CAMBRIDGE BANCORP - Quarter Report: 2020 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2020

OR

For the transition period from _________________ to __________________

Commission File Number: 001-38184

CAMBRIDGE BANCORP

(Exact Name of Registrant as Specified in its Charter)

Registrant’s telephone number, including area code: (617) 876-5500

Securities registered pursuant in Section12(b) of the act:

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 (§ 232.405 of this chapter) 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, 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 Exchange Act).    Yes  ☐    No  ☒

As of July 31, 2020, the registrant had 6,927,592 shares of common stock, $1.00 par value per share, outstanding.

Table of Contents

CAMBRIDGE BANCORP AND SUBSIDIARIES

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

CAMBRIDGE BANCORP AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEETS

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

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CAMBRIDGE BANCORP AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME (LOSS)

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

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CAMBRIDGE BANCORP AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

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

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CAMBRIDGE BANCORP AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

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

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CAMBRIDGE BANCORP AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

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

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CAMBRIDGE BANCORP AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

The unaudited consolidated financial statements include the accounts of Cambridge Bancorp (the “Company”) and its wholly owned subsidiary, Cambridge Trust Company (the “Bank”), and the Bank’s wholly owned subsidiaries, Cambridge Trust Company of New Hampshire Inc., CTC Security Corporation, and CTC Security Corporation III. References to the Company herein relate to the consolidated group of companies. All significant intercompany accounts and transactions have been eliminated in preparation of the consolidated financial statements.

The Company is a state-chartered, federally registered bank holding company headquartered in Cambridge, Massachusetts and was incorporated in 1983. The Company is the sole shareholder of the Bank, a Massachusetts trust company chartered in 1890, which is a commercial bank.  The Company operates as a private bank offering a full range of private banking and wealth management services to its clients.  The private banking business, the Company’s only reportable operating segment is managed as a single strategic unit.  

The unaudited consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) and disclosures necessary to present fairly the Company’s financial position, as of June 30, 2020 and December 31, 2019, respectively, and the results of operations and cash flows for the interim periods presented in accordance with U.S. generally accepted accounting principles (“GAAP”). Interim results are not necessarily reflective of the results of the entire year.

For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”), filed with the Securities and Exchange Commission on March 17, 2020.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. The allowance for credit losses, the fair values of financial instruments, and the valuation of deferred tax assets are particularly subject to change.

Management has reviewed events occurring through August 6, 2020, the date the unaudited consolidated financial statements were available to be issued and determined that no subsequent events occurred requiring adjustment to or disclosure in these financial statements.

On June 1, 2020, the Company completed its merger with Wellesley Bancorp Inc. (“Wellesley”), adding 6 banking offices in Massachusetts. Under the terms of the Agreement and Plan of Merger, each outstanding share of Wellesley common stock was converted into 0.580 shares of the Company’s common stock. As a result of the merger, former Wellesley shareholders received an aggregate of 1,502,814 shares of the Company's common stock.  The total consideration paid amounted to $88.8 million, based on the closing price of $58.00 of the Company's common stock, the value of Wellesley's exercisable options, and cash paid for fractional shares on May 31, 2020.    

The Company accounted for the merger using the acquisition method pursuant to the Business Combinations Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”). Accordingly, the Company recorded merger expenses during the three months and six months ended June 30, 2020 of approximately $4.4 million and $4.6 million, respectively. Additionally, the Company recorded $8.6 million in provision for credit losses to reflect the impact of CECL merger accounting on June 1, 2020.

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The acquisition method requires the acquirer to recognize the assets acquired and the liabilities assumed at their fair values as of the acquisition date. The following table summarizes the estimated fair value of the assets acquired and liabilities assumed as of the date of the acquisition:

Fair value adjustments to assets acquired and liabilities assumed are generally amortized using either an effective yield or straight-line basis over periods consistent with the average life, useful life, and/or contractual term of the related assets and liabilities.

Fair values of the major categories of assets acquired and liabilities assumed were determined as follows:

Cash and Cash Equivalents

The fair values of cash and cash equivalents approximate the respective carrying amounts because the instruments are payable on demand or have short-term maturities.

