EAGLE BANCORP INC - Quarter Report: 2021 March (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2021
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number 0-25923
Eagle Bancorp, Inc.
(Exact name of registrant as specified in its charter)
| Maryland | 52-2061461 | ||||||||||||||||||||||
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||||||||||||||||||||||
7830 Old Georgetown Road, Third Floor, Bethesda, Maryland | 20814 | ||||||||||||||||||||||
| (Address of principal executive offices) | (Zip Code) | ||||||||||||||||||||||
(301) 986-1800
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Securities Registered Pursuant to Section 12(b) of the Act:
| Title of Each Class | Trading Symbol(s) | Name of Each Exchange on Which Registered | ||||||||||||
| Common Stock, $0.01 par value | EGBN | The Nasdaq Stock Market, LLC | ||||||||||||
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, 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.
Large accelerated filer ☒ Accelerated filer ☐
Non-accelerated filer ☐ Smaller Reporting Company ☐
Emerging Growth Company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act Yes ☐ No ☒
As of April 30, 2021, the registrant had 31,962,314 shares of Common Stock outstanding.
EAGLE BANCORP, INC.
TABLE OF CONTENTS
| PART I. | FINANCIAL INFORMATION | |||||||
Consolidated Statements of Income | ||||||||
2
PART I - FINANCIAL INFORMATION
Item 1 – Financial Statements (Unaudited)
EAGLE BANCORP, INC.
Consolidated Balance Sheets (Unaudited)
(dollars in thousands, except per share data)
| March 31, 2021 | December 31, 2020 | ||||||||||
| Assets | |||||||||||
| Cash and due from banks | $ | 9,112 | $ | 8,435 | |||||||
| Federal funds sold | 25,785 | 28,200 | |||||||||
| Interest bearing deposits with banks and other short-term investments | 1,708,374 | 1,752,420 | |||||||||
Investment securities (amortized cost of $1,370,927 and $1,129,057 and allowance for credit losses of $78 and $167 as of March 31, 2021 and December 31, 2020, respectively). | 1,369,107 | 1,151,083 | |||||||||
| Federal Reserve and Federal Home Loan Bank stock | 33,978 | 40,104 | |||||||||
| Loans held for sale | 142,196 | 88,205 | |||||||||
| Loans | 7,526,689 | 7,760,212 | |||||||||
| Less allowance for credit losses | (102,070) | (109,579) | |||||||||
| Loans, net | 7,424,619 | 7,650,633 | |||||||||
| Premises and equipment, net | 15,045 | 13,553 | |||||||||
| Operating lease right-of-use assets | 30,707 | 25,237 | |||||||||
| Deferred income taxes | 44,623 | 38,571 | |||||||||
| Bank owned life insurance | 77,119 | 76,729 | |||||||||
| Goodwill and Intangible assets, net | 105,179 | 105,114 | |||||||||
| Other real estate owned | 4,987 | 4,987 | |||||||||
| Other assets | 137,033 | 134,531 | |||||||||
| Total Assets | $ | 11,127,864 | $ | 11,117,802 | |||||||
| Liabilities and Shareholders’ Equity | |||||||||||
| Liabilities | |||||||||||
| Deposits: | |||||||||||
| Noninterest bearing demand | $ | 2,594,334 | $ | 2,809,334 | |||||||
| Interest bearing transaction | 862,709 | 756,923 | |||||||||
| Savings and money market | 4,875,840 | 4,645,186 | |||||||||
Time, $100,000 or more | 513,998 | 546,173 | |||||||||
| Other time | 351,963 | 431,587 | |||||||||
| Total deposits | 9,198,844 | 9,189,203 | |||||||||
| Customer repurchase agreements | 20,061 | 26,726 | |||||||||
| Other short-term borrowings | 300,000 | 300,000 | |||||||||
| Long-term borrowings | 218,175 | 268,077 | |||||||||
| Operating lease liabilities | 33,338 | 28,022 | |||||||||
| Reserve for unfunded commitments | 5,056 | 5,498 | |||||||||
| Other liabilities | 91,557 | 59,384 | |||||||||
| Total Liabilities | 9,867,031 | 9,876,910 | |||||||||
| Shareholders’ Equity | |||||||||||
Common stock, par value $0.01 per share; shares authorized 100,000,000, shares issued and outstanding 31,960,379 and 31,779,663, respectively | 316 | 315 | |||||||||
| Additional paid in capital | 428,917 | 427,016 | |||||||||
| Retained earnings | 833,598 | 798,061 | |||||||||
| Accumulated other comprehensive (loss) income | (1,998) | 15,500 | |||||||||
| Total Shareholders’ Equity | 1,260,833 | 1,240,892 | |||||||||
| Total Liabilities and Shareholders’ Equity | $ | 11,127,864 | $ | 11,117,802 | |||||||
See Notes to Consolidated Financial Statements.
3
EAGLE BANCORP, INC.
Consolidated Statements of Income (Unaudited)
(dollars in thousands, except per share data)
| Three Months Ended March 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| Interest Income | |||||||||||
| Interest and fees on loans | $ | 89,238 | $ | 96,755 | |||||||
| Interest and dividends on investment securities | 4,395 | 5,427 | |||||||||
| Interest on balances with other banks and short-term investments | 553 | 1,559 | |||||||||
| Interest on federal funds sold | 8 | 60 | |||||||||
| Total interest income | 94,194 | 103,801 | |||||||||
| Interest Expense | |||||||||||
| Interest on deposits | 7,899 | 20,546 | |||||||||
| Interest on customer repurchase agreements | 11 | 87 | |||||||||
| Interest on short-term borrowings | 495 | 357 | |||||||||
| Interest on long-term borrowings | 3,138 | 3,067 | |||||||||
| Total interest expense | 11,543 | 24,057 | |||||||||
| Net Interest Income | 82,651 | 79,744 | |||||||||
| Provision for Credit Losses | (2,350) | 14,310 | |||||||||
| Provision for Unfunded Commitments | (442) | 2,112 | |||||||||
| Net Interest Income After Provision For Credit Losses | 85,443 | 63,322 | |||||||||
| Noninterest Income | |||||||||||
| Service charges on deposits | 977 | 1,425 | |||||||||
| Gain on sale of loans | 5,178 | 944 | |||||||||
| Gain on sale of investment securities | 221 | 822 | |||||||||
| Increase in the cash surrender value of bank owned life insurance | 389 | 414 | |||||||||
| Other income | 3,822 | 1,865 | |||||||||
| Total noninterest income | 10,587 | 5,470 | |||||||||
| Noninterest Expense | |||||||||||
| Salaries and employee benefits | 21,769 | 17,797 | |||||||||
| Premises and equipment expenses | 3,618 | 3,821 | |||||||||
| Marketing and advertising | 886 | 1,078 | |||||||||
| Data processing | 2,814 | 2,496 | |||||||||
| Legal, accounting and professional fees | 2,999 | 6,988 | |||||||||
| FDIC insurance | 2,428 | 1,424 | |||||||||
| Other expenses | 3,473 | 3,743 | |||||||||
| Total noninterest expense | 37,987 | 37,347 | |||||||||
| Income Before Income Tax Expense | 58,043 | 31,445 | |||||||||
| Income Tax Expense | 14,574 | 8,322 | |||||||||
| Net Income | $ | 43,469 | $ | 23,123 | |||||||
| Earnings Per Common Share | |||||||||||
| Basic | $ | 1.36 | $ | 0.70 | |||||||
| Diluted | $ | 1.36 | $ | 0.70 | |||||||
See Notes to Consolidated Financial Statements.
4
EAGLE BANCORP, INC.
Consolidated Statements of Comprehensive Income (Unaudited)
(dollars in thousands)
| Three Months Ended March 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| Net Income | $ | 43,469 | $ | 23,123 | |||||||
| Other comprehensive income, net of tax: | |||||||||||
| Unrealized (loss) gain on securities available for sale | (17,617) | 12,104 | |||||||||
| Reclassification adjustment for net gains included in net income | (166) | (604) | |||||||||
| Total unrealized (loss) gain on investment securities | (17,783) | 11,500 | |||||||||
| Unrealized gain (loss) on derivatives | 573 | (1,325) | |||||||||
| Reclassification adjustment for amounts included in net income | (288) | (69) | |||||||||
| Total unrealized gain (loss) on derivatives | 285 | (1,394) | |||||||||
| Other comprehensive (loss) income | (17,498) | 10,106 | |||||||||
| Comprehensive Income | $ | 25,971 | $ | 33,229 | |||||||
See Notes to Consolidated Financial Statements.
5
EAGLE BANCORP, INC.
Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
(dollars in thousands except share data)
| Accumulated | |||||||||||||||||||||||||||||||||||
| Other | |||||||||||||||||||||||||||||||||||
| Common | Additional Paid | Retained | Comprehensive | Shareholders' | |||||||||||||||||||||||||||||||
| Shares | Amount | in Capital | Earnings | Income (Loss) | Equity | ||||||||||||||||||||||||||||||
| Balance January 1, 2021 | 31,779,663 | $ | 315 | $ | 427,016 | $ | 798,061 | $ | 15,500 | $ | 1,240,892 | ||||||||||||||||||||||||
| Net Income | — | — | — | 43,469 | — | 43,469 | |||||||||||||||||||||||||||||
| Other comprehensive loss, net of tax | — | — | — | — | (17,498) | (17,498) | |||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | 1,825 | — | — | 1,825 | |||||||||||||||||||||||||||||
| Vesting of time based stock awards issued at date of grant, net of shares withheld for payroll taxes | (16,663) | 1 | (1) | — | — | — | |||||||||||||||||||||||||||||
| Vesting of performance based stock awards, net of shares withheld for payroll taxes | 15,686 | — | — | — | — | — | |||||||||||||||||||||||||||||
| Time based stock awards granted | 178,001 | — | — | — | — | — | |||||||||||||||||||||||||||||
| Issuance of common stock related to employee stock purchase plan | 5,158 | — | 139 | — | — | 139 | |||||||||||||||||||||||||||||
Cash dividends declared ($0.25 per share) | — | — | — | (7,932) | — | (7,932) | |||||||||||||||||||||||||||||
| Common stock repurchased | (1,466) | — | (62) | — | — | (62) | |||||||||||||||||||||||||||||
| Balance March 31, 2021 | 31,960,379 | $ | 316 | $ | 428,917 | $ | 833,598 | $ | (1,998) | $ | 1,260,833 | ||||||||||||||||||||||||
| Balance January 1, 2020 | 33,241,496 | $ | 331 | $ | 482,286 | $ | 705,105 | $ | 2,959 | $ | 1,190,681 | ||||||||||||||||||||||||
| Net Income | — | — | — | 23,123 | — | 23,123 | |||||||||||||||||||||||||||||
| — | — | — | (10,931) | — | (10,931) | ||||||||||||||||||||||||||||||
| Other comprehensive income, net of tax | — | — | — | — | 10,106 | 10,106 | |||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | 996 | — | — | 996 | |||||||||||||||||||||||||||||
| Issuance of common stock related to options exercised, net of shares withheld for payroll taxes | — | — | — | — | — | — | |||||||||||||||||||||||||||||
| Vesting of time based stock awards issued at date of grant, net of shares withheld for payroll taxes | (22,183) | — | — | — | — | — | |||||||||||||||||||||||||||||
| Vesting of performance based stock awards, net of shares withheld for payroll taxes | 4,126 | — | — | — | — | — | — | ||||||||||||||||||||||||||||
| Time based stock awards granted | 152,184 | — | — | — | — | — | |||||||||||||||||||||||||||||
| Issuance of common stock related to employee stock purchase plan | 4,476 | — | 196 | — | — | 196 | |||||||||||||||||||||||||||||
Cash dividends declared ($0.22 per share) | — | — | — | (7,225) | — | (7,225) | |||||||||||||||||||||||||||||
| Common stock repurchased | (1,182,841) | (11) | (44,157) | — | (44,168) | ||||||||||||||||||||||||||||||
| Balance March 31, 2020 | 32,197,258 | $ | 320 | $ | 439,321 | $ | 710,072 | $ | 13,065 | $ | 1,162,778 | ||||||||||||||||||||||||
See Notes to Consolidated Financial Statements.
6
EAGLE BANCORP, INC.
Consolidated Statements of Cash Flows (Unaudited)
(dollars in thousands)
| Three Months Ended March 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| Cash Flows From Operating Activities: | |||||||||||
| Net Income | $ | 43,469 | $ | 23,123 | |||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Provision for credit losses | (2,350) | 14,310 | |||||||||
| Provision for unfunded commitments | (442) | 2,112 | |||||||||
| Depreciation and amortization | 1,078 | 1,171 | |||||||||
| Mortgage servicing rights gain | (140) | — | |||||||||
| Gains on sale of loans | (5,178) | (944) | |||||||||
| Securities premium amortization (discount accretion), net | 2,705 | 1,513 | |||||||||
| Origination of loans held for sale | (432,372) | (187,338) | |||||||||
| Proceeds from sale of loans held for sale | 383,559 | 184,953 | |||||||||
| Net increase in cash surrender value of BOLI | (389) | (414) | |||||||||
| Deferred income tax (benefit) expense | — | (562) | |||||||||
| Net gain on sale of investment securities | (221) | (822) | |||||||||
| Stock-based compensation expense | 1,825 | 996 | |||||||||
| Net tax benefits from stock compensation | 144 | (312) | |||||||||
| (Increase) decrease in other assets | (777) | (15,337) | |||||||||
| Increase (decrease) in other liabilities | 20,346 | 13,337 | |||||||||
| Net cash provided by operating activities | 11,257 | 35,786 | |||||||||
| Cash Flows From Investing Activities: | |||||||||||
| Purchases of available-for-sale investment securities | (347,787) | (138,594) | |||||||||
| Proceeds from maturities of available-for-sale securities | 85,116 | 54,426 | |||||||||
| Proceeds from sale/call of available-for-sale securities | 28,505 | 78,030 | |||||||||
| Purchases of Federal Reserve and Federal Home Loan Bank stock | (43) | (9,044) | |||||||||
| Sale of Federal Reserve and Federal Home Loan Bank stock | 6,169 | 4,250 | |||||||||
| Net change in loans | 228,275 | (293,507) | |||||||||
| Net change in premises and equipment | (2,397) | (83) | |||||||||
| Net cash used in investing activities | (2,162) | (304,522) | |||||||||
| Cash Flows From Financing Activities: | |||||||||||
| Increase in deposits | 9,641 | 917,177 | |||||||||
| Net change in customer repurchase agreements | (6,665) | 397 | |||||||||
| Increase in short-term borrowings | — | 50,000 | |||||||||
| Net change in long-term borrowings | (50,000) | 50,000 | |||||||||
| Proceeds from issuance of common stock | 139 | — | |||||||||
| Proceeds from employee stock purchase plan | — | 196 | |||||||||
| Common stock repurchased | (62) | (44,168) | |||||||||
| Cash dividends paid | (7,932) | (7,225) | |||||||||
| Net cash used in financing activities | (54,879) | 966,377 | |||||||||
| Net Decrease In Cash and Cash Equivalents | (45,784) | 697,641 | |||||||||
| Cash and Cash Equivalents at Beginning of Period | 1,789,055 | 241,973 | |||||||||
| Cash and Cash Equivalents at End of Period | $ | 1,743,271 | $ | 939,614 | |||||||
| Supplemental Cash Flows Information: | |||||||||||
| Interest paid | $ | 14,384 | $ | 26,483 | |||||||
| Income taxes paid | $ | — | $ | — | |||||||
| Non-Cash Investing Activities | |||||||||||
| Initial recognition of operating lease right-of-use assets | $ | 7,339 | $ | — | |||||||
| Transfers from loans to other real estate owned | $ | — | $ | 6,750 | |||||||
| Change in fair value of cash flow hedges | $ | 383 | $ | — | |||||||
| Change in fair value of investments | $ | (23,934) | $ | — | |||||||
See Notes to Consolidated Financial Statements.
7
EAGLE BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Summary of Significant Accounting Policies
Basis of Presentation
The Consolidated Financial Statements include the accounts of Eagle Bancorp, Inc. and its subsidiaries (the “Company”). Active subsidiaries include: EagleBank (the “Bank”), Eagle Insurance Services, LLC, Bethesda Leasing, LLC, and Landroval Municipal Finance, Inc., with all significant intercompany transactions eliminated.
The Consolidated Financial Statements of the Company included herein are unaudited. The Consolidated Financial Statements reflect all adjustments, consisting of normal recurring accruals that in the opinion of management, are necessary to present fairly the results for the periods presented. The amounts as of and for the year ended December 31, 2020 were derived from audited Consolidated Financial Statements. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). In addition to the “Critical Accounting Policies” described below, the Company applies the accounting policies contained in Note 1 to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020. The Company believes that the disclosures are adequate to make the information presented not misleading. Certain reclassifications have been made to amounts previously reported to conform to the current period presentation.
Nature of Operations
The Company, through the Bank, conducts a full service community banking business, primarily in Northern Virginia, Suburban Maryland, and Washington, D.C. The primary financial services offered by the Bank include real estate, commercial and consumer lending, as well as traditional deposit and repurchase agreement products. The Bank is also active in the origination and sale of residential mortgage loans, the origination of small business loans, and the origination, securitization and sale of multifamily Federal Housing Administration (“FHA”) loans. The guaranteed portion of small business loans, guaranteed by the Small Business Administration (“SBA”), is typically sold to third party investors in a transaction apart from the loan’s origination. The Bank offers its products and services through twenty banking offices, six lending centers and various electronic capabilities, including remote deposit services and mobile banking services. Eagle Insurance Services, LLC, a subsidiary of the Bank, offers access to insurance products and services through a referral program with a third party insurance broker. Landroval Municipal Finance, Inc., a subsidiary of the Bank, focuses on lending to municipalities by buying debt on the public market as well as direct purchase issuance. Bethesda Leasing, a subsidiary of the Bank, holds title to repossessed real estate.
Use of Estimates
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 value of financial instruments and the status of contingencies are particularly susceptible to significant change.
8
Risks and Uncertainties
The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and has impaired and could continue to impair their ability to fulfill their financial obligations to the Company. The World Health Organization declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The ongoing pandemic has caused significant disruptions in the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates. While there has been no material adverse impact on the Company’s employees and operations to date, COVID-19 could still potentially create widespread business continuity or credit issues for the Company depending on how much longer the pandemic lasts. Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In addition to the general impact of COVID-19, certain provisions of the CARES Act as well as other follow-up stimulus legislative (including the $1.9 trillion "American Rescue Package") and regulatory relief efforts have had and are expected to continue to have a material impact on the Company’s operations.
The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. If the global response to control and manage COVID-19 escalates further or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. While it is not possible to know the full universe or extent that the impact of COVID-19, and resulting measures to curtail its spread, will have on the Company’s operations, the Company is disclosing potentially material items of which it is aware.
Financial position and results of operations
The Company’s fee income has been and could be further reduced due to COVID-19. In keeping with guidance from regulators, the Company is actively working with COVID-19 affected customers to temporarily waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc. In addition, a dollar/fee limit was implemented for Consumers. As recognized and communicated to our customers when we initiated fee waivers, these have now been suspended. At this time, the Company is unable to project the full extent of the materiality of our prior customer relief activities as they do continue in other forms. However, the Company fully recognizes the breadth of the economic impact and its likelihood to impact fee income in future periods.
The Company’s interest income could be reduced due to COVID-19. In keeping with guidance from regulators, the Company is actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time the Company is unable to project the full extent of the materiality of such an impact, but recognizes the breadth of the economic impact may affect its borrowers’ ability to repay in future periods.
Capital and liquidity
While the Company believes that it has sufficient capital to withstand an extended economic recession brought about by COVID-19, its reported and regulatory capital ratios could be adversely impacted by further credit losses.
The Company maintains access to multiple sources of liquidity. Wholesale funding markets have remained open to us, and rates for short term funding have recently been very low. If funding costs were to become elevated for an extended period of time, it could have an adverse effect on the Company’s net interest margin. If an extended recession caused large numbers of the Company’s customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.
Asset valuation
Currently, the Company does not expect COVID-19 to affect its ability to account timely for the assets on its balance sheet; however, this could change in future periods. While certain valuation assumptions and judgments will change to account for pandemic-related circumstances such as widening credit spreads, the Company does not anticipate significant changes in methodology used to determine the fair value of assets measured in accordance with GAAP.
9
The ongoing COVID-19 pandemic has caused and could continue to cause prolonged volatility and potential declines in the Company’s stock price.
Goodwill is subject to impairment testing at the reporting unit level and must be conducted at least annually. The Company performs impairment testing during the fourth quarter of each year or when events or changes in circumstances indicate the assets might be impaired.
Determining the fair value of a reporting unit under the goodwill impairment test is subjective and often involves the use of significant estimates and assumptions. Estimates of fair value are primarily determined using discounted cash flows, market comparisons and recent transactions. These approaches use significant estimates and assumptions including projected future cash flows, discount rates reflecting the market rate of return, projected growth rates and determination and evaluation of appropriate market comparables. Future events could cause the Company to conclude that goodwill or other intangibles have become impaired, which would result in recording an impairment loss. Any resulting impairment loss could have a material adverse impact on the Company's financial condition and results of operations. The Company determined that there were no triggering events and an impairment analysis was not performed as of March 31, 2021. Annual impairment testing of intangibles and goodwill as required by GAAP will be performed in the fourth quarter of 2021.
Business Continuity Plan
The Company has implemented a remote working strategy for many of its employees. The Company does not anticipate incurring additional material cost related to its continued deployment of the remote working strategy. No material operational or internal control challenges or risks have been identified to date. The Company does not anticipate significant challenges to its ability to maintain its systems and controls in light of the measures the Company has taken to prevent the spread of COVID-19. We have established general guidelines for returning to the workplace that include having employees maintain safe distances, staggered work schedules to limit the number of employees in a single location, more frequent cleaning of our facilities and other practices encouraging a safe working environment during this challenging time, including required COVID-19 training programs. The Company does not currently face any material resource constraint through the implementation of its business continuity plans.
Lending operations and accommodations to borrowers
In response to the COVID-19 pandemic and consistent with regulatory guidance, we have also implemented a short-term loan modification program to provide temporary payment relief to certain borrowers who meet the program's qualifications. At March 31, 2021, the Company had no accruing loans 90 days or more past due. The deferred payments along with interest accrued during the deferral period are due and payable on the maturity date of the existing loan. As of March 31, 2021, we had ongoing temporary modifications on approximately 58 loans representing approximately $143 million (approximately 1.9% of total loans) in outstanding balances, as compared to 36 loans representing approximately $72 million (approximately 0.9% of total loans) at December 31, 2020. Additionally, none of the deferrals are reflected in the Company's asset quality measures (i.e. non-performing loans) due to the provision of the CARES Act that permits U.S. financial institutions to temporarily suspend the U.S. GAAP requirements to treat such short-term loan modifications as troubled debt restructurings ("TDRs"). Similar provisions have also been confirmed by interagency guidance issued by the federal banking agencies and confirmed with staff members of the Financial Accounting Standards Board.
The Company actively participates in the Paycheck Protection Program (“PPP”), administered by the Small Business Administration (“SBA”). The PPP loans originated by the Bank generally have terms and earn interest at 1% plus fees. The Company believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As of March 31, 2021, PPP loans totaled $565.0 million to just over 1,800 businesses. The Company understands that loans funded through the PPP program are fully guaranteed by the U.S. government. Should those circumstances change, the Company could be required to provision additional allowance for credit loss through additional credit loss expense charges to earnings. On May 3, 2021, we transacted to sell 849 PPP loans for a total purchase price of $169.0 million. Immediately following this sale, the principal outstanding on PPP loans totaled approximately $378.4 million across 789 notes.
Credit
The Company is working with customers directly affected by COVID-19. The Company is prepared to offer short-term assistance in accordance with regulatory guidelines. As a result of the current economic environment caused by the COVID-19 pandemic, the Company is engaging in more frequent communication with borrowers to better understand their situation and the challenges faced, allowing it to respond proactively as needs and issues arise. Should economic conditions
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worsen, the Company could experience further increases in its required allowance for credit losses (“ACL”) and record additional provision for credit losses. It is possible that the Company’s asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.
Loans
Loans held for investment are stated at the amount of unpaid principal reduced by deferred income (net of costs). Interest on loans is recognized using the simple-interest method on the daily balances of the principal amounts outstanding. Loan origination fees, net of direct loan origination costs, and commitment fees are deferred and amortized as an adjustment to yield over the life of the loan, or over the commitment period, as applicable.
A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company offers various types of concessions when modifying a loan. Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor is often requested. The most common change in terms provided by the Company is an extension of an interest-only term. As of March 31, 2021, all performing TDRs were categorized as interest-only modifications. Refer to the subsection above "Lending operations and accommodations to borrowers" for a discussion on the impact of the CARES Act on TDRs.
A loan is considered past due when a contractually due payment has not been received by the contractual due date. We place a loan on non-accrual status when there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, which is generally when a loan is 90 days past due. When a loan is placed on non-accrual status, all previously accrued and unpaid interest is reversed as a reduction of current period interest income. Interest income is subsequently recognized on a cash basis as long as the remaining book balance of the asset is deemed to be collectible. If collectability is questionable, then cash payments are applied to principal. A loan is placed back on accrual status when both principal and interest are current and it is probable that we will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.
Allowance for Credit Losses- Loans
The ACL is an estimate of the expected credit losses in the loans held for investment portfolio.
ASC 326 requires lifetime expected credit losses to be immediately recognized when a financial asset is originated or purchased. The ACL is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged off against the allowance when they are deemed uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged- off.
Reserves on loans that do not share risk characteristics are evaluated on an individual basis (nonaccrual, TDR). Nonaccrual loans are specifically reviewed for loss potential and when deemed appropriate are assigned a reserve based on an individual evaluation. The remainder of the portfolio, representing all loans not assigned an individual reserve, is segregated by call report codes and a loan-level probability of default (“PD”) / Loss Given Default (“LGD”) cash flow method with and using an exposure at default (“EAD”) model is applied. These historical loss rates are then modified to incorporate our reasonable and supportable forecast of future losses at the portfolio segment level.
The ACL also includes an amount for inherent risks not reflected in the historical analyses. Relevant factors include, but are not limited to, concentrations of credit risk, changes in underwriting standards, experience and depth of lending staff, and trends in delinquencies.
The Company uses regression analysis of historical internal and peer data (as Company loss data is insufficient) to determine suitable credit loss drivers to utilize when modeling lifetime PD and LGD. This analysis also determines how expected PD will be impacted by different forecasted levels of the loss drivers.
A similar process is employed to calculate a reserve assigned to off-balance sheet commitments, specifically unfunded loan commitments and letters of credit. Any needed reserve is recorded in reserve for unfunded commitments (“RUC”) on the Consolidated Balance Sheets. For periods beyond which we are able to develop reasonable and supportable forecasts, we revert to the historical loss rate on a straight-line basis over a twelve-month period.
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The Company uses a loan level PD/LGD cash flow method with an EAD model to estimate expected credit losses. In accordance with ASC 326, expected credit losses are measured on a collective (pooled) basis for financial assets with similar risk characteristics. The bank groups collectively assessed loans using a call report code. Some unique loan types, such as PPP loans, are grouped separately due to their specific risk characteristics.
For each of these loan segments, the Company generates cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speeds, PD rates, and LGD rates. The modeling of expected prepayment speeds is based on historical internal data. EAD is based on each instrument's underlying amortization schedule in order to estimate the bank's expected credit loss exposure at the time of the borrower's potential default.
For our cash flow model, management utilizes and forecasts regional unemployment by using a national forecast and estimating a regional adjustment based on historical differences between the two as the loss driver over our reasonable and supportable period of two years and reverts back to a historical loss rate over twelve months on a straight-line basis over the loan's remaining maturity. In 2021, unemployment projections have started to recover from elevated levels experienced in 2020 as a result of the COVID-19 pandemic. Unemployment projections inform our CECL economic forecast and resulted in a reduction to our ACL during the three months ended March 31, 2021. Management leverages economic projections from reputable and independent third parties to inform its loss driver forecasts over the forecast period.
While our methodology in establishing the ACL attributes portions of the ACL and RUC to the separate loan pools or segments, the entire ACL and RUC is available to absorb credit losses expected in the total loan portfolio and total amount of unfunded credit commitments, respectively. Portfolio segments are used to pool loans with similar risk characteristics and align with our methodology for measuring expected credit losses.
The following table presents a breakdown of the provision for credit losses included in our Consolidated Statements of Income for the applicable periods (in thousands):
| Three Months Ended | Three Months Ended | |||||||||||||
| (dollars in thousands) | March 31, 2021 | March 31, 2020 | ||||||||||||
| Provision for credit losses- loans | (2,261) | 14,310 | ||||||||||||
| Provision for credit losses- AFS debt securities | (89) | — | ||||||||||||
| Total provision for credit losses | (2,350) | 14,310 | ||||||||||||
A summary of our primary portfolio segments is as follows:
Commercial. The commercial loan portfolio is comprised of lines of credit and term loans for working capital, equipment, and other business assets across a variety of industries. These loans are used for general corporate purposes including financing working capital, internal growth, and acquisitions; and are generally secured by accounts receivable, inventory, equipment and other assets of our clients’ businesses.
Paycheck Protection Program. The PPP portfolio is comprised of loans issued under the SBA’s Paycheck Protection Program to support small businesses impacted by the pandemic. PPP loans are approved subject to limited underwriting criteria following SBA guidelines, are unsecured, and are fully guaranteed as to principal and interest by the SBA.
Income producing commercial real estate. Income producing commercial real estate loans are comprised of permanent and bridge financing provided to professional real estate owners/managers of commercial and residential real estate projects and properties who have a demonstrated a record of past success with similar properties. Collateral properties include apartment buildings, office buildings, hotels, mixed-use buildings, retail, data centers, warehouse, and shopping centers. The primary source of repayment on these loans is generally expected to come from lease or operation of the real property collateral. Income producing commercial real estate loans are impacted by fluctuation in collateral values, as well as rental demand and rates.
Owner occupied – commercial real estate. The owner occupied commercial real estate portfolio is comprised of permanent financing provided to operating companies and their related entities for the purchase or refinance of real property wherein their business operates. Collateral properties include industrial property, office buildings, religious facilities, mixed-use property, health care and educational facilities.
