sales organizations, establishing new non-benefit reloadable prepaid card programs and originating Automated Clearing House transactions for new merchant-related payments until the Bank submits to the FDIC and the Delaware State Bank Commissioner a report summarizing the completion of certain BSA-related corrective actions (“BSA Report”).  Until the BSA Report is approved by the FDIC and Delaware State Bank Commissioner, those aspects of the growth of our card payment processing and prepaid card operations will be affected, which, unless offset by growth from existing customers and new customers in other areas of our prepaid card operations, could reduce growth of our deposits and non-interest income and, possibly, limit our ability to raise additional capital on acceptable terms.  The Bank provided the FDIC and the Delaware State Bank Commissioner with the required BSA Report as of December 31, 2019 and it is under review by the regulators.    



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On August 27, 2015, the Bank entered into an Amendment to Consent Order, or the 2014 Consent Order Amendment, with the FDIC, amending the 2014 Consent Order.  The Bank took this action without admitting or denying any additional charges of unsafe or unsound banking practices or violations of law or regulation relating to continued weaknesses in the Bank’s BSA compliance program.  The 2014 Consent Order Amendment provides that the Bank shall not declare or pay any dividend without the prior written consent of the FDIC and for certain assurances regarding management.



On May 11, 2015, the Federal Reserve issued a letter, or the Supervisory Letter, to us as a result of the 2014 Consent Order and the 2014 Consent Order Amendment (which, at the time of the Supervisory Letter, was in proposed form), which provides that we shall not pay any dividends on our common stock or make any interest payments on our trust preferred securities, without the prior written approval of the Federal Reserve.  It further provides that we may not incur any debt (excluding payables in the ordinary course of business) or redeem any shares of our stock, without the prior written approval of the Federal Reserve. The requirement for such approval was lifted by the Federal Reserve in the fourth quarter of 2019, and that letter was terminated at that time.



On December 23, 2015, the Bank entered into a Stipulation and Consent to the Issuance of an Amended Consent Order, Order for Restitution, and Order to Pay Civil Money Penalty with the FDIC, which we refer to as the 2015 Consent Order.  The Bank took this action without admitting or denying any charges of violations of law or regulation.  The 2015 Consent Order amended and restated in its entirety the terms of the 2012 Consent Order.



The 2015 Consent Order was based on FDIC allegations regarding electronic fund transfer, or EFT, error resolution practices, account termination practices and fee practices of various third parties with whom the Bank had previously provided, or currently provides, deposit-related products, whom we refer to as Third Parties.  The 2015 Consent Order continues the Bank's obligations originally set forth in the 2012 Consent Order, including its obligations to increase board oversight of the Bank's compliance management system, or CMS, improve the Bank's CMS, enhance its internal audit program, increase its management and oversight of Third Parties, and correct any apparent violations of law.



In addition to restating the general terms of the 2012 Consent Order, the 2015 Consent Order directs the Bank’s Board of Directors to establish a Complaint and Error Claim Oversight and Review Committee, which we refer to as the Complaint and Error Claim Committee to review and oversee the Bank’s processes and practices for handling, monitoring and resolving consumer complaints and EFT error claims (whether received directly or through Third Parties) and to review management's plans for correcting any weaknesses that may be found in such processes and practices.  The Bank’s Board of Directors appointed the required Complaint and Error Claim Committee on January 29, 2016.



The 2015 Consent Order also requires the Bank to implement a corrective action plan, or CAP, to remediate and provide restitution to those prepaid cardholders who asserted or attempted to assert, or were discouraged from initiating EFT error claims, and to provide restitution to cardholders harmed by EFT error resolution practices.    The 2015 Consent Order requires that if, through the CAP, the Bank identifies prepaid cardholders who have been adversely affected by a denial or failure to resolve an EFT error claim, the Bank will ensure that monetary restitution is made.  The Bank completed its implementation of the CAP on January 15, 2020.  As of the completion date, $1,592,469.20 of restitution was paid to consumers of which $4,352.61 was paid by the Bank and the remaining amount by Third Parties.



The 2015 Consent Order also imposed a $3 million civil money penalty on the Bank, which the Bank has paid and which was recognized as expense in the fourth quarter of 2015.



On March 7, 2018, the Bank entered into a Stipulation and Consent to Order for Restitution and Order To Pay Civil Money Penalty with the FDIC, which we refer to as the 2018 Restitution Order and 2018 CMP Order, respectively.  The Bank took this action without admitting or denying any alleged violations of law or regulation.  The FDIC’s action principally emanated from one of the Bank’s third-party payment processors (“Third-Party Processor”) that suffered an internal system programming glitch.  This inadvertently resulted in consumers that engaged in signature-based point of sale transactions during the period from December 2010 to November 2014 being charged a greater fee than what was disclosed by the Bank.  The FDIC alleged the Bank’s incorrect fee imposition due to the Third-Party Processor error was an unfair or deceptive act or practice and violated Section 5 of the Federal Trade Commission Act. The 2018 CMP Order imposed a $2 million civil money penalty on the Bank which the Bank has paid, and was recognized as expense on September 30, 2017.  The civil money penalty was not subject to any indemnification or recovery from any third party.  



The 2018 Restitution Order required the Bank to develop a written Restitution Plan, subject to independent audit and FDIC non-objection, to ensure impacted consumers are compensated for any incorrectly charged fees.  The 2018 Restitution Order required

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the Bank to make such reimbursements if not otherwise made by the Third-Party Processor and the Bank is indemnified by the Third-Party Processor for such reimbursements.  Impacted consumers were reimbursed by the Third-Party Processor at its own expense.  On December 19, 2019, the FDIC concluded the Bank had fully complied with the 2018 Restitution Order and issued an order terminating the 2018 Restitution Order. 



On December 18, 2019, the Bank’s Board of Directors, without admitting or denying any violations of law, regulation or the provisions of the 2014 Consent Order, executed a Stipulation and Consent to the Issuance of an Order to Pay Civil Money Penalty in the amount of $7.5 million based on supervisory findings during the period of 2013 to 2019 related principally to deficiencies in the Bank’s legacy Bank Secrecy Act/Anti-Money Laundering (BSA/AML) Programs and alleged violations of law during the period, as well as the length of time the Bank has taken to fully implement the corrective actions required by the 2014 Consent Order. The Bank paid this amount, and it was recognized as an expense in the Company’s financial statements in the fourth quarter of 2019.



We cannot assure you that our regulators will ultimately determine that we have met all of the requirements of the 2014 Consent Order, the 2014 Consent Order Amendment, and the 2015 Consent Order, collectively, the Consent Orders, to their satisfaction. If our regulators believe that we have not made sufficient progress in complying with these Consent Orders, they could seek to impose additional regulatory requirements, operational restrictions, enhanced supervision and/or civil money penalties.  If any of these measures is imposed in the future, it could reduce our earnings, result in our incurring losses or otherwise materially adversely affect our financial condition and results of operations and reduce or eliminate our ability to raise additional capital on acceptable terms.  Further, we are at risk of the imposition of additional civil money penalties by our regulators, based on, among other things, apparent violations of law, repeat violations, or supervisory determinations of non-compliance with any consent order.  Depending on the circumstances, the imposition and size of any such penalty is at the discretion of the regulator. While the Bank is contractually indemnified for related losses, civil money penalties, if assessed against the Bank, are not recoverable from third parties. 



Our reputation and business could be damaged by our entry into the Consent Orders and any future enforcement matters with our regulators and other negative publicity.



Reputational risk, or the risk to our business, earnings and capital from negative publicity, is inherent in our business.  Negative publicity can result from actual or alleged conduct in a number of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, inadequate protection of customer data, ethical behavior of our employees, and from actions taken by regulators and others as a result of that conduct.  Damage to our reputation, including as a result of negative publicity associated with the Consent Orders, or future regulatory enforcement actions, could impact our ability to attract new and maintain existing loan and deposit customers, employees and business relationships, and could result in the imposition of additional regulatory requirements, operational restrictions, enhanced supervision and/or civil money penalties.  Such damage could also adversely affect our ability to raise additional capital on acceptable terms.



The provisions contained in the Consent Orders present interpretive challenges that may give rise to a difference of interpretation by us and our regulators.



The provisions of the Consent Orders are subject to interpretation and may give rise to differing views between us and our regulators with respect to their scope and application.  Accordingly, management, employees at all levels, and legal counsel of the Bank face significant challenges in applying the terms of the Consent Orders to the myriad factual scenarios that arise in the ordinary course of business.  While we have sought, and will continue to seek, guidance from our regulators as to the application of the Consent Orders on our business, there can be no assurance that our regulators will provide such guidance or that we and our regulators will interpret the terms of the Consent Orders uniformly in every instance. 



If the regulators interpret the Consent Orders in a manner contrary to our interpretation despite our good faith efforts to comply, including the time required to comply, the FDIC may conclude a violation has occurred, which may result in the imposition of additional regulatory requirements, operational restrictions, enhanced supervision and/or civil money penalties.



We may have difficulty managing our growth which may divert resources and limit our ability to expand our operations successfully.



Our future profitability will depend in part on our continued ability to grow; however, we may not be able to sustain our historical growth rate or be able to grow.  Our future success will depend on the ability of our officers and key employees to continue to implement and improve our operational, financial and management controls, reporting systems and procedures and manage a growing number of customer relationships.  We may not implement improvements to our management information and control

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systems in an efficient or timely manner and may discover deficiencies in existing systems and controls.  Consequently, any future growth may place a strain on our administrative and operational infrastructure.  Any such strain could increase our costs, reduce or eliminate our profitability and reduce the price at which our common shares trade.



New lines of business, and new products and services may result in exposure to new risks and the value and earnings related to existing lines of business are subject to market conditions. 



The Bank has introduced, and in the future, may introduce new products and services to differing markets either alone or in conjunction with third parties.  New lines of business, products or services could have a significant impact on the effectiveness of our system of internal controls or the controls of third parties and could reduce our revenues and potentially generate losses.  There are material inherent risks and uncertainties associated with offering new products and services, especially when new markets are not fully developed or when the laws and regulations regarding a new product are not mature.  New products and services, or entrance into new markets, may require substantial time, resources and capital, and profitability targets may not be achieved.  Factors outside of our control, such as developing laws and regulations, regulatory orders, competitive product offerings and changes in commercial and consumer demand for products or services may also materially impact the successful launch and implementation of new products or services.  Failure to manage these risks, or failure of any product or service offerings to be successful and profitable, could have a material adverse effect on our financial condition and results of operations.  Additionally, there are uncertainties regarding the market values of existing lines of business which are difficult to measure and are subject to market conditions which may change significantly.  We originate significant amounts of loans for sale or securitization in the CMBS markets which are subject to changes in market conditions at the time of sale, and the sales price realized may accordingly change significantly. Should planned sales of loans not take place, credit risks would increase, as loans would be held on the balance sheet as interest earning assets for longer periods. These loans are accounted for at market value, and a decrease in such value would reduce  income and might also impact potential sales, and resulting gains on sale. These loans  were underwritten as if they would be held on the balance sheet, to address the possibility of market disruptions delaying or precluding sales. Holding the loans on balance sheet would result in additional interest income, but might impact the level of new originations and future potential gain on sale.



Changes in interest rates and loan production could reduce our income, cash flows and asset values.



A significant portion of our income and cash flows depends on the difference between the interest rates we earn on interest earning assets, such as loans and investment securities, and the interest rates we pay on interest bearing liabilities such as deposits and borrowings.  The value of our assets, and particularly loans with fixed or capped rates of interest, may also vary with interest rate changes.  We discuss the effects of interest rate changes on the market value of our portfolio and net interest income in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Asset and Liability Management.” Interest rates are highly sensitive to many factors which are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve.  Changes in monetary policy, including changes in interest rates, will influence not only the interest we receive on our loans and investment securities and the amount of interest we pay on deposits, but also our ability to originate loans and obtain deposits and our costs in doing so.  If the rate of interest we pay on our deposits and other borrowings increases more than the rate of interest we earn on our loans and other investments, our net interest income, and therefore our earnings, could decline or we could sustain losses.  Our earnings could also decline or we could sustain losses if the rates on our loans and other investments fall more quickly than those on our deposits and other borrowings.  While the Bank is generally asset sensitive, which implies that significant increases in market rates would generally increase margins, while decreases in interest rates would generally decrease margins, we cannot assure you that increases or decreases in margins will follow such a pattern in the future.  Our net interest income is also determined by our level of loan production to replace loan payoffs and to grow our different loan portfolios. In the case of loans held-for-sale into secondary markets or securitizations, loans must be originated to replace loans sold to maintain related net interest income.  Loan demand may vary for economic and competitive reasons and we cannot assure you that historical rates of loan growth will continue or as to other loan production.  Net interest income is difficult to project, and our models for making such projections are theoretical.  While they may indicate the general direction of changes in net interest income, they do no indicate actual future results. In March 2020, the Federal Reserve instituted an emergency rate cut of 50 basis points, and additional rate cuts may still occur in response to economic and other conditions. These decreases will decrease net interest income, to the extent the reduction is not offset with the impact of loan growth.



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We are subject to lending risks.



There are risks inherent in making all loans.  These risks include interest rate changes over the time period in which loans may be repaid and changes in the national economy or local economies in which our borrowers operate.  Such changes may impact the ability of our borrowers to repay their loans or the value of the collateral securing those loans.  Although we have discontinued our Philadelphia-based commercial lending operations, we still hold a significant number of commercial, construction and commercial mortgage loans, some with relatively large balances.  The deterioration of one or a few of these loans would cause a significant increase in non-performing loans, notwithstanding that such loans are now held-for-sale.  Weak economic conditions have caused increases in our delinquent and defaulted loans in recent years.  We cannot assure you that we will not experience further increases in delinquencies and defaults or that any such increases will not be material.  On a consolidated basis, an increase in non-performing loans could result in an increase in our provision for loan losses or in loan charge-offs and consequent reductions in our earnings.  Our specialty lending operations are subject to additional risks including, with respect to our SBA loans, the risk that the U.S. Government’s partial guaranty on SBA loans is withdrawn due to noncompliance with regulations. For more information about the risks which are specific to the different types of loans we make and which could impact our allowance for loan losses, see Item 1,” Business –Lending Activities.”



There is a significant concentration in prepaid and debit card fee income which is subject to various risks.



We realize a significant portion of our revenues from prepaid and debit card and other prepaid products and services.   Actions by government agencies relating to service charges, or increased regulatory compliance costs, could result in reductions in income which may not be offset by reductions in expense.  Some of our clients have significant volume, the loss of which would materially affect our revenues. The top ten largest contributors to prepaid, debit card and related fees account for 63% of such fees.  Prepaid and debit card deposits comprise a significant portion of the Bank’s deposits.



Regulatory and legal requirements applicable to the prepaid and debit card industry are unique and frequently changing.



Achieving and maintaining compliance with frequently changing legal and regulatory requirements requires a significant investment in qualified personnel, hardware, software and other technology platforms, external legal counsel and consultants and other infrastructure components.  These investments may not ensure compliance or otherwise mitigate risks involved in this business.  Our failure to satisfy regulatory mandates applicable to prepaid financial products could result in actions against us by our regulators, legal proceedings being instituted against us by consumers, or other losses, each of which could reduce our earnings or result in losses, make it more difficult to conduct our operations, or prohibit us from conducting specific operations.  Other risks related to prepaid cards include competition for prepaid, debit and other payment mediums, possible changes in the rules of networks, such as Visa and MasterCard and others, in which the Bank operates and state regulations related to prepaid cards including escheatment.



The potential for fraud in the card payment industry is significant.



Issuers of prepaid  and debit cards and other companies have suffered significant losses in recent years with respect to the theft of cardholder data that has been illegally exploited for personal gain.  The theft of such information is regularly reported and affects individuals and businesses.  Losses from various types of fraud have been substantial for certain card industry participants.  The Bank in many cases has indemnification agreements with third parties; however, such indemnifications may not fully cover losses.  Although fraud has not had a material impact on the profitability of the Bank, it is possible that such activity could impact the Bank in the future.



Risk management processes and strategies must be effective, and concentration of risk increases the potential for losses.



Our risk management processes and strategies must be effective, otherwise losses may result.  We manage asset quality, liquidity, market sensitivity, operational, regulatory, third-party vendor and partner relationship risks and other risks through various processes and strategies throughout the organization.  If our risk management judgments and strategies are not effective, or unanticipated risks arise, our income could be reduced or we could sustain losses.



We may depend in part upon wholesale and brokered certificates of deposit to satisfy funding needs.