Investments

The fair values of securities were based on quoted market prices for identical securities received from an independent, nationally-recognized, third-party pricing service. Prices provided by the independent pricing service were based on recent trading activity and other observable information including, but not limited to, market interest rate curves, referenced credit spreads, and estimated prepayment rates where applicable.

Loans

Fair value was determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected, as adjusted for an estimate of default rate and prepayments, and then applying a market-based discount rate to those cash flows.

Premises and Equipment

The fair value of premises was determined based upon appraisals by licensed real estate appraisers. The appraisal was based upon the best and highest use of the property with the final value determined based upon an analysis of the cost, sales comparison, and income capitalization approaches for the property appraised.

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Deposits

The fair value of acquired savings and transaction deposit accounts was assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. The fair value of time deposits was determined based on the present value of the contractual cash flows over the remaining period to maturity using a market interest rate.

Borrowings

The fair value represents the adjustment necessary because the weighted average interest rate of the Federal Home Loan Bank borrowings differed from the cost of similar funding at the time of acquisition.

Subordinated debt

The fair value represents the adjustment necessary because the interest rate of the subordinated debt differed from the cost of similar funding at the time of acquisition.

Selected Pro Forma Results

The following summarizes the unaudited pro forma results of operations as if the Company merged with Wellesley on December 31, 2019 and 2018, respectively. Amounts represent combined results for the Company and Wellesley. The selected pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the financial results of the combined companies had the acquisition actually been completed at the beginning of the periods presented, nor does it indicate future results for any other interim or full-year period.

Excluded from the pro forma results of operations for the three months and six months ended June 30, 2020 are merger-related costs of approximately $4.4 million and $4.6 million, respectively, recognized by the Company. These costs primarily consisted of contract terminations arising due to the merger, the acceleration of certain compensation and benefit costs, and other merger expenses. The provision recorded on acquired loans of $8.6 million was also excluded as a material, non-recurring adjustment.

Optima Bank & Trust Company

The Company completed its merger with Optima Bank & Trust Company (“Optima”) on April 17, 2019. Under the terms of the Agreement and Plan of Merger, each outstanding share of Optima common stock was converted into $32.00 in cash or 0.3468 shares of the Company’s common stock, with the transaction structured as 95 percent common stock and 5 percent cash.  As a result of the merger, former Optima shareholders received an aggregate of approximately 722,746 shares of the Company’s common stock and an aggregate of approximately $3.5 million in cash. The total consideration paid amounted to $64.3 million.

The Company accounted for the merger using the acquisition method and recorded total assets of $555.7 million, including $30.8 million in goodwill, and assumed total liabilities of $491.4 million.  Additionally, the Company recorded merger expenses of $3.5 million during the three months and six months ended June 30, 2019.  

Accounting Standards Update 2020-04 - Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”). On March 12, 2020, the Financial Accounting Standards Board (“FASB”) issued ASU 2020-04 to ease the potential burden in accounting for reference rate reform. The amendments in ASU 2020-04 are elective and apply to all entities that have contracts, hedging relationships, and other transactions that reference the London Inter-bank Offer Rate (“LIBOR”) or another reference rate expected to be discontinued due to reference rate reform. The new guidance provides the following optional expedients:

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The amendments are effective for all entities from the beginning of an interim period that includes the issuance date of the ASU. An entity may elect to apply the amendments prospectively through December 31, 2022.  The Company is currently assessing the impact the adoption of this guidance will have on our consolidated balance sheets, statements of income (loss), and cash flows.

Accounting Standards Update 2018-15 - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). On August 29, 2018, the FASB issued amended guidance to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The Company adopted the amended guidance on January 1, 2020, using the prospective method, and it did not have a material impact on the consolidated financial statements.

Accounting Standards Update 2018-14 - Changes to the Disclosure Requirements for Defined Benefit Plans (“ASU 2018-14”). On August 28, 2018, the FASB issued guidance to remove, add, and clarify certain disclosures for defined benefit plans. The ASU is effective for fiscal years ending after December 15, 2020; early adoption is permitted and should be applied using the retrospective method to all periods presented. The Company is currently assessing the impact the adoption of this guidance will have on our consolidated balance sheets, statements of income (loss), and cash flows.  