Real Estate Mortgage – Residential. Real estate mortgage residential loans are comprised of consumer mortgages for the purpose of purchasing or refinancing first lien real estate loans secured by primary-residence, second-home, and rental residential real property.
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Construction – commercial and residential. The construction commercial and residential loan portfolio is comprised of loans made to builders and developers of commercial and residential property, for both renovation, new construction, and development projects. Collateral properties include apartment buildings, mixed use property, residential condominiums, single and 1-4 residential property, and office buildings. The primary source of repayment on these loans is expected to come from the sale, permanent financing, or lease of the real property collateral. Construction loans are impacted by fluctuations in collateral values and the ability of the borrower or ultimate purchaser to obtain permanent financing.
Construction – commercial and industrial ("C&I") (owner occupied). The construction C&I (owner occupied) portfolio comprises loans to operating companies and their related entities for new construction or renovation of the real or leased property in which they operate. Generally these loans contain provisions for conversion to an owner occupied commercial real estate or to a commercial loan after completion of construction. Collateral properties include industrial, healthcare, religious facilities, restaurants, and office buildings.
Home Equity. The home equity portfolio is comprised of consumer lines of credit and loans secured by subordinate liens on residential real property.
Other Consumer: The other consumer portfolio is comprised of consumer purpose loans not secured by real property, including personal lines of credit and loans, overdraft lines, and vehicle loans. This category also includes other loan items such as overdrawn deposit accounts as well as loans and loan payments in process.
We have several pass credit grades that are assigned to loans based on varying levels of risk, ranging from credits that are secured by cash or marketable securities, to watch credits which have all the characteristics of an acceptable credit risk but warrant more than the normal level of monitoring. Special mention loans are those that are currently protected by the sound worth and paying capacity of the borrower, but that are potentially weak and constitute an additional credit risk. These loans have the potential to deteriorate to a substandard grade due to the existence of financial or administrative deficiencies. Substandard loans have a well-defined weakness or weaknesses that jeopardizes the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Some substandard loans are inadequately protected by the sound worth and paying capacity of the borrower and of the collateral pledged and may be considered impaired. Substandard loans can be accruing or can be on nonaccrual depending on the circumstances of the individual loans.
Loans classified as doubtful have all the weaknesses inherent in substandard loans with the added characteristics that the weaknesses make collection in full highly questionable and improbable. The possibility of loss is extremely high. All doubtful loans are on nonaccrual.
Classified loans represent the sum of loans graded substandard and doubtful. The methodology used in the estimation of the allowance, which is performed at least quarterly, is designed to be dynamic and responsive to changes in portfolio credit quality and forecasted economic conditions. Changes are reflected in the pool-basis allowance and in specific reserves assigned on an individual basis as the collectability of classified loans is evaluated with new information. As our portfolio has matured, historical loss ratios have been closely monitored. The review of the appropriateness of the allowance is performed by executive management and presented to management committees, Director’s Loan Committee, the Audit Committee, and the Board of Directors. The committees' reports to the Board are part of the Board review on a quarterly basis of our consolidated financial statements.When management determines that foreclosure is probable, and for certain collateral-dependent loans where foreclosure is not considered probable, expected credit losses are based on the estimated fair value of the collateral adjusted for selling costs, when appropriate. A loan is considered collateral-dependent when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral.
Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals and modifications unless management has a reasonable expectation that a loan will be in a trouble debt restructuring.
We do not measure an ACL on accrued interest receivable balances because these balances are written off in a timely manner as a reduction to interest income when loans are placed on nonaccrual status.
Collateral Dependent Financial Assets
Loans that do not share risk characteristics are evaluated on an individual basis. For collateral dependent financial assets where the Company has determined that foreclosure of the collateral is probable, or where the borrower is experiencing
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financial difficulty and the Company expects repayment of the financial asset to be provided substantially through the sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. When repayment is expected to be from the operation of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the NPV from the operation of the collateral. When repayment is expected to be from the sale of the collateral, expected credit losses are calculated as the amount by which the amortized costs basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The ACL may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of the financial asset.
A loan that has been modified or renewed is considered a TDR when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics. The Company’s ACL reflects all effects of a TDR when an individual asset is specifically identified as a reasonably expected TDR. The Company has determined that a TDR is reasonably expected no later than the point when the lender concludes that modification is the best course of action and it is at least reasonably possible that the troubled borrower will accept some form of concession from the lender to avoid a default. Reasonably expected TDRs and executed non-performing TDRs are evaluated individually to determine the required ACL. Refer to the subsection above "Lending operations and accommodations to borrowers" for a discussion on the impact of the CARES Act on TDRs.
Allowance for Credit Losses - Available-for-Sale Debt Securities
For AFS debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either criterion is met, the security’s amortized cost basis is written down to fair value through income. For AFS debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. When evaluating whether credit loss exists, accounting guidance requires that the Company not consider the length of time that fair value has been less than amortized cost. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security is compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. The entire amount of an impairment loss is recognized in earnings only when: (1) the Company intends to sell the security; or (2) it is more likely than not that the Company will have to sell the security before recovery of its amortized cost basis; or (3) the Company does not expect to recover the entire amortized cost basis of the security. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in shareholders’ equity as comprehensive income, net of deferred taxes. Changes in the allowance for credit losses are recorded as a provision for (or reversal of) credit losses. Losses are charged against the allowance when management believes the uncollectibility of an AFS security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Any impairment not recorded through an allowance for credit loss is recognized in other comprehensive income as a non-credit-related impairment. The majority of available-for-sale debt securities as of March 31, 2021 and December 31, 2020 were issued by U.S. agencies. However, as of March 31, 2021, the allowance for credit losses on AFS securities was $78 thousand based on the Company's determination that part of the unrealized loss positions in AFS corporate and municipal securities could be the result of credit losses. See Note 3 Investment Securities for more information.
We have made a policy election to exclude accrued interest from the amortized cost basis of available-for-sale debt securities and report accrued interest separately in accrued interest and other assets in the Consolidated Balance Sheets. Available-for-sale debt securities are placed on non-accrual status when we no longer expect to receive all contractual amounts due, which is generally at 90 days past due. Accrued interest receivable is reversed against interest income when a security is placed on non-accrual status. Accordingly, we do not recognize an allowance for credit loss against accrued interest receivable.
Loan Commitments and Allowance for Credit Losses on Off-Balance Sheet Credit Exposures
Financial instruments include off-balance sheet credit instruments such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.
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The Company records a reserve for unfunded commitments (“RUC”) on off-balance sheet credit exposures through a charge to provision for credit loss expense in the Company’s Consolidated Statement of Income. The RUC on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date under the current expected credit loss model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur, and is included in the RUC on the Company’s Consolidated Balance Sheet.
These statements should be read in conjunction with the audited Consolidated Financial Statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
Other New Authoritative Accounting Guidance
Accounting Standards Adopted in 2021:
ASU 2019-12 "Income Taxes (Topic 740)" ("ASU 2019-12") simplifies the accounting for income taxes by removing certain exceptions and improves the consistent application of GAAP by clarifying and amending other existing guidance. ASU 2019-12 became effective for us on January 1, 2021 and did not have a material impact on our consolidated financial statements.
Accounting Standards Pending Adoption
ASU 2020-4, "Reference Rate Reform (Topic 848)" ("ASU 2020-4") provides optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition away from LIBOR toward new interest rate benchmarks. For transactions that are modified because of reference rate reform and that meet certain scope guidance (i) modifications of loan agreements should be accounted for by prospectively adjusting the effective interest rate and the modification will be considered "minor" so that any existing unamortized origination fees/ costs would carry forward and continue to be amortized and (ii) modifications of lease agreements should be accounted for as a continuation of the existing agreement with no reassessments of the lease classification and the discount rate or remeasurements of lease payments that otherwise would be required for modifications not accounted for as separate contracts. ASU 2020-4 also provides numerous optional expedients for derivative accounting. ASU 2020-4 is effective March 12, 2020 through December 31, 2022. An entity may elect to apply ASU 2020-4 for contract modifications as of January 1, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic within the Codification, the amendments in this ASU must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. We anticipate this ASU will simplify any modifications we execute between the selected start date (yet to be determined) and December 31, 2022 that are directly related to LIBOR transition by allowing prospective recognition of the continuation of the contract, rather than extinguishment of the old contract resulting in writing off unamortized fees/costs. We do not anticipate that the LIBOR transition or the application of this ASU will have material effects on the Company's business operations and consolidated financial statements.
Note 2. Cash and Due from Banks
Regulation D of the Federal Reserve Act requires that banks maintain noninterest reserve balances with the Federal Reserve Bank ("FRB") based principally on the type and amount of their deposits. During the first three months of 2021, the Bank maintained balances at the Federal Reserve sufficient to meet reserve requirements, as well as significant excess reserves, on which interest is paid.
The Company also has deposits with other banks that serve as collateral for derivative positions it holds, totaling $2.6 million at March 31, 2021 and $5.1 million at December 31, 2020.
Additionally, the Bank maintains interest bearing balances with the Federal Home Loan Bank ("FHLB") of Atlanta and noninterest bearing balances with domestic correspondent banks to cover associated costs for services they provide to the Bank.
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Note 3. Investment Securities Available-for-Sale
Amortized cost and estimated fair value of securities available-for-sale are summarized as follows:
| Gross | Gross | Allowance | Estimated | |||||||||||||||||||||||||||||
| March 31, 2021 | Amortized | Unrealized | Unrealized | for Credit | Fair | |||||||||||||||||||||||||||
| (dollars in thousands) | Cost | Gains | Losses | Losses | Value | |||||||||||||||||||||||||||
| U.S. agency securities | $ | 280,147 | $ | 1,247 | $ | (5,859) | $ | — | $ | 275,535 | ||||||||||||||||||||||
| Residential mortgage backed securities | 934,615 | 9,710 | (11,706) | — | 932,619 | |||||||||||||||||||||||||||
| Municipal bonds | 103,230 | 4,352 | (453) | (7) | 107,122 | |||||||||||||||||||||||||||
| Corporate bonds | 52,935 | 1,250 | (481) | (71) | 53,633 | |||||||||||||||||||||||||||
| $ | 1,370,927 | $ | 16,559 | $ | (18,499) | $ | (78) | $ | 1,368,909 | |||||||||||||||||||||||
| Gross | Gross | Estimated | ||||||||||||||||||||||||||||||
| December 31, 2020 | Amortized | Unrealized | Unrealized | Allowance for | Fair | |||||||||||||||||||||||||||
| (dollars in thousands) | Cost | Gains | Losses | Credit Losses | Value | |||||||||||||||||||||||||||
| U.S. agency securities | $ | 181,087 | $ | 1,461 | $ | (627) | $ | — | $ | 181,921 | ||||||||||||||||||||||
| Residential mortgage backed securities | 811,328 | 14,506 | (833) | — | 825,001 | |||||||||||||||||||||||||||
| Municipal bonds | 102,259 | 5,872 | — | (18) | 108,113 | |||||||||||||||||||||||||||
| Corporate bonds | 34,383 | 1,624 | (8) | (149) | 35,850 | |||||||||||||||||||||||||||
| $ | 1,129,057 | $ | 23,463 | $ | (1,468) | $ | (167) | $ | 1,150,885 | |||||||||||||||||||||||
In addition, at March 31, 2021 and December 31, 2020 the Company held $34.0 million and $40.1 million, respectively, in equity securities in a combination of FRB and FHLB stocks, which are required to be held for regulatory purposes and which are not marketable, and therefore are carried at cost.
Accrued interest on available-for-sale securities totaled $4.0 million and $3.5 million at March 31, 2021 and December 31, 2020, respectively, and was included in other assets in the Consolidated Balance Sheets.
Gross unrealized losses and fair value of available-for-sale securities for which an allowance for credit losses has not been recorded, by length of time that individual securities have been in a continuous unrealized loss position are as follows:
| Less than | 12 Months | |||||||||||||||||||||||||||||||||||||||||||
| 12 Months | or Greater | Total | ||||||||||||||||||||||||||||||||||||||||||
| Estimated | Estimated | Estimated | ||||||||||||||||||||||||||||||||||||||||||
| March 31, 2021 | Number of | Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Securities | Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||||||||||||||||||||
| U. S. agency securities | 50 | $ | 197,761 | $ | 5,346 | $ | 38,854 | $ | 513 | $ | 236,615 | $ | 5,859 | |||||||||||||||||||||||||||||||
| Residential mortgage backed securities | 267 | 579,364 | 11,646 | 5,035 | 60 | 584,399 | 11,706 | |||||||||||||||||||||||||||||||||||||
| Corporate bonds | 16 | 23,763 | 481 | — | — | 23,763 | 481 | |||||||||||||||||||||||||||||||||||||
| Municipal bonds | 46 | 26,885 | 453 | — | — | 26,885 | 453 | |||||||||||||||||||||||||||||||||||||
| 379 | $ | 827,773 | $ | 17,926 | $ | 43,889 | $ | 573 | $ | 871,662 | $ | 18,499 | ||||||||||||||||||||||||||||||||
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| Less than | 12 Months | |||||||||||||||||||||||||||||||||||||||||||
| 12 Months | or Greater | Total | ||||||||||||||||||||||||||||||||||||||||||
| Estimated | Estimated | Estimated | ||||||||||||||||||||||||||||||||||||||||||
| December 31, 2020 | Number of | Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Securities | Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||||||||||||||||||||
| U. S. agency securities | 28 | $ | 46,412 | $ | 67 | $ | 41,320 | $ | 560 | $ | 87,732 | $ | 627 | |||||||||||||||||||||||||||||||
| Residential mortgage backed securities | 35 | 170,178 | 782 | 6,419 | 51 | 176,597 | 833 | |||||||||||||||||||||||||||||||||||||
| Corporate bonds | 3 | 5,764 | 8 | — | — | 5,764 | 8 | |||||||||||||||||||||||||||||||||||||
| 66 | $ | 222,354 | $ | 857 | $ | 47,739 | $ | 611 | $ | 270,093 | $ | 1,468 | ||||||||||||||||||||||||||||||||
The majority of the AFS debt securities in an unrealized loss position as of March 31, 2021, consisted of debt securities issued by U.S. government agencies or U.S. government-sponsored enterprises. These securities carry the explicit and/or implicit guarantee of the U.S. government, are widely recognized as “risk free,” and have a long history of zero credit loss.
As of March 31, 2021, total gross unrealized losses were primarily attributable to changes in interest rates, relative to when the investment securities were purchased, and not due to the credit quality of the investment securities. However, as of March 31, 2021, the Company determined that part of the unrealized loss positions in AFS corporate and municipal securities could be the result of credit losses, and therefore, an allowance for credit losses of $78 thousand was recorded. The weighted average duration of debt securities, which comprise 99.9% of total investment securities, is relatively short at 4.6 years. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security's credit rating, prepayment assumptions and other factors such as credit loss assumptions. The Company does not intend to sell the investments and it is more likely than not that the Company will not have to sell the securities before recovery of its amortized cost basis, which may be at maturity.
The amortized cost and estimated fair value of investments available-for-sale at March 31, 2021 and December 31, 2020 by contractual maturity are shown in the table below. Expected maturities for residential mortgage backed securities (“MBS”) will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| March 31, 2021 | December 31, 2020 | |||||||||||||||||||||||||
| Amortized | Estimated | Amortized | Estimated | |||||||||||||||||||||||
| (dollars in thousands) | Cost | Fair Value | Cost | Fair Value | ||||||||||||||||||||||
| U. S. agency securities maturing: | ||||||||||||||||||||||||||
| One year or less | $ | 96,891 | $ | 94,564 | $ | 53,916 | $ | 53,906 | ||||||||||||||||||
| After one year through five years | 125,593 | 125,151 | 110,083 | 110,777 | ||||||||||||||||||||||
| Five years through ten years | 57,663 | 55,820 | 17,087 | 17,240 | ||||||||||||||||||||||
| Residential mortgage backed securities | 934,615 | 932,619 | 811,328 | 825,001 | ||||||||||||||||||||||
| Municipal bonds maturing: | ||||||||||||||||||||||||||
| One year or less | 3,343 | 3,327 | 4,329 | 4,348 | ||||||||||||||||||||||
| After one year through five years | 26,564 | 28,042 | 26,622 | 28,272 | ||||||||||||||||||||||
| Five years through ten years | 71,323 | 73,698 | 69,309 | 73,389 | ||||||||||||||||||||||
| After ten years | 2,000 | 2,062 | 2,000 | 2,121 | ||||||||||||||||||||||
| Corporate bonds maturing: | ||||||||||||||||||||||||||
| One year or less | 500 | 500 | 5,218 | 5,220 | ||||||||||||||||||||||
| After one year through five years | 37,823 | 38,392 | 22,189 | 23,267 | ||||||||||||||||||||||
| After ten years | 14,612 | 14,812 | 6,976 | 7,511 | ||||||||||||||||||||||
| Allowance for Credit Losses | — | (78) | — | (167) | ||||||||||||||||||||||
| $ | 1,370,927 | $ | 1,368,909 | $ | 1,129,057 | $ | 1,150,885 | |||||||||||||||||||
17
For the three months ended March 31, 2021, gross realized gains on sales of investments securities were $386 thousand and there were $165 thousand gross realized losses on sales of investment securities. For the three months ended March 31, 2020, gross realized gains on sales of investments securities were $822 thousand, and there were no gross realized losses on sales of investment securities.
Proceeds from sales and calls of investment securities for the three months ended March 31, 2021 were $28.5 million compared to $78.0 million for the same period in 2020.
The carrying value of securities pledged as collateral for certain government deposits, securities sold under agreements to repurchase, and certain lines of credit with correspondent banks at March 31, 2021 and December 31, 2020 was $270.0 million and $268.4 million, respectively, which is well in excess of required amounts in order to operationally provide significant reserve amounts for new business. As of March 31, 2021 and December 31, 2020, there were no holdings of securities of any one issuer, other than the U.S. Government and U.S. agency securities, which exceeded ten percent of shareholders’ equity.
Note 4. Mortgage Banking Derivatives
As part of its mortgage banking activities, the Bank enters into interest rate lock commitments, which are commitments to originate loans where the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. The Bank then locks in the loan and interest rate with an investor and commits to deliver the loan if settlement occurs (“best efforts”) or commits to deliver the locked loan in a binding (“mandatory”) delivery program with an investor. Certain loans under interest rate lock commitments are covered under forward sales contracts of mortgage backed securities. Forward sales contracts of MBS are recorded at fair value with changes in fair value recorded in noninterest income. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Bank determines the fair value of interest rate lock commitments and delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates, taking into consideration the probability that the interest rate lock commitments will close or will be funded.
Certain additional risks arise from these forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. The Bank does not expect any counterparty to any MBS to fail to meet its obligation. Additional risks inherent in mandatory delivery programs include the risk that, if the Bank does not close the loans subject to interest rate risk lock commitments, it will still be obligated to deliver MBS to the counterparty under the forward sales agreement. Should this be required, the Bank could incur significant costs in acquiring replacement loans or MBS and such costs could have an adverse effect on mortgage banking operations.
The fair value of the mortgage banking derivatives is recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change.
At March 31, 2021, the Bank had mortgage banking derivative financial instruments totaling $2.5 million related to its interest rate lock commitments. At March 31, 2021 the Bank had mortgage banking derivative financial instruments of $191.9 million notional value and $367.7 million at December 31, 2020. The fair value of these mortgage banking derivative instruments at December 31, 2020 was $5.2 million included in other assets.
Included in gain on sale of loans for the three months ended March 31, 2021 there was no net loss relating to mortgage banking derivative instruments as compared to a net loss of $1.3 million for the three months ended March 31, 2020.
Note 5. Loans and Allowance for Credit Losses
The Bank makes loans to customers primarily in the Washington, D.C. metropolitan area and surrounding communities. A substantial portion of the Bank’s loan portfolio consists of loans to businesses secured by real estate and other business assets.
18
Loans, net of unamortized net deferred fees, at March 31, 2021 (unaudited) and December 31, 2020 are summarized by type as follows:
| March 31, 2021 | December 31, 2020 | ||||||||||||||||||||||||||||
| (dollars in thousands) | Amount | % | Amount | % | |||||||||||||||||||||||||
| Commercial | $ | 1,398,155 | 19 | % | $ | 1,437,433 | 19 | % | |||||||||||||||||||||
| PPP loans | 565,018 | 8 | % | 454,771 | 6 | % | |||||||||||||||||||||||
| Income producing - commercial real estate | 3,430,077 | 45 | % | 3,687,000 | 47 | % | |||||||||||||||||||||||
| Owner occupied - commercial real estate | 1,012,457 | 13 | % | 997,694 | 13 | % | |||||||||||||||||||||||
| Real estate mortgage - residential | 71,209 | 1 | % | 76,592 | 1 | % | |||||||||||||||||||||||
| Construction - commercial and residential | 829,481 | 11 | % | 873,261 | 11 | % | |||||||||||||||||||||||
| Construction - C&I (owner occupied) | 152,240 | 2 | % | 158,905 | 2 | % | |||||||||||||||||||||||
| Home equity | 67,167 | 1 | % | 73,167 | 1 | % | |||||||||||||||||||||||
| Other consumer | 885 | — | 1,389 | — | |||||||||||||||||||||||||
| Total loans | 7,526,689 | 100 | % | 7,760,212 | 100 | % | |||||||||||||||||||||||
| Less: allowance for credit losses | (102,070) | (109,579) | |||||||||||||||||||||||||||
Net loans (1) | $ | 7,424,619 | $ | 7,650,633 | |||||||||||||||||||||||||
________________________________________
(1)Excludes accrued interest receivable of $46.4 million and $46.0 million at March 31, 2021 and December 31, 2020, respectively, which is recorded in other assets.
Unamortized net deferred fees amounted to $33.8 million and $30.8 million at March 31, 2021 and December 31, 2020, respectively.
As of March 31, 2021 and December 31, 2020, the Bank serviced $127 million and $124 million, respectively, of multifamily FHA loans, SBA loans and other loan participations that are not reflected as loan balances on the Consolidated Balance Sheets.
Loan Origination / Risk Management
Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. The remainder of the portfolio, representing all loans not assigned an individual reserve, is segregated by call report codes and a loan-level PD/LGD cash flow method using an EAD model is applied. The loss rates are then modified to incorporate our reasonable and supportable forecast of future losses at the portfolio segment level, as well as any necessary qualitative adjustments.
The composition of the Company’s loan portfolio is heavily weighted toward commercial real estate, both owner occupied and income producing real estate. At March 31, 2021, owner occupied - commercial real estate and construction – C&I (owner occupied) represent approximately 15% of the loan portfolio. At March 31, 2021, non-owner occupied commercial real estate and real estate construction represented approximately 56% of the loan portfolio. The combined owner occupied and commercial real estate and construction loans represent approximately 56% of the loan portfolio. Real estate also serves as collateral for loans made for other purposes, resulting in 79% of all loans being secured by real estate. These loans are underwritten to mitigate lending risks typical of this type of loan such as declines in real estate values, changes in borrower cash flow and general economic conditions. The Bank typically requires a maximum loan to value of 80% and minimum cash flow debt service coverage of 1.15 to 1.0. Personal guarantees may be required, but may be limited. In making real estate commercial mortgage loans, the Bank generally requires that interest rates adjust not less frequently than five years.
19
The Company is also an active traditional commercial lender providing loans for a variety of purposes, including working capital, equipment and account receivable financing. This loan category represents approximately 19% of the loan portfolio at March 31, 2021 and was generally variable or adjustable rate. Personal guarantees are generally required, but may be limited. Non-PPP SBA loans represent approximately 1% of the commercial loan category. In originating SBA loans, the Company assumes the risk of non-payment on the unguaranteed portion of the credit as well as potential recourse to the SBA guarantees. The Company generally sells the guaranteed portion of the loan generating noninterest income from the gains on sale, as well as servicing income on the portion participated. SBA loans are subject to the same cash flow analyses as other commercial loans. SBA loans are subject to a maximum loan size established by the SBA as well as internal loan size guidelines.
Approximately 8% of the loan portfolio at March 31, 2021 consists of PPP loans to eligible customers. PPP loans are expected to primarily be repaid via forgiveness provisions (under the CARES Act and subsequent legislation) from the SBA. These loans are fully guaranteed as to principal and interest by the SBA and ultimately by the full faith and credit of the U.S. Government; as a result, they were approved utilizing different underwriting standards than the Bank's other commercial loans. PPP loans are included in the CECL model but do not carry an allowance for credit loss due to the aforementioned government guarantees.
Approximately 1% of the loan portfolio at March 31, 2021 consists of home equity loans and lines of credit and other consumer loans. These credits, while making up a small portion of the loan portfolio, demand the same emphasis on underwriting and credit evaluation as other types of loans advanced by the Bank.
Approximately 1% of the loan portfolio consists of residential mortgage loans. The repricing duration of these loans was 20.5 months at March 31, 2021. These credits represent first liens on residential property loans originated by the Bank. While the Bank’s general practice is to originate and sell (servicing released) loans made by its Residential Lending department, from time to time certain loan characteristics do not meet the requirements of third party investors and these loans are instead maintained in the Bank’s portfolio until they are resold to another investor at a later date or mature.
Loans are secured primarily by duly recorded first deeds of trust or mortgages. In some cases, the Bank may accept a recorded junior trust position. In general, borrowers will have a proven ability to build, lease, manage and/or sell a commercial or residential project and demonstrate satisfactory financial condition. Additionally, an equity contribution toward the project is customarily required.
Construction loans require that the financial condition and experience of the general contractor and major subcontractors be satisfactory to the Bank. Guaranteed, fixed price contracts are required whenever appropriate, along with payment and performance bonds or completion bonds for larger scale projects.
Loans intended for residential land acquisition, lot development and construction are made on the premise that the land: 1) is or will be developed for building sites for residential structures, and 2) will ultimately be utilized for construction or improvement of residential zoned real properties, including the creation of housing. Residential development and construction loans will finance projects such as single family subdivisions, planned unit developments, townhouses, and condominiums. Residential land acquisition, development and construction loans generally are underwritten with a maximum term of 36 months, including extensions approved at origination.
Commercial land acquisition and construction loans are secured by real property where loan funds will be used to acquire land and to construct or improve appropriately zoned real property for the creation of income producing or owner user commercial properties. Borrowers are generally required to put equity into each project at levels determined by the appropriate Loan Committee. Commercial land acquisition and construction loans generally are underwritten with a maximum term of 24 months.
Substantially all construction draw requests must be presented in writing on American Institute of Architects documents and certified either by the contractor, the borrower and/or the borrower’s architect. Each draw request shall also include the borrower’s soft cost breakdown certified by the borrower or their Chief Financial Officer. Prior to an advance, the Bank or its contractor inspects the project to determine that the work has been completed, to justify the draw requisition.
Commercial permanent loans are generally secured by improved real property which is generating income in the normal course of operation. Debt service coverage, assuming stabilized occupancy, must be satisfactory to support a permanent loan. The debt service coverage ratio is ordinarily at least 1.15 to 1.0. As part of the underwriting process, debt service coverage ratios are stress tested assuming a 200 basis point increase in interest rates from their current levels.
20
Commercial permanent loans generally are underwritten with a term not greater than 10 years or the remaining useful life of the property, whichever is lower. The preferred term is between 5 to 7 years, with amortization to a maximum of 25 years.
The Company’s loan portfolio includes acquisition, development and construction (“ADC”) real estate loans including both investment and owner occupied projects. ADC loans amounted to $1.3 billion at March 31, 2021. A portion of the ADC portfolio, both speculative and non-speculative, includes loan funded interest reserves at origination. ADC loans that provide for the use of interest reserves represent approximately 59.4% of the outstanding ADC loan portfolio at March 31, 2021. The decision to establish a loan-funded interest reserve is made upon origination of the ADC loan and is based upon a number of factors considered during underwriting of the credit including: (1) the feasibility of the project; (2) the experience of the sponsor; (3) the creditworthiness of the borrower and guarantors; (4) the borrower equity contribution; and (5) the level of collateral protection. When appropriate, an interest reserve provides an effective means of addressing the cash flow characteristics of a properly underwritten ADC loan. The Company recognizes that one of the risks inherent in the use of interest reserves is the potential masking of underlying problems with the project and/or the borrower’s ability to repay the loan. In order to mitigate these inherent risks, the Company employs a series of reporting and monitoring mechanisms on all ADC loans, whether or not an interest reserve is provided, including: (1) construction and development timelines which are monitored on an ongoing basis which track the progress of a given project to the timeline projected at origination; (2) a construction loan administration department independent of the lending function; (3) third party independent construction loan inspection reports; (4) monthly interest reserve monitoring reports detailing the balance of the interest reserves approved at origination and the days of interest carry represented by the reserve balances as compared to the then current anticipated time to completion and/or sale of speculative projects; and (5) quarterly commercial real estate construction meetings among senior Company management, which includes monitoring of current and projected real estate market conditions. If a project has not performed as expected, it is not the customary practice of the Company to increase loan funded interest reserves.