We may rely in part on funds provided by wholesale deposits and brokered certificates of deposit to support the growth of our loan portfolio.  Wholesale and brokered certificates of deposit are highly sensitive to changes in interest rates and, accordingly, can be a more volatile source of funding.  Use of wholesale and brokered deposits involves the risk that growth supported by such

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deposits would be halted, or the Bank’s total assets could contract, if the rates offered by the Bank were less than those offered by other institutions seeking such deposits, or if the depositors were to perceive a decline in the Bank’s safety and soundness, or both.  In addition, if we were unable to match the maturities of the interest rates we pay for wholesale and brokered certificates of deposit to the maturities of the loans we make using those funds, increases in the interest rates we pay for such funds could decrease our consolidated net interest income.  Moreover, if the Bank ceases to be categorized as “well capitalized” under banking regulations, it will be prohibited from accepting, renewing or rolling over brokered deposits without the consent of the FDIC. 



Our prepaid and debit card and other deposit accounts obtained with the assistance of third parties have been classified as brokered. 



In December 2014, the FDIC issued new guidance classifying prepaid deposit accounts and other deposit accounts obtained in cooperation with third parties as brokered, resulting in the vast majority of the Bank’s deposits being classified as brokered.  We do not believe that these deposits are subject to the volatility risks associated with brokered wholesale deposits or brokered certificates of deposit.  However, if the Bank ceases to be categorized as “well capitalized” under banking regulations, it will be prohibited from accepting, renewing or rolling over brokered deposits without the consent of the FDIC.  In such a case, the FDIC’s refusal to grant consent to our accepting, renewing or rolling over brokered deposits could effectively restrict or eliminate the ability of the Bank to operate its business lines as presently conducted.



We operate in highly competitive markets.



We face substantial competition in all phases of our operations from a variety of different competitors, including commercial banks and their holding companies, credit unions, leasing companies, consumer finance companies, factoring companies, insurance companies and money market mutual funds and card issuers. In 2018, the Office of the Comptroller of the Currency announced that it would begin to accept and evaluate charters for entities that wanted to conduct certain components of a banking business pursuant to a federal charter, known as a "special purpose national bank" ("SPNB") charter.  Intended to promote economic opportunity and spur financial innovation, SPNBs may engage in any of the following activities: paying checks, lending money or taking deposits.  If any such applications are granted, recipients of an SPNB charter may enter the U.S. payments market in which the Bank operates, which could have a material adverse effect on the Bank and its Payments division.

We face national and even global competition with respect to our other products and services, including payment acceptance products and services, private label banking, fleet leasing, government guaranteed lending and  payment solutions.  Our commercial partners and banking customers for these products and services are located throughout the United States, and the competition is strong in each category.  We encounter competition from some of the largest financial institutions in the world as well as smaller specialized regional banks and financial service companies.  Increased competition with any of these product or service offerings could result in reduced pricing and lower profit margins, fragmented market share and a failure to enjoy economies of scale, loss of customer and depositor base, and other risks that individually, or in the aggregate, could have a material adverse effect on our financial condition and results of operations.

Some of the financial services organizations with which we compete are not subject to the same degree of regulation as federally-insured and regulated financial institutions such as ours.  As a result, those competitors may be able to access funding and provide various services more easily or at less cost than we can.

We derive a significant percentage of our deposits, total assets and income from deposit accounts generated with the assistance of diverse independent companies, including those which provide card account marketing services, and investment advisory firms. 



Deposit accounts acquired with the assistance of our top twenty affinity relationships totaled $4.21 billion at December 31, 2019.  The top twenty relationships result in the majority of our payments related income.  We provide oversight over these relationships which must meet all internal and regulatory requirements.  We may exit relationships where such requirements are not met or be required by our regulators to exit such relationships.  Also, an affinity group could terminate a relationship with us for many reasons, including being able to obtain better terms from another provider or dissatisfaction with the level or quality of our services.  If an affinity group relationship were to be terminated, it could materially reduce our deposits, assets and income.  We cannot assure you that we could replace such relationship.  If we cannot replace such relationship, we may be required to seek higher rate funding sources as compared to the exiting affinity group and interest expense might increase.  We may also be required to sell securities or other assets to meet funding needs which would reduce revenues or potentially generate losses.

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Our affinity group marketing strategy has been adopted by other institutions with which we compete.

Several online banking operations as well as the online banking programs of conventional banks have instituted affinity group marketing strategies similar to ours.  As a consequence, we have encountered competition in this area and anticipate that we will continue to do so in the future.  This competition may increase our costs, reduce our revenues or revenue growth or, because we are a relatively small banking operation without the name recognition of other, more established banking operations, make it difficult for us to compete effectively in obtaining affinity group relationships.

Our lending limit may adversely affect our competitiveness.

Our regulatory lending limit as of December 31, 2019 to any one customer or related group of customers was $71.7 million for unsecured loans and $119.5 million for secured loans.  Our lending limit is substantially smaller than that of many financial institutions with which we compete.  While we believe that our lending limit is sufficient for our targeted market of small to mid-size businesses within the four specialty lending operations upon which we focus as well as affinity group members, it may in the future affect our ability to attract or maintain customers or to compete with other financial institutions.  Moreover, to the extent that we incur losses and do not obtain additional capital, our lending limit, which depends upon the amount of our capital, will decrease.

Environmental liability associated with lending activities could result in losses.

In the course of our business, we may foreclose on and take title to properties securing our loans.  If hazardous substances were discovered on any of these properties, we may be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage.  Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination.  In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site, even if we neither own nor operate the disposal site.  Environmental laws may require us to incur substantial expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure.  In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.

As a financial institution whose principal medium for delivery of banking services is the internet, we are subject to risks particular to that medium and other technological risks and costs.

We utilize the internet and other automated electronic processing in our banking services without physical locations, as distinguished from the internet banking service of an established conventional bank.  Independent internet banks often have found it difficult to achieve profitability and revenue growth.  Several factors contribute to the unique problems that internet banks face.  These include concerns for the security of personal information, the absence of personal relationships between bankers and customers, the absence of loyalty to a conventional hometown bank, the customer’s difficulty in understanding and assessing the substance and financial strength of an Internet bank, a lack of confidence in the likelihood of success and permanence of internet banks and many individuals’ unwillingness to trust their personal assets to a relatively new technological medium such as the internet.  As a result, many potential customers may be unwilling to establish a relationship with us.

Many conventional financial institutions offer the option of internet banking and financial services to their existing and prospective customers.  The public may perceive conventional financial institutions as being safer, more responsive, more comfortable to deal with and more accountable as providers of their banking and financial services, including their internet banking services.  We may not be able to offer internet banking and financial services and personal relationship characteristics that have sufficient advantages over the internet banking and financial services and other characteristics of established conventional financial institutions to enable us to compete successfully.

Moreover, both the internet and the financial services industry are undergoing rapid technological changes, with frequent introductions of new technology-driven products and services.  In addition to improving the ability to serve customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs.  Our ability to compete will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations.  Many of our competitors have substantially greater resources to

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invest in technological improvements.  We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.  Such products may also prove costly to develop or acquire.

We face fund transfer and payments-related reputational risks.

Financial institutions, including ourselves, bear fund transfer risks of different types which result from large transaction volumes and large dollar amounts of incoming and outgoing money transfers.  Loss exposure may result if money is transferred from the bank before it is received, or legal rights to reclaim monies transferred are asserted.  Such exposure results from payments which are made to merchants for payment clearing, while customers have statutory periods to reverse their payments. It also results from funds transfers made prior to receipt of offsetting funds, as accommodations to customers.  Transfers could also be made in error.  Additionally, as with other financial institutions, we may incur legal liability or reputational risk, if we unknowingly process payments for companies in violation of money laundering laws or regulations or immoral activities.

Our operations may be interrupted if our network or computer systems, or those of our providers, fail.

Because we deliver our products and services over the internet and outsource several critical functions to third parties, our operations depend on our ability, as well as that of our service providers, to protect computer systems and network infrastructure against interruptions in service due to damage from fire, power loss, telecommunications failure, physical break-ins and computer hacking or similar catastrophic events.  Our operations also depend upon our ability to replace a third-party provider if it experiences difficulties that interrupt our operations or if an operationally essential third-party service terminates.  Service interruptions to customers may adversely affect our ability to obtain or retain customers and could result in regulatory sanctions.  Moreover, if a customer were unable to access his or her account or complete a financial transaction due to a service interruption, we could be subject to a claim by the customer for his or her loss.  While our accounts and other agreements contain disclaimers of liability for these kinds of losses, we cannot predict the outcome of litigation if a customer were to make a claim against us.

A failure of cyber security may result in a loss of customers and our being liable for damages for such failure.

A significant barrier to online and other financial transactions is the secure transmission of confidential information over public networks and other mediums.  The systems we use rely on encryption and authentication technology to provide secure transmission of confidential information.  Advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms used to protect customer transaction data.  If we, or another provider of financial services through the internet, were to suffer damage from a security breach, public acceptance and use of the internet as a medium for financial transactions could suffer.  Any security breach could deter potential customers or cause existing customers to leave, thereby impairing our ability to grow and maintain profitability and, possibly, our ability to continue delivering our products and services through the internet.  We could also be liable for any customer damages arising from such a breach.  Other cyber threats involving theft of confidential information could also result in liability.  Although we, with the help of third-party service providers, intend to continue to implement security technology and establish operational procedures to prevent security breaches, these measures may not be successful.

We outsource many essential services to third-party providers who may terminate their agreements with us, resulting in interruptions to our banking operations.

We obtain essential technological and customer services support for the systems we use from third-party providers.  We outsource our check processing, check imaging, transaction processing, electronic bill payment, statement rendering, and other services to third-party vendors.  For a description of these services, see Item 1, “Business—Other Operations—Third-Party Service Providers.” Our agreements with each service provider are generally cancelable without cause by either party upon specified notice periods.  If one of our third-party service providers terminates its agreement with us and we are unable to replace it with another service provider, our operations may be interrupted.  Even a temporary disruption in services could result in our losing customers, incurring liability for any damages our customers may sustain, or losing revenues.    Moreover, there can be no assurance that a replacement service provider will provide its services at the same or a lower cost than the service provider it replaces.

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We may be affected by government regulation including those mandating capital levels and those specifying limitations resulting from Community Reinvestment Act ratings.

We are subject to extensive federal and state banking regulation and supervision, which has increased in the past several years as a result of stresses the financial system has undergone for an extended period of years.  The regulations are intended primarily to protect our depositors’ funds, the federal deposit insurance fund and the safety and soundness of the Bank, not our stockholders. Regulatory requirements affect lending practices, product offerings, capital structure, investment practices, dividend policy and growth.   Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices.  The capital amounts and classification of us and the Bank are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Moreover, capital requirements may be modified based upon regulatory rules or by regulatory discretion at any time reflecting a variety of factors including deterioration in asset quality.  A failure by either the Bank or us to meet regulatory capital requirements will result in the imposition of limitations on our operations and could, if capital levels drop significantly, result in our being required to cease operations.  Regulatory capital requirements must also be satisfied such that mandated capital ratios are maintained as the Bank grows, or growth may be required to be curtailed.  Moreover, a failure by either the Bank or us to comply with regulatory requirements regarding lending practices, investment practices, customer relationships, anti-money laundering detection and prevention, and other operational practices (see "Business--Regulation Under Banking Law" and “Risk Factors- The entry into the Consent Orders and a supervisory letter from the Federal Reserve, have imposed certain restrictions and requirements upon us and the Bank”) could result in regulatory sanctions and possibly third-party liabilities.  Changes in governing law, regulations or regulatory practices could impose additional costs on us or impair our ability to obtain deposits or make loans and, as a consequence, negatively impact our consolidated revenues and profitability.

As a Delaware-chartered bank whose depositors and financial services customers are located in several states, the Bank may be subject to additional licensure requirements or other regulation of its activities by state regulatory authorities and laws outside of Delaware.  If the Bank’s compliance with licensure requirements or other regulation becomes overly burdensome, we may seek to convert its state charter to a federal charter in order to gain the benefits of federal preemption of some of those laws and regulations. Conversion of the Bank to a federal charter will require the prior approval of the relevant federal bank regulatory authorities, which we may not be able to obtain.  Moreover, even if we obtain approval, there could be a significant period of time between our application and receipt of the approval, and/or any approval we do obtain may be subject to burdensome conditions or restrictions.

Failure to maintain a satisfactory CRA rating may result in business restrictions.  The Bank operates its CRA program under an FDIC-approved CRA Strategic Plan.  The Bank operated an approved plan during the period of July 1, 2018 through December 31, 2019 and now operates under an approved plan for the period of January 1, 2020 through December 31, 2020.  On July 3, 2019, the Bank received its 2018 CRA Performance Evaluation which was completed on November 11, 2018.  The Bank was assigned a “Satisfactory” CRA rating.  The Bank continues to closely monitor its performance in alignment with its CRA Strategic Plan to meet the specified lending, service and investment requirements contained therein.  There can be no assurance that we will maintain a satisfactory rating, and if not maintained, the Bank would be subject to certain business restrictions as required by the Community Reinvestment Act and FDIC regulations. 



 Implemented, proposed and future regulatory and legislative financial reforms may result in new laws and regulations that we expect will increase our compliance burdens and operating costs.



The passage of new laws and the adoption of new rules and regulations cannot be fully or accurately predicted.  Any such proposed laws and regulations may limit our operations, require higher levels of capital and liquidity, create additional compliance burdens, or otherwise impact our operations.  The passage of the Dodd-Frank Act in 2010, and the rules and regulations emanating therefrom, have significantly changed, and will continue to change the bank regulatory structure, and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress.  While a significant number of regulations have already been promulgated to implement the Dodd-Frank Act, many of the details and much of the impact of the Dodd-Frank Act may not be known for lengthy periods, which could have a material adverse effect on the financial services industry, generally, and our company in particular.

The Dodd-Frank Act’s “Durbin Amendment,” which applies to all banks, required the Federal Reserve to adopt a rule establishing debit card interchange fee standards and limits and prohibiting network exclusivity and routing requirements.  The Dodd-

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Frank Act exempts from the debit card interchange fee standards any issuing bank that, together with its affiliates, have assets of less than $10 billion.  Because of our asset size, we are exempt from the debit card interchange fee standards but may lose the exemption if it is amended or we, together with our subsidiaries, surpass $10 billion in assets.

The Federal Reserve has implemented routing regulatory requirements to prohibit network exclusivity arrangements on debit card transactions and ensure merchants will have choices in debit card routing, which apply to us.  The regulations require issuers to make at least two unaffiliated networks available to the merchant, without regard to the method of authentication (PIN or signature), for both debit cards and prepaid cards.  As currently applied, a card issuer can guarantee compliance with the network exclusivity regulations by enabling the debit card to process transactions through one signature network and one unaffiliated PIN network.  Cards usable only with PINs must be enabled with two unaffiliated PIN networks.

On March 21, 2014, the United States Court of Appeals for the District of Columbia Circuit upheld the Federal Reserve’s rules on network exclusivity and interchange fees as written and thereby rejected a challenge brought by a group of merchant trade associations.  On January 21, 2015, the Supreme Court of the United States declined to take an appeal filed by the plaintiff merchant trade associations, effectively ending the litigation and upholding the Federal Reserve’s final rules regarding network exclusivity and interchange fees as written.



It is difficult to predict at this time what specific impact many aspects of the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on regional banks. The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 scaled back portions of the Dodd-Frank Act, and the current administration in the United States may ultimately roll back or modify certain of the regulations adopted since the financial crisis.  However, future changes in bank regulation are uncertain and could negatively impact our business and could increase our operating and compliance costs and obligations, which could reduce or eliminate our ability to generate profits.



The CFPB’s Final Prepaid Rule went into effect on April 1, 2019.  The Final Prepaid Rule represents a material change in the rules and regulations governing prepaid cards.  We rely on prepaid cards as the largest single component of our deposits and the largest single component of our non-interest income.  We cannot reasonably quantify the financial impact, if any, that implementation of the Final Prepaid Rule may have on the Bank’s business, financial condition, or results of operations.

A further downgrade of the U.S. government credit rating could negatively impact our investment portfolio and other operations. 

A significant amount of our investment portfolio is rated by outside ratings agencies as explicitly or implicitly backed by the United States government.  In 2011, the credit rating of the United States government was lowered, and it is possible it may be downgraded further, based upon rating agencies’ evaluations of the effect of increasing levels of government debt and related Congressional actions.  A lowering of the United States government credit ratings may reduce the market value or liquidity of our investment portfolio.