Accounting Standards Update 2018-13 - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). On August 28, 2018, the FASB issued guidance to remove, add, and clarify certain disclosures for fair value measurement. The Company adopted the amended guidance on January 1, 2020 using the prospective method and it did not have an impact on our consolidated balance sheets, statements of income (loss), or cash flows.

Accounting Standards Update 2016-13 - Financial Instruments - Credit Losses (“Topic 326”): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13, which has been codified under Topic 326, replaced the previous GAAP method of calculating loan losses. Previously, GAAP required the use of the incurred loss methodology versus ASU 2016-13 which utilizes an expected loss methodology. The current expected credit loss (“CECL”) methodology incorporates forecasting in addition to historical and current measures. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables, held to maturity and available for sale debt securities. The Company adopted ASU 2016-13 and related amendments on January 1, 2020 using a modified-retrospective approach for all financial assets measured at amortized cost and off-balance-sheet (OBS) credit exposures and recorded additional allowance for credit loss of $481,000 before taxes and a corresponding decrease in retained earnings of $347,000, net of taxes. Results for reporting periods beginning after January 1, 2020 are presented under Topic 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP.

The Company’s CECL methodology consists of quantitative and qualitative components. The quantitative component of the allowance for credit losses (“ACL”) is model based and utilizes a forward-looking macroeconomic forecast, complemented by qualitative components in estimating expected credit losses. The qualitative components of the ACL consider (i) the uncertainty of forward-looking scenarios; (ii) certain portfolio characteristics, such as portfolio concentrations, real estate values, changes in the number and amount of nonaccrual and past due loans; and (iii) model limitations; among others.  

ASU 2016-13 also applies to off-balance sheet credit exposure not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees and other similar investment) and net investments in leases recognized by a lessor in accordance with ASU 2016-02-Leases (Topic 842) on leases.   

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January 1, 2020 CECL Transition (Day 1) Impact

The CECL methodology reflects the Company’s view of the state of the economy and forecasted macroeconomic conditions and their impact on the Company’s loan and investment portfolios as of the adoption date.

The following table illustrates the impact of Topic 326:

Summary of significant accounting policies impacted by Topic 326

Debt Securities

Investment securities are classified as either ‘held to maturity’ or ‘available for sale’ in accordance with the FASB ASC 320, Investments – Debt and Equity Securities. Debt securities that management has the positive intent and ability to hold to maturity are classified as held to maturity. Held to maturity securities are carried at cost and adjusted for the amortization of premiums and the accretion of discounts using the effective-yield or straight-line method.

Debt and equity securities not classified as held to maturity are classified as available for sale and carried at fair value with unrealized after-tax gains and losses reported net as a separate component of shareholders’ equity. The Company classifies its securities based on its intention at the time of purchase.

Allowance for credit losses- held to maturity securities

The Company measures expected credit losses on held to maturity debt securities on a collective basis by security type and risk rating where available. The reserve for each pool is calculated based on a Probability of Default/Loss Given Default (PD/LGD) basis taking into consideration the expected life of each security. Held to maturity securities which are issued by the United States or are guaranteed by U.S. federal agencies do not currently have an allowance for credit loss as the Company determined these securities are either backed by the full faith and credit of the U.S. government and/or there is an unconditional commitment to make interest payments and to return the principal investment in full to investors when a debt security reaches maturity. The Company will evaluate this position no less than annually, however, certain items which may cause the Company to change this methodology include legislative changes that remove a government-sponsored enterprise’s (“GSE”) ability to draw funds from the U.S. government, or legislative changes to housing policy that reduce or eliminate the U.S. government’s implicit guarantee on such securities. For securities which are not U.S. treasury or agency backed, risk ratings are generally sourced from Moody’s or Standard & Poor’s (“S&P”). The Company updates loss given default, probability of default, and recovery rates for each security as that information becomes available but no less than annually. The expected remaining life to maturity of each applicable security is updated quarterly. Any expected credit losses on held to maturity securities would be presented as an allowance rather than as a direct write-down through the income statement if the Company does not intend to sell or believes that it is more- likely- than- not that the Company will be required to sell the security.