21
The following tables detail activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2021 and 2020. PPP loans are excluded from these tables since they do not carry an allowance for credit loss, as these loans are fully guaranteed as to principal and interest by the SBA, whose guarantee is backed by the full faith and credit of the U.S. Government. Allocation of a portion of the allowance to one category of loans does not restrict the use of the allowance to absorb losses in other categories.
| Income Producing - | Owner Occupied - | Real Estate | Construction - | |||||||||||||||||||||||||||||||||||||||||||||||
| Commercial | Commercial | Mortgage - | Commercial and | Home | Other | |||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Commercial | Real Estate | Real Estate | Residential | Residential | Equity | Consumer | Total | ||||||||||||||||||||||||||||||||||||||||||
| Three Months Ended March 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance at beginning of period | $ | 26,569 | $ | 55,385 | $ | 14,000 | $ | 1,020 | $ | 11,529 | $ | 1,039 | $ | 37 | $ | 109,579 | ||||||||||||||||||||||||||||||||||
| Loans charged-off | (4,150) | (1,000) | — | — | (206) | — | (1) | (5,357) | ||||||||||||||||||||||||||||||||||||||||||
| Recoveries of loans previously charged-off | 96 | — | — | — | — | — | 13 | 109 | ||||||||||||||||||||||||||||||||||||||||||
| Net loans (charged-off) recoveries | (4,054) | (1,000) | — | — | (206) | — | 12 | (5,248) | ||||||||||||||||||||||||||||||||||||||||||
| Provision for credit losses- loans | 1,186 | (2,875) | 315 | (101) | (640) | (132) | (14) | (2,261) | ||||||||||||||||||||||||||||||||||||||||||
| Ending balance | $ | 23,701 | $ | 51,510 | $ | 14,315 | $ | 919 | $ | 10,683 | $ | 907 | $ | 35 | $ | 102,070 | ||||||||||||||||||||||||||||||||||
| As of March 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | 5,365 | $ | 5,734 | $ | 1,076 | $ | 330 | $ | — | $ | — | $ | — | $ | 12,505 | ||||||||||||||||||||||||||||||||||
| Collectively evaluated for impairment | 18,336 | 45,776 | 13,239 | 589 | 10,683 | 907 | 35 | 89,565 | ||||||||||||||||||||||||||||||||||||||||||
| Ending balance | $ | 23,701 | $ | 51,510 | $ | 14,315 | $ | 919 | $ | 10,683 | $ | 907 | $ | 35 | $ | 102,070 | ||||||||||||||||||||||||||||||||||
| Three Months Ended March 31, 2020 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance at beginning of period, prior to adoption of ASC 326 | $ | 18,832 | $ | 29,265 | $ | 5,838 | $ | 1,557 | $ | 17,485 | $ | 656 | $ | 25 | $ | 73,658 | ||||||||||||||||||||||||||||||||||
| Impact of adopting ASC 326 | 892 | 11,230 | 4,674 | (301) | (6,143) | 245 | 17 | $ | 10,614 | |||||||||||||||||||||||||||||||||||||||||
| Loans charged-off | — | (550) | — | — | (1,768) | — | — | (2,318) | ||||||||||||||||||||||||||||||||||||||||||
| Recoveries of loans previously charged-off | 69 | — | — | — | — | — | 3 | 72 | ||||||||||||||||||||||||||||||||||||||||||
| Net loans (charged-off) recoveries | 69 | (550) | — | — | (1,768) | — | 3 | (2,246) | ||||||||||||||||||||||||||||||||||||||||||
| Provision for credit losses- loans | 7,553 | 3,606 | (645) | 113 | 3,767 | (83) | (1) | 14,310 | ||||||||||||||||||||||||||||||||||||||||||
| Ending balance | $ | 27,346 | $ | 43,551 | $ | 9,867 | $ | 1,369 | $ | 13,341 | $ | 818 | $ | 44 | $ | 96,336 | ||||||||||||||||||||||||||||||||||
| As of March 31, 2020 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | 7,239 | $ | 1,903 | $ | 375 | $ | 657 | $ | 1,554 | $ | 105 | $ | — | $ | 11,833 | ||||||||||||||||||||||||||||||||||
| Collectively evaluated for impairment | 20,107 | 41,648 | 9,492 | 712 | 11,787 | 713 | 44 | 84,503 | ||||||||||||||||||||||||||||||||||||||||||
| Ending balance | $ | 27,346 | $ | 43,551 | $ | 9,867 | $ | 1,369 | $ | 13,341 | $ | 818 | $ | 44 | $ | 96,336 | ||||||||||||||||||||||||||||||||||
We recorded a reversal of $2.4 million and a $14.3 million provision for credit losses for the three months ended March 31, 2021 and 2020, respectively, under CECL. We recorded $5.2 million and $2.2 million in net charge-offs during the three months ended March 31, 2021 and 2020, respectively.
A loan is considered collateral-dependent when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral.
22
The following table presents the amortized cost basis of collateral-dependent loans by class of loans as of March 31, 2021 and December 31, 2020:
March 31, 2021
| (dollars in thousands) | Business/Other Assets | Real Estate | ||||||||||||
| Commercial | $ | 10,310 | $ | 9,339 | ||||||||||
| Income producing - commercial real estate | 3,193 | 23,135 | ||||||||||||
| Owner occupied - commercial real estate | — | 14,075 | ||||||||||||
| Real estate mortgage - residential | — | 1,942 | ||||||||||||
| Construction - commercial and residential | — | 196 | ||||||||||||
| Home equity | — | 413 | ||||||||||||
| Other consumer | — | — | ||||||||||||
| Total | $ | 13,503 | $ | 49,100 | ||||||||||
December 31, 2020
| (dollars in thousands) | Business/Other Assets | Real Estate | ||||||||||||
| Commercial | $ | 11,326 | $ | 4,026 | ||||||||||
| Income producing - commercial real estate | 3,193 | 15,686 | ||||||||||||
| Owner occupied - commercial real estate | — | 23,159 | ||||||||||||
| Real estate mortgage - residential | — | 2,932 | ||||||||||||
| Construction - commercial and residential | — | 206 | ||||||||||||
| Home equity | — | 415 | ||||||||||||
| Other consumer | — | — | ||||||||||||
| Total | $ | 14,519 | $ | 46,424 | ||||||||||
Credit Quality Indicators
The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company’s primary credit quality indicators are to use an internal credit risk rating system that categorizes loans into pass, watch, special mention, or classified categories. Credit risk ratings are applied individually to those classes of loans that have significant or unique credit characteristics that benefit from a case-by-case evaluation. These are typically loans to businesses or individuals in the classes which comprise the commercial portfolio segment. Groups of loans that are underwritten and structured using standardized criteria and characteristics, such as statistical models (e.g., credit scoring or payment performance), are typically risk rated and monitored collectively. These are typically loans to individuals in the classes which comprise the consumer portfolio segment.
23
The following are the definitions of the Company’s credit quality indicators:
| Pass: | Loans in all classes that comprise the commercial and consumer portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. Management believes that there is a low likelihood of loss related to those loans that are considered pass. | ||||
| Watch: | Loan paying as agreed with generally acceptable asset quality; however the obligor’s performance has not met expectations. Balance sheet and/or income statement has shown deterioration to the point that the obligor could not sustain any further setbacks. Credit is expected to be strengthened through improved obligor performance and/or additional collateral within a reasonable period of time. | ||||
| Special Mention: | Loans in the classes that comprise the commercial portfolio segment that have potential weaknesses that deserve management’s close attention. If not addressed, these potential weaknesses may result in deterioration of the repayment prospects for the loan. The special mention credit quality indicator is not used for classes of loans that comprise the consumer portfolio segment. Management believes that there is a moderate likelihood of some loss related to those loans that are considered special mention. | ||||
| Classified: | Classified (a) Substandard – Loans inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the company will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual loans classified substandard. | ||||
Classified (b) Doubtful – Loans that have all the weaknesses inherent in a loan classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the assets, its classification as an estimated loss is deferred until its more exact status may be determined. | |||||
24
Based on the most recent analysis performed, amortized cost basis of loans by risk category, class and year of origination is as follows:
| March 31, 2021 (dollars in thousands) | Prior | 2017 | 2018 | 2019 | 2020 | 2021 | Total | |||||||||||||||||||||||||||||||||||||
| Commercial | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 413,814 | 221,839 | 217,567 | 155,489 | 181,351 | 75,196 | 1,265,256 | |||||||||||||||||||||||||||||||||||||
| Watch | 35,974 | 23,444 | 19,089 | 7,171 | 10,930 | — | 96,608 | |||||||||||||||||||||||||||||||||||||
| Special Mention | 1,403 | — | 3,366 | 3,980 | 899 | — | 9,648 | |||||||||||||||||||||||||||||||||||||
| Substandard | 22,226 | 1,175 | 2,548 | 569 | 125 | — | 26,643 | |||||||||||||||||||||||||||||||||||||
| Total | 473,417 | — | 246,458 | — | 242,570 | — | 167,209 | — | 193,305 | — | 75,196 | 1,398,155 | ||||||||||||||||||||||||||||||||
| PPP loans | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | — | — | — | — | — | — | — | — | 387,765 | 177,253 | 565,018 | |||||||||||||||||||||||||||||||||
| Total | — | — | — | — | — | — | — | — | 387,765 | 177,253 | 565,018 | |||||||||||||||||||||||||||||||||
| Income producing - commercial real estate | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 822,220 | 273,235 | 665,705 | 579,001 | 501,066 | 10,799 | 2,852,026 | |||||||||||||||||||||||||||||||||||||
| Watch | 161,476 | 107,191 | — | 44,357 | 34,794 | — | 347,818 | |||||||||||||||||||||||||||||||||||||
| Special Mention | 57,448 | — | 42,810 | 51,939 | — | — | 152,197 | |||||||||||||||||||||||||||||||||||||
| Substandard | 63,990 | — | 8,504 | 5,542 | — | — | 78,036 | |||||||||||||||||||||||||||||||||||||
| Total | 1,105,134 | — | 380,426 | — | 717,019 | — | 680,839 | — | 535,860 | — | 10,799 | 3,430,077 | ||||||||||||||||||||||||||||||||
| Owner occupied - commercial real estate | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 423,893 | 134,465 | 132,647 | 67,400 | 48,170 | 18,005 | 824,580 | |||||||||||||||||||||||||||||||||||||
| Watch | 21,916 | 3,266 | 12,030 | 7,175 | 2,041 | — | 46,428 | |||||||||||||||||||||||||||||||||||||
| Special Mention | 446 | — | 81,561 | 19,077 | — | — | 101,084 | |||||||||||||||||||||||||||||||||||||
| Substandard | 26,528 | 1,908 | 1,993 | 9,936 | — | — | 40,365 | |||||||||||||||||||||||||||||||||||||
| Total | 472,783 | — | 139,639 | — | 228,231 | — | 103,588 | — | 50,211 | — | 18,005 | 1,012,457 | ||||||||||||||||||||||||||||||||
| Real estate mortgage - residential | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 20,699 | 10,173 | 13,445 | 17,637 | 5,565 | 1,184 | 68,703 | |||||||||||||||||||||||||||||||||||||
| Watch | 605 | — | — | — | — | — | 605 | |||||||||||||||||||||||||||||||||||||
| Substandard | 1,901 | — | — | — | — | — | 1,901 | |||||||||||||||||||||||||||||||||||||
| Total | 23,205 | — | 10,173 | — | 13,445 | — | 17,637 | — | 5,565 | — | 1,184 | 71,209 | ||||||||||||||||||||||||||||||||
| Construction - commercial and residential | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 73,112 | 233,218 | 230,716 | 108,156 | 107,338 | 15,504 | 768,044 | |||||||||||||||||||||||||||||||||||||
| Watch | 270 | 56,309 | 4,662 | — | — | — | 61,241 | |||||||||||||||||||||||||||||||||||||
| Substandard | — | — | — | 196 | — | — | 196 | |||||||||||||||||||||||||||||||||||||
| Total | 73,382 | — | 289,527 | — | 235,378 | — | 108,352 | — | 107,338 | — | 15,504 | 829,481 | ||||||||||||||||||||||||||||||||
| Construction - C&I (owner occupied) | — | |||||||||||||||||||||||||||||||||||||||||||
| Pass | 17,698 | 7,380 | 19,358 | 23,543 | 42,130 | 693 | 110,802 | |||||||||||||||||||||||||||||||||||||
| Watch | 4,625 | 412 | 5,394 | — | — | — | 10,431 | |||||||||||||||||||||||||||||||||||||
| Special Mention | 137 | — | — | 15,169 | 15,701 | — | 31,007 | |||||||||||||||||||||||||||||||||||||
| Total | 22,460 | — | 7,792 | — | 24,752 | — | 38,712 | — | 57,831 | — | 693 | 152,240 | ||||||||||||||||||||||||||||||||
| Home Equity | — | |||||||||||||||||||||||||||||||||||||||||||
| Pass | 33,548 | 6,850 | 6,631 | 3,704 | 11,675 | 2,910 | 65,318 | |||||||||||||||||||||||||||||||||||||
| Watch | 1,436 | — | — | — | — | — | 1,436 | |||||||||||||||||||||||||||||||||||||
| Substandard | 368 | — | — | 45 | — | — | 413 | |||||||||||||||||||||||||||||||||||||
| Total | 35,352 | — | 6,850 | — | 6,631 | — | 3,749 | — | 11,675 | — | 2,910 | 67,167 | ||||||||||||||||||||||||||||||||
| Other Consumer | — | |||||||||||||||||||||||||||||||||||||||||||
| Pass | 589 | 58 | 88 | 82 | 27 | 34 | 878 | |||||||||||||||||||||||||||||||||||||
| Substandard | 7 | — | — | — | — | — | 7 | |||||||||||||||||||||||||||||||||||||
| Total | 596 | — | 58 | — | 88 | — | 82 | — | 27 | — | 34 | 885 | ||||||||||||||||||||||||||||||||
| Total Recorded Investment | $ | 2,206,329 | $ | — | $ | 1,080,923 | $ | — | $ | 1,468,114 | $ | — | $ | 1,120,168 | $ | — | $ | 1,349,577 | $ | — | $ | 301,578 | 7,526,689 | |||||||||||||||||||||
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| December 31, 2020 (dollars in thousands) | Prior | 2016 | 2017 | 2018 | 2019 | 2020 | Total | |||||||||||||||||||||||||||||||||||||
| Commercial | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 323,660 | 111,886 | 249,541 | 211,551 | 164,166 | 227,095 | 1,287,899 | |||||||||||||||||||||||||||||||||||||
| Watch | 31,903 | 5,315 | 19,145 | 21,013 | 7,740 | 7,979 | 93,095 | |||||||||||||||||||||||||||||||||||||
| Special Mention | 4,969 | 1,692 | 8,969 | 3,385 | 5,599 | 2,169 | 26,783 | |||||||||||||||||||||||||||||||||||||
| Substandard | 17,679 | 5,803 | 1,820 | 3,525 | 829 | — | 29,656 | |||||||||||||||||||||||||||||||||||||
| Total | 378,211 | 124,696 | 279,475 | 239,474 | 178,334 | 237,243 | 1,437,433 | |||||||||||||||||||||||||||||||||||||
| PPP loans | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | — | — | — | — | — | 454,771 | 454,771 | |||||||||||||||||||||||||||||||||||||
| Total | — | — | — | — | — | 454,771 | 454,771 | |||||||||||||||||||||||||||||||||||||
| Income producing - commercial real estate | — | |||||||||||||||||||||||||||||||||||||||||||
| Pass | 560,915 | 347,946 | 397,953 | 622,276 | 643,388 | 512,387 | 3,084,865 | |||||||||||||||||||||||||||||||||||||
| Watch | 152,367 | 62,912 | 91,636 | 89,852 | 44,555 | 34,195 | 475,517 | |||||||||||||||||||||||||||||||||||||
| Special Mention | 213 | — | — | — | 51,969 | — | 52,182 | |||||||||||||||||||||||||||||||||||||
| Substandard | 58,555 | 800 | 4,656 | 4,883 | 5,542 | — | 74,436 | |||||||||||||||||||||||||||||||||||||
| Total | 772,050 | 411,658 | 494,245 | 717,011 | 745,454 | 546,582 | 3,687,000 | |||||||||||||||||||||||||||||||||||||
| Owner occupied - commercial real estate | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 343,371 | 100,272 | 111,996 | 136,644 | 59,681 | 49,584 | 801,548 | |||||||||||||||||||||||||||||||||||||
| Watch | 16,014 | 5,011 | 2,640 | 10,338 | 15,501 | — | 49,504 | |||||||||||||||||||||||||||||||||||||
| Special Mention | 418 | — | — | 83,110 | 19,091 | — | 102,619 | |||||||||||||||||||||||||||||||||||||
| Substandard | 28,228 | 784 | 1,908 | 2,048 | 10,151 | 904 | 44,023 | |||||||||||||||||||||||||||||||||||||
| Total | 388,031 | 106,067 | 116,544 | 232,140 | 104,424 | 50,488 | 997,694 | |||||||||||||||||||||||||||||||||||||
| Real estate mortgage - residential | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 16,310 | 2,693 | 10,199 | 12,746 | 18,209 | 10,116 | 70,273 | |||||||||||||||||||||||||||||||||||||
| Watch | 1,996 | 699 | — | 728 | — | — | 3,423 | |||||||||||||||||||||||||||||||||||||
| Substandard | 1,198 | 1,698 | — | — | — | — | 2,896 | |||||||||||||||||||||||||||||||||||||
| Total | 19,504 | 5,090 | 10,199 | 13,474 | 18,209 | 10,116 | 76,592 | |||||||||||||||||||||||||||||||||||||
| Construction - commercial and residential | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 21,290 | 60,486 | 266,788 | 297,480 | 105,679 | 71,297 | 823,020 | |||||||||||||||||||||||||||||||||||||
| Watch | 929 | — | 42,751 | 3,448 | — | — | 47,128 | |||||||||||||||||||||||||||||||||||||
| Special Mention | 12 | — | — | 2,895 | — | — | 2,907 | |||||||||||||||||||||||||||||||||||||
| Substandard | — | — | 206 | — | — | — | 206 | |||||||||||||||||||||||||||||||||||||
| Total | 22,231 | 60,486 | 309,745 | 303,823 | 105,679 | 71,297 | 873,261 | |||||||||||||||||||||||||||||||||||||
| Construction - C&I (owner occupied) | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 8,278 | 10,476 | 6,637 | 30,340 | 22,209 | 40,101 | 118,041 | |||||||||||||||||||||||||||||||||||||
| Watch | 3,573 | — | 2,118 | 4,935 | — | — | 10,626 | |||||||||||||||||||||||||||||||||||||
| Special Mention | 124 | — | — | — | 14,436 | 15,678 | 30,238 | |||||||||||||||||||||||||||||||||||||
| Total | 11,975 | 10,476 | 8,755 | 35,275 | 36,645 | 55,779 | 158,905 | |||||||||||||||||||||||||||||||||||||
| Home Equity | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 33,226 | 4,493 | 8,227 | 7,827 | 4,224 | 12,924 | 70,921 | |||||||||||||||||||||||||||||||||||||
| Watch | 1,596 | — | — | — | — | — | 1,596 | |||||||||||||||||||||||||||||||||||||
| Substandard | 603 | — | — | — | 47 | — | 650 | |||||||||||||||||||||||||||||||||||||
| Total | 35,425 | 4,493 | 8,227 | 7,827 | 4,271 | 12,924 | 73,167 | |||||||||||||||||||||||||||||||||||||
| Other Consumer | ||||||||||||||||||||||||||||||||||||||||||||
| Pass | 929 | 190 | 64 | 74 | 94 | 31 | 1,382 | |||||||||||||||||||||||||||||||||||||
| Substandard | 7 | — | — | — | — | — | 7 | |||||||||||||||||||||||||||||||||||||
| Total | 936 | 190 | 64 | 74 | 94 | 31 | 1,389 | |||||||||||||||||||||||||||||||||||||
| Total Recorded Investment | $ | 1,628,363 | $ | 723,156 | $ | 1,227,254 | $ | 1,549,098 | $ | 1,193,110 | $ | 1,439,231 | $ | 7,760,212 | ||||||||||||||||||||||||||||||
The Company’s credit quality indicators are generally updated annually; however, credits rated watch or below are reviewed more frequently.
Nonaccrual and Past Due Loans
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As part of its comprehensive loan review process, the Loan Committee or Credit Review Committee carefully evaluate loans which are past-due 30 days or more. The Committees make a thorough assessment of the conditions and circumstances surrounding each delinquent loan. The Bank’s loan policy requires that loans be placed on nonaccrual if they are ninety days past-due, unless they are well secured and in the process of collection. Additionally, Credit Administration specifically analyzes the status of development and construction projects, sales activities and utilization of interest reserves in order to carefully and prudently assess potential increased levels of risk requiring additional reserves.
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The table presents, by class of loan, an aging analysis and the recorded investments in loans past due as of March 31, 2021 (unaudited) and December 31, 2020:
| Loans | Loans | Loans | Total Recorded | |||||||||||||||||||||||||||||||||||||||||
| Current | 30-59 Days | 60-89 Days | 90 Days or | Total Past | Investment in | |||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Loans | Past Due | Past Due | More Past Due | Due Loans | Non-Accrual | Loans | |||||||||||||||||||||||||||||||||||||
| March 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial | $ | 1,371,357 | $ | 6,681 | $ | 1,626 | $ | — | $ | 8,307 | $ | 18,491 | $ | 1,398,155 | ||||||||||||||||||||||||||||||
| PPP loans | 565,018 | — | — | — | — | — | 565,018 | |||||||||||||||||||||||||||||||||||||
| Income producing - commercial real estate | 3,360,794 | 46,811 | 5,315 | — | 52,126 | 17,157 | 3,430,077 | |||||||||||||||||||||||||||||||||||||
| Owner occupied - commercial real estate | 994,842 | 3,336 | 202 | — | 3,538 | 14,077 | 1,012,457 | |||||||||||||||||||||||||||||||||||||
| Real estate mortgage - residential | 68,438 | 829 | — | — | 829 | 1,942 | 71,209 | |||||||||||||||||||||||||||||||||||||
| Construction - commercial and residential | 825,823 | 3,462 | — | — | 3,462 | 196 | 829,481 | |||||||||||||||||||||||||||||||||||||
| Construction - C&I (owner occupied) | 148,373 | 3,453 | 414 | — | 3,867 | — | 152,240 | |||||||||||||||||||||||||||||||||||||
| Home equity | 66,488 | 197 | 69 | — | 266 | 413 | 67,167 | |||||||||||||||||||||||||||||||||||||
| Other consumer | 885 | — | — | — | — | — | 885 | |||||||||||||||||||||||||||||||||||||
| Total | $ | 7,402,018 | $ | 64,769 | $ | 7,626 | $ | — | $ | 72,395 | $ | 52,276 | $ | 7,526,689 | ||||||||||||||||||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial | $ | 1,394,244 | $ | 6,411 | $ | 21,426 | $ | — | $ | 27,837 | $ | 15,352 | $ | 1,437,433 | ||||||||||||||||||||||||||||||
| PPP loans | 454,771 | — | — | — | — | — | 454,771 | |||||||||||||||||||||||||||||||||||||
| Income producing - commercial real estate | 3,616,207 | — | 51,913 | — | 51,913 | 18,880 | 3,687,000 | |||||||||||||||||||||||||||||||||||||
| Owner occupied - commercial real estate | 960,364 | 10,630 | 3,542 | — | 14,172 | 23,158 | 997,694 | |||||||||||||||||||||||||||||||||||||
| Real estate mortgage – residential | 72,231 | 1,430 | — | — | 1,430 | 2,931 | 76,592 | |||||||||||||||||||||||||||||||||||||
| Construction - commercial and residential | 869,723 | 2,992 | 340 | — | 3,332 | 206 | 873,261 | |||||||||||||||||||||||||||||||||||||
| Construction- C&I (owner occupied) | 158,905 | — | — | — | — | — | 158,905 | |||||||||||||||||||||||||||||||||||||
| Home equity | 67,732 | 467 | 4,552 | — | 5,019 | 416 | 73,167 | |||||||||||||||||||||||||||||||||||||
| Other consumer | 1,367 | 21 | 1 | — | 22 | — | 1,389 | |||||||||||||||||||||||||||||||||||||
| Total | $ | 7,595,544 | $ | 21,951 | $ | 81,774 | $ | — | $ | 103,725 | $ | 60,943 | $ | 7,760,212 | ||||||||||||||||||||||||||||||
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The following presents the nonaccrual loans as of March 31, 2021 (unaudited) and December 31, 2020:
| March 31, 2021 | ||||||||||||||||||||
| Nonaccrual with | Nonaccrual with | Total | ||||||||||||||||||
| No Allowance | an Allowance | Nonaccrual | ||||||||||||||||||
| (dollars in thousands) | for Credit Loss | for Credit Loss | Loans | |||||||||||||||||
| Commercial | $ | 8,493 | $ | 9,998 | $ | 18,491 | ||||||||||||||
| Income producing - commercial real estate | 6,092 | 11,065 | 17,157 | |||||||||||||||||
| Owner occupied - commercial real estate | 10,675 | 3,402 | 14,077 | |||||||||||||||||
| Real estate mortgage - residential | — | 1,942 | 1,942 | |||||||||||||||||
| Construction - commercial and residential | 196 | — | 196 | |||||||||||||||||
| Home equity | 413 | — | 413 | |||||||||||||||||
Total (1)(2) | $ | 25,869 | $ | 26,407 | $ | 52,276 | ||||||||||||||
| December 31, 2020 | ||||||||||||||||||||
| Nonaccrual with | Nonaccrual with | Total | ||||||||||||||||||
| No Allowance | an Allowance | Nonaccrual | ||||||||||||||||||
| (dollars in thousands) | for Credit Loss | for Credit Loss | Loans | |||||||||||||||||
| Commercial | $ | 3,263 | $ | 12,089 | $ | 15,352 | ||||||||||||||
| Income producing - commercial real estate | 6,500 | 12,380 | 18,880 | |||||||||||||||||
| Owner occupied - commercial real estate | 18,941 | 4,217 | 23,158 | |||||||||||||||||
| Real estate mortgage - residential | 1,234 | 1,697 | 2,931 | |||||||||||||||||
| Construction - commercial and residential | — | 206 | 206 | |||||||||||||||||
| Home equity | 416 | — | 416 | |||||||||||||||||
Total (1)(2) | $ | 30,354 | $ | 30,589 | $ | 60,943 | ||||||||||||||
(1)Excludes TDRs that were performing under their restructured terms totaling $10.3 million at March 31, 2021 and $10.5 million at December 31, 2020.
(2)Gross interest income of $0.8 million and $3.7 million would have been recorded for the three months ended March 31, 2021 and December 31, 2020, respectively, if nonaccrual loans shown above had been current and in accordance with their original terms, while no interest was actually recorded on such loans for the three months ended March 31, 2021 or 2020. See Note 1 to the Consolidated Financial Statements for a description of the Company’s policy for placing loans on nonaccrual status.
Modifications
A modification of a loan constitutes a TDR when the borrower is experiencing financial difficulty and the modification constitutes a concession. The Company offers various types of concessions when modifying a loan. Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor is often requested. The most common change in terms provided by the Company is an extension of an interest-only term. As of March 31, 2021, all performing TDRs were categorized as interest-only modifications.
Loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan. An allowance for impaired consumer and commercial loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent. Management exercises significant judgment in developing these estimates.
29
In response to the COVID-19 pandemic and its economic impact to our customers, we implemented a short-term modification program that complies with the CARES Act and ASC 310-40 to provide temporary payment relief to those borrowers directly impacted by COVID-19 who were not more than 30 days past due as of December 31, 2019. This program allows for a deferral of payments for 90 days, which we extended for an additional 90 days, for a maximum of 180 days on a cumulative and successive basis. The deferred payments along with interest accrued during the deferral period are due and payable on the maturity date. As of March 31, 2021, we granted ongoing temporary modifications on approximately 58 loans representing approximately $143 million (1.9% of total loans) in outstanding exposure. Additionally, none of the deferrals are reflected in the Company's asset quality measures (i.e. non-performing loans) due to the provision of the CARES Act that permits U.S. financial institutions to temporarily suspend the GAAP requirements to treat such short-term loan modifications as TDR. Similar provisions have also been confirmed by interagency guidance issued by the federal banking agencies and confirmed with staff members of the Financial Accounting Standards Board.
The following table presents by class, the recorded investment of loans modified in TDRs held by the Company for the periods ended March 31, 2021 and 2020.
| Three Months Ended March 31, 2021 | ||||||||||||||||||||||||||||||||||||||
| Income | Owner | |||||||||||||||||||||||||||||||||||||
| Number | Producing - | Occupied - | Construction - | |||||||||||||||||||||||||||||||||||
| of | Commercial | Commercial | Commercial | |||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Contracts | Commercial | Real Estate | Real Estate | Real Estate | Total | ||||||||||||||||||||||||||||||||
| Troubled debt restructurings | ||||||||||||||||||||||||||||||||||||||
| Restructured accruing | 5 | $ | 1,157 | $ | 9,171 | $ | — | $ | — | $ | 10,328 | |||||||||||||||||||||||||||
| Restructured nonaccruing | 3 | 101 | 6,342 | — | — | 6,443 | ||||||||||||||||||||||||||||||||
| Total | 8 | $ | 1,258 | $ | 15,513 | $ | — | $ | — | $ | 16,771 | |||||||||||||||||||||||||||
| Specific allowance | $ | 547 | $ | 2,976 | $ | — | $ | — | $ | 3,523 | ||||||||||||||||||||||||||||
| Restructured and subsequently defaulted | $ | 101 | $ | 6,342 | $ | — | $ | — | $ | 6,443 | ||||||||||||||||||||||||||||
| Three Months Ended March 31, 2020 | ||||||||||||||||||||||||||||||||||||||
| Income | Owner | |||||||||||||||||||||||||||||||||||||
| Number | Producing - | Occupied - | Construction - | |||||||||||||||||||||||||||||||||||
| of | Commercial | Commercial | Commercial | |||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Contracts | Commercial | Real Estate | Real Estate | Real Estate | Total | ||||||||||||||||||||||||||||||||
| Troubled debt restructurings | ||||||||||||||||||||||||||||||||||||||
| Restructured accruing | 11 | $ | 1,438 | $ | 15,574 | $ | 860 | $ | — | $ | 17,872 | |||||||||||||||||||||||||||
| Restructured nonaccruing | 2 | 137 | — | 2,370 | — | 2,507 | ||||||||||||||||||||||||||||||||
| Total | 13 | $ | 1,575 | $ | 15,574 | $ | 3,230 | $ | — | $ | 20,379 | |||||||||||||||||||||||||||
| Specific allowance | $ | — | $ | 1,007 | $ | — | $ | — | $ | 1,007 | ||||||||||||||||||||||||||||
| Restructured and subsequently defaulted | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||||||||||||||||||
The Company had eight TDRs at March 31, 2021 totaling approximately $16.8 million. Five of these loans totaling approximately $10.3 million are performing under their modified terms as of March 31, 2021. For the first three months of 2021 and 2020, there was one and no performing TDR loans each, totaling $101 thousand and zero, respectively, that defaulted on their modified terms. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on non-accrual status. For the three months ended March 31, 2021, one previously nonperforming restructured loan had
30
its collateral sold and all principal collected along with partial collection of delinquent interest; in addition, one restructured loan purchased as part of the 2014 acquisition of Virginia Heritage Bank has now had its full carrying value collected, while additional payments will recover previously written off principal and interest. No similar transactions occurred during the three months ended March 31, 2020. During the three months ended March 31, 2021 and 2020, no loans were re-underwritten and removed from TDR status. Loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. The allowance may be increased, adjustments may be made in the allocation of the allowance or partial charge-offs may be taken to further write-down the carrying value of the loan. For the three months ended March 31, 2021 and 2020, there were no loans modified in a TDR and four loans modified into a TDR totaling approximately $1.3 million, respectively.