Potential acquisitions may disrupt our business and dilute stockholder value.  



Acquiring other banks or businesses involves various risks including, but not limited to:



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From time to time we evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies.  As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving cash, debt or equity securities may occur at any time.  Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of our tangible book value and net income per common share may occur in connection with any future transaction.  Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on our financial condition and results of operations.  The Consent Orders likely constrain us from making acquisitions.



We may be subject to potential liability and business risk from actions by our regulators related to supervision of third parties.



Our regulators or auditors may require us to increase the level and manner of our oversight of the third parties which provide marketing services which generate most of our accounts and through which we offer products and services.  Although we have added significant compliance staff and have used outside consultants, our internal and external compliance examiners must be satisfied with the results of such augmentation and enhancement.  We cannot assure you that we will satisfy all related requirements.  See “Risk Factors   The entry into the Consent Orders and a supervisory letter from the Federal Reserve, have imposed certain restrictions and requirements upon us and the Bank”.  Not achieving a compliance management system which is deemed adequate could result in sanctions against the Bank.  Our ongoing review and analysis of our compliance management system and implementation of any changes resulting from that review and analysis will likely result in increased non-interest expense.



The Bank may be subject to civil money penalties in connection with examination findings.

 

Like all regulated banking institutions, we are at risk of the imposition of civil money penalties by our regulators, based on, among other things, apparent violations of law, repeat violations, or supervisory determinations of non-compliance with any consent order.  Depending on the circumstances, the imposition and size of any such penalty is at the discretion of the regulator.  While the Bank is contractually indemnified for related losses, civil money penalties, if assessed against the Bank, are not recoverable from third parties. 



We are subject to tax audits, and challenges to our tax positions or adverse changes or interpretations of tax laws could result in tax liability.



We are subject to federal and applicable state income tax laws and regulations and related audits.  We are also periodically subject to state escheat audits.  Income tax and escheat laws and regulations are often complex and require significant judgment in determining our effective tax rate and in evaluating our tax positions.  Challenges of such determinations may adversely affect our effective tax rate, tax payments or financial condition.



Recently enacted U.S. tax legislation made significant changes to federal tax law, including the taxation of corporations, by, among other changes, reducing the corporate income tax rate, disallowing certain deductions that had previously been allowed, and altering the expensing of capital expenditures.  The implementation and evaluation of these changes may require significant judgment and substantial planning on our behalf.  These judgments and plans may require us to take new and different tax positions that if challenged could adversely affect our effective tax rate, tax payments or financial condition.

 

In addition, the new tax legislation remains subject to potential amendments, technical corrections, and further regulatory guidance and interpretation, any of which could lessen or increase certain adverse impacts on us.  Furthermore, as the new tax legislation goes into effect, future changes may occur at the federal or state level that could result in unfavorable adjustments to our tax liability.



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The appraised fair value of the assets from our discontinued commercial loan operations may be more than the amounts received upon sale or other disposition.



Various internal and external inputs were utilized to analyze fair value of the discontinued commercial loan portfolio and the investment in unconsolidated entity which reflects the financing of the securitization of a portion of the discontinued assets.  The valuations are estimates and actual sales prices could be significantly less than the estimates, which could materially affect our results of operations in future quarters.



We cannot predict whether income resulting from the reinvestment of proceeds from the loans we hold will match or exceed the income from loan dispositions.



We are seeking to sell or otherwise dispose of the loans in our discontinued commercial loan operations and expect that we will obtain a significant amount of cash from these dispositions.  Although we believe, based upon current market conditions, that we will be able to invest such proceeds profitably, reinvestment income is difficult to predict and depends upon a number of economic and market conditions beyond our control, including interest rates and the availability of suitable investments.  We cannot assure you that we will be able to generate the same level of income from the reinvested proceeds as we generated from the loan portfolio being sold, or that suitable investments will be available to us.  If not, our revenues and net income could be reduced materially.



Any future FDIC insurance premium increases will adversely affect our earnings.

   

Any further assessments or special assessments that the FDIC levies will be recorded as an expense during the appropriate period and will decrease our earnings.  On February 9, 2011, the FDIC adopted a final rule which redefines the deposit insurance assessment base as required by the Dodd-Frank Act.  The final rule sets the deposit insurance assessment base as average consolidated total assets minus average tangible equity.  It also sets a new assessment rate schedule which reflects assessment rate adjustments based upon regulatory examination classification with increased rates for brokered deposits.  The final rule became effective on April 1, 2011.  If the Bank’s rating is changed, insurance premiums will increase which will adversely affect our earnings. 



We have had material weaknesses in internal control over financial reporting in the past and cannot assure you that additional material weaknesses will not be identified in the future. Our failure to implement and maintain effective internal control over financial reporting could result in material misstatements in our financial statements which could require us to restate financial statements, cause investors to lose confidence in our reported financial information and have a negative effect on our stock price.



As previously reported, our management had identified material weaknesses in our internal and disclosure controls over financial reporting that resulted in a restatement of our financial statements in 2014 for that year and for prior periods.  These weaknesses related to the timing of the recognition of loan losses and the recognition of other loan losses.  We believe these weaknesses have been remediated.  However, we cannot assure you that additional significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified in the future.  Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in additional material weaknesses, cause us to fail to meet our periodic reporting obligations or result in material misstatements in our financial statements.  Any such failure could also adversely affect the results of periodic management evaluations and annual auditor attestation reports regarding the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgated under Section 404.  The existence of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements, cause us to fail to meet our reporting obligations and cause investors or customers to lose confidence in our reported financial information, leading to a decline in our stock price or a loss of business, and could result in stockholder actions against us for damages. 



Unclaimed funds from deposit accounts or represented by unused value on prepaid cards present compliance and other risks.



Unclaimed funds held in deposit accounts or represented by unused balances on prepaid cards may be subject to state escheatment laws where the Bank is the actual holder of the funds and when, after a period of time as set forth in applicable state law, the rightful owner of the funds cannot be readily located and/or identified. The Bank implements controls to comply with state unclaimed property laws and regulations, however these laws and regulations are often open to interpretation, particularly when being applied to unused balances on prepaid card products.  State regulators may choose to initiate collection or other litigation action against the Bank for unreported abandoned property, and such actions may seek to assess fines and penalties.



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A prolonged U.S. government shutdown or default by the U.S. on government obligations could harm our results of operations.



Our results of operations, including revenue, non-interest income, expenses and net interest income, could be adversely affected in the event of widespread financial and business disruption due to a default by the United States on U.S. government obligations or a prolonged failure to maintain significant U.S. government operations, particularly those pertaining to the SBA.  Any such failure to maintain such U.S. government operations would impede our ability to originate SBA loans and our ability to sell such loans. 



Severe weather, natural disasters, acts of war or terrorism or other adverse external events could harm the Company's business.



Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business. The nature and level of severe weather and/or natural disasters cannot be predicted and may be exacerbated by global climate change. Severe weather and natural disasters could harm our operations through interference with communications, including the interruption or loss of our computer systems, which could prevent or impede us from gathering deposits, originating loans and processing and controlling the flow of business, as well as through the destruction of facilities and our operational, financial and management information systems. Additionally, the United States remains a target for potential acts of war or terrorism. Such severe weather, natural disasters, acts of war or terrorism or other adverse external events could negatively impact our business operations or the stability of our deposit base, cause significant property damage, adversely impact the values of collateral securing our loans and/or interrupt our borrowers' abilities to conduct their business in a manner to support their debt obligations, which could result in losses and increased provisions for credit losses. There is no assurance that our business continuity and disaster recovery program can adequately mitigate the risks of such business disruptions and interruptions.



Pandemic events could have a material adverse effect on our operations and our financial condition.



The outbreak of disease on a 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.  Such an event may also impact our ability to manage those portions of our business or operations which rely on vendors and suppliers from other countries or regions impacted by such a pandemic event.



We may be adversely impacted by the transition from LIBOR as a reference rate.



In July 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021, and for LIBOR to be replaced with an alternative reference rate that will be calculated in a different manner. Consequently, at this time, it is not possible to predict whether and to what extent banks will continue to provide submissions for the calculation of LIBOR. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes in views or alternatives may be on the markets for LIBOR-indexed financial instruments. Substantially all of our commercial mortgages held for sale are indexed to LIBOR. Additionally, the interest rates of certain of our investment securities and our trust preferred securities are indexed to LIBOR. The transition from LIBOR could create considerable costs and additional risk. Since proposed alternative rates are calculated differently, payments under contracts referencing new rates will differ from those referencing LIBOR. The transition will change our market risk profiles, requiring changes to risk and pricing models, valuation tools, product design and hedging strategies. Furthermore, failure to adequately manage this transition process with our customers could adversely impact our reputation. Although we are currently unable to assess what the ultimate impact of the transition from LIBOR will be, failure to adequately manage the transition could have a material adverse effect on our business, financial condition and results of operations.



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Risks related to ownership of our common stock.



The trading volume in our common stock is less than that of many financial services companies, which may reduce the price at which our common stock would otherwise trade.



Although our common stock is traded on The NASDAQ Global Select Market, the trading volume is less than that of many financial services companies.  A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time.  This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control.  Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall.



An investment in our common stock is not an insured deposit.



Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity.  Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and is subject to the same market forces that affect the price of common stock in any company.  As a result, if you acquire our common stock, you may lose some or all of your investment.



Our ability to issue additional shares of our common stock, or the issuance of such additional shares, may reduce the price at which our common stock trades.



We cannot predict whether future issuances of shares of our common stock or the availability of shares for resale in the open market will decrease the market price per share of our common stock.  We are not restricted from issuing additional shares of common stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive shares of common stock.  Sales of a substantial number of shares of our common stock in the public market or the perception that such sales might occur could materially adversely affect the market price of the shares of our common stock.  The exercise of any options granted to directors, executive officers and other employees under our stock compensation plans, the vesting of restricted stock grants, the issuance of shares of common stock in acquisitions and other issuances of our common stock also could have an adverse effect on the market price of the shares of our common stock.  The existence of options, or shares of our common stock reserved for issuance as restricted shares of our common stock may materially adversely affect the terms upon which we may be able to obtain additional capital in the future through the sale of equity securities. 

 

Future offerings of debt, which would be senior to our common stock upon liquidation, and/or preferred equity securities which may be senior to our common stock for purposes of dividend distributions or upon liquidation, may reduce the market price at which our common stock trades.



In the future, we may attempt to increase our capital resources or, if the Bank’s capital ratios fall below the required minimums, we could be forced to raise additional capital by making additional offerings of debt or preferred equity securities, including medium-term notes, senior or subordinated notes or preferred stock.  Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive distributions of our available assets prior to the holders of our common stock.  Holders of our common stock are not entitled to preemptive rights or other protections against dilution.



The Bank’s ability to pay dividends is subject to regulatory limitations which, to the extent we require such dividends in the future, may affect our ability to pay our obligations and pay dividends.



We are a separate legal entity from the Bank and our other subsidiaries, and we do not have significant operations of our own.  We have historically depended on the Bank’s cash and liquidity, as well as dividends, to pay our operating expenses.  Various federal and state statutory provisions limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval.  The Bank is also subject to limitations under state law regarding the payment of dividends, including the requirement that dividends may be paid only out of net profits.  In addition to these explicit limitations, it is possible, depending upon the financial condition of the Bank and other factors, that federal and state regulatory agencies could take the position that payment of dividends by the Bank would constitute an unsafe or unsound banking practice and may therefore seek to prevent the Bank from paying such dividends.  Moreover, under the 2014 Consent Order Amendment, the Bank may not pay dividends without the approval of the FDIC.  See “Risk Factors-Risks Relating to Our Business-The entry into the Consent has imposed certain restrictions and requirements upon us and the Bank.”  Although we believe we have sufficient existing liquidity for our needs for the foreseeable

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future, there is risk that, if the amendment remains undischarged for a lengthy period and the Bank is unable to obtain FDIC approval for one or more dividends, we may not be able to service our obligations as they become due or to pay dividends on our common stock or preferred stock.  Even if, absent the amendment, the Bank has the capacity to pay dividends, it is not obligated to pay the dividends.  Its Board of Directors may determine, as it did in the past, to retain some or all of its earnings to support or increase its capital base. 



Anti-takeover provisions of our certificate of incorporation, bylaws and Delaware law may make it more difficult for holders of our common stock to receive a change in control premium.



Certain provisions of our certificate of incorporation and bylaws could make a merger, tender offer or proxy contest more difficult, even if such events were perceived by many of our stockholders as beneficial to their interests.  These provisions include in particular our ability to issue shares of our common stock and preferred stock with such provisions as our board of directors may approve without further shareholder approval.  In addition, as a Delaware corporation, we are subject to Section 203 of the Delaware General Corporation Law which, in general, prevents an interested stockholder, defined generally as a person owning 15% or more of a corporation’s outstanding voting stock, from engaging in a business combination with our company for three years following the date that person became an interested stockholder unless certain specified conditions are satisfied.



Item 1B. Unresolved Staff Comments.



None.



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Item 2. Properties.  

Our executive office and banking facility are located at 409 Silverside Road, Wilmington, Delaware.  We maintain business development offices in New York, New York, Chicago, Illinois, and Morrisville, North Carolina.  Leasing offices are located in Charlotte, North Carolina, Crofton, Maryland, Kent, Washington, Logan, Utah, Orlando, Florida, Raritan, New Jersey, and Warminster, Pennsylvania.  Prepaid and debit card offices and other executive offices are located in Minneapolis, Minnesota, and Sioux Falls, South Dakota.  The Philadelphia, Pennsylvania, Tampa, Florida and a portion of the New York properties are no longer occupied by the Company, and have been subleased to outside parties, which pay the majority of the rent.  Locations and certain additional information regarding our offices and other material properties at December 31, 2019 are listed below.  We own a property in Orlando, Florida which houses our leasing operations business, consisting of a stand-alone building of 8,850 square feet. 

We believe that our offices are suitable and adequate for our operations.

Item 3. Legal Proceedings.  



For a discussion of the Consent Orders issued by the FDIC to the Bank and a supervisory letter the Company received from the Federal Reserve, see Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations- Regulatory Actions” and “Risk Factors- Risks relating to Our Business, the entry into the Consent Orders and a supervisory letter from the Federal Reserve, have imposed certain restrictions and requirements upon us and the Bank.”



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The Company received a subpoena from the SEC, dated March 22, 2016, relating to an investigation by the SEC of the Company's restatement of its financial statements for the years ended December 31, 2010 through December 31, 2013 and the interim periods ended March 31, 2014, June 30, 2014 and September 30, 2014, which restatement was filed with the SEC on September 28, 2015, and the facts and circumstances underlying the restatement.  On September 19, 2019, the Company agreed, without admitting or denying any of the SEC’s allegations, to resolve the investigation by consenting to the entry of an order by the SEC that: (1) the Company will cease and desist from committing or causing any violations of the books-and-records provisions of the Securities Exchange Act and the relevant rules thereunder; and (2) the Company will pay a penalty of $1.4 million (the “Settlement Payment”) to the SEC.  The Company recognized a charge in its third fiscal quarter in the amount of the Settlement Payment.  As a result of the settlement certain costs to the Company related to the investigation will cease, including the legal costs of the investigation, compliance with the SEC’s subpoena, and cooperation with the SEC.



On July 16, 2018, certain investors in a hotel project of one of the Bank’s former borrowers, 550 Seabreeze Development LLC (“Seabreeze Development”), filed an adversary action against the Bank and others in the United States Bankruptcy Court of the Southern District of Florida. The note for the related loan was sold in the second quarter of 2018 and the loan is no longer on the Bank’s books. The adversary action was filed within the context of a Chapter 11 bankruptcy proceeding in which Seabreeze Development is the debtor, and alleged that the Bank and others defrauded the plaintiffs into investing a total of $10.5 million in the project.  Three causes of actions were asserted against the Bank: (i) fraud in the inducement; (ii) civil conspiracy; and (iii) aiding and abetting fraud.  The Bank believed the claims were without merit and vigorously defended against them.  On November 1, 2018, the bankruptcy court entered an order dismissing the claims against the Bank for lack of jurisdiction.  The order further stated that the dismissal was without prejudice, and that the plaintiffs may file their causes of action in an appropriate forum.  On February 7, 2019, certain investors filed a new action in the Circuit Court of the 11th Judicial Circuit in and for Miami-Dade Country, Florida, asserting: (i) fraudulent misrepresentation; (ii) negligent misrepresentation; (iii) aiding and abetting fraud; and (iv) civil conspiracy.  Three additional investors were included as plaintiffs in the matter, increasing the total amount at issue to $12 million.  The Bank filed a motion to dismiss the state court action as to the Bank and on October 16, 2019, the state court granted the Bank’s motion and dismissed the plaintiffs’ claims against the Bank without prejudice.



On June 12, 2019, the Bank was served with a qui tam lawsuit filed in the Superior Court of the State of Delaware, New Castle County.  The Delaware Department of Justice intervened in the litigation.  The case is titled The State of Delaware, Plaintiff, Ex rel. Russell S. Rogers, Plaintiff-Relator, v. The Bancorp Bank, Interactive Communications International, Inc., and InComm Financial Services, Inc., Defendants.  The lawsuit alleges that the defendants violated the Delaware False Claims Act by not paying balances on certain open-loop “Vanilla” prepaid cards to the State of Delaware as unclaimed property.  The complaint seeks actual and treble damages, statutory penalties, and attorneys’ fees.  The Bank denies the allegations and is defending itself.  The Bank and other defendants filed a motion to dismiss the action, but the motion was denied on February 7, 2020.  At this time, the Company is unable to determine whether the ultimate resolution of the matter will have a material adverse effect on our financial condition or operations.



In addition, we are a party to various routine legal proceedings arising out of the ordinary course of our business.  Management believes that none of these actions, individually or in the aggregate, will have a material adverse effect on our financial condition or operations.

Item 4. Mine Safety Disclosures.

Not applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.



Our common stock trades on the NASDAQ Global Select Market under the symbol “TBBK.” As of February 20, 2020, there were 57,385,556 shares of common stock outstanding held of record by 5,414 shareholders.



We have not paid cash dividends on our common stock since our inception, and do not currently have plans to pay cash dividends on our common stock.  Our payment of dividends is subject to restrictions discussed in Item 1, “Business—Regulation under Banking Law,” and in Item 1A, “Risk Factors-Risks Relating to Our Business-The entry into the Consent Orders and a supervisory letter from the Federal Reserve, have imposed certain restrictions and requirements upon us and the Bank.”  Moreover, irrespective of such restrictions, it is our intent to retain earnings, if any, to increase our capital and fund the development and growth

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of our operations subject to regulatory restrictions. Our board of directors will determine any changes in our dividend policy based upon its analysis of factors it deems relevant.  We expect that these factors would include our earnings, financial condition, cash requirements, regulatory capital levels and available investment opportunities. 



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Performance graph 



The following graph compares the performance of our common stock to the NASDAQ Composite Index and the NASDAQ Bank Stock Index.  The graph shows the value of $100 invested in our common stock and both indices on December 31, 2014 for a five-year period and the change in the value of our common stock compared to the indices as of the end of each year.  The graph assumes the reinvestment of all dividends.  Historical stock price performance is not necessarily indicative of future stock price performance.











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The following graph reflects stock performance since 2014, compared to the KBW bank index, which is an industry recognized peer group of regional and money center banks.

































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Item 6. Selected Financial Data.



The following table sets forth selected financial data as of and for the years ended December 31, 2019, 2018, 2017, 2016 and 2015.  We derived the selected financial data from our consolidated financial statements for those periods included in this annual report on Form 10-K or our prior annual reports on Form 10-K.  We have reclassified certain amounts in our historical audited consolidated financial statements, including amounts related to assets and liabilities reclassified as held-for-sale during these periods.  These reclassifications had no effect on our reported net income (loss).  



You should read the selected financial data in this table together with, and such selected financial data is qualified by reference to, our consolidated financial statements and the notes to those restated consolidated financial statements in Item 8 of this report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this report.







































Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.



The following discussion provides information to assist in understanding our financial condition and results of operations. This discussion should be read in conjunction with our consolidated financial statements and related notes appearing in Item 8 of this report.

Overview

In 2019, we recorded net income of $51.3 million and income before tax of $72.5 million in continuing operations compared to $87.5 million and $119.8 million, respectively, in 2018.  The decrease in income before tax of $47.3 million reflected a $65.0 million gain on sale of the Safe Harbor Individual Retirement Account (SHIRA) portfolio in 2018.  The decrease also reflected civil money penalties of $7.5 million to the FDIC and $1.4 million to the SEC in 2019.  After adjusting for the civil money penalties and gain on sale, income before tax of $81.4 million in 2019 was $26.6 million, or 48.6%, higher than the $54.8 million for 2018.  The $26.6 million increase reflected a $20.4 million, or 16.9%, increase in net interest income and a $15.3 million, or 17.3%  increase in non-interest income, excluding the SHIRA gain on sale.  These increases were partially offset with an $8.3 million, or 5.5%, increase in non-interest expense, excluding the civil money penalties.  The increase in net interest income primarily reflected the impact of higher balances of commercial real estate loans held for sale and other loan growth and higher loan yields resulting from Federal Reserve rate increases in 2018.  The impact of the prior year rate increases was partially offset by Federal Reserve rate decreases in the latter part of 2019.  In 2019 compared to 2018, the largest component of non-interest income, prepaid, debit and related fees increased $10.5 million, or 19.2%, to $65.1 million.  Gain on sale of loans increased $3.6 million, or 17.4%, to $24.1 million which resulted primarily from a higher volume of loans sold into securitizations in 2019.  Service fees on deposit accounts decreased $3.5 million, or 97.9%, to $75,000 as a result of the sale of the SHIRA portfolio.  As a result of the sale of the SHIRA portfolio, this income category will be substantially eliminated.  In 2018, $3.7 million of charges resulted from the investment in unconsolidated entity while in 2019 there were no such charges.  That investment resulted from the sale of certain discontinued loans into a securitization in 2014. See Note W to the financial statements. The aforementioned $8.3 million increase in non-interest expense, exclusive of the 2019 civil money penalties, resulted primarily from increases in salaries and benefits. Salaries and benefits increased $14.4 million, or 18.1%, to $94.3 million, reflecting higher incentive compensation for loan, deposit and fee production and higher IT and other infrastructure expense.  The increase in salaries and benefits was partially offset by decreases in legal, FDIC insurance, data processing and other expenses.



In 2014, we discontinued our Philadelphia commercial lending operations following our determination that those operations were inconsistent with our strategic focus on what we believe to be lower risk and more granular and national lines of business.  We currently focus our lending activities upon four specialty lending segments: SBLOC and IBLOC loans, SBA loans, vehicle fleet and equipment leasing, and the origination of loans for sale into commercial securitizations.  These loans are made nationally.  At year end 2019, our net discontinued assets amounted to $140.7 million compared to $197.8 million at year end 2018.  As these balances are reduced, either through sales or repayment, we plan to invest the proceeds into our continuing lending lines. Additionally, at year end

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2019 a balance of $39.2 million in investment in unconsolidated entity reflected the remaining balance of the investment in  discontinued loans and related assets sold into a securitization.



Critical Accounting Policies and Estimates

Our accounting and reporting policies conform with generally accepted accounting principles in the United States and to general practices within the financial services industry.  The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes.  Actual results could differ from those estimates. We believe that the determination of our allowance for loan and lease losses and our determination of the fair value of financial instruments involve a higher degree of judgment and complexity than our other significant accounting policies.

We determine our allowance for loan and lease losses with the objective of maintaining a reserve level we believe to be sufficient to absorb our estimated probable credit losses.  We base our determination of the adequacy of the allowance on periodic evaluations of our loan portfolio and other relevant factors.  However, this evaluation is inherently subjective as it requires material estimates, including, among others, expected default probabilities, the amount of loss we may incur on a defaulted loan, expected commitment usage, the amounts and timing of expected future cash flows on impaired loans, value of collateral, estimated losses on consumer loans and residential mortgages, and general amounts for historical loss experience.  We also evaluate economic conditions and uncertainties in estimating losses and inherent risks in our loan portfolio.  To the extent actual outcomes differ from our estimates, we may need additional provisions for loan losses.  Any such additional provisions for loan losses will be a direct charge to our earnings.  See “Allowance for Loan and Lease Losses.”

The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.  We estimate the fair value of a financial instrument using a variety of valuation methods.  Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value.  When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value.  When observable market prices do not exist, we estimate fair value.  Our valuation methods and inputs consider factors such as types of underlying assets or liabilities, rates of estimated credit losses, interest rate or discount rate and collateral.  Our best estimate of fair value involves assumptions including, but not limited to, various performance indicators, such as historical and projected default and recovery rates, credit ratings, current delinquency rates, loan-to-value ratios and the possibility of obligor refinancing.

At the end of each quarter, we assess the valuation hierarchy for each asset or liability measured.  From time to time, assets or liabilities may be transferred within hierarchy levels due to changes in availability of observable market inputs to measure fair value at the measurement date.  Transfers into or out of hierarchy levels are based upon the fair value at the beginning of the reporting period.

We periodically review our investment portfolio to determine whether unrealized losses on securities are temporary, based on evaluations of the creditworthiness of the issuers or guarantors, and underlying collateral, as applicable.  In addition, we consider the continuing performance of the securities.  We recognize credit losses through the consolidated statement of operations.  If management believes market value losses are temporary and that we have the ability and intention to hold those securities to maturity, we recognize the reduction in other comprehensive income, through equity.  We evaluate whether an other than temporary impairment exists by considering primarily the following factors: (a) the length of time and extent to which the fair value has been less than the amortized cost of the security, (b) changes in the financial condition, credit rating and near-term prospects of the issuer, (c) whether the issuer is current on contractually obligated interest and principal payments, (d) changes in the financial condition of the security’s underlying collateral and (e) the payment structure of the security.  If other than temporary impairment is determined, we estimate expected future cash flows to determine the credit loss amount with a quantitative and qualitative process that incorporates information received from third-party sources and internal assumptions and judgments regarding the future performance of the security.

We account for our stock-based compensation plans based on the fair value of the awards made, which include stock options, restricted stock, and performance based shares.  To assess the fair value of the awards made, management makes assumptions as to expected stock price volatility, option terms, forfeiture rates and dividend rates.  All of these estimates and assumptions may be susceptible to significant change that may impact earnings in future periods.

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We account for income taxes under the liability method whereby we determine deferred tax assets and liabilities based on the difference between the carrying values on our consolidated financial statements and the tax basis of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse.  Deferred tax expense (benefit) is the result of changes in deferred tax assets and liabilities.

Regulatory Actions



The Bank entered into a Stipulation and Consent to the Issuance of a Consent Order effective August 7, 2012, which we refer to as the 2012 Consent Order.  The Bank took this action without admitting or denying any charges of unsafe or unsound banking practices or violations of law or regulation.  Under the 2012 Consent Order, the Bank agreed to increase its supervision of third-party relationships, develop new written compliance and related internal audit compliance programs, develop a new third-party risk management program and screen new third-party relationships as provided in the Consent Order. As part of the Consent Order, the Bank agreed to pay a civil money penalty in the amount of $172,000, which was paid in 2012.  The 2012 Consent Order was amended and restated in 2015 as noted below.



On June 5, 2014, the Bank entered into a Stipulation and Consent to the Issuance of a Consent Order with the FDIC, which we refer to as the 2014 Consent Order.  The Bank took this action without admitting or denying any charges of unsafe or unsound banking practices or violations of law or regulation relating to the Bank’s Bank Secrecy Act, or BSA, compliance program.  The 2014 Consent Order requires the Bank to take certain affirmative actions to comply with its BSA obligations.  Satisfaction of the requirements of the 2014 Consent Order is subject to the review of the FDIC and the Delaware State Bank Commissioner.  The Bank has and expects to continue to expend significant management and financial resources to address the Bank’s BSA compliance program which will reduce our net income. Expenses associated with the required look back review were significant in 2015 and 2016. The look back review was completed in the third quarter of 2016.



The 2014 Consent Order restricts the Bank from signing and boarding new independent sales organizations, establishing new non-benefit reloadable prepaid card programs and originating Automated Clearing House transactions for new merchant-related payments until the Bank submits to the FDIC and the Delaware State Bank Commissioner a report summarizing the completion of certain BSA-related corrective actions (“BSA Report”).  Until the BSA Report is approved by the FDIC and Delaware State Bank Commissioner, those aspects of the growth of our card payment processing and prepaid card operations will be affected, which, unless offset by growth from existing customers and new customers in other areas of our prepaid card operations, could reduce growth of our deposits and non-interest income and, possibly, limit our ability to raise additional capital on acceptable terms.  The Bank provided the FDIC and the Delaware State Bank Commissioner with the required BSA Report as of December 31, 2019 and it is now under review by the regulators.    



On August 27, 2015, the Bank entered into an Amendment to Consent Order, or the 2014 Consent Order Amendment, with the FDIC, amending the 2014 Consent Order.  The Bank took this action without admitting or denying any additional charges of unsafe or unsound banking practices or violations of law or regulation relating to continued weaknesses in the Bank’s BSA compliance program.  The 2014 Consent Order Amendment provides that the Bank shall not declare or pay any dividend without the prior written consent of the FDIC and for certain assurances regarding management.



On May 11, 2015, the Federal Reserve issued a letter, or the Supervisory Letter, to us as a result of the 2014 Consent Order and the 2014 Consent Order Amendment (which, at the time of the Supervisory Letter, was in proposed form), which provides that we shall not pay any dividends on our common stock or make any interest payments on our trust preferred securities, without the prior written approval of the Federal Reserve.  It further provides that we may not incur any debt (excluding payables in the ordinary course of business) or redeem any shares of our stock, without the prior written approval of the Federal Reserve. The requirement for such approval was lifted by the Federal Reserve in the fourth quarter of 2019, and the Supervisory Letter was terminated at that time.



On December 23, 2015, the Bank entered into a Stipulation and Consent to the Issuance of an Amended Consent Order, Order for Restitution, and Order to Pay Civil Money Penalty with the FDIC, which we refer to as the 2015 Consent Order. The Bank took this action without admitting or denying any charges of violations of law or regulation.  The 2015 Consent Order amended and restated in its entirety the terms of the 2012 Consent Order. 



The 2015 Consent Order was based on FDIC allegations regarding electronic fund transfer, or EFT, error resolution practices, account termination practices and fee practices of various third parties with whom the Bank had previously provided, or currently provides, deposit-related products whom we refer to as Third Parties.  The 2015 Consent Order continues the Bank's obligations

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originally set forth in the 2012 Consent Order, including its obligations to increase board oversight of the Bank's compliance management system, or CMS, improve the Bank's CMS, enhance its internal audit program, increase its management and oversight of Third Parties, and correct any apparent violations of law.



In addition to restating the general terms of the 2012 Consent Order, the 2015 Consent Order directs the Bank’s Board of Directors to establish a Complaint and Error Claim Oversight and Review Committee, which we refer to as the Complaint and Error Claim Committee to review and oversee the Bank’s processes and practices for handling, monitoring and resolving consumer complaints and EFT error claims (whether received directly or through Third Parties) and to review management's plans for correcting any weaknesses that may be found in such processes and practices.  The Bank’s Board of Directors appointed the required Complaint and Error Claim Committee on January 29, 2016.



The 2015 Consent Order also requires the Bank to implement a corrective action plan, or CAP, to remediate and provide restitution to those prepaid cardholders who asserted or attempted to assert, or were discouraged from initiating EFT error claims, and to provide restitution to cardholders harmed by EFT error resolution practices.    The 2015 Consent Order requires that if, through the CAP, the Bank identifies prepaid cardholders who have been adversely affected by a denial or failure to resolve an EFT error claim, the Bank will ensure that monetary restitution is made.  The Bank completed its implementation of the CAP on January 15, 2020.  As of the completion date, $1,592,469.20 of restitution was paid to consumers of which $4,352.61 was paid by the Bank and the remaining amount by Third Parties.



The 2015 Consent Order also imposed a $3 million civil money penalty on the Bank, which the Bank has paid and which was recognized as expense in the fourth quarter of 2015.  

On March 7, 2018, the Bank entered into a Stipulation and Consent to Order for Restitution and Order To Pay Civil Money Penalty with the FDIC, which we refer to as the 2018 Restitution Order and 2018 CMP Order, respectively.  The Bank took this action without admitting or denying any alleged violations of law or regulation.  The FDIC’s action principally emanated from one of the Bank’s third-party payment processors (“Third-Party Processor”) that suffered an internal system programming glitch.  This inadvertently resulted in consumers that engaged in signature-based point of sale transactions during the period from December 2010 to November 2014 being charged a greater fee than what was disclosed by the Bank.  The FDIC alleged the Bank’s incorrect fee imposition due to the Third-Party Processor error was an unfair or deceptive act or practice and violated Section 5 of the Federal Trade Commission Act.  The 2018 CMP Order imposed a $2 million civil money penalty on the Bank which the Bank has paid, and was recognized as expense on September 30, 2017.