Allowance for credit losses-available for sale securities

The Company measures expected credit losses on available for sale securities based upon the gain or loss position of the security. For available-for sale debt securities in an unrealized loss position, which the Company does not intend to sell, or it is not more likely than not that the Company will be required to sell the security before recovery of our amortized cost, the Company evaluates qualitative criteria to determine any expected loss. This includes among other items the financial health of, and specific prospects for the issuer, including whether the issuer is in compliance with the terms and covenants of the security. The Company also evaluates quantitative

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criteria including determining whether there has been an adverse change in expected future cash flows of the security. If the Company does not expect to recover the entire amortized cost basis of the security, an allowance for credit losses would be recorded, with a related charge to earnings, limited by the amount of the fair value of the security less its amortized cost. If the Company intends to sell the security or it is more likely than not that the Company will be required to sell the debt security before recovery of its amortized cost basis, the Company recognizes the entire difference between the security’s amortized cost basis and its fair value in earnings.

Loans

Loans are reported at the amount of their outstanding principal, including deferred loan origination fees and costs, reduced by unearned discounts, and the allowance for credit losses. Loans are considered delinquent when a payment of principal and/or interest becomes past due 30 days following its scheduled payment due date. Loans on which the accrual of interest has been discontinued are designated as non-accrual loans. Loans are removed from non-accrual when they become less than 90 days past due and when concern no longer exists as to the collectability of principal or interest.

Allowance for Credit Losses - Loans

Losses on loan receivables are estimated and recognized upon origination of the loan, based on expected credit losses for the life of the loan balance as of the period end date. The Company uses a discounted cash flow method incorporating probability of default and loss given default forecasted based on statistically derived economic variable loss drivers combined with qualitative factors to estimate expected credit losses. This process includes estimates which involve modeling loss projections attributable to existing loan balances, considering historical experience, current conditions and future expectations for homogeneous pools of loans over the reasonable and supportable forecast period. As stated above, the Company also performs a qualitative assessment beyond model estimates, and apply qualitative adjustments as management deems necessary. The reasonable and supportable forecast period is determined based upon the accuracy level of historical loss forecast estimates, the specific loan level models and methodology utilized, and considers material changes in growth and credit strategy, and business changes which may not be applicable within the current environment. For periods beyond a reasonable and supportable forecast interval, the Company reverts to historical information over a period for which comparable data is available. The historical information either experienced by the Company, or by a selection of peer banks when appropriate, is derived from a combination of recessionary and non-recessionary performance periods for which data is available. Similar to the reasonable and supportable forecast period, the Company reassesses the reversion period at the segment level, considering any required adjustments for differences in underwriting standards, portfolio mix, and other relevant data shifts over time.

The Company generally segments its loan receivable population into homogeneous pools of loans. Consistent with the Company’s other assumptions, the Company regularly reviews segmentation to determine whether the segmentation pools remain relevant as risk characteristics change. When a loan no longer meets the criteria of its initial pooling as a result of credit deterioration or other changes, the Company may evaluate the credit for estimated losses on an individual basis if it determines that they no longer retain the same risk characteristics.  To the extent that there are a multitude of these loans with new similar credit characteristics, the Company would anticipate a change to the pooling methodology. Loans that do not share risk characteristics are evaluated on an individual basis and are also not included in the collective evaluation. For loans with real estate collateral, when management determines that foreclosure is probable, expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate.

The Company evaluates the loan allowance for credit losses quarterly. The Company regularly reviews our collection experience (including delinquencies and net charge-offs) in determining our allowance for credit losses. The Company also considers its historical loss experience to date based on actual defaulted loans and overall portfolio indicators including delinquent and non-accrual loans, trends in loan volume and lending terms, credit policies and other observable environmental factors such as unemployment and interest rate changes.