Note 6. Leases
A lease is defined as a contract that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. On January 1, 2019, the Company adopted ASU No. 2016-2 “Leases” (Topic 842) and has adopted all subsequent ASUs that modified Topic 842. For the Company, Topic 842 primarily affected the accounting treatment for operating lease agreements in which the Company is the lessee.
Substantially all of the leases in which the Company is the lessee are comprised of real estate property for branch offices, ATM locations, and corporate office space. Substantially all of our leases are classified as operating leases, and as such, were previously not recognized on the Company’s Consolidated Balance Sheets. With the adoption of Topic 842, operating lease agreements were required to be recognized on the Consolidated Balance Sheets as a right-of-use (“ROU”) asset and a corresponding lease liability.
As of March 31, 2021, the Company had $30.7 million of operating lease ROU assets and $33.3 million of operating lease liabilities on the Company’s Consolidated Balance Sheets. As of December 31, 2020, the Company had $25.2 million of operating lease ROU assets and $28.0 million of operating lease liabilities on the Company’s Consolidated Balance Sheets. The Company elects not to recognize ROU assets and lease liabilities arising from short-term leases, leases with initial terms of twelve months or less, or equipment leases (deemed immaterial) on the Consolidated Balance Sheets.
The leases contain terms and conditions of options to extend or terminate the lease which are recognized as part of the ROU assets and lease liabilities when an economic benefit to exercise the option exists and there is a 90% probability that the Company will exercise the option. If these criteria are not met, the options are not included in ROU assets and lease liabilities.
As of March 31, 2021, our leases do not contain material residual value guarantees or impose restrictions or covenants related to dividends or the Company’s ability to incur additional financial obligations. As of March 31, 2021, there were no leases that have been signed but did not yet commence as of the reporting date that create significant rights and obligations for the Company.
The following table presents lease costs and other lease information.
| Three Months Ended | ||||||||||||||||||||
| (dollars in thousands) | March 31, 2021 | March 31, 2020 | ||||||||||||||||||
| Lease Cost | ||||||||||||||||||||
| Operating Lease Cost (Cost resulting from lease payments) | $ | 2,159 | $ | 1,998 | ||||||||||||||||
| Variable Lease Cost (Cost excluded from lease payments) | 250 | 267 | ||||||||||||||||||
| Sublease Income | (87) | (87) | ||||||||||||||||||
| Net Lease Cost | $ | 2,322 | $ | 2,178 | ||||||||||||||||
| Operating Lease - Operating Cash Flows (Fixed Payments) | $ | 2,304 | $ | 2,206 | ||||||||||||||||
| Right-of-Use Assets - Operating Leases | $ | 30,707 | $ | 25,655 | ||||||||||||||||
| Weighted Average Lease Term - Operating Leases | 6.24 | yrs | 4.84 | yrs | ||||||||||||||||
| Weighted Average Discount Rate - Operating Leases | 3.37 | % | 4.00 | % | ||||||||||||||||
31
Future minimum payments for operating leases with initial or remaining terms of more than one year as of March 31, 2021 were as follows:
| (dollars in thousands) | ||||||||
| Twelve Months Ended: | ||||||||
| March 31, 2022 | $ | 8,199 | ||||||
| March 31, 2023 | 4,519 | |||||||
| March 31, 2024 | 6,040 | |||||||
| March 31, 2025 | 5,268 | |||||||
| March 31, 2026 | 4,277 | |||||||
| Thereafter | 10,720 | |||||||
| Total Future Minimum Lease Payments | 39,023 | |||||||
| Amounts Representing Interest | (5,685) | |||||||
| Present Value of Net Future Minimum Lease Payments | $ | 33,338 | ||||||
Note 7. Other Derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments.
Cash Flow Hedges of Interest Rate Risk
The Company uses interest rate swap agreements to assist in its interest rate risk management. The Company’s objective in using interest rate derivatives designated as cash flow hedges is to add stability to interest expense and to better manage its exposure to interest rate movements. To accomplish this objective, the Company utilizes interest rate swaps as part of its interest rate risk management strategy intended to mitigate the potential risk of rising interest rates on the Bank’s cost of funds. The notional amounts of the interest rate swaps designated as cash flow hedges do not represent amounts exchanged by the counterparties, but rather, the notional amount is used to determine, along with other terms of the derivative, the amounts to be exchanged between the counterparties. The interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from one counterparty in exchange for the Company making fixed payments. The Company’s intent is to hedge its exposure to the variability in potential future interest rate conditions on existing financial instruments.
For derivatives designated as cash flow hedges, changes in the fair value of the derivative are initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions.
As of March 31, 2021 and December 31, 2020, the Company had one designated cash flow hedge interest rate swap transaction outstanding associated with the Company's variable rate deposits. Amounts reported in accumulated other comprehensive income related to designated cash flow hedge derivatives will be reclassified to interest income/expense as interest payments are made/received on the Company’s variable-rate assets/liabilities. The Company's sole designated cash flow hedge matured during April 2021. Accordingly, the Company estimates (based on existing interest rates) that $60 thousand will be reclassified as an increase in interest expense during April 2021.
Non-designated Hedges
Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers. The Company executes interest rate caps and swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings.
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The Company entered into credit risk participation agreements ("RPAs") with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower's performance related to interest rate derivative contracts. The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers' credit spread to that exposure. Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities.
Credit-risk-related Contingent Features
The Company has agreements with each of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, then the Company could also be declared in default on its derivative obligations.
The Company is exposed to credit risk in the event of nonperformance by the interest rate derivative counterparty. The Company minimizes this risk by entering into derivative contracts with only large, stable financial institutions, and the Company has not experienced, and does not expect, any losses from counterparty nonperformance on the interest rate derivatives. The Company monitors counterparty risk in accordance with the provisions of ASC Topic 815, "Derivatives and Hedging." In addition, the interest rate derivative agreements contain language outlining collateral-pledging requirements for each counterparty.
The interest rate derivative agreements detail: 1) that collateral be posted when the market value exceeds certain threshold limits associated with the secured party’s exposure; 2) if the Company defaults on any of its indebtedness (including default where repayment of the indebtedness has not been accelerated by the lender), then the Company could also be declared in default on its derivative obligations; 3) if the Company fails to maintain its status as a well-capitalized institution then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements.
As of March 31, 2021, the aggregate fair value of the derivative contract with credit risk contingent features (i.e., containing collateral posting or termination provisions based on our capital status) that was in a net liability position totaled $474 thousand. The Company has a minimum collateral posting threshold with its derivative counterparty. As of March 31, 2021, the Company was required to post collateral totaling $1.0 million with its derivative counterparty against its obligations under this agreement. If the Company had breached any provisions under the agreement at March 31, 2021, it could have been required to settle its obligations under the agreement at the termination value.
The table below identifies the balance sheet category and fair value of the Company’s designated cash flow hedge derivative instruments and non-designated hedges as of March 31, 2021 (unaudited) and December 31, 2020.
| March 31, 2021 | December 31, 2020 | |||||||||||||||||||||||||||||||
| (dollars in thousands) | Notional Amount | Fair Value | Balance Sheet Category | Fair Value | Balance Sheet Category | |||||||||||||||||||||||||||
| Derivatives not designated as hedging instruments | ||||||||||||||||||||||||||||||||
| Interest rate product | $ | 217,398 | $ | 3,637 | Other Assets | $ | 3,491 | Other Assets | ||||||||||||||||||||||||
| Mortgage banking derivatives | $ | 191,902 | $ | 2,514 | Other Assets | 5,213 | Other Assets | |||||||||||||||||||||||||
| $ | 409,300 | $ | 6,151 | Other Assets | $ | 8,704 | Other Assets | |||||||||||||||||||||||||
| Derivatives designated as hedging instruments | ||||||||||||||||||||||||||||||||
| Interest rate product | $ | 100,000 | $ | 133 | Other Liabilities | $ | 516 | Other Liabilities | ||||||||||||||||||||||||
| Derivatives not designated as hedging instruments | ||||||||||||||||||||||||||||||||
| Interest rate product | $ | 217,398 | $ | 3,516 | Other Liabilities | 3,653 | Other Liabilities | |||||||||||||||||||||||||
| Other Contracts | $ | 26,789 | $ | 78 | Other Liabilities | 118 | Other Liabilities | |||||||||||||||||||||||||
| $ | 244,187 | $ | 3,594 | Other Liabilities | $ | 3,771 | Other Liabilities | |||||||||||||||||||||||||
| Net Derivatives on the balance sheet | $ | 3,727 | $ | 4,287 | ||||||||||||||||||||||||||||
| Cash and other collateral | $ | 2,550 | 4,168 | |||||||||||||||||||||||||||||
| Net Derivative Amounts | $ | 1,177 | $ | 119 | ||||||||||||||||||||||||||||
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The table below presents the pre-tax net gains (losses) of the Company’s designated cash flow hedges for the three months ended March 31, 2021 and 2020:
| The Effect of Fair Value and Cash Flow Hedge Accounting on Accumulated Other Comprehensive Income | ||||||||||||||||||||||||||||||||
| Location of Gain or (Loss) | Amount of Gain or (Loss) | |||||||||||||||||||||||||||||||
| Amount of Gain (Loss) Recognized | Recognized from | Reclassified from Accumulated | ||||||||||||||||||||||||||||||
| Derivatives in Subtopic | in OCI on Derivative | Accumulated Other | OCI into Income | |||||||||||||||||||||||||||||
| 815-20 Hedging | Three Months Ended March 31, | Comprehensive Income into | Three Months Ended March 31, | |||||||||||||||||||||||||||||
| Relationships (dollars in thousands) | 2021 | 2020 | Income | 2021 | 2020 | |||||||||||||||||||||||||||
| Derivatives in Cash Flow Hedging Relationships | ||||||||||||||||||||||||||||||||
| Interest Rate Products | $ | (844) | $ | (1,521) | Interest Expense | $ | (385) | $ | 28 | |||||||||||||||||||||||
| Total | $ | (844) | $ | (1,521) | $ | (385) | $ | 28 | ||||||||||||||||||||||||
able below presents the effect of the Company’s derivative financial instruments on the Consolidated Statements of Income for the three months ended March 31, 2021 and 2020:
| The Effect of Fair Value and Cash Flow Hedge Accounting on the Statements of Income | ||||||||||||||
| Location and Amount of Gain or (Loss) Recognized in Income on | ||||||||||||||
| Fair Value and Cash Flow Hedging Relationships (in 000's) | ||||||||||||||
| Three Months Ended March 31, | ||||||||||||||
| 2021 | 2020 | |||||||||||||
| Interest Expense | ||||||||||||||
| Total amounts of income and expense line items presented in the consolidated statement of income in which the effects of fair value or cash flow hedges are recorded | $ | (384) | $ | 28 | ||||||||||
| Gain or (loss) on cash flow hedging relationships in Subtopic 815-20 | ||||||||||||||
| Interest contracts | ||||||||||||||
| Amount of gain or (loss) reclassified from accumulated other comprehensive income into income | $ | (384) | $ | 28 | ||||||||||
| Amount of gain or (loss) reclassified from accumulated other comprehensive income into income as a result that a forecasted transaction is no longer probable of occurring | $ | — | $ | — | ||||||||||
| Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income - Included Component | $ | (384) | $ | 28 | ||||||||||
| Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income - Excluded Component | $ | — | $ | — | ||||||||||
| Effect of Derivatives Not Designated as Hedging Instruments on the Statements of Income | ||||||||||||||||||||
| Amount of Income (Loss) | ||||||||||||||||||||
| Recognized in Income on | ||||||||||||||||||||
| Location of | Derivative | |||||||||||||||||||
| Derivatives Not Designated as Hedging | (Loss) Recognized in | Three Months Ended March 31, | ||||||||||||||||||
| Instruments under Subtopic 815-20 | Income on Derivative | 2021 | 2020 | |||||||||||||||||
| Interest Rate Products | Other income / (expense) | $ | 283 | $ | (168) | |||||||||||||||
| Mortgage banking derivatives | Other income / (expense) | 2,514 | 663 | |||||||||||||||||
| Other Contracts | Other income / (expense) | 40 | (66) | |||||||||||||||||
| Total | $ | 2,837 | $ | 429 | ||||||||||||||||
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Note 8. Long-Term Borrowings
The following table presents information related to the Company’s long-term borrowings as of March 31, 2021 (unaudited) and December 31, 2020.
| (dollars in thousands) | March 31, 2021 | December 31, 2020 | ||||||||||||
Subordinated Notes, 5.75% | $ | 70,000 | $ | 70,000 | ||||||||||
Subordinated Notes, 5.0% | 150,000 | 150,000 | ||||||||||||
FHLB Advance, 1.81% | — | 50,000 | ||||||||||||
| Less: unamortized debt issuance costs | (1,825) | (1,923) | ||||||||||||
| Long-term borrowings | $ | 218,175 | $ | 268,077 | ||||||||||
On August 5, 2014, the Company completed the sale of $70.0 million of its 5.75% subordinated notes, due September 1, 2024 (the “2024 Notes”). The 2024 Notes were offered to the public at par and qualify as Tier 2 capital for regulatory purposes to the fullest extent permitted under the Basel III Rule capital requirements. The net proceeds were approximately $68.8 million, which includes $1.2 million in deferred financing costs which are being amortized over the life of the 2024 Notes.
On July 26, 2016, the Company completed the sale of $150.0 million of its 5.00% Fixed-to-Floating Rate Subordinated Notes, due August 1, 2026 (the “2026 Notes”). The 2026 Notes were offered to the public at par and qualify as Tier 2 capital for regulatory purposes to the fullest extent permitted under the Basel III Rule capital requirements. The net proceeds were approximately $147.4 million, which includes $2.6 million in deferred financing costs which are being amortized over the life of the 2026 Notes. We are in the process of evaluating the impact of the expected discontinuation of LIBOR on the 2026 notes.
On February 26, 2020, the Bank borrowed $50 million dollars under its borrowing arrangement with the FHLB at a fixed rate of 1.81% with a maturity date of February 26, 2030 as part of the overall asset liability strategy and to support loan growth. In the first quarter of 2021, we realized a net gain of $911 thousand on the cancellation of this debt.
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Note 9. Net Income per Common Share
The calculation of net income per common share for the three months ended March 31, 2021 and 2020 (unaudited) was as follows:
| Three Months Ended March 31, | ||||||||||||||
| (dollars and shares in thousands, except per share data) | 2021 | 2020 | ||||||||||||
| Basic: | ||||||||||||||
| Net income | $ | 43,469 | $ | 23,123 | ||||||||||
| Average common shares outstanding | 31,870 | 32,850 | ||||||||||||
| Basic net income per common share | $ | 1.36 | $ | 0.70 | ||||||||||
| Diluted: | ||||||||||||||
| Net income | $ | 43,469 | $ | 23,123 | ||||||||||
| Average common shares outstanding | 31,870 | 32,850 | ||||||||||||
| Adjustment for common share equivalents | 53 | 25 | ||||||||||||
| Average common shares outstanding-diluted | 31,923 | 32,875 | ||||||||||||
| Diluted net income per common share | $ | 1.36 | $ | 0.70 | ||||||||||
| Anti-dilutive shares | 4 | 26 | ||||||||||||
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Note 10. Other Comprehensive Income
The following table presents the components of other comprehensive income (loss) for the three months ended March 31, 2021 and 2020 (unaudited).
| (dollars in thousands) | Before Tax | Tax Effect | Net of Tax | |||||||||||||||||
| Three Months Ended March 31, 2021 | ||||||||||||||||||||
| Net unrealized gain (loss) on securities available-for-sale | $ | (23,713) | $ | 6,096 | $ | (17,617) | ||||||||||||||
| Less: Reclassification adjustment for net gains (losses) included in net income | (221) | 55 | (166) | |||||||||||||||||
| Total unrealized gain (loss) | (23,934) | 6,151 | (17,783) | |||||||||||||||||
| Net unrealized gain (loss) on derivatives | 767 | (194) | 573 | |||||||||||||||||
| Less: Reclassification adjustment for gain (loss) included in net income | (384) | 96 | (288) | |||||||||||||||||
| Total unrealized gain (loss) | 383 | (98) | 285 | |||||||||||||||||
| Other Comprehensive Income (Loss) | $ | (23,551) | $ | 6,053 | $ | (17,498) | ||||||||||||||
| Three Months Ended March 31, 2020 | ||||||||||||||||||||
| Net unrealized gain (loss) on securities available-for-sale | $ | 16,736 | $ | (4,632) | $ | 12,104 | ||||||||||||||
| Less: Reclassification adjustment for net gains (losses) included in net income | (822) | (218) | (604) | |||||||||||||||||
| Total unrealized gain (loss) | 15,914 | (4,850) | 11,500 | |||||||||||||||||
| Net unrealized gain (loss) on derivatives | (1,989) | 664 | (1,325) | |||||||||||||||||
| Less: Reclassification adjustment for gain (loss) included in net income | (94) | (25) | (69) | |||||||||||||||||
| Total unrealized gain (loss) | (2,083) | 639 | (1,394) | |||||||||||||||||
| Other Comprehensive Income (Loss) | $ | 13,831 | $ | (4,211) | $ | 10,106 | ||||||||||||||
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The following table presents the changes in each component of accumulated other comprehensive income (loss), net of tax, for the three months ended March 31, 2021 and 2020.
| Securities | Accumulated Other | |||||||||||||||||||
| Available | Comprehensive Income | |||||||||||||||||||
| (dollars in thousands) | For Sale | Derivatives | (Loss) | |||||||||||||||||
| Three Months Ended March 31, 2021 | ||||||||||||||||||||
| Balance at Beginning of Period | $ | 16,168 | $ | (668) | $ | 15,500 | ||||||||||||||
| Other comprehensive income (loss) before reclassifications | (17,617) | 573 | (17,044) | |||||||||||||||||
| Amounts reclassified from accumulated other comprehensive income (loss) | (166) | (288) | (454) | |||||||||||||||||
| Net other comprehensive income (loss) during period | (17,783) | 285 | (17,498) | |||||||||||||||||
| Balance at End of Period | $ | (1,615) | $ | (383) | $ | (1,998) | ||||||||||||||
| Securities | Accumulated Other | |||||||||||||||||||
| Available | Comprehensive Income | |||||||||||||||||||
| (dollars in thousands) | For Sale | Derivatives | (Loss) | |||||||||||||||||
| Three Months Ended March 31, 2020 | ||||||||||||||||||||
| Balance at Beginning of Period | $ | 3,109 | $ | (150) | $ | 2,959 | ||||||||||||||
| Other comprehensive income (loss) before reclassifications | 12,104 | (1,325) | 10,779 | |||||||||||||||||
| Amounts reclassified from accumulated other comprehensive loss | (604) | (69) | (673) | |||||||||||||||||
| Net other comprehensive income (loss) during period | 11,500 | (1,394) | 10,106 | |||||||||||||||||
| Balance at End of Period | $ | 14,609 | $ | (1,544) | $ | 13,065 | ||||||||||||||
The following tables present the amounts reclassified out of each component of accumulated other comprehensive income (loss) for the three months ended March 31, 2021 and 2020.
| Amount Reclassified from | ||||||||||||||||||||
| Accumulated Other | Affected Line Item in | |||||||||||||||||||
| Details about Accumulated Other | Comprehensive (Loss) Income | the Statement Where | ||||||||||||||||||
| Comprehensive Income Components | Three Months Ended March 31, | Net Income is Presented | ||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | ||||||||||||||||||
| Realized gain on sale of investment securities | $ | 221 | $ | 822 | Gain on sale of investment securities | |||||||||||||||
| Interest income derivative deposits | 384 | 94 | Interest income on deposits | |||||||||||||||||
| Income tax expense | (151) | (243) | Income tax expense | |||||||||||||||||
| Total Reclassifications for the Period | $ | 454 | $ | 673 | Net Income | |||||||||||||||
Note 11. Fair Value Measurements
The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1 Quoted prices in active exchange markets for identical assets or liabilities; also includes certain U.S. Treasury and other U.S. Government and agency securities actively traded in over-the-counter markets.
Level 2 Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data; also includes derivative contracts whose value is determined using a pricing model with observable market inputs or can be derived principally from or
38
corroborated by observable market data. This category generally includes certain U.S. Government and agency securities, corporate debt securities, derivative instruments, and residential mortgage loans held for sale.
Level 3 Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs for single dealer nonbinding quotes not corroborated by observable market data. This category generally includes certain private equity investments, retained interests from securitizations, and certain collateralized debt obligations.
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Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis as of March 31, 2021 (unaudited) and December 31, 2020.
| Significant | Significant | |||||||||||||||||||||||||
| Other | Other | |||||||||||||||||||||||||
| Observable | Unobservable | |||||||||||||||||||||||||
| Quoted Prices | Inputs | Inputs | Total | |||||||||||||||||||||||
| (dollars in thousands) | (Level 1) | (Level 2) | (Level 3) | (Fair Value) | ||||||||||||||||||||||
| March 31, 2021 | ||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||
| Investment securities available-for-sale: | ||||||||||||||||||||||||||
| U. S. agency securities | $ | — | $ | 275,535 | $ | — | $ | 275,535 | ||||||||||||||||||
| Residential mortgage backed securities | — | 932,619 | — | 932,619 | ||||||||||||||||||||||
| Municipal bonds | — | 107,122 | — | 107,122 | ||||||||||||||||||||||
| Corporate bonds | — | 52,133 | 1,500 | 53,633 | ||||||||||||||||||||||
| Loans held for sale | — | 142,196 | — | 142,196 | ||||||||||||||||||||||
| Interest rate caps | — | 3,607 | — | 3,607 | ||||||||||||||||||||||
| Mortgage banking derivatives | — | — | 2,514 | 2,514 | ||||||||||||||||||||||
| Total assets measured at fair value on a recurring basis as of March 31, 2021 | $ | — | $ | 1,513,212 | $ | 4,014 | $ | 1,517,226 | ||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||
| Interest rate swap derivatives | $ | — | $ | 133 | $ | — | $ | 133 | ||||||||||||||||||
| Derivative liability | — | 78 | — | 78 | ||||||||||||||||||||||
| Interest rate caps | — | 3,486 | — | 3,486 | ||||||||||||||||||||||
| Total liabilities measured at fair value on a recurring basis as of March 31, 2021 | $ | — | $ | 3,697 | $ | — | $ | 3,697 | ||||||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||
| Investment securities available-for-sale: | ||||||||||||||||||||||||||
| U. S. agency securities | $ | — | $ | 181,921 | $ | — | $ | 181,921 | ||||||||||||||||||
| Residential mortgage backed securities | — | 825,001 | — | 825,001 | ||||||||||||||||||||||
| Municipal bonds | — | 108,113 | — | 108,113 | ||||||||||||||||||||||
| Corporate bonds | — | 34,350 | 1,500 | 35,850 | ||||||||||||||||||||||
| Loans held for sale | — | 88,205 | — | 88,205 | ||||||||||||||||||||||
| Interest rate caps | — | 3,413 | — | 3,413 | ||||||||||||||||||||||
| Mortgage banking derivatives | — | — | 5,213 | 5,213 | ||||||||||||||||||||||
| Total assets measured at fair value on a recurring basis as of December 31, 2020 | $ | — | $ | 1,241,003 | $ | 6,713 | $ | 1,247,716 | ||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||
| Interest rate swap derivatives | $ | — | $ | 516 | $ | — | $ | 516 | ||||||||||||||||||
| Derivative liability | — | 118 | — | 118 | ||||||||||||||||||||||
| Interest rate caps | — | 3,574 | — | 3,574 | ||||||||||||||||||||||
| Total liabilities measured at fair value on a recurring basis as of December 31, 2020 | $ | — | $ | 4,208 | $ | — | $ | 4,208 | ||||||||||||||||||
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Investment securities available-for-sale: Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange. Level 2 securities include U.S. agency debt securities, mortgage backed securities issued by Government Sponsored Entities and municipal bonds. Securities classified as Level 3 include securities in less liquid markets, the carrying amounts approximate the fair value.
Loans held for sale: The Company has elected to carry loans held for sale at fair value. This election reduces certain timing differences in the Consolidated Statement of Income and better aligns with the management of the portfolio from a business perspective. Fair value is derived from secondary market quotations for similar instruments. Gains and losses on sales of residential mortgage loans are recorded as a component of noninterest income in the Consolidated Statements of Income. Gains and losses on sales of multifamily FHA securities are recorded as a component of noninterest income in the Consolidated Statements of Income. As such, the Company classifies loans subjected to fair value adjustments as Level 2 valuation.
The following tables summarize the difference between the aggregate fair value and the aggregate unpaid principal balance for loans held for sale measured at fair value as of March 31, 2021 (unaudited) and December 31, 2020.
| March 31, 2021 | ||||||||||||||||||||
| Aggregate Unpaid | ||||||||||||||||||||
| (dollars in thousands) | Fair Value | Principal Balance | Difference | |||||||||||||||||
| Loans held for sale | $ | 142,196 | $ | 139,606 | $ | 2,590 | ||||||||||||||
| December 31, 2020 | ||||||||||||||||||||
| Aggregate Unpaid | ||||||||||||||||||||
| (dollars in thousands) | Fair Value | Principal Balance | Difference | |||||||||||||||||
| Loans held for sale | $ | 88,205 | $ | 86,551 | $ | 1,654 | ||||||||||||||
There were no residential mortgage loans held for sale that were 90 or more days past due or on nonaccrual status as of March 31, 2021 or December 31, 2020.
Interest rate swap derivatives: These derivative instruments consist of interest rate swap agreements, which are accounted for as cash flow hedges under ASC 815. The Company’s derivative position is classified within Level 2 of the fair value hierarchy and is valued using models generally accepted in the financial services industry and that use actively quoted or observable market input values from external market data providers and/or non-binding broker-dealer quotations. The fair value of the derivatives is determined using discounted cash flow models. These models’ key assumptions include the contractual terms of the respective contract along with significant observable inputs, including interest rates, yield curves, nonperformance risk and volatility. Derivative contracts are executed with a Credit Support Annex, which is a bilateral agreement that requires collateral postings when the market value exceeds certain threshold limits. These agreements protect the interests of the Company and its counterparties should either party suffer a credit rating deterioration.
Credit risk participation agreements: The Company enters into credit risk participation agreements (“RPAs”) with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower’s performance related to interest rate derivative contracts. The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers’ credit spread to that exposure. Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities. Accordingly, RPAs fall within Level 2.
Interest rate caps: The Company entered into an interest rate cap agreement ("cap") with an institutional counterparty, under which the Company will receive cash if and when market rates exceed the cap's strike rate. The fair value of the cap is calculated by determining the total expected asset or liability exposure of the derivatives. Total expected exposure incorporates both the current and potential future exposure of the derivative, derived from using observable inputs, such as yield curves and volatilities. Accordingly, the cap falls within Level 2.
Mortgage banking derivatives for loans settled on a mandatory basis: The Company relied on a third-party pricing service to value its mortgage banking derivative financial assets and liabilities, which the Company classifies as a Level 3
41
valuation. The external valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale includes grouping the interest rate lock commitments by interest rate and terms, applying an estimated pull-through rate based on historical experience, and then multiplying by quoted investor prices determined to be reasonably applicable to the loan commitment groups based on interest rate, terms, and rate lock expiration dates of the loan commitment groups. The Company also relies on an external valuation model to estimate the fair value of its forward commitments to sell residential mortgage loans (i.e., an estimate of what the Company would receive or pay to terminate the forward delivery contract based on market prices for similar financial instruments), which includes matching specific terms and maturities of the forward commitments against applicable investor pricing.
Mortgage banking derivative for loans settled best efforts basis: The significant unobservable input (Level 3) used in the fair value measurement of the Company's interest rate lock commitments is the pull through ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. An increase in the pull through ratio (i.e. higher percentage of loans are estimated to close) will increase the gain or loss. The pull through ratio is largely dependent on the loan processing stage that a loan is currently in. The pull through rate is computed by the Company's secondary marketing consultant using historical data and the ratio is periodically reviewed by the Company for reasonableness.
The following is a reconciliation of activity for assets and liabilities measured at fair value based on Significant Other Unobservable Inputs (Level 3):
| Investment | Mortgage Banking | |||||||||||||||||||
| (dollars in thousands) | Securities | Derivatives | Total | |||||||||||||||||
| Assets: | ||||||||||||||||||||
| Beginning balance at January 1, 2021 | $ | 1,500 | $ | 5,213 | $ | 6,713 | ||||||||||||||
| Realized gain (loss) included in earnings | — | (2,699) | (2,699) | |||||||||||||||||
| Ending balance at March 31, 2021 | $ | 1,500 | $ | 2,514 | $ | 4,014 | ||||||||||||||
| Liabilities: | ||||||||||||||||||||
| Beginning balance at January 1, 2021 | $ | — | $ | — | $ | — | ||||||||||||||
| Ending balance at March 31, 2021 | $ | — | $ | — | $ | — | ||||||||||||||
| Investment | Mortgage Balancing | |||||||||||||||||||
| (dollars in thousands) | Securities | Derivatives | Total | |||||||||||||||||
| Assets: | ||||||||||||||||||||
| Beginning balance at January 1, 2020 | $ | 10,931 | $ | 280 | $ | 11,211 | ||||||||||||||
| Realized (loss) gain included in earnings | — | 4,933 | 4,933 | |||||||||||||||||
| Migrated to level 2 valuation | (9,233) | — | (9,233) | |||||||||||||||||
| Reclass fair value asset to cost method | (198) | — | (198) | |||||||||||||||||
| Ending balance at December 31, 2020 | $ | 1,500 | $ | 5,213 | $ | 6,713 | ||||||||||||||
| Liabilities: | ||||||||||||||||||||
| Beginning balance at January 1, 2020 | $ | — | $ | 66 | $ | 66 | ||||||||||||||
| Realized gain included in earnings | — | (66) | (66) | |||||||||||||||||
| Ending balance at December 31, 2020 | $ | — | $ | — | $ | — | ||||||||||||||
The other equity and debt securities classified as Level 3 consist of one corporate bond of a local banking company and equity investments in the form of common stock of two local banking companies which are not publicly traded, and for which the carrying amounts approximate fair value.
For Level 3 assets measured at fair value on a recurring or nonrecurring basis as of March 31, 2021 and December 31, 2020, the significant unobservable inputs used in the fair value measurements were as follows:
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| March 31, 2021 | December 31, 2020 | ||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Valuation Technique | Description | Range | Weighted Average (1) | Fair Value | Weighted Average (1) | Fair Value | ||||||||||||||||||||||||||||||||||
| Mortgage banking derivatives | Pricing Model | Pull Through Rate | 81.2% - 91.9% | 83.30 | % | $ | 2,514 | 0 | 79.14 | % | 76.25 | $ | 5,213 | ||||||||||||||||||||||||||||
(1) Unobservable inputs for mortgage banking derivatives were weighted by loan amount.
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
The Company measures certain assets at fair value on a nonrecurring basis and the following is a general description of the methods used to value such assets.
At March 31, 2021, substantially all of the Company’s individually evaluated loans were evaluated based upon the fair value of the collateral. In accordance with ASC Topic 820, individually evaluated loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.
Other real estate owned: Other real estate owned is initially recorded at fair value less estimated selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral, which the Company classifies as a Level 3 valuation. Assets measured at fair value on a nonrecurring basis are included in the table below:
| Significant | Significant | |||||||||||||||||||||||||
| Other | Other | |||||||||||||||||||||||||
| Observable | Unobservable | |||||||||||||||||||||||||
| Quoted Prices | Inputs | Inputs | Total | |||||||||||||||||||||||
| (dollars in thousands) | (Level 1) | (Level 2) | (Level 3) | (Fair Value) | ||||||||||||||||||||||
| March 31, 2021 | ||||||||||||||||||||||||||
| Commercial | $ | — | $ | — | $ | 14,284 | $ | 14,284 | ||||||||||||||||||
| Income producing - commercial real estate | — | — | 20,595 | 20,595 | ||||||||||||||||||||||
| Owner occupied - commercial real estate | — | — | 13,000 | 13,000 | ||||||||||||||||||||||
| Real estate mortgage - residential | — | — | 1,368 | 1,368 | ||||||||||||||||||||||
| Construction - commercial and residential | — | — | 196 | 196 | ||||||||||||||||||||||
| Home equity | — | — | 414 | 414 | ||||||||||||||||||||||
| Other consumer | — | — | — | — | ||||||||||||||||||||||
| Other real estate owned | — | — | 4,987 | 4,987 | ||||||||||||||||||||||
| Total assets measured at fair value on a nonrecurring basis as of March 31, 2021 | $ | — | $ | — | $ | 54,844 | $ | 54,844 | ||||||||||||||||||
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| Significant | Significant | |||||||||||||||||||||||||
| Other | Other | |||||||||||||||||||||||||
| Observable | Unobservable | |||||||||||||||||||||||||
| Quoted Prices | Inputs | Inputs | Total | |||||||||||||||||||||||
| (dollars in thousands) | (Level 1) | (Level 2) | (Level 3) | (Fair Value) | ||||||||||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||||
| Impaired loans: | ||||||||||||||||||||||||||
| Commercial | $ | — | $ | — | $ | 9,285 | $ | 9,285 | ||||||||||||||||||
| Income producing - commercial real estate | — | — | 21,638 | 21,638 | ||||||||||||||||||||||
| Owner occupied - commercial real estate | — | — | 21,930 | 21,930 | ||||||||||||||||||||||
| Real estate mortgage - residential | — | — | 2,602 | 2,602 | ||||||||||||||||||||||
| Construction - commercial and residential | — | — | 103 | 103 | ||||||||||||||||||||||
| Home equity | — | — | 416 | 416 | ||||||||||||||||||||||
| Other real estate owned | — | — | 4,987 | 4,987 | ||||||||||||||||||||||
| Total assets measured at fair value on a nonrecurring basis as of December 31, 2020 | $ | — | $ | — | $ | 60,961 | $ | 60,961 | ||||||||||||||||||
Fair Value of Financial Instruments
The Company discloses fair value information about financial instruments for which it is practicable to estimate the value, whether or not such financial instruments are recognized on the balance sheet. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by quoted market price, if one exists.
Quoted market prices, if available, are shown as estimates of fair value. Because no quoted market prices exist for a portion of the Company’s financial instruments, the fair value of such instruments has been derived based on management’s assumptions with respect to future economic conditions, the amount and timing of future cash flows and estimated discount rates. Different assumptions could significantly affect these estimates. Accordingly, the net realizable value could be materially different from the estimates presented below. In addition, the estimates are only indicative of individual financial instrument values and should not be considered an indication of the fair value of the Company taken as a whole.
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The estimated fair value of the Company’s financial instruments at March 31, 2021 (unaudited) and December 31, 2020 are as follows:
| Fair Value Measurements | ||||||||||||||||||||||||||||||||
| Quoted Prices (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||||||||||||||||||||
| Carrying | ||||||||||||||||||||||||||||||||
| (dollars in thousands) | Value | Fair Value | ||||||||||||||||||||||||||||||
| March 31, 2021 | ||||||||||||||||||||||||||||||||
| Assets | ||||||||||||||||||||||||||||||||
| Cash and due from banks | $ | 9,112 | $ | 9,112 | $ | 9,112 | $ | — | $ | — | ||||||||||||||||||||||
| Federal funds sold | 25,785 | 25,785 | — | 25,785 | — | |||||||||||||||||||||||||||
| Interest bearing deposits with other banks | 1,708,374 | 1,708,374 | — | 1,708,374 | — | |||||||||||||||||||||||||||
| Investment securities | 1,369,107 | 1,369,107 | — | 1,367,607 | 1,500 | |||||||||||||||||||||||||||
| Federal Reserve and Federal Home Loan Bank stock | 33,978 | 33,978 | — | 33,978 | — | |||||||||||||||||||||||||||
| Loans held for sale | 142,196 | 142,196 | — | 142,196 | — | |||||||||||||||||||||||||||
| Loans | 7,424,619 | 7,369,359 | — | — | 7,369,359 | |||||||||||||||||||||||||||
| Bank owned life insurance | 77,119 | 77,119 | — | 77,119 | — | |||||||||||||||||||||||||||
| Annuity investment | 14,360 | 14,360 | — | 14,360 | — | |||||||||||||||||||||||||||
| Mortgage banking derivatives | 2,514 | 2,514 | — | — | 2,514 | |||||||||||||||||||||||||||
| Interest rate caps | 3,607 | 3,607 | — | 3,607 | — | |||||||||||||||||||||||||||
| Liabilities | ||||||||||||||||||||||||||||||||
| Noninterest bearing deposits | 2,594,334 | 2,594,334 | — | 2,594,334 | — | |||||||||||||||||||||||||||
| Interest bearing deposits | 5,738,549 | 5,738,549 | — | 5,738,549 | — | |||||||||||||||||||||||||||
| Time deposits | 865,961 | 879,569 | — | 879,569 | — | |||||||||||||||||||||||||||
| Customer repurchase agreements | 20,061 | 20,061 | — | 20,061 | — | |||||||||||||||||||||||||||
| Borrowings | 518,175 | 526,754 | — | 526,754 | — | |||||||||||||||||||||||||||
| Interest rate swap derivatives | 133 | 133 | — | 133 | — | |||||||||||||||||||||||||||
| Credit risk participation agreement | 78 | 78 | — | 78 | — | |||||||||||||||||||||||||||
| Interest rate caps | 3,486 | 3,486 | — | 3,486 | — | |||||||||||||||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||||||||||
| Assets | ||||||||||||||||||||||||||||||||
| Cash and due from banks | $ | 8,435 | $ | 8,435 | $ | 8,435 | $ | — | $ | — | ||||||||||||||||||||||
| Federal funds sold | 28,200 | 28,200 | — | 28,200 | ||||||||||||||||||||||||||||
| Interest bearing deposits with other banks | 1,752,420 | 1,752,420 | — | 1,752,420 | ||||||||||||||||||||||||||||
| Investment securities | 1,150,885 | 1,150,885 | — | 1,149,385 | 1,500 | |||||||||||||||||||||||||||
| Federal Reserve and Federal Home Loan Bank stock | 40,104 | 40,104 | — | 40,104 | — | |||||||||||||||||||||||||||
| Loans held for sale | 88,205 | 88,205 | — | 88,205 | — | |||||||||||||||||||||||||||
| Loans | 7,650,633 | 7,608,687 | — | — | 7,608,687 | |||||||||||||||||||||||||||
| Bank owned life insurance | 76,729 | 76,729 | — | 76,729 | — | |||||||||||||||||||||||||||
| Annuity investment | 14,468 | 14,468 | — | 14,468 | — | |||||||||||||||||||||||||||
| Mortgage banking derivative | 5,213 | 5,213 | — | — | 5,213 | |||||||||||||||||||||||||||
| Interest rate caps | 3,413 | 3,413 | — | 3,413 | — | |||||||||||||||||||||||||||
| Liabilities | ||||||||||||||||||||||||||||||||
| Noninterest bearing deposits | 2,809,334 | 2,809,334 | — | 2,809,334 | — | |||||||||||||||||||||||||||
| Interest bearing deposits | 756,923 | 756,923 | — | 756,923 | — | |||||||||||||||||||||||||||
| Time deposits | 977,760 | 993,500 | — | 993,500 | — | |||||||||||||||||||||||||||
| Customer repurchase agreements | 26,726 | 26,726 | — | 26,726 | — | |||||||||||||||||||||||||||
| Borrowings | 568,077 | 575,435 | — | 575,435 | — | |||||||||||||||||||||||||||
| Interest rate swap derivatives | 516 | 516 | — | 516 | — | |||||||||||||||||||||||||||
| Credit risk participation agreements | 118 | 118 | — | 118 | — | |||||||||||||||||||||||||||
| Interest rate caps | 3,574 | 3,574 | — | 3,574 | — | |||||||||||||||||||||||||||
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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources of Eagle Bancorp, Inc. (the “Company”) and its subsidiaries as of the dates and periods indicated. This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this report and the Management Discussion and Analysis in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
This report contains forward-looking statements within the meaning of the Securities Exchange Act of 1934 (the “Exchange Act”), as amended, including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies and regarding general economic conditions. In some cases, forward-looking statements can be identified by use of words such as “may,” “will,” “can,” “anticipates,” “believes,” “expects,” “plans,” “estimates,” “potential,” “assume," "probable," "possible," "continue,” “should,” “could,” “would,” “strive," "seeks," "deem," "projections," "forecast," "consider," "indicative," "uncertainty," "likely," "unlikely," ""likelihood," "unknown," "attributable," "depends," "intends," "generally," "feel" "typically," "judgment," "subjective" and similar words or phrases. These statements are based upon current and anticipated economic conditions, nationally and in the Company’s market (including the macroeconomic and other challenges and uncertainties resulting from the coronavirus (“COVID-19”) pandemic, including on our credit quality and business operations), interest rates and interest rate policy, competitive factors and other conditions, which by their nature are not susceptible to accurate forecast, and are subject to significant uncertainty. For details on factors that could affect these expectations, see the risk factors contained in this report and the risk factors and other cautionary language included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, and in other periodic and current reports filed by the Company with the Securities and Exchange Commission. Because of these uncertainties and the assumptions on which this discussion and the forward-looking statements are based, actual future operations and results in the future may differ materially from those indicated herein. Readers are cautioned against placing undue reliance on any such forward-looking statements. The Company’s past results are not necessarily indicative of future performance, and nothing contained herein is meant to or should be considered and treated as earnings guidance of future quarters’ performance projections. All information is as of the date of this report. Any forward-looking statements made by or on behalf of the Company speak only as to the date they are made. Except to the extent required by applicable law or regulation, the Company undertakes no obligation to revise or update publicly any forward looking statement for any reason.
GENERAL
The Company is a growth-oriented, one-bank holding company headquartered in Bethesda, Maryland, which is currently celebrating twenty-three years of successful operations. The Company provides general commercial and consumer banking services through EagleBank (the “Bank”), its wholly owned banking subsidiary, a Maryland chartered bank which is a member of the Federal Reserve System. The Company was organized in October 1997, to be the holding company for the Bank. The Bank was organized in 1998 as an independent, community oriented, full service banking alternative to the super regional financial institutions, which dominate the Company’s primary market area. The Company’s philosophy is to provide superior, personalized service to its customers. The Company focuses on relationship banking, providing each customer with a number of services and becoming familiar with and addressing customer needs in a proactive, personalized fashion. The Bank currently has a total of twenty branch offices, including nine in Northern Virginia, six in Suburban Maryland, and five in Washington, D.C.
The Bank offers a broad range of commercial banking services to its business and professional clients, as well as full service consumer banking services to individuals living and/or working primarily in the Bank’s market area. The Bank emphasizes providing commercial banking services to sole proprietors, small and medium-sized businesses, non-profit organizations and associations, and investors living and working in and near the primary service area. These services include the usual deposit functions of commercial banks, including business and personal checking accounts, “NOW” accounts and money market and savings accounts, business, construction, and commercial loans, residential mortgages and consumer loans, and cash management services. The Bank is also active in the origination and sale of residential mortgage loans and the origination of Small Business Administration ("SBA”) loans. The residential mortgage loans are originated for sale to third-party investors, generally large mortgage and banking companies, under best efforts and or mandatory delivery commitments with the investors to purchase the loans subject to compliance with pre-established criteria. The decision whether to sell residential mortgage loans on a mandatory or best efforts lock basis is a function of multiple factors, including but not limited to overall market volumes of mortgage loan originations, forecasted “pull-through” rates of origination, loan closing operational considerations, pricing differentials between the two methods, and availability and pricing of various interest rate hedging strategies associated with the mortgage origination pipeline. The Company continually monitors these factors to maximize profitability and minimize operational and interest rate risks.
46
The Bank generally sells the guaranteed portion of the SBA loans in a transaction apart from the loan origination generating noninterest income from the gains on sale, as well as servicing income on the portion participated. The Company originates multifamily Federal Housing Administration ("FHA”) loans through the Department of Housing and Urban Development’s Multifamily Accelerated Program (“MAP”). The Company securitizes these loans through the Government National Mortgage Association (“Ginnie Mae”) MBS I program and sells the resulting securities in the open market to authorized dealers in the normal course of business, and periodically bundles and sells the servicing rights. Bethesda Leasing, LLC, a subsidiary of the Bank, holds title to and manages other real estate owned (“OREO”) assets. Eagle Insurance Services, LLC, a subsidiary of the Bank, offers access to insurance products and services through a referral program with a third party insurance broker. Additionally, the Bank offers investment advisory services through referral programs with third parties. Landroval Municipal Finance, Inc., a subsidiary of the Bank, focuses on lending to municipalities by buying debt on the public market as well as direct purchase issuance.
Impact of COVID-19
In March 2020, the outbreak of COVID-19 was recognized as a pandemic by the World Health Organization. The spread of COVID-19 has created a global public health crisis that has resulted in unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity in the United States and globally, including the markets that we serve. Governmental responses to the pandemic have included orders closing nonessential businesses, directing individuals to restrict their movements, observe social distancing, and shelter in place. These actions, together with responses to the pandemic by businesses and individuals, have resulted in rapid decreases in commercial and consumer activity, temporary closures of many businesses that have led to a loss of revenues and a rapid increase in unemployment, material decreases in oil and gas prices and in business valuations, disrupted global supply chains, market downturns and volatility, changes in consumer behavior related to COVID-19 pandemic fears, related emergency response legislation and an expectation that Federal Reserve policy will maintain a low interest rate environment for the foreseeable future. Since the inception of the pandemic in March of 2020, much progress has been made in reopening economies back up domestically and abroad. In the United States and in other nations around the world, the availability of vaccination to immunize the masses ramped up significantly in the first quarter of 2021. While there is a hopeful reason to be optimistic, we remain cautious given the potential for lingering effects of the pandemic.
Certain of our business and consumer customers have experienced and continue to experience varying degrees of financial distress. In order to protect the health of our customers and employees, and to comply with applicable government directives, we have modified our business practices, including directing employees to work from home insofar as is possible, implementing our business continuity plans and protocols to the extent necessary, and our branches have modified hours and advanced safety measures. We have established general guidelines for returning that include having employees maintain safe distances, staggered work schedules to limit the number of employees in a single location, more frequent cleaning of our facilities and other practices encouraging a safe working environment during this challenging time, including required COVID-19 training programs.
On March 27, 2020, the CARES Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act created the Paycheck Protection Program (the "PPP"), a program designed to aid small- and medium-sized businesses through federally guaranteed loans distributed through banks. These loans are intended to guarantee payroll and other costs to help those businesses remain viable and allow their workers to pay their bills.
As an SBA preferred lender, the Bank is participating in the PPP program, and at March 31, 2021, had an outstanding balance of PPP loans of $565.0 million to just over 1,800 business' loans. The statutory interest rate on these loans is 1.00% and the average yield, which includes fee and cost amortization, was 3.50% for the first quarter of 2021. On May 3, 2021, we transacted to sell 849 PPP loans for a total purchase price of $169.0 million. Immediately following this sale, the principal outstanding on PPP loans totaled approximately $378.4 million across 789 notes.
There have also been various governmental actions taken or proposed to provide forms of relief, such as streamlining the application process for forgiveness of all PPP loans under $50,000, limiting debt collections efforts, including foreclosures, and encouraging or requiring extensions, modifications or forbearance, with respect to certain loans and fees. Following the CARES Act, the Consolidated Appropriations Act was signed in to law on December 27, 2020 which expanded and modified the PPP as well as provided additional COVID-19 support. Subsequently, the American Rescue Plan Act of 2021 was signed in to law on March 11, 2021 providing an additional $1.9 trillion in relief in the form of testing and vaccination sites along with direct stimulus checks. Governmental actions taken in response to the COVID-19 pandemic have not always been coordinated or consistent across jurisdictions but, in general, have been expanding in scope and intensity. The efficacy and ultimate effect of these actions is not known.
47
In response to the COVID-19 pandemic, we have also implemented a short-term loan modification program to provide temporary payment relief to certain borrowers who meet the program's qualifications. Initial modifications under the program have predominantly been for 90 days, with a second 90 day modification if warranted. The deferred payments along with interest accrued during the deferral period are due and payable on the existing maturity date of the existing loan. As of March 31, 2021, we had ongoing temporary modifications on approximately 58 loans representing $143.4 million (approximately 1.9% of total loans) in outstanding balances. Overall, through the twelve months of the pandemic ending March 31, 2021, the Bank's COVID-19 modification program has granted temporary modifications on approximately 787 loans representing approximately $1.6 billion in outstanding balances. At March 31, 2021, the level of loans currently in COVID-19 related modification is $143 million.
Some of these deferrals may have met the criteria for treatment under U.S. generally accepted accounting principles ("GAAP") as troubled debt restructurings ("TDRs"). Additionally, none of the deferrals are reflected in the Company's asset quality measures (i.e. non-performing loans) due to the provision of the CARES Act that permits U.S. financial institutions to temporarily suspend the U.S. GAAP requirements to treat such short-term loan modifications as TDR. Similar provisions have also been confirmed by interagency guidance issued by the federal banking agencies and confirmed with staff members of the Financial Accounting Standards Board.
Steadily improving economic forecasts, improved unemployment numbers, improvement of credits in the portfolio along with a reduction in total loans, higher provisioning in 2020 associated with the implementation of the expected loss methodology for determining our provision for credit losses as required by the Current Expected Credit Loss ("CECL") standard described below, resulted in a negative provision for credit losses for the first three months of 2021. We continue to monitor the impact of COVID-19 closely even as economic forecasts improve. In addition, we continue to monitor the effects that have resulted from the CARES Act and other legislative and regulatory developments related to COVID-19; however, the extent to which the COVID-19 pandemic could impact our operations and financial results during the remainder of 2021 is highly uncertain.
CRITICAL ACCOUNTING POLICIES
The Company’s Consolidated Financial Statements are prepared in accordance with GAAP and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the Consolidated Financial Statements; accordingly, as this information changes, the Consolidated Financial Statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or a valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The Company applies the accounting policies contained in Note 1 to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 and Note 1 to the Consolidated Financial Statements included in this report. There have been no significant changes to the Company’s accounting policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 except as indicated below and in “Accounting Standards Adopted in 2021” in Note 1 to the Consolidated Financial Statements in this report.
Provision for Credit Losses and Provision for Unfunded Commitments
A consequence of lending activities is that we may incur credit losses, so we record an allowance for credit losses ("ACL") with respect to loan receivables and a reserve for unfunded commitments (“RUC”) as estimates of those losses. The amount of such losses will vary depending upon the risk characteristics of the loan portfolio as affected by economic conditions such as changes in interest rates, the financial performance of borrowers and regional unemployment rates, which management estimates by using a national forecast and estimating a regional adjustment based on historical differences between the two.
CECL requires an estimate of the credit losses expected over the life of an exposure (or pool of exposures). The Provision for Unfunded Commitments represents the expected credit losses on off-balance sheet commitments such as unfunded commitments to extend credit and standby letters of credit. The RUC is determined by estimating future draws and applying the expected loss rates on those draws.
48
Management has significant discretion in making the judgments inherent in the determination of the provisions for credit loss, ACL, and the RUC. Our determination of these amounts requires significant reliance on estimates and significant judgment as to the amount and timing of expected future cash flows on loans, significant reliance on historical loss rates on homogenous portfolios, consideration of our quantitative and qualitative evaluation of economic factors, and the reliance on our reasonable and supportable forecasts.
The Provision for Credit Losses ("PCL") represents the expected credit losses arising from the Company's loan and
AFS securities portfolios.
The Company uses a loan-level probability of default ("PD")/ loss given default ("LGD") cash flow method with an exposure at default ("EAD") model to estimate expected credit losses for the commercial, income producing – commercial real estate, owner occupied – commercial real estate, real estate mortgage - residential, construction – commercial and residential, construction – C&I (owner occupied), home equity, and other consumer loan pools. For each of these loan segments, the Company generates cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speed, probability of default, and loss given default. The modeling of expected prepayment speeds is based on historical internal data. PPP loans are included in the model but do not carry a reserve, as these loans are fully guaranteed by the
SBA, whose guarantee is backed by the full faith and credit of the U.S. Government.
The Company uses regression analysis of historical internal and peer data (as Company loss data is insufficient) to determine suitable loss drivers to utilize when modeling lifetime probability of default and loss given default. This analysis also determines how expected probability of default will react to forecasted levels of the loss drivers. For our cash flow model, management utilizes and forecasts regional unemployment by using a national forecast and estimating a regional adjustment based on historical differences between the two as a loss driver over our reasonable and supportable period of two years, and reverts back to a historical loss rate over the following twelve months on a straight-line basis. Improved unemployment projections, which inform our CECL economic forecast reduced our loss reserve during the three months ended March 31, 2021. Management leverages economic projections from reputable and independent third parties to inform its loss driver forecasts over the forecast period.
The ACL also includes an amount for inherent risks not reflected in the historical analyses. Relevant factors include, but are not limited to, concentrations of credit risk, changes in underwriting standards, experience and depth of lending staff, and trends in delinquencies. While our methodology in establishing the reserve for credit losses attributes portions of the ACL and RUC to the commercial and consumer portfolio segments, the entire ACL and RUC is available to absorb credit losses expected in the total loan portfolio and total amount of unfunded credit commitments, respectively.
Under CECL, reserve for credit losses are significantly influenced by the composition, characteristics and quality of our loan portfolio, as well as the prevailing economic conditions and forecasts utilized. Material changes to these and other relevant factors may result in greater volatility to the reserve for credit losses, and therefore, greater volatility to our reported earnings. For example, the COVID-19 pandemic has negatively impacted the performance outlook in the Accommodation & Food Service segment of our loan portfolio, which informs our CECL economic forecast and increased our loss reserve for the three months ended March 31, 2021. See Notes 1 and 5 to the Consolidated Financial Statements for more information on the provision for credit losses.
Goodwill and Other Intangibles
Goodwill is subject to impairment testing at the reporting unit level and must be conducted at least annually. The Company performs impairment testing during the fourth quarter of each year or when events or changes in circumstances indicate the assets might be impaired.
Determining the fair value of a reporting unit under the goodwill impairment test involves judgement and often involves the use of significant estimates and assumptions. Estimates of fair value are primarily determined using discounted cash flows, market comparisons and recent transactions. These approaches use significant estimates and assumptions including projected future cash flows, discount rates reflecting the market rate of return, projected growth rates and determination and evaluation of appropriate market comparables. Future events could cause the Company to conclude that goodwill or other intangibles have become impaired, which would result in recording an impairment loss. Any resulting impairment loss could have a material adverse impact on the Company's financial condition and results of operations. Annual impairment testing of intangibles and goodwill as required by GAAP will be performed in the fourth quarter of 2021.
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RESULTS OF OPERATIONS
Earnings Summary
Net income for the three months ended March 31, 2021 was $43.5 million compared to $23.1 million for the three months ended March 31, 2020, a 88% increase. Net income per basic and diluted common share for the three months ended March 31, 2021 was $1.36 compared to $0.70 per basic and diluted common share for the same period in 2020, a 94% increase.
Net income increased for the three months ended March 31, 2021 relative to the same period in 2020 due primarily to a reversal of the provision for credit losses and significant gain on sale of residential mortgages, whereas the first quarter of 2020 included provisions for credit losses at the beginning of the COVID-19 pandemic, as well as, mark-to-market losses related to a hedge position on mortgage operations. In particular, the provision for credit losses decreased to a net credit of $2.4 million for the three months ended March 31, 2021 compared to $14.3 million for the same period in 2020, a 116% decrease (see "Provision for Credit Losses" section below for further details on drivers of the change).
Total revenue (i.e. net interest income plus noninterest income) was $93.2 million for the first quarter of 2021 as compared to $85.2 million in the same period of 2020. The most significant portion of revenue is net interest income, which increased to $82.7 million for the three months ended March 31, 2021 compared to $79.7 million for the same period in 2020. The increase in net interest income was primarily due to an increase in assets, which more than offset the decline in net interest margin.
The net interest margin, which measures the difference between interest income and interest expense (i.e. net interest income) as a percentage of earning assets, was 2.98% for the three months ended March 31, 2021 and 3.49% for the same period in 2020. The drivers of the change are detailed in the "Net Interest Income and Net Interest Margin" section below.
The benefit of noninterest sources funding earning assets decreased by 34 basis points to 24 basis points for the three months ended March 31, 2021 as compared to 58 basis points for the same period in 2020, due to significantly lower market interest rates. The combination of a 17 basis point decrease in the net interest spread and a 34 basis point decrease in the value of noninterest sources resulted in a 51 basis point decrease in the net interest margin for the three months ended March 31, 2021 as compared to the same period in 2020.
Total noninterest income for the three months ended March 31, 2021 increased to $10.6 million from $5.5 million for the three months ended March 31, 2020, a 94% increase. The largest factor behind the increase was the gain on sale of loans which increased from $944 thousand to $5.2 million between the three months ended March 31, 2021 and March 31, 2020 due to higher gains on the sale of residential mortgage loans ($4.2 million). For further information on the components and drivers of these changes see "Noninterest Income" section below.
Gain on sale of loans for the three months ended March 31, 2021 was $5.2 million compared to $944 thousand for the three months ended March 31, 2020, an increase of 449%. The change was primarily due to a loss on a negative mark-to-market hedge position in the residential mortgage operation in the first quarter of 2020 as contrasted to low interest rates driving more residential mortgage activity in the first quarter of 2021.
Other income for the three months ended March 31, 2021 increased to $3.8 million from $1.9 million for the three months ended March 31, 2020, a 105% increase, due substantially to $911 thousand gain from the cancellation of an FHLB borrowing, swap fee income of $695 thousand and $576 thousand higher gains associated with the origination, securitization, sale and servicing of FHA loans.
Noninterest expenses totaled $38.0 million for the three months ended March 31, 2020, as compared to $37.3 million for the three months ended March 31, 2020, a 2% increase. See the "Noninterest Expense" section for further detail on the components and drivers of the change.
Income tax expenses were $14.6 million for the three months ended March 31, 2021 an increase of 75.1%, compared to the same period in 2020. The components and drivers of the change are discussed in the "Income Tax Expense" section below.
The efficiency ratio, which measures the ratio of noninterest expense to total revenue, was 40.74% for the first quarter of 2021, as compared to 43.83% for the first quarter of 2020.
The Company believes it has effectively managed its net interest income over the past twelve months by growing its balance sheet over the past twelve months.
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At March 31, 2021, total loans (including PPP loans) were 3.0% lower than they were at December 31, 2020, and average loans were 0.99% higher in the first three months of 2021 as compared to the first three months of 2020 (which did not include any PPP loans as the program had not yet started). PPP loans represented $565 million of total loans at the end of the first quarter 2021. Excluding PPP loans, the decrease in loan balance is mostly attributable to elevated payoffs and prepays due in part to successful completion of construction projects and low nominal interest rates. From a liquidity and funding perspective, the Company continues to benefit from funding from the build in both interest bearing and noninterest bearing accounts. At March 31, 2021, total deposits were 0.1% higher than deposits at December 31, 2020, while average deposits were 24.7% higher for the first three months of 2021 compared with the first three months of 2020. This has allowed the Company to sustain strong primary and secondary sources of liquidity.
On May 3, 2021, we transacted to sell 849 PPP loans for a total purchase price of $169.0 million. Immediately following this sale, the principal outstanding on PPP loans totaled approximately $378.4 million across 789 notes.
In terms of the average asset composition or mix, loans, which generally have higher yields than securities and other earning assets, represented 68.8% and 83.4% of average earning assets for the first three months of 2021 and 2020, respectively. The decline was primarily a result of strong deposit inflows in the second and third quarters of 2020, which significantly increased cash and securities.
The ratio of common equity to total assets decreased to 11.33% at March 31, 2021 from 11.64% at March 31, 2020, as strong deposit inflows significantly increased assets held in cash and securities; average assets increased by 21.9%. As discussed later in “Capital Resources and Adequacy,” the regulatory capital ratios of the Bank and Company remain above well capitalized levels.
For the three months ended March 31, 2021, the Company reported an annualized return on average assets (“ROAA”) of 1.53%, as compared to 0.98% for the three months ended March 31, 2020. Total shareholders’ equity was $1.26 billion and $1.24 billion at March 31, 2021 and December 31, 2020, respectively, an increase of 1.6%. The annualized return on average common equity (“ROACE”) for the three months ended March 31, 2020 was 14.05% as compared to 7.81% for the three months ended March 31, 2020. The annualized return on average tangible common equity (“ROATCE”) for the three months ended March 31, 2021 was 15.33% as compared to 8.56% for the three months ended March 31, 2020. The increase in these ratios was primarily due to substantially lower provision of credit losses.
Net Interest Income and Net Interest Margin
Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. Earning assets are composed primarily of loans, investment securities, and interest bearing deposits with other banks and other short term investments. The cost of funds represents interest expense on deposits, customer repurchase agreements and other borrowings. Noninterest bearing deposits and capital are other components representing funding sources (refer to discussion above under Results of Operations). Changes in the volume and mix of assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income.
Net interest income was $82.7 million for the three months ended March 31, 2021 and $79.7 million for the same period in 2020, which reflects the strong growth in average earning assets from deposit inflows increasing cash and securities, partially offset by a decline in the net interest margin, as explained below.
The net interest margin was 2.98% for the three months ended March 31, 2021 and 3.49% for the same period in 2020. The decline reflects the impact of lower rates on increased cash and securities balances, partially offset by improved funding mix and lower funding costs.
In the first quarter of 2021 as compared to the first quarter of 2020, average U.S. Treasury rates in the two to five year range decreased by approximately 78 basis points and the average yield curve flattened. The Company experienced 51 basis points of net interest margin compression between the first quarter of 2020 as compared to the first quarter of 2021 (from 3.49% to 2.98%). In addition, our cost of funds declined 64 basis points (from 1.06% to 0.42%), while the yield on earning assets declined by 115 basis points (from 4.55% to 3.40%). Average liquidity for the first quarter 2021 was $2.1 billion versus $619 million for the first quarter of 2020. The yield on our loan assets was negatively impacted by the low interest rate environment in the first quarter of 2021 as legacy fixed rate loans originated in higher rate eras matured and paid off. A substantial portion of the variable rate loan portfolio has interest rate floors that cushioned the decline in loan yields.
Average earning asset yields decreased 115 basis points to 3.40% for the three months ended March 31, 2021, as compared to 4.55% for the same period in 2020. The average cost of interest bearing liabilities decreased by 98 basis points (to 0.66% from 1.64%) for the three months ended March 31, 2021 as compared to the same period in 2020. Combining the change
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in the yield on earning assets and the costs of interest bearing liabilities, the net interest spread decreased by 17 basis points for the three months ended March 31, 2021 as compared to 2020 (2.74% as compared to 2.91%).
The table below presents the average balances and rates of the major categories of the Company’s assets and liabilities for the three months ended March 31, 2021 and 2020. Included in the table are measurements of interest rate spread and margin. Interest rate spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the interest rate paid on interest bearing liabilities. While the interest rate spread provides a quick comparison of earnings rates versus cost of funds, management believes that margin provides a better measurement of performance. The net interest margin (as compared to net interest spread) includes the effect of noninterest bearing sources in its calculation. Net interest margin is net interest income expressed as a percentage of average earning assets.
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Eagle Bancorp, Inc.
Consolidated Average Balances, Interest Yields And Rates (Unaudited)
(dollars in thousands)
| Three Months Ended March 31, | |||||||||||||||||||||||||||||||||||
| 2021 | 2020 | ||||||||||||||||||||||||||||||||||
| Average Balance | Interest | Average Yield/Rate | Average Balance | Interest | Average Yield/Rate | ||||||||||||||||||||||||||||||
| ASSETS | |||||||||||||||||||||||||||||||||||
| Interest earning assets: | |||||||||||||||||||||||||||||||||||
| Interest bearing deposits with other banks and other short-term investments | $ | 2,103,679 | $ | 553 | 0.11 | % | $ | 588,148 | $ | 1,559 | 1.07 | % | |||||||||||||||||||||||
Loans held for sale (1) | 104,784 | 739 | 2.82 | % | 38,749 | 354 | 3.65 | % | |||||||||||||||||||||||||||
Loans (1) (2) | 7,726,716 | 88,499 | 4.65 | % | 7,650,993 | 96,401 | 5.07 | % | |||||||||||||||||||||||||||
Investment securities available for sale (2) | 1,268,952 | 4,395 | 1.40 | % | 867,666 | 5,427 | 2.52 | % | |||||||||||||||||||||||||||
| Federal funds sold | 32,309 | 8 | 0.10 | % | 30,618 | 60 | 0.79 | % | |||||||||||||||||||||||||||
| Total interest earning assets | 11,236,440 | 94,194 | 3.40 | % | 9,176,174 | 103,801 | 4.55 | % | |||||||||||||||||||||||||||
| Total noninterest earning assets | 390,775 | 356,317 | |||||||||||||||||||||||||||||||||
| Less: allowance for credit losses | 109,379 | 84,828 | |||||||||||||||||||||||||||||||||
| Total noninterest earning assets | 281,396 | 271,489 | |||||||||||||||||||||||||||||||||
| TOTAL ASSETS | $ | 11,517,836 | $ | 9,447,663 | |||||||||||||||||||||||||||||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | |||||||||||||||||||||||||||||||||||
| Interest bearing liabilities: | |||||||||||||||||||||||||||||||||||
| Interest bearing transaction | $ | 771,321 | $ | 427 | 0.22 | % | $ | 805,134 | $ | 1,666 | 0.83 | % | |||||||||||||||||||||||
| Savings and money market | 4,839,348 | 3,970 | 0.33 | % | 3,337,958 | 11,082 | 1.34 | % | |||||||||||||||||||||||||||
| Time deposits | 921,208 | 3,503 | 1.54 | % | 1,287,310 | 7,798 | 2.44 | % | |||||||||||||||||||||||||||
| Total interest bearing deposits | 6,531,877 | 7,900 | 0.49 | % | 5,430,402 | 20,546 | 1.52 | % | |||||||||||||||||||||||||||
| Customer repurchase agreements | 20,615 | 11 | 0.22 | % | 30,008 | 87 | 1.17 | % | |||||||||||||||||||||||||||
| Other short-term borrowings | 300,003 | 495 | 0.66 | % | 220,058 | 357 | 0.64 | % | |||||||||||||||||||||||||||
| Long-term borrowings | 253,132 | 3,137 | 4.96 | % | 235,882 | 3,067 | 5.14 | % | |||||||||||||||||||||||||||
| Total interest bearing liabilities | 7,105,627 | 11,543 | 0.66 | % | 5,916,350 | 24,057 | 1.64 | % | |||||||||||||||||||||||||||
| Noninterest bearing liabilities: | |||||||||||||||||||||||||||||||||||
| Noninterest bearing demand | 3,069,372 | 2,266,362 | |||||||||||||||||||||||||||||||||
| Other liabilities | 88,057 | 73,771 | |||||||||||||||||||||||||||||||||
| Total noninterest bearing liabilities | 3,157,429 | 2,340,133 | |||||||||||||||||||||||||||||||||
| Shareholders’ Equity | 1,254,780 | 1,191,180 | |||||||||||||||||||||||||||||||||
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 11,517,836 | $ | 9,447,663 | |||||||||||||||||||||||||||||||
| Net interest income | $ | 82,651 | $ | 79,744 | |||||||||||||||||||||||||||||||
| Net interest spread | 2.74 | % | 2.91 | % | |||||||||||||||||||||||||||||||
| Net interest margin | 2.98 | % | 3.49 | % | |||||||||||||||||||||||||||||||
| Cost of funds | 0.42 | % | 1.06 | % | |||||||||||||||||||||||||||||||
(1)Loans placed on nonaccrual status are included in average balances. Net loan fees and late charges included in interest income on loans totaled $7.8 million and $4.3 million for the three months ended March 31, 2021 and 2020, respectively.
(2)Interest and fees on loans and investments exclude tax equivalent adjustments.
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Provision for Credit Losses
The provision for credit losses represents the amount of expense charged to current earnings to fund the ACL on loans and the ACL on available for sale investment securities. The amount of the allowance for credit losses on loans is based on many factors that reflect management’s assessment of the risk in the loan portfolio. Those factors include historical losses based on internal and peer data, economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio, and internal loan processes of the Company and Bank.
The provision for unfunded commitments is presented separately on the Statement of Income. This provision considers the probability that unfunded commitments will fund.
Management has developed a comprehensive analytical process to monitor the adequacy of the allowance for credit losses. The process and guidelines were developed utilizing, among other factors, the guidance from federal banking regulatory agencies, relevant available information, from internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, loan concentrations, credit quality, or term as well as for changes in environmental conditions, such as changes in unemployment rates, property values or other relevant factors. Refer to additional detail regarding these forecasts in the “Cash Flow Method" section of Note 1 to the Consolidated Financial Statements.
The results of this process, in combination with conclusions of the Bank’s outside consultants’ review of the risk inherent in the loan portfolio, support management’s assessment as to the adequacy of the allowance at the balance sheet date. Please refer to the discussion under “Critical Accounting Policies” above and in Note 1 to the Consolidated Financial Statements for an overview of the methodology management employs on a quarterly basis to assess the adequacy of the allowance and the provisions charged to expense. Also, refer to the table on the next page which reflects activity in the allowance for credit losses.
During the three months ended March 31, 2021, the ACL on loans reflected a reversal of $2.4 million in provision for credit losses attributable to the ACL for loans and $5.2 million in net charge-offs, which were attributable primarily a variety of commercial C&I credits, which included two restaurants, one commercial real estate credit for a hotel and two Small Business Administration ("SBA") credits. The provision for credit losses on loans for the same period in 2020 was $14.3 million. The higher provisioning in the first quarter of 2020, as compared to the first quarter of 2021, was primarily due to the impact of COVID-19 on our actual and expected future credit losses. The reversal was also fueled by improved macroeconomic outlook, better unemployment rate, improvement of credits in the loan portfolio, and a reduction in total loans. Net charge-offs of $5.2 million in the first quarter of 2021 represented an annualized 0.27% of average loans, excluding loans held for sale, as compared to $2.2 million, or an annualized 0.12% of average loans, excluding loans held for sale, in the first quarter of 2020.
As part of its comprehensive loan review process, internal loan and credit committees carefully evaluate loans that are past-due 30 days or more. The Committees make a thorough assessment of the conditions and circumstances surrounding each delinquent loan. The Bank’s loan policy requires that loans be placed on nonaccrual if they are ninety days past-due, unless they are well secured and in the process of collection. Additionally, Credit Administration specifically analyzes the status of development and construction projects, sales activities and utilization of interest reserves in order to carefully and prudently assess potential increased levels of risk requiring additional reserves.
The maintenance of a high quality loan portfolio, with an adequate allowance for credit losses, will continue to be a primary management objective for the Company. The Company’s goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include carefully enforcing loan policies and procedures, evaluating each borrower’s business plan during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and obtaining collateral to mitigate economic loss in the event of liquidation.
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The following table sets forth activity in the allowance for credit losses for the periods indicated (unaudited).
Three Months Ended March 31, | ||||||||||||||
| (dollars in thousands) | 2021 | 2020 | ||||||||||||
| Balance at beginning of period | $ | 109,579 | $ | 73,658 | ||||||||||
| Impact of adopting CECL | — | 10,614 | ||||||||||||
| Charge-offs: | ||||||||||||||
| Commercial | 4,150 | — | ||||||||||||
| Income producing - commercial real estate | 1,000 | 550 | ||||||||||||
| Owner occupied - commercial real estate | — | — | ||||||||||||
| Real estate mortgage - residential | — | — | ||||||||||||
| Construction - commercial and residential | 206 | 1,768 | ||||||||||||
| Construction - C&I (owner occupied) | — | — | ||||||||||||
| Home equity | — | — | ||||||||||||
| Other consumer | 1 | — | ||||||||||||
| Total charge-offs | 5,357 | 2,318 | ||||||||||||
| Recoveries: | ||||||||||||||
| Commercial | 96 | 69 | ||||||||||||
| Income producing - commercial real estate | — | — | ||||||||||||
| Owner occupied - commercial real estate | — | — | ||||||||||||
| Real estate mortgage - residential | — | — | ||||||||||||
| Construction - commercial and residential | — | — | ||||||||||||
| Construction - C&I (owner occupied) | — | — | ||||||||||||
| Home equity | — | — | ||||||||||||
| Other consumer | 13 | 3 | ||||||||||||
| Total recoveries | 109 | 72 | ||||||||||||
| Net charge-offs | 5,248 | 2,246 | ||||||||||||
| Provision for Credit Losses- Loans | (2,261) | 14,310 | ||||||||||||
| Balance at end of period | $ | 102,070 | $ | 96,336 | ||||||||||
| Annualized ratio of net charge-offs during the period to average loans outstanding during the period | 0.27 | % | 0.12 | % | ||||||||||
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The following table reflects the allocation of the allowance for credit losses at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses or charge-offs and does not restrict the use of the allowance to absorb losses in any category.
| March 31, 2021 | December 31, 2020 | |||||||||||||||||||||||||
| (dollars in thousands) | Amount | % (1) | Amount | % (1) | ||||||||||||||||||||||
| Commercial | $ | 23,701 | 19 | % | $ | 26,569 | 19 | % | ||||||||||||||||||
| PPP loans | — | 8 | % | — | 6 | % | ||||||||||||||||||||
| Income producing - commercial real estate | 51,510 | 45 | % | 55,385 | 47 | % | ||||||||||||||||||||
| Owner occupied - commercial real estate | 14,315 | 13 | % | 14,000 | 13 | % | ||||||||||||||||||||
| Real estate mortgage - residential | 919 | 1 | % | 1,020 | 1 | % | ||||||||||||||||||||
| Construction - commercial and residential | 8,342 | 11 | % | 9,092 | 11 | % | ||||||||||||||||||||
| Construction - C&I (owner occupied) | 2,341 | 2 | % | 2,437 | 2 | % | ||||||||||||||||||||
| Home equity | 907 | 1 | % | 1,039 | 1 | % | ||||||||||||||||||||
| Other consumer | 35 | — | % | 37 | — | % | ||||||||||||||||||||
| Total allowance | $ | 102,070 | 100 | % | $ | 109,579 | 100 | % | ||||||||||||||||||
(1) Represents the percent of loans in each category to total loans.
Nonperforming Assets
As shown in the table below, the Company’s level of nonperforming assets, which is comprised of loans delinquent 90 days or more, and nonaccrual loans, which includes the nonperforming portion of TDRs and OREO, totaled $57.3 million at March 31, 2021 representing 0.51% of total assets, as compared to $65.9 million of nonperforming assets, or 0.59% of total assets, at December 31, 2020.
At March 31, 2021, the Company had no accruing loans 90 days or more past due. Management remains attentive to early signs of deterioration in borrowers’ financial conditions and to taking the appropriate action to mitigate risk. Furthermore, the Company is diligent in placing loans on nonaccrual status and believes, based on its loan portfolio risk analysis, that its allowance for credit losses, at 1.36% of total loans at March 31, 2021, is adequate to absorb expected credit losses within the loan portfolio at that date.
CECL allows for institutions to evaluate individual loans in the event that the asset does not share similar risk characteristics with its original segmentation. This can occur due to credit deterioration, increased collateral dependency or other factors leading to impairment. In particular, the Company individually evaluates loans on non-accrual and those identified as TDRs, though it may individually evaluate other loans or groups of loans as well if it determines they no longer share similar risk with their assigned segment. Reserves on individually assessed loans are determined by one of two methods: the fair value of collateral or the discounted cash flow. Fair value of collateral is used for loans determined to be collateral dependent, and the fair value represents the net realizable value of the collateral, adjusted for sales costs, commissions, senior liens, etc. The continuing payments are discounted over the expected life at the loan’s original contract rate and include adjustments for risk of default.
Loans are considered to have been modified in a TDR when, due to a borrower's financial difficulties, the Company makes unilateral concessions to the borrower that it would not otherwise consider. Concessions could include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Alternatively, management, from time-to-time and in the ordinary course of business, implements renewals, modifications, extensions, and/or changes in terms of loans to borrowers who have the ability to repay on reasonable market-based terms, as circumstances may warrant. Such modifications are not considered to be TDRs, as the accommodation of a borrower's request does not rise to the level of a concession if the modified transaction is at market rates and terms and/or the borrower is not experiencing financial difficulty. For example: (1) adverse weather conditions may create a short term cash flow issue for an otherwise profitable retail business that suggests a temporary interest-only period on an amortizing loan; (2) there may be delays in absorption on a real estate project that reasonably suggests extension of the loan maturity at market terms; or (3) there may be maturing loans to borrowers with demonstrated repayment ability who are not in a position at the time of maturity to obtain alternate long-term financing. The determination of whether a restructured loan is a TDR requires consideration of all of the facts and circumstances surrounding the change in terms, and the exercise of prudent business judgment. The Company had eight TDRs at March 31, 2021 totaling approximately $16.8 million. five of these loans totaling approximately $10.3 million are performing under their modified terms. A default is considered to have occurred once the TDR
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is past due 90 days or more or it has been placed on nonaccrual. Commercial and consumer loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. The allowance may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan. For both the three months ended March 31, 2021 and 2020, there were no loans modified in a TDR.
There is uncertainty regarding the region’s overall economic outlook given lack of clarity over how long COVID-19 will continue to impact our region. Management has been working with customers on payment deferrals to assist companies in managing through this crisis. Through March 31, 2021, we granted approximately 787 temporary modifications representing approximately $1.6 billion in outstanding balances (approximately 21% of total loans), including 729 temporary modifications representing $1.5 billion the majority of which have returned to pre-modification terms. Current deferrals total $143 million on 58 notes as of March 31, 2021. Some of these deferrals may have met the criteria for treatment under GAAP as TDRs. Additionally, none of the deferrals are reflected in the Company’s asset quality measures (i.e. non-performing loans) due to the provision of the CARES Act that permits U.S. financial institutions to temporarily suspend the GAAP requirements to treat such short-term loan modifications as TDRs. Similar provisions have also been confirmed by interagency guidance issued by the federal banking agencies and confirmed with staff members of the Financial Accounting Standards Board.
Total nonperforming loans amounted to $52.3 million at March 31, 2021 (0.69% of total loans) compared to $60.9 million at December 31, 2020 (0.79% of total loans).
Included in nonperforming assets at March 31, 2021 and December 31, 2020 was $4.9 million of OREO consisting of 4 foreclosed properties. While the Company has seen some softness in the market for ultra high-end residential properties in recent history, there is still an underpinning of demand for residential properties across lower price points. This is particularly true in light of COVID-19 and a general desire for increased space as some figure working from home may be part of future working arrangements.
OREO properties are carried at fair value less estimated costs to sell. It is the Company's policy to obtain third party appraisals prior to foreclosure, and to obtain updated third party appraisals on OREO properties generally not less frequently than annually. Generally, the Company would obtain updated appraisals or evaluations where it has reason to believe, based upon market indications (such as comparable sales, legitimate offers below carrying value, broker indications and similar factors), that the current appraisal does not accurately reflect current value. There were no sales of an OREO property during the first three months of 2021 or 2020.
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The following table shows the amounts of nonperforming assets at the dates indicated (unaudited for March 31, 2021).
| (dollars in thousands) | March 31, 2021 | December 31, 2020 | ||||||||||||
| Nonaccrual Loans: | ||||||||||||||
| Commercial | $ | 18,491 | $ | 15,352 | ||||||||||
| Income producing - commercial real estate | 17,157 | 18,879 | ||||||||||||
| Owner occupied - commercial real estate | 14,077 | 23,158 | ||||||||||||
| Real estate mortgage - residential | 1,942 | 2,932 | ||||||||||||
| Construction - commercial and residential | 196 | 206 | ||||||||||||
| Construction - C&I (owner occupied) | — | — | ||||||||||||
| Home equity | 413 | 416 | ||||||||||||
| Other consumer | — | — | ||||||||||||
| Accruing loans-past due 90 days | — | — | ||||||||||||
| Total nonperforming loans (1) | 52,276 | 60,943 | ||||||||||||
| Other real estate owned | 4,987 | 4,987 | ||||||||||||
| Total nonperforming assets | $ | 57,263 | $ | 65,930 | ||||||||||
| Coverage ratio, allowance for credit losses to total nonperforming loans | 195.25 | % | 179.80 | % | ||||||||||
| Ratio of nonperforming loans to total loans | 0.69 | % | 0.79 | % | ||||||||||
| Ratio of nonperforming assets to total assets | 0.51 | % | 0.59 | % | ||||||||||
________________________________________________________
(1)Nonaccrual loans reported in the table above include one loan totaling $101 thousand that migrated from a performing TDR during the three months ended March 31, 2021, as compared to the three months ended March 31, 2020 when there were four loans totaling $1.3 million that migrated from a performing TDR.
Significant variation in the amount of nonperforming loans may occur from period to period because the amount of nonperforming loans depends largely on the condition of a relatively small number of individual credits and borrowers relative to the total loan portfolio.
At March 31, 2021, there were $95.5 million of performing loans considered to be potential problem loans, defined as loans that are not included in the 90 days past due, nonaccrual or restructured categories, but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms, which may in the future result in disclosure in the past due, nonaccrual or restructured loan categories. Potential problem loans increased to $95.5 million at March 31, 2021 from $91.2 million at December 31, 2020. The Company has taken a conservative posture with respect to risk rating its loan portfolio. Based upon their status as potential problem loans, these loans receive heightened scrutiny and ongoing intensive risk management.
Noninterest Income
Total noninterest income includes service charges on deposits, gain on sale of loans, gain on sale of investment securities, income from bank owned life insurance (“BOLI”) and other income.
Total noninterest income for the three months ended March 31, 2021 increased to $10.6 million from $5.5 million for the three months ended March 31, 2020, a 94% increase. Gain on sale of loans for the three months ended March 31, 2021 increased to $5.2 million from $944 thousand for the three months ended March 31, 2020, a 449% increase, due to higher gains on the sale of residential mortgage loans in 2021 ($5.0 million) and the gain for the three months ended March 31, 2020 was net of a $2.6 million mark-to-market loss on a hedge position. Residential mortgage loan locked commitments were $422.2 million for the first quarter of 2020 as compared to $303.3 million for the first quarter 2021. Service charges on deposits for the three months ended March 31, 2021 decreased to $1.0 million from $1.4 million for the three months ended March 31, 2020, a 31% decrease, due to to a decrease in insufficient funds fees.
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The decision whether to sell residential mortgage loans on a mandatory or best efforts lock basis is a function of multiple factors, including but not limited to overall market volumes of mortgage loan originations, forecasted “pull -through” rates of origination, loan underwriting and closing operational considerations, pricing differentials between the two methods, and availability and pricing of various interest rate hedging strategies associated with the mortgage origination pipeline. The Company continually monitors these factors to maximize profitability and minimize operational and interest rate risks.
Other income for the three months ended March 31, 2021 increased to $3.8 million from $1.9 million for the three months ended March 31, 2020, an 105% increase, primarily due to a $911 thousand gain on FHLB debt extinguishment, $695 thousand gain on swap fees, and a $576 thousand gain on FHA servicing fees. Gain on sale of investment securities were $221 thousand for the three months ended March 31, 2021 compared to $822 thousand for the same period in 2020.
Servicing agreements relating to the Ginnie Mae mortgage-backed securities program require the Company to advance funds to make scheduled payments of principal, interest, taxes and insurance, if such payments have not been received from the borrowers. The Company will generally recover funds advanced pursuant to these arrangements under the FHA insurance and guarantee program. However, in the interim, the Company must absorb the cost of the funds it advances during the time the advance is outstanding. The Company must also bear the costs of attempting to collect on delinquent and defaulted mortgage loans. In addition, if a defaulted loan is not cured, the mortgage loan would be canceled as part of the foreclosure proceedings and the Company would not receive any future servicing income with respect to that loan. At March 31, 2021, the Company had one loan outstanding under FHA mortgage loan servicing agreements for $3.1 million. To the extent the mortgage loans underlying the Company’s servicing portfolio experience delinquencies, the Company would be required to dedicate cash resources to comply with its obligation to advance funds as well as incur additional administrative costs related to increases in collection efforts.
The Company originates residential mortgage loans and, pending market conditions and other factors outlined above, may utilize either or both "mandatory delivery" and “best efforts” forward loan sale commitments to sell those loans, servicing released. Loans sold are subject to repurchase in circumstances where documentation is deficient, the underlying loan becomes delinquent, or there is fraud by the borrower. Loans sold are subject to penalty if the loan pays off within a specified period following loan funding and sale. The Bank considers these potential recourse provisions to be a minimal risk, but has established a reserve under GAAP for possible repurchases. There were no repurchases due to fraud by the borrower during the three months ended March 31, 2021. The reserve amounted to $193 thousand at March 31, 2021 and is included in other liabilities on the Consolidated Balance Sheets.
Beyond the participation in the PPP program, the Company is an originator of SBA loans and its practice is to sell the guaranteed portion of those loans at a premium. There was $223 thousand of income from this source for the three months ended March 31, 2021 compared to $119 thousand for the same period in 2020. Activity in SBA loan sales to secondary markets can vary widely from quarter to quarter. See "Note 1: Summary of Significant Accounting Policies" for details regarding the Company’s participation in the PPP program.
Noninterest Expense
Total noninterest expense includes salaries and employee benefits, premises and equipment expenses, marketing and advertising, data processing, legal, accounting and professional, FDIC insurance, and other expenses.
Total noninterest expenses totaled $38.0 million for the three months ended March 31, 2021, as compared to $37.3 million for the three months ended March 31, 2020, a 2% increase due substantially to the following:
Salaries and employee benefits were $21.8 million for the three months ended March 31, 2021, as compared to $17.8 million for the same period in 2020, an increase of $4.0 million or 22%. The increase was due to increased headcount, increased incentive bonus accruals based on economic outlook in the first quarter of 2021 (gradual reopening of economy) compared to accruals in the first quarter of 2020 (on-set of COVID-19 pandemic), and an increase in the number of shares granted and vested in 2021.
At March 31, 2021, the Company’s full time equivalent staff numbered 508 as compared to 494 at March 31, 2020.
Premises and equipment expenses amounted to $3.6 million and $3.8 million for the three months ended March 31, 2021 and 2020, respectively, a 5% decrease.
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Marketing and advertising expenses totaled $886 thousand for the three months ended March 31, 2021 and $1.1 million for the same period in 2020. The decrease was due to repurposing of marketing initiatives due to COVID-19, which resulted in a cutback of print, digital and radio advertising as well as a reduction in event-related sponsorships due to cancellations and virtual modifications to event structures.
Data processing expense increased to $2.8 million for the three months ended March 31, 2021 from $2.5 million for the same period in 2020, a 13% increase related to an increase in licensing fees.
Legal, accounting and professional fees decreased by $4.0 million from $7.0 million to $3.0 million, for the three months ended March 31, 2021 compared to the three months ended March 31, 2020 from , as the Bank recognized an increase in receivables on legal expenditures associated with insurance coverage where we believe we have a high likelihood of recovery pursuant to our D&O insurance policies. The Bank does not include any offset for potential claims we may have in the future as to which recovery is impossible to predict at this time. Legal fees and expenditures were $964 thousand and $5.0 million for the three months ended March 31, 2021 and 2020, respectively, and were primarily associated with previously disclosed ongoing governmental investigations and related subpoenas and document requests, as well as, our defense of the previously disclosed class action lawsuit. In connection with which we, each of the other defendants and the lead plaintiff, on behalf of the class, reached an agreement to settle in the days following the non-binding mediation on April 13, 2021. The amount of legal fees and expenditures for the year is net of expected insurance coverage where we believe we have a high likelihood of recovery pursuant to our D&O insurance policies but does not include any offset for potential claims we may have in the future as to which recovery is impossible to predict at this time. See Part II, Item 1- "Legal Proceedings" for more information.
FDIC expenses were $2.4 million for the three months ended March 31, 2021 compared to $1.4 million for the same period in 2020, a 71% increase. The increases for the first three months of 2021 compared to the same period in 2020 were due to a higher deposit base.
The major components of other expenses include broker fees, franchise taxes, director compensation and insurance expense. Other expenses decreased to $3.5 million for the three months ended March 31, 2021 from $3.7 million for the same period in 2020, a 7% decrease.
The efficiency ratio, which measures the ratio of noninterest expense to total revenue, was 40.74% for the first quarter of 2021, as compared to 43.83% for the first quarter of 2020. The improvement in the first quarter of 2021 over the first quarter of 2020 was due to increases in noninterest income and net interest income, while non-interest expenses remained relatively flat.
As a percentage of average assets, total noninterest expense (annualized) was 1.32% for the three months ended March 31, 2021 as compared to 1.58% for the same period in 2020.
Income Tax Expense
The Company’s ratio of income tax expense to pre-tax income (“effective tax rate”) for the first quarter of 2021 was 25.1% as compared to 26.5% for the first quarter of 2020. The decrease was due to an increase in Low Income Housing Tax Credits in the first quarter 2021.
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FINANCIAL CONDITION
Summary
Total assets at both March 31, 2021 and December 31, 2020 were $11.1 billion. Total loans (excluding loans held for sale) were $7.5 billion at March 31, 2021, a 3.0% decrease, as compared to $7.8 billion at December 31, 2020, as we have continued to focus on serving our current loan clients and maintaining credit quality, over expanding the loan portfolio at lower rates and less favorable terms. Loans held for sale amounted to $142.2 million at March 31, 2021 and $88.2 million at December 31, 2020, a 61.2% increase. The investment portfolio totaled $1.4 billion at March 31, 2021. As compared to December 31, 2020, the investment portfolio at March 31, 2021 increased by $212 million, or 18.9%, primarily due to the deployment of deposit inflows into higher yielding assets.
Total deposits at both March 31, 2021 and December 31, 2020 were $9.2 billion. We continue to work on expanding the breadth and depth of our existing relationships while we pursue building new relationships. Total borrowed funds (excluding customer repurchase agreements) were $518.2 million at March 31, 2021, as compared to $568.1 million at December 31, 2020.
Total shareholders’ equity was $1.26 billion and $1.24 billion as of March 31, 2021 and December 31, 2020, respectively, an increase of $20 million. This increase was primarily from earnings of $43.5 million less $17.5 million in unrealized losses on AFS securities (net of taxes) and $7.9 million in dividends declared.
The Company’s capital ratios remain substantially in excess of regulatory minimum and buffer requirements, with a total risk based capital ratio of 17.86% at March 31, 2021, as compared to 17.04% at December 31, 2020, common equity tier 1 (“CET1”) risk based capital was 14.42% at March 31, 2021 compared to 13.49% at December 31, 2020, tier 1 risk based capital ratios of 14.42% at March 31, 2021, as compared to 13.49% at December 31, 2020, and a tier 1 leverage ratio of 10.28% at March 31, 2021, as compared to 10.31% at December 31, 2020.
The ratio of common equity to total assets was 11.33% at March 31, 2021, as compared to 11.16% at December 31, 2020. Book value per share was $39.45 at March 31, 2021, a 1% increase over $39.05 at December 31, 2020. In addition, the tangible common equity ratio was 10.48% at March 31, 2021, as compared to 10.31% at December 31, 2020. Tangible book value per share was $36.16 at March 31, 2021, a 1% increase over $35.74 at December 31, 2020. Refer to the “Use of Non-GAAP Financial Measures” section for additional detail and a reconciliation of GAAP to non-GAAP financial measures.
In order to be considered well-capitalized, the Bank must have a CET1 risk based capital ratio of 6.5%, a Tier 1 risk-based ratio of 8.0%, a total risk-based capital ratio of 10.0% and a leverage ratio of 5.0%. The Company and the Bank exceed all these requirements and satisfy the capital conservation buffer of 2.5% of CET1 capital required to engage in capital distribution. Failure to maintain the required capital conservation buffer would limit the ability of the Company and the Bank to pay dividends, repurchase shares or pay discretionary bonuses.
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Loans, net of amortized deferred fees and costs, at March 31, 2021 (unaudited) and December 31, 2020 by major category are summarized below.
| March 31, 2021 | December 31, 2020 | ||||||||||||||||||||||
| (dollars in thousands) | Amount | % | Amount | % | |||||||||||||||||||
| Commercial | $ | 1,398,155 | 19 | % | $ | 1,437,433 | 19 | % | |||||||||||||||
| PPP loans | 565,018 | 8 | % | 454,771 | 6 | % | |||||||||||||||||
| Income producing - commercial real estate | 3,430,077 | 45 | % | 3,687,000 | 47 | % | |||||||||||||||||
| Owner occupied - commercial real estate | 1,012,457 | 13 | % | 997,694 | 13 | % | |||||||||||||||||
| Real estate mortgage - residential | 71,209 | 1 | % | 76,592 | 1 | % | |||||||||||||||||
| Construction - commercial and residential | 829,481 | 11 | % | 873,261 | 11 | % | |||||||||||||||||
| Construction - C&I (owner occupied) | 152,240 | 2 | % | 158,905 | 2 | % | |||||||||||||||||
| Home equity | 67,167 | 1 | % | 73,167 | 1 | % | |||||||||||||||||
| Other consumer | 885 | — | % | 1,389 | — | % | |||||||||||||||||
| Total loans | 7,526,689 | 100 | % | 7,760,212 | 100 | % | |||||||||||||||||
| Less: allowance for credit losses | (102,070) | (109,579) | |||||||||||||||||||||
Net loans (1) | $ | 7,424,619 | $ | 7,650,633 | |||||||||||||||||||
(1)Excludes accrued interest receivable of $46.4 million and $30.8 million at March 31, 2021 and December 31, 2020, respectively, which is recorded in other assets.
In its lending activities, the Company seeks to develop and expand relationships with clients whose businesses and individual banking needs will grow with the Bank. Superior customer service, local decision making, and accelerated turnaround time from application to closing have been significant factors in growing the loan portfolio and meeting the lending needs in the markets served, while maintaining sound asset quality.
Loans outstanding were $7.5 billion at March 31, 2021, a decrease of $233.5 million, or 3%, as compared to $7.8 billion at December 31, 2020. If PPP loans are excluded, the balance was $7.0 billion at March 31, 2021, a decrease of 4.7% from December 31, 2020. On May 3, 2021, we transacted to sell 849 PPP loans for a total purchase price of $169.0 million. Immediately following this sale, the principal outstanding on PPP loans totaled approximately $378.4 million across 789 notes. This past quarter, we faced headwinds in the form of low loan demand and a competitive, low interest rate environment. We also experienced elevated payoffs and prepayments due in part to successful project completions and low nominal interest rates. Notwithstanding an increased supply of residential units, multi-family commercial real estate leasing and collections in the Bank’s market area have held up well, particularly for well-located close-in projects. As a general matter, there has been some softening and slow decision making relative to renewals in the office leasing market. Overall, commercial real estate values have generally held up well, but we continue to be cautious of the capitalization rates at which some assets are trading and as a result we are being cautious with our valuations. Commercial loans meet reasonable underwriting standards, including appropriate collateral and cash flow necessary to support debt service. Valuations associated with the moderately priced housing market have generally been increasing, with well-located, Metro-accessible properties garnering a premium. We believe we are well positioned to originate loans for large commercial projects, and also see a path to growing the loan portfolio as economic conditions improve and more opportunities arise. The potential impact from the COVID-19 pandemic has not yet been fully reflected in the market across all asset types. Please refer to the COVID-19 risk factor in Item 1A below.
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Loan Portfolio Exposures- COVID-19:
Industry segments within the Loan Portfolio as of March 31, 2021 that we believe may have heightened risk from the COVID-19 pandemic include:
| Industry | Principal Balance (in 000’s) | % of Loan Portfolio | |||||||||||||||
| Accommodation & Food Services | $ | 807,237 | (1) | 10.7 | % | ||||||||||||
| Retail Trade | 85,878 | (2) | 1.1 | % | |||||||||||||
| Commercial Real Estate exposure (not included above) | |||||||||||||||||
| Restaurant | 42,386 | 0.6 | % | ||||||||||||||
| Hotel | 26,255 | 0.3 | % | ||||||||||||||
| Retail | 374,863 | 5.0 | % | ||||||||||||||
| Total | $ | 1,336,619 | 17.8 | % | |||||||||||||
1 Includes $152,135 of PPP loans.
2 Includes $7,339 of PPP loans.
Concerns over exposures to the Accommodation and Food Service industry and Retail Trade are the most immediate at this time. Accommodation and Food Service exposure represents 10.7% of the Bank’s loan portfolio as of March 31, 2021 among 297 customers. Retail Trade exposure represents 1.1% of the Bank’s loan portfolio and represented 150 customers. The Bank has ongoing extensive outreach to these customers and is assisting where necessary with PPP loans and payment deferrals or interest-only periods in the short term while customers work to adopt to the evolving landscape of the COVID-19 pandemic. The uncertain duration and severity of the pandemic and the timing of recovery may impact future credit challenges in these areas.
Although not evidenced at March 31, 2021, it is anticipated that some portion of the CRE loans secured by the above property types could be impacted by the tenancies associated with impacted industries. The Bank is working with CRE investor borrowers and monitoring rent collections as part of our portfolio management oversight.
Deposits and Other Borrowings
The principal sources of funds for the Bank are core deposits, consisting of demand deposits, money market accounts, NOW accounts, savings accounts and certificates of deposit. The deposit base includes transaction accounts, time and savings accounts, which customers use for cash management and which provide the Bank with a source of fee income and cross-marketing opportunities, as well as an attractive source of lower cost funds. To meet funding needs during periods of high loan demand and seasonal variations in core deposits, the Bank utilizes alternative funding sources such as secured borrowings from the Federal Home Loan Banks (the “FHLB”), federal funds purchased lines of credit from correspondent banks and brokered deposits from regional and national brokerage firms and IntraFi Network, LLC (“IntraFi”).
For the three months ended March 31, 2021, noninterest bearing deposits decreased $215.0 million as compared to December 31, 2020, while interest bearing deposits increased by $224.6 million during the same period.
From time to time, the Bank accepts brokered time deposits, generally in denominations of less than $250 thousand, from national brokerage networks, including IntraFi. Additionally, the Bank participates in the Certificates of Deposit Account Registry Service (the “CDARS”) and the Insured Cash Sweep product (“ICS”), which provide for reciprocal (“two-way”) transactions among banks facilitated by IntraFi for the purpose of maximizing FDIC insurance. The Bank also is able to obtain one-way CDARS deposits and participates in IntraFi’s Insured Network Deposit (“IND”). At March 31, 2021, total deposits included $2.7 billion of brokered deposits (excluding the CDARS and ICS two-way) which represented 29.6% of total deposits. At December 31, 2020, total brokered deposits (excluding the CDARS and ICS two-way) were $2.4 billion, or 26.2% of total deposits. The CDARS and ICS two-way component represented $760.2 million, or 8%, of total deposits and $790.0 million, or 9%, of total deposits at March 31, 2021 and December 31, 2020, respectively. These sources are believed by the Company to represent a reliable and cost efficient alternative funding source for the Bank. However, to the extent that the condition, regulatory position or reputation of the Company or Bank deteriorates, or to the extent that there are significant changes in
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market interest rates which the Company and Bank do not elect to match, we may experience an outflow of brokered deposits. In that event, we would be required to obtain alternate sources for funding.
At March 31, 2021, the Company had $2.6 billion in noninterest bearing demand deposits, representing 28% of total deposits, compared to $2.8 billion of noninterest bearing demand deposits at December 31, 2020, or 31% of total deposits. Average noninterest bearing deposits of total deposits for the first three months of 2021 and 2020 were 32% and 30%. The Bank also offers business NOW accounts and business savings accounts to accommodate those customers who may have excess short term cash to deploy in interest earning assets.
As an enhancement to the basic noninterest bearing demand deposit account, the Company offers a sweep account, or “customer repurchase agreement,” allowing qualifying businesses to earn interest on short-term excess funds that are not suited for either a certificate of deposit or a money market account. The balances in these accounts were $20.1 million at March 31, 2021 compared to $26.7 million at December 31, 2020. Customer repurchase agreements are not deposits and are not insured by the FDIC, but are collateralized by U.S. agency securities and/or U.S. agency backed mortgage backed securities. These accounts are particularly suitable to businesses with significant fluctuation in the levels of cash flows. Attorney and title company escrow accounts are examples of accounts which can benefit from this product, as are customers who may require collateral for deposits in excess of FDIC insurance limits but do not qualify for other pledging arrangements. This program requires the Company to maintain a sufficient investment securities level to accommodate the fluctuations in balances which may occur in these accounts.
At March 31, 2021 the Company had $866.0 million in time deposits. Time deposits decreased by $111.8 million from year end December 31, 2020. The Bank raises and renews time deposits through its branch network, for its public funds customers, and through brokered certificates of deposits ("CDs") to meet the needs of its community of savers and as part of its interest rate risk management and liquidity planning.
The Company had no outstanding balances under its federal funds lines of credit provided by correspondent banks (which are unsecured) at March 31, 2021 and December 31, 2020. At March 31, 2021 and December 31, 2020, the Company had $300 million of FHLB short-term advances borrowed as part of the overall asset liability strategy and to support loan growth. Outstanding FHLB advances are secured by collateral consisting of a blanket lien on qualifying loans in the Bank’s commercial mortgage, residential mortgage and home equity loan portfolios.
Long-term borrowings outstanding at March 31, 2021 included the Company’s August 5, 2014 issuance of $70.0 million of subordinated notes, due September 1, 2024, and the Company’s July 26, 2016 issuance of $150.0 million of subordinated notes, due August 1, 2026. For additional information on the subordinated notes, please refer to Note 8 to the Consolidated Financial Statements included in this report.
Liquidity Management
Liquidity is a measure of the Company’s and Bank’s ability to meet loan demand and to satisfy depositor withdrawal requirements in an orderly manner. The Bank’s primary sources of liquidity consist of cash and cash balances due from correspondent banks, excess reserves at the Federal Reserve, loan repayments, federal funds sold and other short-term investments, maturities and sales of investment securities, income from operations and new core deposits into the Bank. The Bank’s investment portfolio of debt securities is held in an available-for-sale status which allows for flexibility, subject to holdings held as collateral for customer repurchase agreements and public funds, to generate cash from sales as needed to meet ongoing loan demand. These sources of liquidity are considered primary and are supplemented by the ability of the Company and Bank to borrow funds or issue brokered deposits, which are termed secondary sources of liquidity and which are substantial.
Additionally, the Bank can purchase up to $155 million in federal funds on an unsecured basis from its correspondents, against which there was no amount outstanding at March 31, 2021, and can obtain unsecured funds under one-way CDARS and ICS brokered deposits in the amount of $1.7 billion, against which there was $685 million outstanding at March 31, 2021. The Bank also has a commitment from IntraFi to place up to $1.8 billion of brokered deposits from its IND program in amounts requested by the Bank, as compared to an actual balance of $1.7 billion at March 31, 2021. At March 31, 2021, the Bank was also eligible to make advances from the FHLB up to $1.6 billion based on loans pledged as collateral to the FHLB, of which there was $300 million outstanding at March 31, 2021. The Bank may enter into repurchase agreements as well as obtain additional borrowing capabilities from the FHLB, provided adequate collateral exists to secure these lending relationships. The Bank also has a back-up borrowing facility through the Discount Window at the Federal Reserve Bank of Richmond (“Federal Reserve Bank”). This facility, which amounts to approximately $611 million, is collateralized with specific loan assets
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identified to the Federal Reserve Bank. It is anticipated that, except for periodic testing, this facility would be utilized for contingency funding only.
The loss of deposits through disintermediation is one of the greater risks to liquidity. Disintermediation occurs most commonly when rates rise and depositors withdraw deposits seeking higher rates in alternative savings and investment sources than the Bank may offer. The Bank was founded under a philosophy of relationship banking and, therefore, believes that it has less of an exposure to disintermediation and resultant liquidity concerns than do many banks. The Bank makes competitive deposit interest rate comparisons weekly and feels its interest rate offerings are competitive.
There is, however, a risk that some deposits would be lost if rates were to increase and the Bank elected not to remain competitive with its deposit rates. Under those conditions, the Bank believes that it is well positioned to use other sources of funds such as FHLB borrowings, brokered deposits, repurchase agreements and correspondent banks’ lines of credit to offset a decline in deposits in the short run. Over the long-term, an adjustment in assets and change in business emphasis could compensate for a potential loss of deposits. The Bank also maintains a marketable investment portfolio to provide flexibility in the event of significant liquidity needs. The Asset Liability Committee of the Bank (the “ALCO”) and the full Board of Directors of the Bank have adopted policy guidelines which emphasize the importance of core deposits, adequate asset liquidity and a contingency funding plan. Additionally, as noted above, if the condition, regulatory treatment or reputation of the Company or Bank deteriorates, we may experience an outflow of brokered deposits as a result of our inability to attract them or to accept or renew them. In that event, we would be required to obtain alternate sources for funding.
Our primary and secondary sources of liquidity remain strong. Average deposits increased 13% for the first quarter of 2021 as compared to the fourth quarter of 2020. We maintain a very liquid investment portfolio, including significant overnight liquidity. Average short term liquidity was $2.1 billion in first quarter of 2021, which is above EagleBank’s average needs. Secondary sources of liquidity amount to $2.3 billion.
At March 31, 2021, under the Bank’s liquidity formula, it had $6.2 billion of primary and secondary liquidity sources. The amount is deemed adequate to meet current and projected funding needs.
Commitments and Contractual Obligations
Loan commitments outstanding and lines and letters of credit at March 31, 2021 are as follows:
| (dollars in thousands) | ||||||||
| Unfunded loan commitments | $ | 1,913,148 | ||||||
| Unfunded lines of credit | 93,836 | |||||||
| Letters of credit | 65,776 | |||||||
| Total | $ | 2,072,760 | ||||||
Unfunded loan commitments are agreements whereby the Bank has made a commitment and the borrower has accepted the commitment to lend to a customer as long as there is satisfaction of the terms or conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee before the commitment period is extended. In many instances, borrowers are required to meet performance milestones in order to draw on a commitment as is the case in construction loans, or to have a required level of collateral in order to draw on a commitment as is the case in asset based lending credit facilities. Since commitments may expire without being drawn, the total commitment amount does not necessarily represent future cash requirements. As of March 31, 2021, unfunded loan commitments included $191.9 million related to interest rate lock commitments on residential mortgage loans and were of a short-term nature slightly.
Unfunded lines of credit are agreements to lend to a customer as long as there is no violation of the terms or conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since commitments may expire without being drawn, the total commitment amount does not necessarily represent future cash requirements. The pipeline of loan commitments remains strong.
Letters of credit include standby and commercial letters of credit. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance by the Bank’s customer to a third party. Standby letters of credit generally become payable upon the failure of the customer to perform according to the terms of the underlying contract with the third party. Standby letters of credit are generally not drawn. Commercial letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn when the underlying transaction is consummated between the
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customer and a third party. The contractual amount of these letters of credit represents the maximum potential future payments guaranteed by the Bank. The Bank has recourse against the customer for any amount it is required to pay to a third party under a letter of credit, and holds cash and or other collateral on those standby letters of credit for which collateral is deemed necessary.
Asset/Liability Management and Quantitative and Qualitative Disclosures about Market Risk
A fundamental risk in banking is exposure to market risk, or interest rate risk, since a bank’s net income is largely dependent on net interest income. The Bank’s ALCO formulates and monitors the management of interest rate risk through policies and guidelines established by it and the full Board of Directors and through review of detailed reports discussed quarterly. In its consideration of risk limits, the ALCO considers the impact on earnings and capital, the level and direction of interest rates, liquidity, local economic conditions, outside threats and other factors. Banking is generally a business of managing the maturity and repricing mismatch inherent in its asset and liability cash flows and to provide net interest income growth consistent with the Company’s profit objectives.
During the three months ended March 31, 2021, the Company was able to produce a net interest margin of 2.98% as compared to 3.49% during the same period in 2020, and continue to manage its overall interest rate risk position. The Company, along with many other banks, continues to be challenged in 2021 during a period of extremely low interest rates together with relatively low loan demand.
The Company, through its ALCO and ongoing financial management practices, monitors the interest rate environment in which it operates and adjusts the rates and maturities of its assets and liabilities to remain competitive and to achieve its overall financial objectives subject to established risk limits. In the current and expected future interest rate environment, the Company has been maintaining its investment portfolio to manage the balance between yield and risk in its portfolio of mortgage backed securities should interest rates remain at current levels. Further, the Company has been managing the investment portfolio to provide liquidity and some additional yield over cash. Additionally, the Company has limited call risk in its U.S. agency investment portfolio. During the three months ended March 31, 2021, the average investment portfolio balance increased by $401.3 million, or 46%, as compared to average balance for the three months ended March 31, 2020. The cash received from deposit growth along with cash flows from the investment portfolio were deployed into loans, the purchase of replacement investments and held in cash.
The percentage mix of municipal securities was 8% of total investments at March 31, 2021 and 9% at December 31, 2020. The portion of the portfolio invested in mortgage backed securities was 69% and 72% at March 31, 2021 and December 31, 2020, respectively. The portion of the portfolio invested in U.S. agency investments was 16% at March 31, 2021 and 10% at December 31, 2020. Shorter duration floating rate corporate bonds were 4% and 3% of total investments at March 31, 2021 and December 31, 2020, respectively, and SBA bonds, which are included in mortgage backed securities, were 4% and 6% of total investments at March 31, 2021 and December 31, 2020, respectively. The duration of the investment portfolio increased to 4.7 years at March 31, 2021 from 3.2 years at December 31, 2020.
The re-pricing duration of the loan portfolio was 19 months at March 31, 2021 as compared to 21 months at December 31, 2020 with fixed rate loans amounting to 46% and 45% of total loans at March 31, 2021 and December 31, 2020, respectively. Variable and adjustable rate loans comprised 54% (offset by 7.5% from the dilution impact of PPP loans) and 55% of total loans at March 31, 2021 and December 31, 2020, respectively. Variable rate loans are generally indexed to either the one month LIBOR interest rate, or the Wall Street Journal prime interest rate, while adjustable rate loans are indexed primarily to the five year U.S. Treasury interest rate.
The duration of the deposit portfolio decreased to 40 months at March 31, 2021 from 42 months at December 31, 2020. The decrease since December 31, 2020 was due substantially to maturity and aging in of the CD portfolio.
The net unrealized loss before income tax on the investment portfolio was $1.9 million at March 31, 2021 as compared to a net unrealized gain before tax of $20.1 million at March 31, 2020. The move to a net unrealized loss from a net unrealized gain on the investment portfolio was due primarily to higher interest rates at March 31, 2021 along with a changing portfolio mix. At March 31, 2021, the net unrealized loss position represented 0.14% of the investment portfolio’s book value.
There can be no assurance that the Company will be able to successfully achieve its optimal asset liability mix, as a result of competitive pressures, customer preferences and the inability to perfectly forecast future interest rates and movements.
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One of the tools used by the Company to manage its interest rate risk is the static gap analysis presented below. The Company also employs an earnings simulation model on a quarterly basis to monitor its interest rate sensitivity and risk and to model its balance sheet cash flows and the related income statement effects in different interest rate scenarios. The model utilizes current balance sheet data and attributes and is adjusted for assumptions as to investment maturities (including prepayments), loan prepayments, interest rates, and the level of noninterest income and noninterest expense. The data is then subjected to a “shock test” which assumes a simultaneous change in interest rates up 100, 200, 300, and 400 basis points or down 100 and 200, along the entire yield curve, but not below zero. The results are analyzed as to the impact on net interest income, net income and the market equity over the next twelve and twenty-four month periods from March 31, 2021. In addition to analysis of simultaneous changes in interest rates along the yield curve, changes based on interest rate “ramps” is also performed. This analysis represents the impact of a more gradual change in interest rates, as well as yield curve shape changes.
For the analysis presented below, at March 31, 2021, the simulation assumes a 50 basis point change in interest rates on money market and interest bearing transaction deposits for each 100 basis point change in market interest rates in a decreasing interest rate shock scenario with a floor of 0 basis points (compared to a floor 10 basis points in the same analysis as of March 31, 2020), and assumes a 70 basis point change in interest rates on money market and interest bearing transaction deposits for each 100 basis point change in market interest rates in an increasing interest rate shock scenario. The floor rate in the analysis was lowered due to the fact that in the current interest rate environment, there are interest bearing accounts with current rates less than 10 basis points.
The Company’s analysis at March 31, 2021 shows a moderate effect on net interest income (over the next 12 months) as well as a moderate effect on the economic value of equity when interest rates are shocked both down 100 and 200 basis points and up 100, 200, 300, and 400 basis points. This moderate impact is due substantially to the significant level of variable rate and repriceable assets and liabilities and related shorter relative durations. The repricing duration of the investment portfolio at March 31, 2021 is 5 years, the loan portfolio 1.8 years, the interest bearing deposit portfolio 3.3 years, and the borrowed funds portfolio 5 years.
The following table reflects the result of simulation analysis on the March 31, 2021 asset and liabilities balances:
| Change in interest rates (basis points) | Percentage change in net interest income | Percentage change in net income | Percentage change in market value of portfolio equity | ||||||||||||||||||||
| + | 400 | 7.6% | 13.1% | 2.8% | |||||||||||||||||||
| + | 300 | 4.3% | 7.3% | 2.0% | |||||||||||||||||||
| + | 200 | 1.1% | 1.9% | 1.3% | |||||||||||||||||||
| + | 100 | (1.0)% | (1.6)% | 0.6% | |||||||||||||||||||
| — | — | — | — | ||||||||||||||||||||
| - | 100 | (4.0)% | (6.8)% | (7.5)% | |||||||||||||||||||
| - | 200 | (4.6)% | (7.7)% | (20.0)% | |||||||||||||||||||
The results of the simulation are within the relevant policy limits adopted by the Company for percentage change in net interest income. For net interest income, the Company has adopted a policy limit of -10% for a 100 basis point change, -12% for a 200 basis point change, -18% for a 300 basis point change and -24% for a 400 basis point change. For the market value of equity, the Company has adopted a policy limit of -12% for a 100 basis point change, -15% for a 200 basis point change, -25% for a 300 basis point change and -30% for a 400 basis point change. The amounts in the first quarter exceeded these limits due to the already low level of rates on non-maturing deposit instruments. Management has determined that due to the level of market rates at March 31, 2021, interest rate shocks of -100, -200, -300 and -400 basis points leave the Bank with near zero down to negative rate instruments and are not considered practical or informative. The changes in net interest income, net income and the economic value of equity in higher interest rate shock scenarios at March 31, 2021 are not considered to be excessive. The impact of (4.0)% in net interest income and (6.8)% in net income given a 100 basis point decrease in market interest rates reflects in large measure the impact of variable rate loans and fed funds sold repricing downward while deposits remain at expected floor rates and are not expected to have lower interest rates.
In the first quarter of 2021, the Company continued to manage its interest rate sensitivity position to moderate levels of risk, as indicated in the simulation results above. The interest rate risk position at March 31, 2021, was relatively similar to the December 31, 2020 position for both the up and down rate scenarios.
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Although certain assets and liabilities may have similar maturities or repricing periods, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that limit changes in interest rates on a short-term basis and over the life of the loan. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in modeling. Finally, the ability of many borrowers to service their debt may decrease in the event of a significant interest rate increase.
During the first quarter of 2021, average market interest rates increased across the yield curve. Overall, there was a steepening of the yield curve as compared to the fourth quarter of 2020 with rate increases being more significant at the longer end of the yield curve.
As compared to the first quarter of 2020, the average two-year U.S. Treasury rate decreased by 95 basis points from 1.08% to 0.13%, the average five year U.S. Treasury rate decreased by 53 basis points from 1.14% to 0.61% and the average ten year U.S. Treasury rate decreased by 5 basis points from 1.37% to 1.32%. The Company’s net interest margin was 2.98% for the first quarter of 2021 and 3.49% in the first quarter of 2020. The Company believes that the net interest margin in the most recent quarter as compared to 2020’s first quarter has been consistent with its interest rate risk analysis.
Gap Position
Banks and other financial institutions earnings are significantly dependent upon net interest income, which is the difference between interest earned on earning assets and interest expense on interest bearing liabilities. Net interest income represented 89% and 94% of the Company’s revenue for the first quarter of 2021 and 2020, respectively.
In falling interest rate environments, net interest income is maximized with longer term, higher yielding assets being funded by lower yielding short-term funds, or what is referred to as a negative mismatch or gap. Conversely, in a rising interest rate environment, net interest income is maximized with shorter term, higher yielding assets being funded by longer-term liabilities or what is referred to as a positive mismatch or gap.
The gap position, which is a measure of the difference in maturity and repricing volume between assets and liabilities, is a means of monitoring the sensitivity of a financial institution to changes in interest rates. The chart below provides an indication of the sensitivity of the Company to changes in interest rates. A negative gap indicates the degree to which the volume of repriceable liabilities exceeds repriceable assets in given time periods.
At March 31, 2021, the Company had a negative gap position of approximately $107 million or 0.96% of total assets, out to three months, and a positive cumulative gap position of $167 million, or 1.5% of total assets out to twelve months; as compared to a negative gap position of approximately $376 million or 3.76% of total assets out to three months and a positive cumulative gap position of $472 million of 4.72% of total assets out to 12 months at March 31, 2020. The change in the gap position at March 31, 2021 as compared to December 31, 2020 was due to term deposits moving into overnight deposits in the low and flat interest rate environment, and the maturity of a $100 million pay fixed balance sheet swap in April 2021. Such a change in the gap position is not deemed material to the Company's overall interest rate risk position, which relies more heavily on simulation analysis that captures the full opportunity within the balance sheet. The current position is within guideline limits established by the ALCO. While management believes that this overall position creates a reasonable balance in managing its interest rate risk and maximizing its net interest margin within plan objectives, there can be no assurance as to the actual results.
Management has carefully considered its strategy to maximize interest income by reviewing interest rate levels, economic indicators and call features within its investment portfolio, as well as interest rate floors within its loan portfolio. These factors have been discussed with the ALCO and management believes that current strategies remain appropriate to current economic and interest rate trends.
If interest rates increase by 100 basis points, the Company’s net interest income and net interest margin are expected to increase modestly due to the impact of significant volumes of variable rate assets more than offsetting the assumption of an increase in money market interest rates by 70% of the change in market interest rates.
If interest rates decline by 100 basis points, the Company’s net interest income and margin are expected to decline modestly as the impact of lower market rates on a large amount of liquid assets more than offsets the ability to lower interest rates on interest bearing liabilities.
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Because competitive market behavior does not necessarily track the trend of interest rates but at times moves ahead of financial market influences, the change in the cost of liabilities may be different than anticipated by the gap model. If this were to occur, the effects of a declining interest rate environment may not be in accordance with management’s expectations.
Gap Analysis
March 31, 2021
(dollars in thousands)
| Repricible in: | 0-3 months | 4-12 months | 13-36 months | 37-60 months | Over 60 months | Total Rate Sensitive | Non Sensitive | Total | ||||||||||||||||||||||||||||||||||||||||||
| RATE SENSITIVE ASSETS: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Investment securities | $ | 122,403 | $ | 108,415 | $ | 310,435 | $ | 228,198 | $ | 599,656 | $ | 1,369,107 | ||||||||||||||||||||||||||||||||||||||
Loans (1)(2) | 3,682,415 | 800,853 | 1,603,352 | 895,599 | 686,666 | 7,668,885 | ||||||||||||||||||||||||||||||||||||||||||||
| Fed funds and other short-term investments | 1,734,159 | — | — | — | — | 1,734,159 | ||||||||||||||||||||||||||||||||||||||||||||
| Other earning assets | 77,119 | — | — | — | — | 77,119 | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 5,616,096 | $ | 909,268 | $ | 1,913,787 | $ | 1,123,797 | $ | 1,286,322 | $ | 10,849,270 | 278,594 | $ | 11,127,864 | |||||||||||||||||||||||||||||||||||
| RATE SENSITIVE LIABILITIES: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Noninterest bearing demand | $ | 89,083 | $ | 248,618 | $ | 544,481 | $ | 407,081 | $ | 1,305,071 | $ | 2,594,334 | ||||||||||||||||||||||||||||||||||||||
| Interest bearing transaction | 862,709 | — | — | — | — | 862,709 | ||||||||||||||||||||||||||||||||||||||||||||
| Savings and money market | 4,550,840 | — | — | — | 325,000 | 4,875,840 | ||||||||||||||||||||||||||||||||||||||||||||
| Time deposits | 200,285 | 237,733 | 376,718 | 48,095 | 3,130 | 865,961 | ||||||||||||||||||||||||||||||||||||||||||||
| Customer repurchase agreements and fed funds purchased | 20,061 | — | — | — | — | 20,061 | ||||||||||||||||||||||||||||||||||||||||||||
| Other borrowings | — | 148,618 | — | 69,557 | 300,000 | 518,175 | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 5,722,978 | $ | 634,969 | $ | 921,199 | $ | 524,733 | $ | 1,933,201 | $ | 9,737,080 | 129,951 | $ | 9,867,031 | |||||||||||||||||||||||||||||||||||
| GAP | $ | (106,883) | $ | 274,299 | $ | 992,587 | $ | 599,065 | $ | (646,878) | $ | 1,112,190 | ||||||||||||||||||||||||||||||||||||||
| Cumulative GAP | $ | (106,883) | $ | 167,416 | $ | 1,160,003 | $ | 1,759,068 | $ | 1,112,190 | ||||||||||||||||||||||||||||||||||||||||
| Cumulative gap as percent of total assets | (0.96) | % | 1.50 | % | 10.42 | % | 15.81 | % | 9.99 | % | ||||||||||||||||||||||||||||||||||||||||
| OFF BALANCE-SHEET: | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest Rate Swaps - LIBOR based | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||||||||||||||||||||||||||||
| Interest Rate Swaps - Fed Funds based | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | — | $ | — | |||||||||||||||||||||||||||||||||||
| GAP | $ | (106,883) | $ | 274,299 | $ | 992,587 | $ | 599,065 | $ | (646,878) | $ | 1,112,190 | ||||||||||||||||||||||||||||||||||||||
| Cumulative GAP | $ | (106,883) | $ | 167,416 | $ | 1,160,003 | $ | 1,759,068 | $ | 1,112,190 | ||||||||||||||||||||||||||||||||||||||||
| Cumulative gap as percent of total assets | (0.96) | % | 1.50 | % | 10.42 | % | 15.81 | % | 9.99 | % | ||||||||||||||||||||||||||||||||||||||||
(1)Includes loans held for sale
(2)Nonaccrual loans are included in the over 60 months category
Capital Resources and Adequacy
The assessment of capital adequacy depends on a number of factors such as asset quality and mix, liquidity, earnings performance, changing competitive conditions and economic forces, stress testing, regulatory measures and policy, as well as the overall level of growth and complexity of the balance sheet. The adequacy of the Company’s current and future capital needs is monitored by management on an ongoing basis. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.
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The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. The Company, like many community banks, has focused on commercial real estate loans, and the Company has experienced growth in its commercial real estate portfolio in recent years. At March 31, 2021, we did not exceed these regulatory concentration thresholds, we continue to monitor our concentration in commercial real estate lending and remain in compliance with the guidance issued by the federal banking regulators. Construction, land and land development loans represent 92% of total risk based capital. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened risk management procedures, and strong underwriting criteria with respect to its commercial real estate portfolio. Loan monitoring practices include but are not limited to periodic stress testing analysis to evaluate changes to cash flows, owing to interest rate increases and declines in net operating income. Nevertheless, as our commercial real estate concentration fluctuates each quarter, we may be required to maintain higher levels of capital, which could require us to obtain additional capital, and may adversely affect shareholder returns. The Company has an extensive Capital Plan and Policy, which includes pro-forma projections including stress testing within which the Board of Directors has established internal minimum targets for regulatory capital ratios that are in excess of well capitalized ratios.
The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five categories, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is only adequately capitalized, regulatory approval is required to, among other things, accept, renew or roll-over brokered deposits. If a bank is undercapitalized, capital distributions and growth and expansion are limited, and plans for capital restoration are required.
The Board of Governors of the Federal Reserve Board and the FDIC have adopted rules (the “Basel III Rules”) implementing the Basel Committee on Banking Supervision's capital guidelines for U.S. banks (commonly known as Basel III). Under the Basel III Rules, the Company and Bank are required to maintain, inclusive of the capital conservation buffer of 2.5%, a minimum CET1 ratio of 7.0%, a minimum ratio of Tier 1 capital to risk-weighted assets of 8.5%, a minimum total capital to risk-weighted assets ratio of 10.5%, and a minimum leverage ratio of 4.0%. At March 31, 2021, the Company and the Bank meet all these requirements, and satisfy the requirement to maintain a capital conservation buffer of 2.5% of CET1 capital for capital adequacy purposes.
During the fourth quarter of 2020, the Company started a new Repurchase Program. Under the Board approval in December, the Company may repurchase up to an aggregate of 1,588,848 shares of its common stock (inclusive of shares remaining under the initial authorization), through December 31, 2021, subject to earlier termination by the Board of Directors (the “Repurchase Program Extension”).
The Company announced a regular quarterly cash dividend on March 31, 2021 of $0.25 per share to shareholders of record on April 21, 2021 and payable on May 3, 2021.
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The actual capital amounts and ratios for the Company and Bank as of March 31, 2021 (unaudited) and December 31, 2020 are presented in the table below.
| Company | Bank | Minimum Required For Capital | To Be Well Capitalized Under Prompt Corrective | |||||||||||||||||||||||||||||||||||
| Actual | Actual | Adequacy | Action | |||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Amount | Ratio | Amount | Ratio | Purposes | Regulations* | ||||||||||||||||||||||||||||||||
| As of March 31, 2021 | ||||||||||||||||||||||||||||||||||||||
| CET1 capital (to risk weighted assets) | $ | 1,173,421 | 14.42 | % | $ | 1,282,555 | 15.79 | % | 7.00 | % | 6.50 | % | ||||||||||||||||||||||||||
| Total capital (to risk weighted assets) | 1,453,707 | 17.86 | % | 1,370,841 | 16.88 | % | 10.50 | % | 10.00 | % | ||||||||||||||||||||||||||||
| Tier 1 capital (to risk weighted assets) | 1,173,421 | 14.42 | % | 1,282,555 | 15.79 | % | 8.50 | % | 8.00 | % | ||||||||||||||||||||||||||||
| Tier 1 capital (to average assets) | 1,173,421 | 10.28 | % | 1,282,555 | 11.27 | % | 4.00 | % | 5.00 | % | ||||||||||||||||||||||||||||
| As of December 31, 2020 | ||||||||||||||||||||||||||||||||||||||
| CET1 capital (to risk weighted assets) | $ | 1,137,896 | 13.49 | % | $ | 1,244,028 | 14.90 | % | 7.00 | % | 6.50 | % | ||||||||||||||||||||||||||
| Total capital (to risk weighted assets) | 1,438,224 | 17.04 | % | 1,338,356 | 16.03 | % | 10.50 | % | 10.00 | % | ||||||||||||||||||||||||||||
| Tier 1 capital (to risk weighted assets) | 1,137,896 | 13.49 | % | 1,224,028 | 14.90 | % | 8.50 | % | 8.00 | % | ||||||||||||||||||||||||||||
| Tier 1 capital (to average assets) | 1,137,896 | 10.31 | % | 1,224,028 | 11.29 | % | 4.00 | % | 5.00 | % | ||||||||||||||||||||||||||||
* Applies to Bank only
Bank and holding company regulations, as well as Maryland law, impose certain restrictions on dividend payments by the Bank, as well as restricting extensions of credit and transfers of assets between the Bank and the Company. At March 31, 2021 the Bank could pay dividends to the Company to the extent of its earnings so long as it maintained the minimum required capital ratios listed in the table above.
In December 2018, federal banking regulators issued a final rule that provides an optional three-year phase-in period for the adverse regulatory capital effects of adopting the CECL methodology pursuant to new accounting guidance for the recognition of credit losses on certain financial instruments, effective January 1, 2020. In March 2020, the federal banking regulators issued an interim final rule that provides banking organizations with an alternative option to temporarily delay for two years the estimated impact of the adoption of the CECL methodology on regulatory capital, followed by the three-year phase-in period. The cumulative amount that is not recognized in regulatory capital will be phased in at 25 percent per year beginning January 1, 2022. We have elected to adopt the March 2020 interim final rule.
Use of Non-GAAP Financial Measures
The Company considers the following non-GAAP measurements useful for investors, regulators, management and others to evaluate capital adequacy and to compare against other financial institutions. The tables below provide a reconciliation of these non-GAAP financial measures with financial measures defined by GAAP.
Tangible common equity to tangible assets (the "tangible common equity ratio"), tangible book value per common share, the annualized return on average tangible common equity, and efficiency ratio are non-GAAP financial measures derived from GAAP-based amounts. The Company calculates the tangible common equity ratio by excluding the balance of intangible assets from common shareholders' equity and dividing by tangible assets. The Company calculates tangible book value per common share by dividing tangible common equity by common shares outstanding, as compared to book value per common share, which the Company calculates by dividing common shareholders' equity by common shares outstanding. The Company calculates the ROATCE by dividing net income available to common shareholders by average tangible common equity which is calculated by excluding the average balance of intangible assets from the average common shareholders’ equity. The Company calculates the efficiency ratio by dividing noninterest expense by the sum of net interest income and noninterest income. The efficiency ratio measures a bank’s overhead as a percentage of its revenue. The Company considers this information important to shareholders as tangible equity is a measure that is consistent with the calculation of capital for bank regulatory purposes, which excludes intangible assets from the calculation of risk based ratios and as such is useful for investors, regulators, management and others to evaluate capital adequacy and to compare against other financial institutions.
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GAAP Reconciliation (Unaudited)
(dollars in thousands except per share data)
| Three Months Ended | |||||||||||
| March 31, 2021 | March 31, 2020 | ||||||||||
| Common shareholders’ equity | $ | 1,260,833 | $ | 1,162,777 | |||||||
| Less: Intangible assets | (105,179) | (104,695) | |||||||||
| Tangible common equity | $ | 1,155,654 | $ | 1,058,082 | |||||||
| Book value per common share | $ | 39.45 | $ | 36.11 | |||||||
| Less: Intangible book value per common share | (3.29) | (3.25) | |||||||||
| Tangible book value per common share | $ | 36.16 | $ | 32.86 | |||||||
| Total assets | $ | 11,127,864 | $ | 9,992,219 | |||||||
| Less: Intangible assets | (105,179) | (104,695) | |||||||||
| Tangible assets | $ | 11,022,685 | $ | 9,887,524 | |||||||
| Tangible common equity ratio | 10.48 | % | 10.70 | % | |||||||
| Average common shareholders’ equity | $ | 1,254,780 | $ | 1,191,180 | |||||||
| Less: Average intangible assets | (105,164) | (104,697) | |||||||||
| Average tangible common equity | $ | 1,149,616 | $ | 1,086,483 | |||||||
| Net Income Available to Common Shareholders | $ | 43,469 | $ | 23,123 | |||||||
| Average tangible common equity | $ | 1,086,016 | $ | 1,086,483 | |||||||
Annualized Return on Average Tangible Common Equity | 15.33 | % | 8.56 | % | |||||||
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Please refer to Item 2 of this report, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the caption “Asset/Liability Management and Quantitative and Qualitative Disclosure about Market Risk.”
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures. The Company’s management, under the supervision and with the participation of the Chief Executive Officer, Executive Chairman and Chief Financial Officer, evaluated, as of the last day of the period covered by this report, the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) under the Exchange Act. Based on that evaluation, the Chief Executive Officer, Executive Chairman and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of March 31, 2021 were effective to provide reasonable assurance that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required and that it is accumulated and communicated to our management, including the Chief Executive Officer, Executive Chairman and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) that occurred during the first quarter of 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
There have been no material changes in the status of the legal proceedings previously disclosed in Part I, Item 3 of the Company's Annual Report on Form 10-K for the year ended December 31, 2020, except as follows.
From time to time, the Company and its subsidiaries are involved in various legal proceedings incidental to their business in the ordinary course, including matters in which damages in various amounts are claimed. Based on information currently available, the Company does not believe that the liabilities (if any) resulting from such legal proceedings will have a material effect on the financial position of the Company. However, in light of the inherent uncertainties involved in such matters, ongoing legal expenses or an adverse outcome in one or more of these matters could materially and adversely affect the Company's financial condition, results of operations or cash flows in any particular reporting period, as well as its reputation.
On July 24, 2019, a putative class action lawsuit was filed in the United States District Court for the Southern District of New York (“SDNY”) against the Company, its current and former President and Chief Executive Officer and its current and former Chief Financial Officer, on behalf of persons similarly situated, who purchased or otherwise acquired Company securities between March 2, 2015 and July 17, 2019. On November 7, 2019, the court appointed a lead plaintiff and lead counsel in that matter, and on January 21, 2020, the lead plaintiff filed an amended complaint on behalf of the same class against the same defendants as well as the Company’s former General Counsel. The plaintiff alleges that certain of the Company’s 10-K reports and other public statements and disclosures contained materially false or misleading statements about, among other things, the effectiveness of its internal controls and related party loans, in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and Section 20 (a) of that act, resulting in injury to the purported class members as a result of the decline in the value of the Company’s common stock following the disclosure of increased legal expenses associated with certain government investigations involving the Company. As previously disclosed by the Company, on December 24, 2020, by stipulation of the parties, the United States District Court for the Southern District of New York stayed the putative class action lawsuit filed against the Company, its current and former President and Chief Executive Officer, its current and former Chief Financial Officer and its former General Counsel on behalf of persons who purchased or otherwise acquired Company securities between March 2, 2015 and July 17, 2019 (the “class”), pending a non-binding mediation that had been scheduled for April 13, 2021. Immediately following the non-binding mediation, the lead plaintiff, on behalf of the class, the Company and each of the other defendants continued a settlement dialogue and reached an agreement to settle the putative class action lawsuit, involving a total payment by the Company of $7.5 million in exchange for the release of all of the defendants from all alleged claims in the class action suit, without any admission or concession of wrongdoing by the Company or the other defendants. The agreement remains subject to final documentation, court approval and other customary conditions. The Company expects that the full amount of a final settlement will be paid by the Company’s insurance carriers under applicable insurance policies. There can be no assurance, however, that the agreement will be fully documented, receive court approval and/or meet all other conditions.
As previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, on January 25, 2021, the Company entered into a settlement agreement with respect to a previously disclosed shareholder demand letter, covering substantially the same subject matters as the disclosed civil securities class action litigation pending in SDNY. The letter demanded that the Board undertake an investigation into the Board’s and management’s alleged violations of law and alleged breaches of fiduciary duties, and take appropriate actions following such investigation. As required by DC Superior Court administrative procedures, shareholder's counsel first filed a derivative action complaint against the individual directors and officers named in the demand letter, and the Company as nominal Defendant before filing the executed stipulation of settlement accompanied by the shareholder's brief in support of their unopposed motion to approve the settlement. Court approval of the stipulation of settlement remains pending a hearing currently scheduled for May 12, 2021. Although the Company believes the stipulation of settlement is in the best interests of the Company’s shareholders, there can be no assurance that the stipulation of settlement will be approved by the court.
Recently, the Company has engaged in preliminary discussions with a shareholder regarding a demand letter previously received by the Board of Directors from such shareholder, largely relating to the subject matters covered by the putative class action lawsuit described above. The letter demanded that the Board undertake an investigation into the Board’s and management’s alleged violations of law and alleged breaches of fiduciary duties, and take appropriate actions following such investigation. The Company cannot predict the outcome of those discussions, or whether they will result in a settlement or shareholder derivative litigation.
The Company has received various document requests and subpoenas from securities and banking regulators and U.S. Attorney’s offices in connection with investigations, which the Company believes relate to the Company’s identification,
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classification and disclosure of related party transactions; the retirement of certain former officers and directors; and the relationship of the Company and certain of its former officers and directors with a local public official, among other things. The Company is cooperating with these investigations. There have been no regulatory restrictions placed on the Company’s ability to fully engage in its banking business as presently conducted as a result of these ongoing investigations. We are, however, unable to predict the duration, scope or outcome of these investigations. The amount of legal fees and expenditures for the year is net of expected insurance coverage where we believe we have a high likelihood of recovery pursuant to our D&O insurance policies, but does not include any offset for potential claims we may have in the future as to which recovery is impossible to predict at this time.
Item 1A - Risk Factors
The COVID-19 pandemic has adversely affected, and is likely to continue to adversely affect, our customers and other businesses in our market area, as well as counterparties and third party vendors. The resulting adverse impacts on our business, financial condition, liquidity and results of operations have been, and may continue to be significant.
The COVID-19 pandemic and the resulting containment measures have resulted in widespread economic and financial disruptions that have adversely affected, and are likely to continue to adversely effect, our customers and other businesses in our market area, as well as counterparties and third-party vendors. We continue to see the impact of the pandemic on our business, which we expect may potentially worsen, particularly since there remains ongoing uncertainty as to how long the COVID-19 pandemic and related containment measures will continue, both in our market area and the rest of the country. This impact has been, in certain areas, and could continue to be significant, adverse and potentially material. The full extent of this impact, and the resulting impact on our business, financial condition, liquidity and results of operations, remains inestimable at this time, and will depend on a number of evolving factors and future developments beyond our control and that we are unable to predict, including the duration, spread and severity of the pandemic; the nature, extent and effectiveness of containment measures; the timing of development and widespread availability of medical treatments or vaccines; the extent and duration of the effect on the economy, unemployment, consumer confidence and consumer and business spending; the impact and continued availability of monetary, fiscal and other economic policies and programs designed to provide economic assistance to individuals and small businesses; and how quickly and to what extent normal economic and operating conditions can resume. It is also possible that any adverse impacts of the pandemic and containment measures may continue once the pandemic is controlled and the containment measures are lifted.
Many of the risks described in the risk factors and other cautionary language included in the Company's Annual Report on Form 10-K for the year ended December 31, 2020, and current reports filed by the Company with the Securities and Exchange Commission will likely be exacerbated, and the impact of such risks will likely be magnified, as a result of the COVID-19 pandemic. We expect the negative impacts of the COVID-19 pandemic on our business, financial condition, liquidity and results of operations to be the most severe in the following areas:
•Loan Credit Quality. The significant disruption resulting from the COVID-19 pandemic has been materially affecting the businesses of our customers and of their customers, which impacts their creditworthiness, their ability to pay amounts owed to us and our ability to collect those amounts. Further, volatile and unpredictable ongoing market conditions, both as a result of impacts from the COVID-19 pandemic and otherwise, may negatively impact our ability to achieve our long-term loan growth objectives. As loan volume represents our largest contributor to our net interest income, such market conditions, including a continuation of the historically low interest rate environment, may have a material negative impact on our loan credit quality, our short-term and long-term strategy and our results of operations. Among the industry’s most clearly impacted by the pandemic are the Accommodation and Food Service industry, exposure to which represents 10.7% of our loan portfolio as of March 31, 2021, and the Retail Trade industry, which represents 1.3% of our loan portfolio as of March 31, 2021. In addition, approximately 5.9% of our loan portfolio as of March 31, 2021 is secured by commercial real estate loans secured by restaurants, hotels or retail properties. These areas may have a longer recovery period than other industries. Despite high home sales volumes and our strong performance in gains from residential mortgage loans for the quarter ended March 31, 2020, such volumes and performance are not stable and economic conditions are may likely result in future material declines in real estate values and home sales volumes, and an increase in tenants failing to make or deferring rent payments. A large portion of our loan portfolio is related to real estate, with 57% consisting of commercial real estate and real estate construction loans, and 79% of our loans being secured by real estate. As a result of actual or expected credit losses, we may downgrade loans, increase our allowance for loan losses, and write-down or charge-off credit relationships, any of which would negatively impact our results of operations. In addition, market upheavals are likely to affect the value of real estate and commercial assets. In the event of foreclosure, it is unlikely that we will be able to sell the foreclosed property at a price that will allow us to recoup a significant portion of the delinquent loan.
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•Increased Demands on Capital and Liquidity. We have experienced increased volume of loan originations, particularly SBA loans pursuant to the PPP created by recent legislation. Certain of these SBA loans have mandated interest rates that are lower than our usual rates and may not be purchased by the SBA or other third parties within expected timeframes. In addition, borrowers may draw on existing lines of credit or seek additional loans to finance their businesses. These factors may result in reduced levels of capital and liquidity being available to originate more profitable loans, which will negatively impact our ability to serve our existing customers and our ability to attract new customers.
•PPP Administration and Compliance. Due to the short timeframe between the passing of the CARES Act and the beginning of the PPP, there continues to be some ambiguity in the laws, rules and guidance regarding the day-to-day mechanics and operations of the program, and particularly how banks should administer the program as we move into the loan forgiveness stage. There is no guarantee that the Bank will, in all instances, be able to avoid potential processing issues, administrative pitfalls or other obstacles that may present from time to time, and any such issues, pitfalls or other obstacles that arise may result in adverse impacts on our operational and strategic objectives. Further, due to the “first come first served” nature of the PPP, the loans originated under this program may present potential fraud risk and operational risk, increasing the risk that loan forgiveness may not be obtained by the borrowers and that the government guaranty may not be honored. In particular, there is risk that some borrowers may not qualify for the loan forgiveness feature due to the conduct of the borrower after the loans were originated. These factors may result in us having to hold a significant amount of these low-yield loans in our portfolio for an extended period of time, which may negatively impact our broader business performance and results of operations.
•Deposit Business. As a result of the COVID-19 pandemic, deposit customers are expected to retain higher levels of cash. While increased low-interest deposits could have a positive impact in the short-term, we would not expect these funds to be replenished as customers use deposit funds for liquidity for their business and individual needs. If deposit levels decline, our available liquidity would decline, and we could be forced to obtain liquidity on terms less favorable than current deposit terms, which would in turn compress margins and negatively impact our results of operations.
•Interest Rate Risk. Our net interest income, lending activities, deposits and profitability have been and could continue to be negatively affected by volatility in interest rates caused by uncertainties stemming from the COVID-19 pandemic. In March 2020, the Federal Reserve lowered the target range for the federal funds rate to a range from 0 to 0.25 percent. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in current fair market values of our assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results or financial condition.
•Operational Risk. Current and future restrictions on our workforce's access to our facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems as well as information, applications, payment systems and other services provided by third parties. In response to COVID-19, we have modified our business practices by directing a portion of our employees to work remotely from their homes to minimize interruptions to our operations. These actions will likely result in increased spending on our business continuity efforts, such as technology and readiness procedures for returning to our offices. We could also experience an increased strain on our risk management policies, including, but not limited to, the effectiveness and accuracy of our models, given the lack of data inputs and comparable precedent. Further, technology in employees' homes may not be as robust as in our offices and could cause the networks, information systems, applications, and other tools available to employees to be more limited or less reliable than in our offices. The continuation of these work-from-home measures also introduces additional operational risk, including related to the effectiveness of our anti-money laundering and other compliance programs, as well as increased cybersecurity risk. These cyber risks include greater phishing, malware, and other cybersecurity attacks, vulnerability to disruptions of our information technology infrastructure and telecommunications systems for remote operations, increased risk of unauthorized dissemination of confidential information, limited ability to restore the systems in the event of a systems failure or interruption, greater risk of a security breach resulting in destruction or misuse of valuable information, and potential impairment of our ability to perform critical functions, including wiring funds, all of which could expose us to risks of data or financial loss, litigation and liability and could seriously disrupt our operations and the operations of any impacted customers. Furthermore, while our current plans to return to our offices remain fluid as federal, state and local guidelines continue to evolve, the execution of these plans, and in particular, any delays in executing such plans, may negatively impact our ability to attract and retain qualified personnel. Even after the market fully recovers from the impacts of the COVID-19 pandemic, differences in the demands, expectations and priorities of the workforce may require us to rethink and amend our recruiting and retention strategies in order to attract and keep new employees. There is no guarantee that we will be successful in gaining or maintaining a competitive edge against our
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peer banks in terms of hiring new talent in the near or long term, and any failure to do so may materially impact our business operations and long-term growth.
•External Vendors and Service Providers. We rely on many outside service providers that support our day-to-day operations including data processing and electronic communications, real estate appraisal, loan servicers and local and federal government agencies, offices and courthouses. In light of the containment measures responding to COVID-19, many of these entities may limit the availability and access of their services, which may impact our business. For example, loan origination could be delayed due to the limited availability of real estate appraisers for the collateral. Loan closings could be delayed related to reductions in available staff in recording offices or the closing of courthouses, which slows the process for title work, mortgage and UCC filings. If the third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.
•Strategic and Reputational Risk. The pandemic and containment measures have caused us to modify our strategic plans and business practices, and we may take further actions that we determine are in the best interests of our colleagues, customers and business partners. If we do not respond appropriately to the pandemic, or if customers or other stakeholders do not perceive our response to be adequate, we could suffer damage to our reputation and our brand, which could materially adversely affect our business. We also face an increased risk of litigation and governmental and regulatory scrutiny as a result of the effects of the pandemic on market and economic conditions and actions governmental authorities take in response to those conditions, as detailed in the Note 1 to the Consolidated Financial Statements.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
(a) Sales of Unregistered Securities. | None | ||||
(b) Use of Proceeds. | Not Applicable | ||||
(c) Issuer Purchases of Securities. | |||||
| Period | Total Number of Shares Purchased (2) | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (1) | ||||||||||||||||||||||
| January 1 - 31, 2021 | — | — | — | 1,588,848 | ||||||||||||||||||||||
| February 1- 28, 2021 | 1,466 | $ | 42.46 | 1,466 | 1,587,382 | |||||||||||||||||||||
| March 1- 31, 2021 | — | — | — | 1,587,382 | ||||||||||||||||||||||
| Total | 1,466 | $ | 42.46 | 1,466 | ||||||||||||||||||||||
_______________________________
(1)On December 16, 2020, the Company's Board of Directors adopted a new share repurchase program to take effect starting January 1, 2021, after the expiration of the previous repurchase program on December 31, 2020. The Board of Directors authorized the repurchase of 1,588,848 shares of common stock, or approximately 5% of the Company's outstanding shares of common stock, under the new repurchase program, which will expire on December 31, 2021, subject to earlier termination of the program by the Board of Directors. The program was announced by a press release dated December 17, 2020 and a Form 8-K filed on December 17, 2020.
(2)Includes shares of the Company’s common stock acquired by the Company in connection with satisfaction of tax withholding obligations on vested restricted shares.
Item 3 - Defaults Upon Senior Securities
None
Item 4 - Mine Safety Disclosures
Not Applicable
Item 5 - Other Information
(a) Required 8-K Disclosures
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Item 5.02 Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers.
(e) On April 26, 2021, the Compensation Committee of the Company's Board of Directors approved the performance goals and payment ranges for the 2021-2023 performance period (as set forth below) for performance based awards under the Company’s 2021-2023 Long-Term Incentive Plan (the LTIP”). A copy of the LTIP is included herein as Exhibit 10.2.
| Measures | Weight | Threshold | Target | Stretch/Maximum | ||||||||||
| Return on Average Assets (KRX Index)* | 50% | Median | 62.5 % Percentile | 75 % Percentile | ||||||||||
| Total Shareholder Return (KRX Index)* | 50% | Median | 62.5 % Percentile | 75 % Percentile | ||||||||||
| Payout Range (% of Target) | 100% | 50% | 100% | 150% | ||||||||||
*The Index is the KBW Regional Bank Index (KRX)
(b) Changes in Procedures for Director Nominations | None | ||||
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Item 6 - Exhibits
| Supplemental Executive Retirement Plan Agreement dated as of January 29, 2020, between EagleBank and Charles D. Levingston, as amended by the Amendment to the Supplemental Executive Retirement Plan Agreement dated as of May 7, 2021, between EagleBank and Charles D. Levingston | ||||||||
| 2021-2023 Long-Term Incentive Plan | ||||||||
| Certification of Susan G. Riel | ||||||||
| Certification of Norman R. Pozez | ||||||||
| Certification of Charles D. Levingston | ||||||||
| Certification of Susan G. Riel | ||||||||
| Certification of Norman R. Pozez | ||||||||
| Certification of Charles D. Levingston | ||||||||
| 101 | Interactive data files pursuant to Rule 405 of Regulation S-T: | |||||||
| (i) Consolidated Balance Sheets at March 31, 2021, December 31, 2020 | ||||||||
| (ii) Consolidated Statement of Income for the three months ended March 31, 2021 and 2020 | ||||||||
| (iii) Consolidated Statement of Comprehensive Income for the three months ended March 31, 2021 and 2020 | ||||||||
| (iv) Consolidated Statement of Changes in Shareholders’ Equity for the three months ended March 31, 2021 and 2020 | ||||||||
| (v) Consolidated Statement of Cash Flows for the three months ended March 31, 2021 and 2020 | ||||||||
| (vi) Notes to the Consolidated Financial Statements | ||||||||
| 104 | The cover page of this Quarterly Report on Form 10-Q, formatted in Inline XBRL | |||||||
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| EAGLE BANCORP, INC. | ||||||||
| Date: May 10, 2021 | By: | /s/ Susan G. Riel | ||||||
| Susan G. Riel, President and Chief Executive Officer of the Company | ||||||||
| Date: May 10, 2021 | By: | /s/ Charles D. Levingston | ||||||
| Charles D. Levingston, Executive Vice President and Chief Financial Officer of the Company | ||||||||
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