The 2018 Restitution Order required the Bank to develop a written Restitution Plan, subject to independent audit and FDIC non-objection, to ensure impacted consumers are compensated for any incorrectly charged fees.  The 2018 Restitution Order required the Bank to make such reimbursements if not otherwise made by the Third-Party Processor and the Bank is indemnified by the Third-Party Processor for such reimbursements.  Impacted consumers were reimbursed by the Third-Party Processor at its own expense.    The civil money penalty was not subject to any indemnification or recovery from any third party.   On December 19, 2019, the FDIC concluded the Bank had fully complied with the 2018 Restitution Order and issued an order terminating the 2018 Restitution Order. 

On December 18, 2019, the Bank’s Board of Directors, without admitting or denying any violations of law, regulation or the provisions of the 2014 Consent Order, executed a Stipulation and Consent to the Issuance of an Order to Pay Civil Money Penalty in the amount of $7.5 million based on supervisory findings during the period of 2013 to 2019 related principally to deficiencies in the Bank’s legacy Bank Secrecy Act/Anti-Money Laundering (BSA/AML) Programs and alleged violations of law during the period, as well as the length of time the Bank has taken to fully implement the corrective actions required by the 2014 Consent Order. The Bank paid this amount, and it was recognized as an expense in the Company’s financial statements in the fourth quarter of 2019.

Results of Operations

Overview:  Net interest income continued its upward trend in 2019, increasing $20.4 million over the prior year, primarily as a result of  higher balances of commercial loans originated for sale.  Net interest income also benefited from increases in other loan categories.  From year end 2018 to year end 2019, SBLOC and IBLOC, SBA and leasing balances grew 30%, 22% and 10%, respectively.    Net interest income also reflected higher yields  resulting from the Federal Reserve’s 2018 interest rate increases, the impact of which was partially offset by Federal Reserve rate reductions in latter 2019.  While our loans generally adjust more fully to Federal Reserve interest rate changes, funding costs generally adjust to only a portion of such rate changes.  For 2019, funding costs were 22 basis points higher than 2018 compared to a 32 basis point increase in yield on interest earning assets.  Reflecting the above

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factors, net interest income increased by $20.4 million or 16.9% in 2019 compared to the prior year.  The provision for loan and lease losses increased $815,000 to $4.4 million in 2019 as decreases in provisions for small business loans and leasing were more than offset by a $1.0 million provision for other consumer loans.  Non-interest income in 2019 decreased by $49.7 million. That decrease reflected a $65.0 million gain on sale of the SHIRA portfolio in 2018 which was partially offset by an increase of $10.5 million in prepaid, debit card and related fees in 2019.



In 2019, total non-interest expense increased $17.2 million to $168.5 million, reflecting a $14.4 million increase in salaries and employee benefits and $8.9 million in civil money penalties which were partially offset by decreases of $2.5 million in legal fees, $1.8 million in FDIC insurance expense and $1.3 million in data processing expense. 



In 2017, income tax expense was impacted by legislation reducing federal corporate income tax rates.  As a result, deferred tax assets were adjusted to the new rates, decreasing the value of those assets and increasing tax expense in that year.  The lower 21% federal corporate tax rate was effective for 2018 and 2019.



In 2014, the Bank discontinued its regional Philadelphia commercial loan division to focus on its aforementioned national specialty lending lines of business.  At year end 2019, our net discontinued assets amounted to $140.7 million compared to $197.8 million at year end 2018.  Net commercial discontinued loans included in those totals were, respectively, $70.6  million and $118.1 million.  These loans consisted primarily of loans secured by commercial real estate including construction and land loans.  As these balances are reduced, either through sales or repayment, we plan to invest the proceeds into our continuing lending lines.  Efforts to sell or otherwise dispose of these loans continue and if not sold, the loans will be retained.  We also retain the financing receivable of $39.2 million from the 2014 Walnut Street securitization. See Note W to the financial statements.  That entity is also primarily comprised of discontinued commercial real estate loans, including construction and land loans or real estate collateral resulting from the default of such loans.

At December 31, 2019, our total loans amounted to $1.82 billion, an increase of $322.3 million, or 21.5%, over the $1.50 billion balance at December 31, 2018, reflecting growth in all major categories of loans.  Our investment securities available-for-sale increased $84.4 million to $1.32 billion from $1.24 billion between those respective dates as reinvestments were accelerated when long term rates increased.  

Net Income: 2019 compared to 2018.  Net income from continuing operations was $51.3 million in 2019 compared to $87.5 million in 2018 while income before taxes was, respectively, $72.5 million and $119.8 million, a decrease of $47.3 million.  In 2019, net interest income grew by $20.4 million and non-interest income decreased $49.7 million.  The $20.4 million, or 16.9%, increase in 2019 net interest income over 2018 resulted primarily from higher balances of commercial loans originated for sale.  Net interest income also benefited from increases in other loan categories.  From year end 2018 to year end 2019, SBLOC and IBLOC, SBA and leasing balances grew 30%, 22% and 10%, respectively.    The $49.7 million decrease in non-interest income reflected a $65.0 million gain on sale of the SHIRA portfolio in 2018 and a $10.5 million increase in prepaid, debit card and related fees in 2019.



In 2019 compared to 2018, the primary drivers of fee income, prepaid, debit and related fees and fees on ACH, card and other payment processing fees, increased 17.8% to $74.5 million.  Gain on sale of loans increased $3.6 million to $24.1 million which resulted primarily from a higher volume of loans sold into securitizations in 2019. Additionally, in 2018, $3.7 million of charges resulted from the investment in unconsolidated entity while we had no such charges in 2019.  That investment resulted from the sale of certain discontinued loans into a securitization in 2014.  See Note W to the financial statements.    In 2019, total non-interest expense increased $17.2 million to $168.5 million, reflecting a $14.4 increase in salaries and employee benefits and $8.9 million in civil money penalties which were partially offset by decreases of $2.5 million in legal fees, $1.8 million in FDIC expense and $1.3 million in data processing expense.  Salary and benefits expense increased by $14.4 million reflecting higher incentive compensation for loan, deposit and fee production and higher information technology and loan and payments infrastructure expense.  In 2019, non-interest expense included $8.9 million of expense for a $1.4 million SEC civil money penalty and a $7.5 million FDIC civil money penalty. FDIC insurance expense decreased $1.8 million in 2019, primarily as a result of a decrease in the insurance rate applicable to the Bank.



In 2017, income tax expense was impacted by legislation reducing federal corporate income tax rates.  As a result, deferred tax assets were adjusted to the new rates, decreasing the value of those assets and increasing tax expense in that year.  The lower 21% federal corporate tax rate was effective for 2018 and 2019. The combined federal and state income tax rate was 29% in 2019. It was higher than the 27% rate in 2018 primarily as a result of the non-deductibility of $8.9 million of civil penalties in 2019.



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Reflecting these changes, net income from continuing operations amounted to $51.3 million in 2019 compared to $87.5 million in 2018, or continuing operations earnings per diluted share of $0.89 compared to $1.53 in 2018.  Net income from discontinued operations was $291,000 for 2019 compared to $1.1 million for 2018.  Including discontinued operations, diluted income per share was $0.90 for 2019 compared to $1.55 for 2018 on net income of $51.6 million and $88.7 million, respectively.



Net Income: 2018 compared to 2017.  Net income from continuing operations was $87.5 million in 2018 compared to $17.3 million in 2017 while income before taxes was, respectively, $119.8 million and $40.4 million, an increase of $79.4 million.  In 2018, net interest income grew by $14.2 million and non-interest income increased $62.2 million which accounted for the majority of the increase.  The $14.2 million, or 13.3%, increase in 2018 net interest income over 2017 resulted primarily from loan growth and higher yields, reflecting Federal Reserve rate increases. From year end 2017 to year end 2018, SBLOC, SBA and leasing balances grew 8%, 17% and 5%, respectively.    The $62.2 million increase in non-interest income reflected a $65.0 million gain on sale of the SHIRA portfolio and a $3.2 million reduction in service fees on deposit accounts related to that portfolio.



In 2018 compared to 2017, the primary drivers of fee income, prepaid and debit card fees and fees on ACH, card and other payment processing fees, increased 6.0% to $63.3 million.  Gain on sale of loans increased $2.6 million to $20.5 million which resulted primarily from a higher volume of loans sold into securitizations in 2018.  Additionally, in 2018, $3.7 million of charges resulted from the investment in unconsolidated entity while such charges in 2017 were $20,000. That investment resulted from the sale of certain discontinued loans into a securitization in 2014.  See Note W to the financial statements.    In 2018, total non-interest expense decreased $3.6 million to $151.3 million, reflecting a $4.0 million reduction in data processing expense resulting from a renegotiated contract and reduced transaction volume resulting from the planned exit of an affinity group which had changed ownership.  Salary and benefits expense increased by $4.0 million reflecting higher BSA and compliance expenses and higher incentive compensation expense.  In 2017, non-interest expense included $2.3 million of expense for an FDIC civil money penalty.  FDIC insurance expense decreased $1.3 million in 2018, primarily as a result of a decrease in the insurance rate applicable to the Bank.



In 2017, income tax expense was impacted by legislation reducing federal corporate income tax rates.  As a result, deferred tax assets were adjusted to the new rates, decreasing the value of those assets and increasing tax expense in that year. The lower 21% corporate tax rate was effective for 2018 and the combined federal and state income tax rate in 2018 was 27%.



Reflecting these changes, net income from continuing operations amounted to $87.5 million in 2018 compared to $17.3 million in 2017, or continuing operations income per diluted share of $1.53 compared to $0.31 in 2017.  Net income from discontinued operations was $1.1 million for 2018 compared to $4.3 million for 2017.  Including discontinued operations, diluted income per share was $1.55 for 2018 compared to $0.39 for 2017 on net income of $88.7 million and $21.7 million, respectively.



Net Interest Income: 2019 compared to 2018.  Our net interest income for 2019 increased to $141.3 million, an increase of $20.4 million, or 16.9%, from $120.8 million for 2018, reflecting a $31.6 million, or 21.4%, increase in interest income to $179.6 million from $148.0 million for 2018.    The increase in net interest income primarily reflected the impact of higher balances of commercial real estate loans held for sale and other loan growth  and higher loan yields resulting from Federal Reserve rate increases in 2018. The impact of the prior year rate increases was partially offset by Federal Reserve rate decreases in the latter part of 2019.   Our average loans and leases increased 24.9% to $2.42 billion in 2019 from $1.94 billion for 2018, while related interest income increased $31.8 million on a tax equivalent basis. The largest increases in average loans and leases and related interest income was in commercial loans originated for sale, which respectively increased $300.2 million and $17.6 million. Small business loan, SBLOC and IBLOC and leasing interest income respectively increased $6.3 million, $6.1 million and $2.4 million.  Our average investment securities were $1.41 billion for 2019 compared to $1.38 billion for 2018, while related interest income increased $245,000 on a tax equivalent basis.

Our net interest margin (calculated by dividing net interest income by average interest earning assets) for 2019 increased 13 basis points to 3.32% from 3.19% for 2018.  The increase reflected higher yields on variable rate loans resulting from the aforementioned Federal Reserve increases, partially offset by decreased yields on taxable investment securities. While the yield on loans increased to 5.25% from 4.92%, the yield on taxable investment securities decreased to 3.01% from 3.05%. The decrease reflected higher premium amortization resulting from prepayments. The average yield on our interest earning assets increased to 4.18% from 3.86% for 2018, an increase of 32 basis points, while the cost of total deposits and interest bearing liabilities increased to 0.92% for 2019 from 0.70% for 2018, an increase of 22 basis points. While variable rate loans and securities adjusted more fully to Federal Reserve rate changes, deposits adjusted only partially to the Federal Reserve changes.  In 2019, average demand and interest checking deposits amounted to $3.82 billion, compared to $3.50 billion in 2018, an increase of 9.1%.  The yield on those deposits increased to 0.80% in 2019 compared to 0.66% in 2018.  Savings and money market balances  averaged $37.7 million in 2019

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compared to $362.3 million in 2018 with an average 0.48% rate in 2019 compared to 0.79% in 2018.  The decrease reflected the SHIRA sale.

Net Interest Income: 2018 compared to 2017.  Our net interest income for 2018 increased to $120.8 million, an increase of $14.2 million, or 13.3%, from $106.7 million for 2017, reflecting a $25.9 million, or 21.3%, increase in interest income to $148.0 million from $122.0 million for 2017.  The increase in net interest income resulted primarily from higher loan balances and higher yields.  Our average loans and leases increased 8.5% to $1.94 billion in 2018 from $1.78 billion for 2017, while related interest income increased $16.0 million on a tax equivalent basis.  Our average investment securities were $1.38 billion for 2018 compared to $1.30 billion for 2017, while related interest income increased $5.7 million on a tax equivalent basis.  Yields on both loans and investment securities increased as a result of the impact of the Federal Reserve’s rate increases on variable rate loans and securities. 

Our net interest margin (calculated by dividing net interest income by average interest earning assets) for 2018 increased 15 basis points to 3.19% from 3.04% for 2017.  The increase reflected higher yields on variable rate loans and securities resulting from the aforementioned Federal Reserve increases.  The average yield on our interest earning assets increased to 3.86% from 3.37% for 2017, an increase of 49 basis points, while the cost of total deposits and interest bearing liabilities increased to 0.70% for 2018 from 0.40% for 2017, an increase of 30 basis points. While variable rate loans adjusted more fully to Federal Reserve rate increases, deposits adjusted only partially to Federal Reserve rate increases.  In 2018, average demand and interest checking deposits amounted to $3.50 billion, compared to $3.37 billion in 2017, an increase of 3.8%.  The yield on those deposits increased to 0.66% in 2018 compared to 0.36% in 2017.  Savings and money market balances averaged $362.3 million in 2018 compared to $439.6 million in 2017 with an average 0.79% rate in 2018 compared to 0.51% in 2017.  The decrease reflected the SHIRA sale.

Average Daily Balance.  The following table presents the average daily balances of assets, liabilities, and shareholders’ equity and the respective interest earned or paid on interest earning assets and interest bearing liabilities, as well as average rates for the periods indicated:

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In 2019 compared to 2018, average interest earning assets increased to $4.30 billion, an increase of $463.3 million, or 12.1%, from 2018.  The increase reflected a $482.2 million, or 24.9%, increase in average loans and leases.  The increase resulted primarily from higher balances in loans originated for sale into securitizations,  SBLOC and IBLOC, SBA and leasing.  Average balances of

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investment securities increased $28.6 million, or 2.1%, as reinvestments were accelerated when long term rates increased.  Average demand and interest checking deposits increased $317.9 million, or 9.1%.  In 2018 compared to 2017, average interest earning assets increased to $3.84 billion, an increase of $199.4 million or 5.5% from 2017, reflecting higher loan balances including loans held for sale.  Average investment securities increased $85.2 million or 6.6%.  Average demand and interest checking deposits increased $127.3 million, or 3.8%.



Volume and Rate Analysis.  The following table sets forth the changes in net interest income attributable to either changes in volume (average balances) or to changes in average rates from 2017 through 2019 on a tax equivalent basis.  The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.





Provision for Loan and Lease Losses.  Our provision for loan and lease losses was $4.4 million for 2019, $3.6 million for 2018 and $2.9 million for 2017.  Provisions are based on our evaluation of the adequacy of our allowance for loan and lease losses, particularly in light of current economic conditions.  That evaluation reflected the impact of the levels of charge-offs.  The provision for loan and lease losses increased $815,000 over the prior year, to $4.4 million in 2019, as decreases in provisions for small business loans and leasing were more than offset by a $1.0 million provision for other consumer loans.  The $1.0 million provision resulted primarily from the loss on a home equity line of credit.  In September 2016, this product became inactive and is no longer being marketed to customers, and the current unimpaired portfolio balance is $2.8 million, consisting of 32 accounts averaging $88,000. The increase in the 2018 provision over 2017 reflected higher provisions for SBA non-real estate and leasing.  At December 31, 2019, our allowance for loan and lease losses amounted to $10.2 million, or 0.56%, of total loans.  We believe that our allowance is adequate to cover expected losses.  For more information about our provision and allowance for loan and lease losses and our loss experience see “—Financial Condition—Allowance for Loan and Lease Losses” and “—Summary of Loan and Lease Loss Experience,” below.

Non-Interest Income: 2019 compared to 2018.  Non-interest income was $104.1 million for 2019, compared to $153.8 million for 2018.  The $49.7 million decrease reflected a $65.0 million gain on the sale of the SHIRA portfolio in 2018.  In 2019 compared to 2018, the primary drivers of fee income, prepaid, debit and related fees and fees on ACH, card and other payment processing fees, increased $11.2 million, or 17.8%, to $74.5 million.  The majority of the growth resulted from prepaid, debit and related fees which increased $10.5 million, or 19.2%, to $65.1 million, primarily as a result of transaction volume increases from new clients and organic growth from existing clients.  ACH, card and other payment processing fees, which increased $723,000, or 8.4%,

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to $9.4 million reflected increases in payment volume, especially from the rapid funds transfer product.  That product allows customers to transfer funds from their bank account to their payee’s account in minutes.  Gain on sale of loans increased $3.6 million to $24.1 million, which resulted primarily from a higher volume of loans sold into securitizations in 2019 which more than offset the decrease in market spreads.  Any gain or loss is subject to market conditions. 

Non-Interest Income: 2018 compared to 2017.  Non-interest income was $153.8 million for 2018, compared to $91.5 million for 2017.  The $62.2 million increase reflected a $65.0 million gain on the sale of the SHIRA portfolio and a $3.2 million reduction in service fees on deposit accounts related to that portfolio.  In 2018 compared to 2017, the primary drivers of fee income, prepaid and debit card fees and fees on ACH, card and other payment processing fees, increased $3.6 million, or 6.0%, to $63.3 million.  The majority of the growth resulted from card payment and ACH processing fees, which increased $2.3 million, or 37.0%, to $8.7 million reflecting increases in payment volume, especially from the rapid funds transfer product.  That product allows customers to transfer funds from their bank account to their payee’s account in minutes.  Prepaid and debit card fees increased $1.3 million, or 2.4%, to $54.6 million, primarily as a result of transaction volume increases from new clients and organic growth from existing clients.  Gain on sale of loans increased $2.6 million to $20.5 million which resulted primarily from a higher volume of loans sold into securitizations in 2018.  Additionally, in 2018, $3.7 million of charges resulted from the investment in unconsolidated entity while such charges in 2017 were $20,000.  The charges reflected continued clarification of market and credit loss related assumptions based on information from available sources including updated market information and projections of potential future loan losses based on new facts or circumstances.  See “Non-performing loans, loans 90 days delinquent and still accruing, and troubled debt restructurings” for a description of the charge related to one of those loans.  The investment in unconsolidated entity resulted from the sale of certain discontinued loans into a securitization in 2014. See Note W to the financial statements.  The vast majority of the $3.6 million of service fees on deposit accounts in 2018 resulted from the IRA and health savings portfolios which have now been sold.

Non-Interest Expense: 2019 compared to 2018.  Total non-interest expense in 2019 was $168.5 million, an increase of $17.2 million, or 11.4%, over the $151.3 million in 2018.  Salary expense increased $14.4 million to $94.3 million in 2019, an increase of 18.1% over the $79.8 million in 2018.  The increase reflected higher incentive compensation for loan, deposit and fee production and higher information technology and loan and payments infrastructure expense.  Depreciation and amortization decreased $301,000 to $3.7 million, or 7.5%, from $4.0 million in 2018, which reflected reduced spending on fixed assets and equipment.  Rent and occupancy increased $1.2 million to $6.6 million, or 21.1%, from $5.5 million in 2018, which reflected newly leased space for the commercial real estate loan origination department.  Data processing expense decreased $1.3 million, or 20.9%, to $4.9 million from $6.2 million in 2018.  The decrease reflected the impact of a renegotiated data processing contract and lower account and transaction volume as a result of the planned exit of an affinity program which had changed ownership and the SHIRA sale.  Printing and supplies expense decreased $269,000, or 29.7%, to $637,000 from $906,000 in 2018.  The decrease reflected a reduction for SHIRA accounts which were transferred in the third quarter of 2018, in connection with the related sale.  Audit expense decreased $217,000, or 10.8%, to $1.8 million from $2.0 million in 2018, which reflected decreased regulatory and tax compliance audit fees.  Legal expense decreased $2.5 million, or 32.2%, to $5.3 million from $7.8 million in 2018.  The decrease in legal expense reflected lower fees related to regulatory matters including fees associated with an SEC subpoena related to the restatement of the financial statements (see “—Regulatory Actions”).  Amortization of intangible assets remained consistent at $1.5 million in 2019 and 2018.  FDIC insurance decreased $1.8 million, or 20.3%, to $7.0 million from $8.8 million in 2018, which reflected the impact of a decrease in the FDIC assessment rate.  Software expense decreased $573,000, or 4.3%, to $12.7 million from $13.3 million in 2018.  The decrease reflected reduced expenditures for technology infrastructure to improve efficiency and scalability, including BSA software to satisfy BSA regulatory requirements.  Insurance expense decreased $103,000, or 4.0%, to $2.5 million from $2.6 million in 2018.  Telecom and information technology network communications expense increased $120,000, or 8.7%, to $1.5 million from $1.4 million in 2018.  Securitization and servicing expense decreased $36,000, or 30.8%, to $81,000 from $117,000 in 2018.  Consulting expense remained consistent at $3.2 million in 2019 and 2018.  Other non-interest expense decreased $394,000, or 3.0%, to $12.9 million from $13.3 million in 2018.  The decrease resulted primarily from decreases of $317,000 in credit bureau expense, $280,000 for prepaid and debit deposit account losses, $163,000 for customer identification expense and $100,000 for postage.  These decreases were partially offset by a $748,000 increase in travel.

 

Non-Interest Expense: 2018 compared to 2017.  Total non-interest expense in 2018 was $151.3 million, a decrease of $3.6 million, or 2.3%, over the $154.9 million in 2017.  Salary expense increased $4.0 million to $79.8 million in 2018, an increase of 5.3% over the $75.8 million in 2017. The increase reflected increases in BSA and compliance expenses and higher incentive compensation expense.  Depreciation and amortization decreased $455,000 to $4.0 million, or 10.2%, from $4.5 million in 2017, which reflected reduced spending on fixed assets and equipment.  Rent and occupancy decreased $206,000 to $5.5 million, or 3.6%, from $5.7 million in 2017. Data processing expense decreased $4.0 million, or 39.1%, to $6.2 million from $10.2 million in 2017.  The decrease reflected the impact of a renegotiated data processing contract and lower account and transaction volume as a result of the planned exit

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of an affinity program which had changed ownership.  Printing and supplies expense decreased $448,000, or 33.1%, to $906,000 from $1.4 million in 2017. The decrease reflected a reduction for health savings accounts which were sold in the second quarter of 2017 and safe harbor accounts which were transferred in the third quarter of 2018.  Audit expense increased $320,000, or 19.0%, to $2.0 million from $1.7 million in 2017, which reflected increased regulatory and tax compliance audit fees.  Legal expense decreased $227,000, or 2.8%, to $7.8 million from $8.1 million in 2017.  The decrease in legal expense reflected lower fees related to regulatory matters including fees associated with an SEC subpoena related to the restatement of the financial statements (see “—Regulatory Actions”).  Amortization of intangible assets remained consistent at $1.5 million in 2018 and 2017.  FDIC insurance decreased $1.3 million, or 12.7%, to $8.8 million from $10.1 million in 2017, which reflected the impact of a decrease in the FDIC assessment rate.  Software expense increased $707,000, or 5.6%, to $13.3 million from $12.6 million in 2017.  The increase reflected additional information technology infrastructure to improve efficiency and scalability, including BSA software to satisfy BSA regulatory requirements.  Insurance expense increased $245,000, or 10.5%, to $2.6 million from $2.3 million in 2017.  The increase reflected the impact of increased limits for liability coverages.  Telecom and information technology network communications expense decreased $420,000, or 23.4%, to $1.4 million from $1.8 million in 2017, reflecting cost cutting efforts including the closure of certain locations.  Securitization and servicing expense decreased $53,000, or 31.2%, to $117,000 from $170,000 in 2017.  Consulting expense increased $1.0 million, or 45.4%, to $3.2 million from $2.2 million in 2017.  The increased expense reflected increased BSA and other regulatory compliance consulting.  Other non-interest expense decreased $199,000, or 1.5%, to $13.3 million from $13.5 million in 2017.  The decrease resulted primarily from decreases of $365,000 for operations losses and recoveries, $314,000 for prepaid and debit deposit account losses, $228,000 for correspondent bank fees and $161,000 for customer identification expense.  These decreases were partially offset by a $573,000 increase in travel.

Income Tax Benefit and Expense

Income tax expense for continuing operations was $21.2 million, $32.2 million and $23.1 million, respectively, for 2019, 2018 and 2017.  The tax expense rate of 29.3% in 2019 was higher than the 26.9% rate in the prior year, primarily as the result of the non-deductibility of $8.9 million of civil money penalties.  The difference between those rates and the federal statutory rate of 21% consisted primarily of state income taxes. The 57.1% tax expense rate in 2017 primarily reflected an adjustment through tax expense for the difference between the prior 34% and 21% tax rate which was effective for 2018, applied to total net deferred tax assets.  Tax expense in 2017 was increased by that 13% differential to recognize the decrease in future value of those deferred tax assets. 

Liquidity and Capital Resources

Liquidity defines our ability to generate funds to support asset growth, meet deposit withdrawals, satisfy borrowing needs and otherwise operate on an ongoing basis.  We invest the funds we do not need for daily operations primarily in our interest bearing account at the Federal Reserve. Interest-bearing balances at the Federal Reserve Bank, maintained on an overnight basis, averaged $472.3 million for 2019, compared to $460.6 million for 2018. 



Our primary source of funding has been deposits.  The sale of the SHIRA portfolio was the primary factor in the $324.6 million reduction of average savings and money market balances in 2019 compared to 2018. That reduction was partially offset by growth in prepaid and debit card and other payments deposit accounts.  That growth was reflected in a $317.9 million increase in average demand and interest checking balances. Additionally, $170.4 million of average time deposits were newly utilized in 2019 to fund increased commercial real estate originations held for sale. As a result, average deposits amounted to $4.03 billion in 2019 compared to $3.86 billion in 2018. Overnight borrowings were also used to fund such increased originations, and average borrowings  increased to $129.0 million in 2019 from $20.3 million in 2018.   

 

Our primary source of liquidity is available for sale securities which amounted to $1.32 billion at December 31, 2019 compared to $1.24 billion at December 31, 2018.  In excess of $800 million of our available-for-sale securities are U.S. government agency securities which are highly liquid and which may be pledged as collateral for our Federal Home Loan Bank line of credit.

Loan repayments, also a source of funds, were exceeded by new loan disbursements during 2019.  As a result, at December 31, 2019 outstanding loans amounted to $1.82 billion, compared to $1.50 billion at the prior year end, an increase of $322.3 million, which was generally funded by deposits.  Commercial loans held-for-sale increased to $1.18 billion from $688.5 million between those respective dates, an increase of $492.1 million.  The increase reflected increases in originations.  In 2018 and 2019, the Company sold significant amounts of commercial loans held-for-sale and plans to continue that practice in 2020. 

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While we do not have a traditional branch system, we believe that our core deposits, which include our demand, interest checking, savings and money market accounts, have similar characteristics to those of a bank with a branch system.  The majority of our deposit accounts are obtained with the assistance of third parties and as a result are classified as brokered by the FDIC.  The FDIC guidance for classification of deposit accounts as brokered is relatively broad, and generally includes accounts which were referred to or “placed” with the institution by other companies.  If the Bank ceases to be categorized as “well capitalized” under banking regulations, it will be prohibited from accepting, renewing or rolling over brokered deposits without the consent of the FDIC.  In such a case, the FDIC’s refusal to grant consent to our accepting, renewing or rolling over brokered deposits could effectively restrict or eliminate the ability of the Bank to operate its business lines as presently conducted.

We focus on customer service which we believe has resulted in a history of customer loyalty.  Stability, lower cost compared to certain other funding sources and customer loyalty comprise key characteristics of core deposits which we believe are comparable to core deposits of peers with branch systems.  Certain components of our deposits do experience seasonality, creating greater excess liquidity at certain times in 2019.  The largest deposit inflows occur in the first quarter of the year when certain of our accounts are credited with tax refund payments from the U.S. Treasury. 

While consumer transaction accounts including prepaid and debit card accounts comprise the majority of our funding needs, we maintain secured borrowing lines with the Federal Home Loan Bank, or the FHLB, and the Federal Reserve.  As of December 31, 2019, we had lines of credit exceeding $250 million with the FHLB and $1.0 billion with the Federal Reserve.  The FHLB line can be increased to more than $800 million, by pledging U.S. agency securities.  These lines may be collateralized by specified types of loans or securities.  As of December 31, 2019, we had no amounts outstanding on these borrowing lines.  We expect to continue to maintain our facilities with the FHLB and Federal Reserve.  We actively monitor our positions and contingent funding sources on a daily basis.



As a result of the discontinuance of our commercial loan operations, we have received and expect to continue to receive during 2020, cash proceeds from the sale or repayment of discontinued assets.  We currently anticipate that these proceeds will be deployed into loans in our continuing operations.  Approximately $140.7 million of discontinued assets remained on our balance sheet as of December 31, 2019 (compared to $197.8 million at the prior year end), consisting primarily of loans secured by commercial real estate.  If not sold, these loans will be retained until repaid.  We also retain the financing receivable from the 2014 Walnut Street securitization for a portion of the discontinued commercial loans.  At December 31, 2019, the balance of that receivable was $39.2 million, compared to $59.3 million at the prior year end.



Included in our cash and cash-equivalents at December 31, 2019, were $924.5 million of interest earning deposits, which primarily consisted of deposits with the Federal Reserve.  These amounts may vary on a daily basis.  Accordingly, the majority of our available liquidity is comprised of the aforementioned available-for-sale securities and lines of credit with the FHLB and Federal Reserve.



In 2019, $173.9 million of securities sales and repayments exceeded purchases of $157.5 million.  In 2018, $213.2 million of securities sales and repayments exceeded purchases of $134.8 million.  In 2017, $569.7 million of securities sales and repayments were comparable to purchases of $579.9 million.  At December 31, 2019, we had outstanding commitments to fund loans, including unused lines of credit, of $2.34 billion, the vast majority of which are SBLOC lines of credit which are variable rate.  We attempt to increase such line usage; however, usage has been historically consistent and the majority of these lines of credit have historically not been drawn upon.   As shown in the consolidated statements of cash flows, cash required to fund loans was $326.0 million in 2019, $115.1 million in 2018 and $172.9 million in 2017.



As a holding company conducting substantially all of our business through our bank subsidiary, our need for liquidity consists principally of cash needed to make required interest payments on our trust preferred securities.  As of December 31, 2019, we had approximate cash reserves of $13.3 million at the holding company.  Current quarterly interest payments on the $13.4 million of trust preferred securities are approximately $180,000 based on a floating rate of 3.25% over the three-month London Interbank Offered Rate, or LIBOR.  A Supervisory Letter from the  Federal Reserve, requiring its approval for any dividend from us, was lifted in 2019.  FDIC approval is required for any dividend from the Bank to us, which, apart from the $13.3 million of cash on hand, is our principal source of liquidity.  See Item 1, “Business—Regulation under Banking Law,” and Item 1A, “Risk Factors-Risks Relating to Our Business-The entry into the Consent Orders has imposed certain restrictions and requirements upon us and the Bank.” 



We expect that the conditions under which the 2014 Consent Order Amendment was issued will be remediated and the FDIC will permit the Bank to resume paying dividends to us to fund holding company operations.  There can, however, be no assurance that the FDIC will, in fact, allow the resumption of Bank dividends to us upon completion of the remediation or, if allowed, as to the

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timing thereof.  Accordingly, there is risk that we will need to obtain alternate sources of funding at the holding company level to service our trust preferred securities.  There can be no assurance that such sources would be available to us on acceptable terms or at all.



We must comply with capital adequacy guidelines issued by the FDIC.  A bank must, in general, have a Tier 1 leverage ratio of 5.0%, a ratio of Tier I capital to risk-weighted assets of 8.0%, a ratio of total capital to risk-weighted assets of 10.0% and a ratio of common equity to risk-weighted assets of 6.50% to be considered “well capitalized”.  The Tier I leverage ratio is the ratio of Tier 1 capital to average assets for the period. “Tier I capital” includes common shareholders’ equity, certain qualifying perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less intangibles.  At December 31, 2019, we were “well capitalized” under banking regulations.



The following table sets forth our regulatory capital amounts and ratios for the periods indicated:







Asset and Liability Management



The management of rate sensitive assets and liabilities is essential to controlling interest rate risk and optimizing interest margins.  An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line with general market rates.  Interest rate sensitivity measures the relative volatility of an institution’s interest margin resulting from changes in market interest rates.



As a financial institution, potential interest rate volatility is a primary component of our market risk.  Fluctuations in interest rates will ultimately impact the level of our earnings and the market value of all of our interest earning assets, other than those with short-term maturities.  We do not own any trading assets. We used hedging transactions only for fixed rate commercial loans originated for sale into secondary securities markets. We have discontinued making fixed rate loans requiring hedging transactions.



We have adopted policies designed to manage net interest income and preserve capital over a broad range of interest rate movements.  To effectively administer the policies and to monitor our exposure to fluctuations in interest rates, we maintain an asset/liability committee, consisting of the Bank’s Chief Executive Officer, Chief Accounting Officer, Chief Financial Officer and Chief Credit Officer. This committee meets quarterly to review our financial results, develop strategies to optimize margins and to respond to market conditions.  The primary goal of our policies is to optimize margins and manage interest rate risk, subject to overall policy constraints for prudent management of interest rate risk.



We monitor, manage and control interest rate risk through a variety of techniques, including use of traditional interest rate sensitivity analysis (also known as “gap analysis”) and an interest rate risk management model.  With the interest rate risk management model, we project future net interest income and then estimate the effect of various changes in interest rates and balance

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sheet growth rates on that projected net interest income.  We also use the interest rate risk management model to calculate the change in net portfolio value over a range of interest rate change scenarios.  Traditional gap analysis involves arranging our interest earning assets and interest bearing liabilities by repricing periods and then computing the difference (or “interest rate sensitivity gap”) between the assets and liabilities that we estimate will reprice during each time period and cumulatively through the end of each time period.

 

Both interest rate sensitivity modeling and gap analysis are done at a specific point in time and involve a variety of significant estimates and assumptions.  Interest rate sensitivity modeling requires, among other things, estimates of how much and when yields and costs on individual categories of interest earning assets and interest bearing liabilities will respond to general changes in market rates, future cash flows and discount rates.  Gap analysis requires estimates as to when individual categories of interest sensitive assets and liabilities will reprice, and assumes that assets and liabilities assigned to the same repricing period will reprice at the same time and in the same amount.  Gap analysis does not account for the fact that repricing of assets and liabilities is discretionary and subject to competitive and other pressures.  A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities.  A gap is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets.  During a period of falling interest rates, a positive gap would tend to adversely affect net interest income, while a negative gap would tend to result in an increase in net interest income, all else equal.  During a period of rising interest rates, a positive gap would tend to result in an increase in net interest income while a negative gap would tend to affect net interest income adversely.



The following table sets forth the estimated maturity or repricing structure of our interest earning assets and interest bearing liabilities at December 31, 2019.  Except as stated below, the amounts of assets or liabilities shown which reprice or mature during a particular period were determined in accordance with the contractual terms of each asset or liability.  Loans currently at their interest rate floors are classified at their maturity date, though they are tied to variable interest rates.  The majority of demand and interest bearing demand deposits and savings deposits are assumed to be “core” deposits, or deposits that will generally remain with us regardless of market interest rates.  We estimate the repricing characteristics of these deposits based on historical performance, past experience, judgmental predictions and other deposit behavior assumptions.  However, we may choose not to reprice liabilities proportionally to changes in market interest rates for competitive or other reasons.  Additionally, although non-interest bearing demand accounts are not paid interest, we estimate certain of the balances will reprice as a result of the contractual fees that are paid to the affinity groups which are based upon a rate index, and therefore are included in interest expense. We have adjusted the demand and interest checking balances in the table downward, to better reflect the impact of their partial adjustment to changes in rates. Loan and security balances, which adjust more fully to market rate changes, are based upon actual balances. The table does not assume any prepayment of fixed-rate loans and mortgage-backed securities are scheduled based on their anticipated cash flow, including prepayments based on historical data and current market trends.  The table does not necessarily indicate the impact of general interest rate movements on our net interest income because the repricing and related behavior of certain categories of assets and liabilities is beyond our control as, for example, prepayments of loans and withdrawal of deposits.  As a result, certain assets and liabilities indicated as repricing within a stated period may, in fact, reprice at different times and at different rate levels.









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The method used to analyze interest rate sensitivity in this table has a number of limitations.  Certain assets and liabilities may react differently to changes in interest rates even though they reprice or mature in the same or similar time periods.  The interest rates on certain assets and liabilities may change at different times than changes in market interest rates, with some changing in advance of changes in market rates and some lagging behind changes in market rates.  Additionally, the actual prepayments and withdrawals we experience when interest rates change may deviate significantly from those assumed in calculating the data shown in the table.



Because of the limitations in the gap analysis discussed above, we believe that interest sensitivity modeling may more accurately reflect the effects of our exposure to changes in interest rates, notwithstanding its own limitations.  Net interest income simulation considers the relative sensitivities of the consolidated balance sheet including the effects of interest rate caps on adjustable rate mortgages and the relatively stable aspects of core deposits.  As such, net interest income simulation is designed to address the probability of interest rate changes and the behavioral response of the consolidated balance sheet to those changes.  Market Value of Portfolio Equity, or MVPE, represents the modeled fair value of the net present value of assets, liabilities and off-balance sheet items.



We believe that the assumptions utilized in evaluating our estimated net interest income are reasonable; however, the interest rate sensitivity of our assets, liabilities and off-balance sheet financial instruments as well as the estimated effect of changes in interest rates on estimated net interest income could vary substantially if different assumptions are used or actual experience differs from presumed behavior of various deposit and loan categories.  The following table shows the effects of interest rate shocks on our MVPE and net interest income.  Rate shocks assume that current interest rates change immediately and sustain parallel shifts.  For interest rate increases or decreases of 100 and 200 basis points, our policy includes a guideline that our MVPE ratio should not decrease more than 10% and 15%, respectively, and that net interest income should not decrease more than 10% and 15%, respectively.  As illustrated in the following table, we complied with our asset/liability policy at December 31, 2019.  While our modeling suggests an increase in market rates will have a positive impact on margin (as shown in the table below), the amount of such increase cannot be determined, and there can be no assurance any increase will be realized. 



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If we should experience a mismatch in our desired gap ranges or an excessive decline in our MVPE subsequent to an immediate and sustained change in interest rate, we have a number of options available to remedy such a mismatch.  We could restructure our investment portfolio through the sale or purchase of securities with more favorable repricing attributes.  We could also emphasize loan products with appropriate maturities or repricing attributes, or we could emphasize deposits or obtain borrowings with desired maturities.



We do not use derivatives except for swaps outstanding for fixed rate loans which were originated for sale.  The swaps hedge interest rate risk between the time the loans are disbursed and sold.

 

Historically, we have used variable rate loans as the principal means of limiting interest rate risk.  The Bank’s SBLOC, IBLOC and SBA loans are primarily variable rate as are the vast majority of commercial loans generated for sale.  We continue to evaluate market conditions and may change our current gap strategy in response to changes in those conditions.

Financial Condition

General.  Our total assets at December 31, 2019 were $5.66 billion, of which our total loans and commercial loans held-for-sale from continuing operations were $3.00 billion and our assets held-for-sale from discontinued operations were $140.7 million, $115.9 million of which were loans.  At December 31, 2018, our total assets were $4.44 billion, of which our total loans and loans held-for-sale from continuing operations were $2.19 billion and our assets held-for-sale from discontinued operations were $197.8 million, $170.7 million of which were loans.  Investment securities available-for-sale increased to $1.32 billion at December 31, 2019 from $1.24 billion at December 31, 2018.  The increase in total assets at December 31, 2019 reflected increased originations of commercial loans held for sale and loan growth.

Interest Earning Deposits and Federal Funds Sold.  At December 31, 2019, we had a total of $924.5 million of interest earning deposits, comprised primarily of balances at the Federal Reserve, which pays interest on such balances. At December 31, 2018, we had $551.9 million of such balances. The increase reflected higher deposit balances, including $475.0 million of short term certificates of deposit used to fund increased commercial mortgage loan origination which are held for sale.

Investment Portfolio. The Financial Accounting Standards Board Accounting Standards Codification (ASC) 320, Investments—Debt and Equity Securities, requires that debt and equity securities classified as available-for-sale be reported at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Marking an available-for-sale portfolio to market (fair value) results in fluctuations in the level of shareholders’ equity and equity-related financial ratios as market interest rates and market demand for such securities cause the fair value of fixed-rate securities to fluctuate.  Debt securities for which we have the positive intent and ability to hold to maturity are classified as held-to-maturity and are carried at amortized cost.

For detailed information on the composition and maturity distribution of our investment portfolio, see Note D to the Consolidated Financial Statements.  Total investment securities increased to $1.41 billion on December 31, 2019, an increase of $84.3 million, or 6.4%, from a year earlier.  The increase in investment securities reflected the acceleration of purchases when long term rates increased.  

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Other securities included in the held-to-maturity classification at December 31, 2019 consisted of three securities secured by diversified portfolios of corporate securities and one single-issuer trust preferred security.



The trust preferred security is an unrated security issued by an insurance company with a book value of $9.2 million and a fair value of $7.2 million.



A total of $75.2 million of other debt securities is comprised of three securities secured by diversified portfolios of corporate securities, and have a fair value of $75.9 million.



Under the accounting guidance related to the recognition of other-than-temporary impairment charges on debt securities, an impairment on a debt security is deemed to be other-than-temporary if it meets either of the following conditions: i) we intend to sell or it is more likely than not we will be required to sell the security before a recovery in value, or ii) we do not expect to recover the entire amortized cost basis of the security.  If we intend to sell or it is more likely than not we will be required to sell the security before a recovery in value, a charge is recorded in net realized losses in the consolidated statement of operations equal to the difference between the fair value and amortized cost basis of the security.  For those other-than-temporarily impaired debt securities which do not meet the first condition and for which we do not expect to recover the entire amortized cost basis, the difference between the security’s amortized cost basis and the fair value is separated into the portion representing a credit impairment, which is recorded in net realized losses in the consolidated statement of operations, and the remaining impairment, which is recorded in other comprehensive income.  Generally, a security’s credit impairment is the difference between its amortized cost basis and the best estimate of its expected future cash flows discounted at the security’s effective yield prior to impairment.  The previous amortized cost basis, less the impairment recognized in net realized losses on the consolidated income statement, becomes the security’s new cost basis.  We recognized no other-than-temporary impairment charges related to trust preferred securities classified in our held-to-maturity portfolio for 2019, 2018 and 2017. 

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The following table presents the book value and the approximate fair value for each major category of our investment securities portfolio.  At December 31, 2019 and 2018, our investments were categorized as either available-for-sale or held-to-maturity (in thousands).













Investments in FHLB and Atlantic Central Bankers Bank stock are recorded at cost and amounted to $5.3 million at December 31, 2019 and $1.1 million at December 31, 2018.  Both the FHLB and Atlantic Central Bankers Bank require its correspondent banking institutions to hold stock as a condition of membership. The increase resulted from an increase in FHLB stock, required to permit increased overnight borrowings.



At December 31, 2019 and 2018, investment securities with a fair value of approximately $262.0 million and $116.0 million, respectively, were pledged to secure a line of credit with the FHLB.  At December 31, 2019 and 2018, investment securities with a fair value of approximately $0 and $169.5 million, respectively, were pledged to secure a line of credit with the Federal Reserve.  



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The following tables show the contractual maturity distribution and the weighted average yields of our investment securities portfolio as of December 31, 2019 (in thousands):



















* The average yield of asset backed securities is as follows: collateralized loan obligation securities 3.31%, federally insured student loan securities 3.24%.

** If adjusted to their taxable equivalents, yields would approximate 1.77%, 3.56% and 3.35% for zero to one year, one to five years and five to ten years, respectively, at a Federal tax rate of 21%.













Loans Held-for-Sale.  Loans held-for-sale are comprised of commercial mortgage loans and SBA loans originated for sale or securitization in the secondary market.  The fair value of commercial mortgage loans and the SBA loans originated for sale is based on purchase commitments, quoted prices for the same or similar loans or fair market valuations based on other market information. The analysis is performed on an individual loan basis for commercial mortgage loans and a pooled basis for SBA loans.  Commercial loans held-for-sale increased to $1.18 billion at December 31, 2019 from $688.5 million at December 31, 2018.  The increase resulted from an increase in the volume of commercial real estate loans originated for future sale or securitization.



Loan Portfolio. We have developed a detailed credit policy for our lending activities and utilize loan committees to oversee the lending function.  SBLOC, IBLOC and other consumer loans, SBL, Leases and CMBS each have their own loan committee.  The Chief Executive Officer and Chief Credit Officer serve on all loan committees.  Each committee also includes lenders from that particular type of specialty lending.  The Chief Credit Officer is responsible for both regulatory compliance and adherence to our internal credit policy.  Key committee members have lengthy experience and certain of them have had similar positions at substantially larger institutions.

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We originate substantially all of our portfolio loans, although from time to time we purchase lease pools.  If a proposed loan should exceed our lending limit, we would sell a participation in the loan to another financial institution.  The following table summarizes our loan portfolio, not including loans held-for-sale, by loan category for the periods indicated (in thousands):



*SBL loans consist primarily of SBA loans. SBL loans held for sale consist of the U.S. government guaranteed portion of SBA loans.  The following table shows SBL loans and SBL loans held-for-sale for the periods indicated (in thousands):





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The following table presents selected loan categories by maturity for the periods indicated (in thousands):







Allowance for Loan and Lease Losses.  We review the adequacy of our allowance for loan and lease losses on at least a quarterly basis to determine a provision for loan losses in an amount necessary to maintain our allowance at a level that is appropriate, based on management’s estimate of inherent losses.  Our estimates of loan and lease losses are intended to, and, in management’s opinion, do meet the criteria for accrual of loss contingencies in accordance with ASC 450, Contingencies and ASC 310, Receivables.  The process of evaluating this adequacy has two basic elements: first, the identification of problem loans or leases based on current financial information and the fair value of the underlying collateral; and second, a methodology for estimating general loss reserves.  For loans or leases classified as “special mention” or “substandard”, we reserve all estimated losses at the time we classify the loan or lease.  This “specific” portion of the allowance is the total of potential, although unconfirmed, losses for individually classified loans.  In this process, we establish specific reserves based on an analysis of the most probable sources of repayment and liquidation of collateral.  While each impaired loan is individually evaluated, not every loan requires a reserve when the collateral value and estimated cash flows exceed the current balance. When loans are classified as troubled debt restructurings, their collateral is valued and a specific reserve is established if the collateral valuation, less disposition costs, is lower than the recorded value of the loan.  At December 31, 2019, there were eleven troubled debt restructured loans with a balance of $2.1 million which had specific reserves of $1.0 million. These reserves related to the non-guaranteed portion of SBA loans for start-up businesses. 



The second phase of our analysis represents an allocation of the allowance.  This methodology analyzes pools of loans that have similar characteristics and applies historical loss experience and other factors for each pool including management’s experience with similar loan and lease portfolios at other institutions, the historic loss experience of our peers and a review of statistical information from various industry reports to determine the allocable portion of the allowance.  This estimate is intended to represent the potential and inherent losses within the portfolio.  Individual loan pools are created for major loan categories: SBLOC and IBLOC, SBA loans, direct lease financing and other specialty lending and consumer loans.  We augment historical experience for each loan pool by accounting for such items as current economic conditions, current loan portfolio performance, loan policy or management changes, loan concentrations, increases in our lending limit, average loan size and other factors as appropriate.  Our chief credit officer oversees the loan review department, which measures the adequacy of the allowance for loan and lease losses independently of loan production officers. A description of loan review coverage targets is as follows.



At December 31, 2019, in excess of 50% of the total continuing loan portfolio was reviewed. The targeted coverages and scope of the reviews are risk-based and vary according to each portfolio.  These thresholds are maintained as follows:



Security Backed Lines of Credit (SBLOC) – The targeted review threshold for 2019 was 40% with the largest 25% of SBLOCs by commitment to be reviewed annually.  A random sampling of a minimum of 20 of the remaining loans will be reviewed each quarter.  At December 31, 2019, approximately 55% of the SBLOC portfolio had been reviewed.



Insurance Backed Lines of Credit (IBLOC) – The targeted review threshold for 2019 was 40%, with the largest 25% of IBLOCs by commitment to be reviewed annually.  A random sampling of a minimum of 20 of the remaining loans will be reviewed each quarter.  At December 31, 2019, approximately 57% of the IBLOC portfolio had been reviewed. 

   

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 SBA Loans – The targeted review or rated threshold for 2019 was 100%, to be rated and/or reviewed within 90 days of funding, less fully guaranteed loans purchased for CRA.  The 100% coverage includes loans rated by designated SBA department personnel, with a review threshold for the independent loan review department of all loans exceeding $1.0 million and any classified loans.  At December 31, 2019, approximately 100% of the government guaranteed loan portfolio had been rated and/or reviewed.



Direct Lease Financing – The targeted review threshold for 2019 was 35%.  At December 31, 2019, approximately 54% of the leasing portfolio had been reviewed. All lease relationships exceeding $1.0 million are reviewed.

 

Commercial Mortgaged Backed Securities (Floating Rate) – The targeted review threshold for 2019 was 100%. Floating rate loans will be reviewed initially within 90 days of funding and will be monitored on an ongoing basis as to payment status.  Subsequent reviews will be performed based on a sampling each quarter.  Each floating rate loan will be reviewed if any available extension options are exercised.  At December 31, 2019, approximately 100% of the CMBS floating rate loans on the books for more than 90 days had been reviewed.  



Commercial Mortgaged Backed Securities (Fixed Rate) – 100% of fixed rate loans that are unable to be readily sold on the secondary market and remain on the Bank's books after nine months will be reviewed at least annually.  At December 31, 2019, approximately 100% of the CMBS fixed rate portfolio had been reviewed.



Specialty Lending – Specialty Lending, defined as commercial loans unique in nature that do not fit into other established categories, have a review coverage threshold of 100% for non-Community Reinvestment Act (“CRA”) loans.  At December 31, 2019, approximately 100% of the non-CRA loans had been reviewed.



Home Equity Lines of Credit, or HELOC – The targeted review threshold for 2019 was 50%.  The largest 25% of HELOCs by commitment will be reviewed annually.  A random sampling of a minimum of ten of the remaining loans will be reviewed each quarter. At December 31, 2019, approximately 85% of the HELOC portfolio had been reviewed.

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The following table presents delinquencies by type of loan for December 31, 2019 and 2018 (in thousands):







Although we consider our allowance for loan and lease losses to be adequate based on information currently available, future additions to the allowance may be necessary due to changes in economic conditions, our ongoing loss experience and that of our peers, changes in management’s assumptions as to future delinquencies, recoveries and losses, deterioration of specific credits and management’s intent with regard to the disposition of loans and leases.



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The following table presents an allocation of the allowance for loan and lease losses among the types of loans or leases in our portfolio at December 31, 2019, 2018, 2017, 2016 and 2015 (in thousands): 







Summary of Loan and Lease Loss Experience.  The following tables summarize our credit loss experience for each of the periods indicated (in thousands):







The following table summarizes select asset quality ratios for each of the periods indicated:



(1) Non-performing loans are defined as nonaccrual loans and loans 90 days past due and still accruing interest and are both included in our ratios.

The ratio of the allowance for loan and lease losses to total loans decreased to 0.56% at December 31, 2019 compared to 0.58% at December 31, 2018.  The lower ratio in 2019 reflected an increase in the allowance which was relatively less than the increase in loan balances.  The largest component of the increase in the allowance to $10.2 million at year end 2019 from from $8.7 million at year end 2018 was in the non guaranteed portion of SBA loans which comprise the majority of small business (SBL) loans. The allowance on SBL loan increased $1.1 million between those dates. The increase reflected the impact of  historical charge-off ratios and qualitative factors which may increase such ratios, applied against the related loan category balance at period end.  In addition, the total allowance includes allowances on specific loans (see “-Allowance for Loan and Lease Losses”).  For the year 2019, the largest segment of the loan portfolio continued to be SBLOC, which has historically experienced low levels of losses as a result of the marketable securities collateralizing these loans and related loan to value requirements (see Item 1. “Business-Lending-SBL Loans”).  The ratio of the allowance for loan losses to non-performing loans decreased to 113.0% at December 31, 2019 from 158.19% over the prior year end, reflecting an increase in non-performing loans, especially SBL non-real estate and leasing, which exceeded the relative increase in the allowance for loan losses.  The ratio of non-performing assets to total assets increased to 0.16% from 0.12% primarily as a result of the increase in non-performing loans.  The ratio of net charge-offs to average loans increased to 0.12% for 2019 compared to 0.10% for the prior year, reflecting loan growth and an increase in net charge-offs in 2019 to $2.8 million from $2.0 million.

Net Charge-Offs.  Net charge-offs were $2.8 million in 2019, $2.0 million in 2018 and $2.2 million in 2017.  The increase in net charge-offs in 2019 compared to 2018 was primarily due to a $1.1 million consumer loan charge-off in 2019.  That charge off resulted from a home equity line of credit.  In September 2016, this product became inactive and is no longer being marketed to customers, and the current unimpaired portfolio balance is $2.8 million, consisting of 32 accounts averaging $88,000.

Non-Performing Loans, Loans 90 Days Delinquent and Still Accruing, and Troubled Debt Restructurings.  Loans are considered to be non-performing if they are on a non-accrual basis or they are past due 90 days or more and still accruing interest.  A loan which is past due 90 days or more and still accruing interest remains on accrual status only when it is both adequately secured as to principal and interest, and is in the process of collection.  Troubled debt restructurings are loans with terms that have been renegotiated to provide a reduction or deferral of interest or principal because of a weakening in the financial positions of the

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borrowers.  The following tables summarize our non-performing loans, other real estate owned (OREO) and our loans past due 90 days or more still accruing interest. 







In February 2020, a single borrower under financial stress, became delinquent on vehicle loans, the total balance of which as of March 6, 2020 was $15.7 million. The Company is in discussions with the borrower for accelerated repayment.   While the Company’s estimates of the disposition value of the vehicles exceed the amounts due, there can be no assurance that all amounts will be fully collected or recovered from vehicle sales. Further, should the borrower declare bankruptcy, related court actions may impact the timing or amount of recovery.



The loans that were modified for the years ended December 31, 2019 and 2018 and considered troubled debt restructurings are as follows (in thousands):







The balances below provide information as to how the loans were modified as troubled debt restructured loans at December 31, 2019 and 2018 (in thousands):









We had no commitments to extend credit related to one loan classified as a troubled debt restructuring as of December 31, 2019 and a commitment to extend $27,000 to one loan classified as a troubled debt restructuring as of December 31, 2018.



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The following table summarizes as of December 31, 2019 loans that were restructured within the last 12 months that have subsequently defaulted (in thousands).









Please see “Investment in Unconsolidated Entity” below for discussion of a large restructured loan which is accounted for at fair value.

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The following table provides information about impaired loans at December 31, 2019 and 2018 (in thousands):





We had $5.8 million of non-accrual loans at December 31, 2019, compared to $4.5 million of non-accrual loans at December 31, 2018.  The $1.3 million increase reflected $6.2 million of loans placed on non-accrual status, partially offset by $2.5 million of loan charge-offs and $2.4 million of loan payments.    Loans past due 90 days or more still accruing interest amounted to $3.3 million 

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and $954,000 at December 31, 2019 and December 31, 2018, respectively.  The $2.3 million increase reflected $4.5 million of additions, partially offset by $1.0 million of loan payments, $82,000 of charge-offs, and $1.1 million of transfers to repossessed assets.  We had no OREO at December 31, 2019 and December 31, 2018. 



We evaluate loans under an internal loan risk rating system as a means of identifying problem loans.  The following table provides information by credit risk rating indicator for each segment of the loan portfolio excluding loans held-for-sale at the dates indicated (in thousands):







*For information on targeted loan review thresholds see “-Allowance for Loan Losses”

 

Investment in Unconsolidated Entity.  On December 30, 2014, the Bank sold a portion of its discontinued commercial loan portfolio.  The purchaser of the loan portfolio was a newly formed entity, Walnut Street 2014-1 Issuer, LLC or Walnut Street.  The price paid to the Bank for the loan portfolio with a face value of approximately $267.6 million was approximately $209.6 million, of which approximately $193.6 million was in the form of two notes issued by Walnut Street to the Bank; a senior note in the principal amount of approximately $178.2 million bearing interest at 1.5% per year and maturing in December 2024 and a subordinate note in the principal amount of approximately $15.4 million, bearing interest at 10.0% per year and maturing in December 2024.  At December 31, 2019, a balance of $39.2 million remained on the consolidated balance sheet, representing the remaining balances of these notes.   Interest is not being accrued on this investment and changes in its value, determined by discounting estimated future cash flows, are recorded in the income statement under “change in value of investment in unconsolidated entity”.  In 2019, there was no net decrease in value, compared to a $3.7 million decrease in value in 2018.  A $30 million credit, collateralized by a commercial retail property with multiple tenants, is comprised of a $17.0 million loan which had been sold to Walnut Street, and $13.0 million which is

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included in commercial loans held-for-sale. In 2019, this loan was marked down by $1.6 million after having previously been marked down by $1.9 million.  Both markdowns resulted primarily from updated appraisals. The charges to Walnut Street  were based on the ratio of the $17.0 million owned by that entity to the $30 million loan balance, with the remainder of the charges reflected in net realized and unrealized gains on commercial loans originated for sale.  The underlying collateral which was written down consisted of a multi-tenant shopping center.  On March 13, 2019, we renewed this loan for four years and reduced the interest rate to the following: LIBOR plus 2% in year one, increasing .5% each year until the fourth year when  the rate will be LIBOR plus 3.5% which will also be the rate for  a one year extension, if exercised.   The loan is performing in accordance with those restructured terms.  The retail space is partially leased and appears to be on a path toward stabilization, based upon negotiations with prospective tenants. We previously noted that collateral securing two loans recorded at $12.1 million was in the process of disposition.  The collateral has subsequently been disposed of at the  approximate carrying value of the loans, which was reflected in the reduction in the balance of investment in unconsolidated entity.  



Assets Held-for-Sale from Discontinued Operations.  Assets held-for-sale as a result of discontinued operations, primarily commercial, commercial mortgage and construction loans, amounted to $140.7 million at December 31, 2019 and were comprised of $115.9 million of net loans and $24.8 million of other real estate owned.  The balance of other real estate owned includes a Florida mall, which has been written down to $15.0 million.  We expect to continue our efforts to dispose of the mall, which was appraised in September 2018 for $16.9 million.  We previously noted that collateral comprised of multiple commercial properties  recorded at $12.8 million as being in the process of disposition. The collateral has subsequently been partially disposed of and the remaining collateral was marked down on the basis of an updated appraisal.  As a result, a related net loss of $1.6 million was recorded in income from discontinued operations.  At December 31, 2019, $4.3 million of commercial real estate collateral remained on the books, after being marked down to its fourth quarter 2019 appraisal.



At December 31, 2018, discontinued assets of $197.8 million were comprised of $170.6 million of net loans and $27.2 million of other real estate owned. 



Deposits.  Our primary source of funding is deposit acquisition.  We offer a variety of deposit accounts with a range of interest rates and terms, including prepaid and debit card and demand and money market accounts.  The majority of deposit balances are comprised of accounts obtained with the assistance of third parties.  At December 31, 2019, we had total deposits of $5.05 billion compared to $3.94 billion at December 31, 2018, which reflected an increase of $1.12 billion, or 28.4%, between 2019 and 2018.  The increase reflected $475.0 million of short-term time deposits utilized to fund increased originations of commercial real estate held for sale.  The increase in deposits also reflects growth in prepaid and debit card accounts and daily balance variances.  A diversified group of prepaid and debit card accounts, which have an established history of stability and lower cost than certain other types of funding, comprise the majority of our deposits.  Prepaid accounts include general purpose reloadable, debit, medical spending, payroll, gift, commercial, incentive plan and other accounts.  The following table presents the average balance and rates paid on deposits for the periods indicated (in thousands):











Short-Term Borrowings.  We had no outstanding advances from the FHLB at December 31, 2019 on our line of credit with them. The Bank also has a line of credit with the Federal Reserve, which we discuss in “Liquidity and Capital Resources”.  We had no outstanding amounts borrowed on the Bank’s lines of credit at December 31, 2019. We do not have any policy prohibiting us from incurring debt.  Tables showing information for securities sold under repurchase agreements and short-term borrowings are as follows.



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As of December 31, 2019, we had two established statutory business trusts: The Bancorp Capital Trust II and The Bancorp Capital Trust III, which we refer to as the Trusts.  In each case, we own all the common securities of the Trust.  These trusts issued preferred capital securities to investors and invested the proceeds in us through the purchase of junior subordinated debentures issued by us.  These debentures are the sole assets of the trusts.  The $10.3 million of debentures issued to The Bancorp Capital Trust II on November 28, 2007, mature on March 15, 2038 and bear interest equal to 3-month LIBOR plus 3.25%.  The $3.1 million of debentures issued to The Bancorp Capital Trust III on November 28, 2007 mature on March 15, 2038, and bear interest at a floating annual rate equal to 3-month LIBOR plus 3.25%.

Long-term Borrowings.  At December 31, 2019 and 2018, we had long term borrowings of $41.0 million and $41.7 million respectively, which consisted of sold loans which were accounted for as a secured borrowing, because they did not qualify for true sale accounting.  

Shareholders’ Equity.  At December 31, 2019, we had $484.5 million in shareholders’ equity compared to $406.8 million at the prior year end.  The increase primarily reflected 2019 earnings as the Company has not paid cash dividends.  The difference also reflected the increase in market value of securities resulting from the decrease in longer term interest rates. 

Off-balance Sheet Commitments

We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers.  These financial instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in our consolidated financial statements.

Credit risk is defined as the possibility of sustaining a loss due to the failure of the other parties to a financial instrument to perform in accordance with the terms of the contract.  The maximum exposure to credit loss under commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments.  We use the same underwriting standards and policies in making credit commitments as we do for on-balance sheet instruments.

Financial instruments whose contract amounts represent potential credit risk for us at December 31, 2019, were our unused commitments to extend credit, which were approximately $2.34 billion, and standby letters of credit, which were approximately $3.5 million, at December 31, 2019.  The vast majority of commitments reflect SBLOC commitments, which are variable rate, and

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connected to lines of credit collateralized by marketable securities. The amount of the line is generally based upon the value of the collateral, and not expected usage. The majority of these available lines are not drawn upon.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and many require the payment of a fee.  Standby letters of credit are conditional commitments issued that guarantee the performance of a customer to a third party.  Since we expect that many of the commitments or letters of credit we issue will not be fully drawn upon, the total commitment or letter of credit amounts do not necessarily represent future cash requirements.  We evaluate each customer’s creditworthiness on a case-by-case basis.  We base the amount of collateral we obtain when we extend credit on our credit evaluation of the customer. Collateral held varies but may include real estate, marketable securities, pledged deposits, equipment and accounts receivable.

Contractual Obligations and Other Commitments

The following table sets forth our contractual obligations and other commitments, including off-balance sheet commitments, representing required and potential cash outflows as of December 31, 2019:



Impact of Inflation

The primary impact of inflation on our operations is on our operating costs.  Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature.  As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.  Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services.  While we anticipate that inflation will affect our future operating costs, we cannot predict the timing or amounts of any such effects.

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Recently Issued Accounting Standards

Information on recent accounting pronouncements is set forth in Note B, item 23, to the consolidated financial statements included in this report and is incorporated herein by this reference.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Information with respect to quantitative and qualitative disclosures about market risk is included under the section entitled “Asset and Liability Management” in Part

2 Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. 

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Item 8. Financial Statements and Supplementary Data.











REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



Board of Directors and Shareholders

The Bancorp, Inc.

Opinion on the financial statements

We have audited the accompanying consolidated balance sheets of The Bancorp, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.



We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated March 13, 2020 expressed an unqualified opinion.



Change in accounting principle

As  discussed in Note B to the financial statements, the Company has changed its method of accounting for leases in 2019 due to the adoption of ASU 2016-02, Leases (Topic 842). 



Basis for opinion

These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on the Company’s financial statements based on our audits.  We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.



We conducted our audits in accordance with the standards of the PCAOB.  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.  Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.  Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements.  We believe that our audits provide a reasonable basis for our opinion.





/s/ Grant Thornton LLP

We have served as the Company’s auditor since 2000.

Philadelphia, Pennsylvania

March 13, 2020





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THE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



The accompanying notes are an integral part of these consolidated financial statements. 

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THE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS







The accompanying notes are an integral part of these consolidated financial statements. 

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The accompanying notes are an integral part of these consolidated financial statements. 

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The accompanying notes are an integral part of these consolidated financial statements. 

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THE BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)





The accompanying notes are an integral part of these consolidated financial statements.