The underlying assumptions, estimates and assessments the Company uses to estimate the allowance for credit losses reflects the Company’s best estimate of model assumptions and forecasted conditions at that time. Changes in such estimates can significantly affect the allowance and provision for credit losses. It is possible and likely that the Company will experience credit losses that are different from the current estimates. Charge-offs are deducted from the allowance for credit losses when the Company considers the principal to be uncollectible, and subsequent recoveries are added to the allowance, generally at the time cash is received on a charged-off account.

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Allowance for Unfunded Commitments

The expected credit losses for unfunded commitments are measured over the contractual period of the Company’s exposure to credit risk.  The estimate of credit loss incorporates assumptions for both the likelihood and amount of funding over the estimated life of the commitments, for the risk of loss, and current conditions and expectations. Management periodically reviews and updates its assumptions for estimated funding rates based on historical rates, and factors such as portfolio growth, changes to organizational structure, economic conditions, borrowing habits, or any other factor which could impact the likelihood that funding will occur. The Company does not reserve for unfunded commitments which are unconditionally cancellable.

Acquired Loans

Acquired loans are recorded at fair value at the date of acquisition based on a discounted cash flow methodology that considers various factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and a discount rate reflecting the Company’s assessment of risk inherent in the cash flow estimates. Certain larger purchased loans are individually evaluated while certain purchased loans are grouped together according to similar risk characteristics and are treated in the aggregate when applying various valuation techniques. These cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change.

Starting January 1, 2020, loans acquired in a business combination that have experienced more-than-insignificant deterioration in credit quality since origination are considered purchased credit deteriorated (“PCD”) loans. The Company evaluated acquired loans for deterioration in credit quality based on, but not limited to, the following: (1) non-accrual status; (2) troubled debt restructured designation; (3) risk ratings of special mention, substandard or doubtful; (4) watchlist credits; and (5) delinquency status, including loans that are current on acquisition date, but had been previously delinquent. At the acquisition date, an estimate of expected credit losses is made for groups of PCD loans with similar risk characteristics and individual PCD loans without similar risk characteristics. This initial allowance for credit losses is allocated to individual PCD loans and added to the purchase price or acquisition date fair values to establish the initial amortized cost basis of the PCD loans. As the initial allowance for credit losses is added to the purchase price, there is no credit loss expense recognized upon acquisition of a PCD loan. Any difference between the unpaid principal balance of PCD loans and the amortized cost basis is considered to relate to noncredit factors and results in a discount or premium. Discounts and premiums are recognized through interest income on a level-yield method over the life of the loans. 

For acquired loans not deemed PCD at acquisition, the differences between the initial fair value and the unpaid principal balance are recognized as interest income on a level-yield basis over the lives of the related loans. At the acquisition date, an initial allowance for expected credit losses is estimated and recorded as credit loss expense. The subsequent measurement of expected credit losses for all acquired loans is the same as the subsequent measurement of expected credit losses for originated loans.

See Note 8 – Loans and the Allowance for Credit Losses for a detailed discussion of the Company’s allowance for credit losses.  

See Note 2 - Basis of Presentation and Summary of Significant Accounting Policies to our 2019 annual consolidated financial statements in our 2019 Form 10-K, for additional information on our other significant accounting policies.

At June 30, 2020 and December 31, 2019, cash and cash equivalents totaled $60.7 million and $61.3 million, respectively. There were no amounts required to be maintained at the Federal Reserve Bank of Boston (“FRB”) at June 30, 2020. At December 31, 2019, the Company maintained $31.5 million of cash and equivalents at the FRB Boston to satisfy reserve requirements. Additionally, at June 30, 2020 and December 31, 2019, respectively, the Company pledged $500,000 to the New Hampshire Banking Department relating to Cambridge Trust Company of New Hampshire, Inc.’s operations in that state.  The Company also pledged cash collateral to derivative counterparties totaling $37.4 million and $10.4 million at June 30, 2020 and December 31, 2019, respectively. See Note 18 - Derivatives and Hedging Activities for a discussion of the Company’s derivative and hedging activities.

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Investment securities have been classified in the unaudited consolidated balance sheets according to management’s intent. The carrying amounts of securities and their approximate fair values were as follows: