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REPUBLIC FIRST BANCORP INC - Quarter Report: 2019 September (Form 10-Q)

frbk20190930_10q.htm
 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[ X ]

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2019.

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: 000-17007

 

Republic First Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Pennsylvania

23-2486815

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

   

50 South 16th Street, Philadelphia, Pennsylvania

19102

(Address of principal executive offices)

(Zip code)

 

215-735-4422

(Registrant’s telephone number, including area code)

Not Applicable

(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

 

FRBK

 

Nasdaq Global Market

 

 

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 [X]   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 [X]   NO [  ]

 

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

 

Large accelerated filer [   ]

Accelerated filer [X]

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 [X]

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date.

 

Common Stock, $0.01 per share

58,842,778

Title of Class

Number of Shares Outstanding as of November 8, 2019

 

 

 

 

 

REPUBLIC FIRST BANCORP, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

     

Part I: Financial Information

Page

     

Item 1.

Financial Statements

 
 

Consolidated balance sheets as of September 30, 2019 and December 31, 2018 (unaudited) 

1

  Consolidated statements of operations for the three and nine months ended September 30, 2019 and 2018 (unaudited) 2
 

Consolidated statements of comprehensive income (loss) for the three and nine months ended September 30, 2019 and 2018 (unaudited)

3

 

Consolidated statements of cash flows for the nine months ended September 30, 2019 and 2018 (unaudited)

4

 

Consolidated statements of changes in shareholders’ equity for the three and nine months ended September 30, 2019 and 2018 (unaudited)

5

 

Notes to consolidated financial statements (unaudited)

6

     

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

37

     

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

58

     

Item 4.

Controls and Procedures

58
     

Part II: Other Information

 
     

Item 1.

Legal Proceedings

59
     

Item 1A.

Risk Factors

59

     

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

59

     

Item 3.

Defaults Upon Senior Securities

59

     

Item 4.

Mine Safety Disclosures

59

     

Item 5.

Other Information

59

     

Item 6.

Exhibits

60

     

Signatures

61

 

 

 

 

 

Republic First Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

September 30, 2019 and December 31, 2018

(Dollars in thousands, except per share data)

(unaudited)

 

   

September 30,

2019

   

December 31,

2018

 

ASSETS

               

Cash and due from banks

  $ 57,562     $ 35,685  

Interest bearing deposits with banks

    143,915       36,788  

Cash and cash equivalents

    201,477       72,473  

Investment securities available for sale, at fair value

    379,962       321,014  

Investment securities held to maturity, at amortized cost (fair value of $699,054 and $747,323, respectively)

    687,425       761,563  

Restricted stock, at cost

    2,371       5,754  

Mortgage loans held for sale, at fair value

    18,734       20,887  

Other loans held for sale

    2,476       5,404  

Loans receivable (net of allowance for loan losses of $8,467 and $8,615, respectively)

    1,560,913       1,427,983  

Premises and equipment, net

    111,573       87,661  

Other real estate owned, net

    6,653       6,223  

Accrued interest receivable

    9,277       9,025  

Operating lease right-of-use asset

    65,860       -  

Goodwill

    5,011       5,011  

Other assets

    34,189       30,299  

Total Assets

  $ 3,085,921     $ 2,753,297  
                 

LIABILITIES AND SHAREHOLDERS' EQUITY

               

Liabilities

               

Deposits

               

Demand – non-interest bearing

  $ 595,869     $ 519,056  

Demand – interest bearing

    1,227,969       1,042,561  

Money market and savings

    698,991       676,993  

Time deposits

    217,203       154,257  

Total Deposits

    2,740,032       2,392,867  

Short-term borrowings

    -       91,422  

Accrued interest payable

    1,655       558  

Other liabilities

    12,482       12,002  

Operating lease liability

    69,646       -  

Subordinated debt

    11,263       11,259  

Total Liabilities

    2,835,078       2,508,108  
                 

Shareholders’ Equity

               

Preferred stock, par value $0.01 per share: 10,000,000 shares authorized; no shares issued and outstanding

    -       -  

Common stock, par value $0.01 per share: 100,000,000 shares authorized; shares issued 59,371,623 as of September 30, 2019 and 59,318,073 as of December 31, 2018; shares outstanding 58,842,778 as of September 30, 2019 and 58,789,228 as of December 31, 2018

    594       593  

Additional paid in capital

    271,412       269,147  

Accumulated deficit

    (9,731 )     (8,716 )

Treasury stock at cost (503,408 shares as of September 30, 2019 and December 31, 2018)

    (3,725 )     (3,725 )

Stock held by deferred compensation plan (25,437 shares as of September 30, 2019 and December 31, 2018)

    (183 )     (183 )

Accumulated other comprehensive loss

    (7,524 )     (11,927 )

Total Shareholders’ Equity

    250,843       245,189  

Total Liabilities and Shareholders’ Equity

  $ 3,085,921     $ 2,753,297  

 

(See notes to consolidated financial statements)

 

1

 

 

 

Republic First Bancorp, Inc. and Subsidiaries

Consolidated Statements of Operations

For the Three and Nine Months Ended September 30, 2019 and 2018

(Dollars in thousands, except per share data)

(unaudited)

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 

Interest income:

                               

Interest and fees on taxable loans

  $ 18,298     $ 16,353     $ 53,827     $ 45,342  

Interest and fees on tax-exempt loans

    409       411       1,249       1,148  

Interest and dividends on taxable investment securities

    6,652       6,511       21,134       19,536  

Interest and dividends on tax-exempt investment securities

    72       130       131       367  

Interest on federal funds sold and other interest-earning assets

    777       153       1,631       388  

Total interest income

    26,208       23,558       77,972       66,781  

Interest expense:

                               

Demand- interest bearing

    3,753       1,948       11,897       4,754  

Money market and savings

    1,813       1,308       4,893       3,454  

Time deposits

    1,123       386       2,608       1,121  

Other borrowings

    137       770       681       1,528  

Total interest expense

    6,826       4,412       20,079       10,857  

Net interest income

    19,382       19,146       57,893       55,924  

Provision for loan losses

    450       500       750       1,700  

Net interest income after provision for loan losses

    18,932       18,646       57,143       54,224  

Non-interest income:

                               

Loan and servicing fees

    257       320       1,156       839  

Mortgage banking income

    2,797       2,580       8,048       7,948  

Gain on sales of SBA loans

    944       816       2,593       2,654  

Service fees on deposit accounts

    1,990       1,386       5,450       3,887  

Gain (loss) on sale of investment securities

    520       -       1,103       (1 )

Other non-interest income

    46       29       175       107  

Total non-interest income

    6,554       5,131       18,525       15,434  

Non-interest expenses:

                               

Salaries and employee benefits

    14,314       11,203       40,378       32,731  

Occupancy

    2,994       1,975       8,270       5,976  

Depreciation and amortization

    1,740       1,285       4,700       4,107  

Legal

    462       276       1,024       916  

Other real estate owned

    799       378       1,653       881  

Appraisal and other loan expenses

    476       583       1,327       1,316  

Advertising

    698       290       1,467       916  

Data processing

    1,434       1,009       3,780       2,773  

Insurance

    301       181       752       690  

Professional fees

    661       498       1,864       1,476  

Automated teller machine expenses

    526       498       1,689       1,327  

Regulatory assessments and costs

    62       396       904       1,258  

Taxes, other

    288       243       782       733  

Other operating expenses

    3,069       2,018       8,412       6,564  

Total non-interest expense

    27,824       20,833       77,002       61,664  

Income (loss) before provision (benefit) for income taxes

    (2,338 )     2,944       (1,334 )     7,994  

Provision (benefit) for income taxes

    (516 )     622       (319 )     1,524  

Net income (loss)

  $ (1,822 )   $ 2,322     $ (1,015 )   $ 6,470  

Net income (loss) per share:

                               

Basic

  $ (0.03 )   $ 0.04     $ (0.02 )   $ 0.11  

Diluted

  $ (0.03 )   $ 0.04     $ (0.02 )   $ 0.11  

 

(See notes to consolidated financial statements)

 

2

 

 

 

Republic First Bancorp, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

For the Three and Nine Months Ended September 30, 2019 and 2018

(Dollars in thousands)

(unaudited)

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
                                 

Net income (loss)

  $ (1,822 )   $ 2,322     $ (1,015 )   $ 6,470  
                                 

Other comprehensive income (loss), net of tax

                               

Unrealized gains (losses) on securities (pre-tax $720, ($3,202), $5,495, and $(12,210), respectively)

    583       (2,500 )     4,456       (9,536 )

Reclassification adjustment for securities (gains) losses (pre-tax ($520), $-, ($1,103), and $1, respectively)

    (217 )     -       (894 )     1  

Net unrealized gains (losses) on securities

    366       (2,500 )     3,562       (9,535 )

Net unrealized holding losses on securities transferred from available-for-sale to held-to-maturity:

                               

Amortization of net unrealized holding losses to income during the period (pre-tax $393, $37, $1,037, and $106 respectively)

    318       29       841       83  
                                 

Total other comprehensive income (loss)

    684       (2,471 )     4,403       (9,452 )
                                 

Total comprehensive income (loss)

  $ (1,138 )   $ (149 )   $ 3,388     $ (2,982 )

 

(See notes to consolidated financial statements)

 

3

 

 

 

Republic First Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2019 and 2018

(Dollars in thousands)

(unaudited)

 

   

Nine Months Ended September 30,

 
   

2019

   

2018

 

Cash flows from operating activities

               

Net income (loss)

  $ (1,015 )   $ 6,470  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

               

Provision for loan losses

    750       1,700  

Write down of other real estate owned

    240       18  

Depreciation and amortization

    4,700       4,107  

Stock based compensation

    2,005       1,584  

Net (gain) loss on sale of investment securities

    (1,103 )     1  

Amortization of premiums on investment securities

    2,257       2,271  

Accretion of discounts on retained SBA loans

    (1,083 )     (1,073 )

Fair value adjustments on SBA servicing assets

    1,106       1,252  

Proceeds from sales of SBA loans originated for sale

    37,916       36,811  

SBA loans originated for sale

    (32,395 )     (34,969 )

Gains on sales of SBA loans originated for sale

    (2,593 )     (2,654 )

Proceeds from sales of mortgage loans originated for sale

    246,816       355,181  

Mortgage loans originated for sale

    (239,045 )     (335,734 )

Fair value adjustment for mortgage loans originated for sale

    285       474  

Gains on sales of mortgage loans originated for sale

    (6,215 )     (6,400 )

Amortization of debt issuance costs

    4       5  

Non-cash expense related to leases

    924       -  

Increase in accrued interest receivable and other assets

    (4,524 )     (1,278 )

Increase (decrease) in accrued interest payable and other liabilities

    2,996       (1,049 )

Net cash provided by operating activities

    12,026       26,717  
                 

Cash flows from investing activities

               

Purchase of investment securities available for sale

    (150,734 )     (81,744 )

Purchase of investment securities held to maturity

    -       (61,083 )

Proceeds from the sale of securities available for sale

    54,742       5,713  

Proceeds from the maturity or call of securities available for sale

    41,571       39,409  

Proceeds from the maturity or call of securities held to maturity

    73,890       46,156  

Redemption of restricted stock

    3,383       2  

Net increase in loans

    (133,667 )     (217,967 )

Net proceeds from sale of other real estate owned

    401       495  

Premises and equipment expenditures

    (28,612 )     (11,072 )

Net cash used in investing activities

    (139,026 )     (280,091 )
                 

Cash flows from financing activities

               

Net proceeds from exercise of stock options

    261       668  

Net increase in demand, money market and savings deposits

    284,219       324,658  

Net increase in time deposits

    62,946       12,405  

Repayment of short-term borrowings

    (91,422 )     -  

Net cash provided by financing activities

    256,004       337,731  
                 

Net increase in cash and cash equivalents

    129,004       84,357  

Cash and cash equivalents, beginning of year

    72,473       61,942  

Cash and cash equivalents, end of period

  $ 201,477     $ 146,299  
                 

Supplemental disclosures

               

Interest paid

  $ 18,982     $ 10,749  

Non-cash transfers from loans to other real estate owned

  $ 1,071     $ 315  

Conversion of subordinated debt to common stock

  $ -     $ 10,094  

 

(See notes to consolidated financial statements)

 

4

 

 

 

Republic First Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

For the Three and Nine Months Ended September 30, 2019 and 2018

(Dollars in thousands)

(unaudited)

 

   

 

 

Common

Stock

   

 

Additional

Paid in

Capital

   

 

 

Accumulated

Deficit

   

 

 

Treasury

Stock

   

Stock Held by

Deferred

Compensation

Plan

   

Accumulated

Other

Comprehensive

Loss

   

 

Total Shareholders’

Equity

 
                                                         

Balance July 1, 2019

  $ 594     $ 270,789     $ (7,909 )   $ (3,725 )   $ (183 )   $ (8,208 )   $ 251,358  
                                                         

Net loss

                    (1,822 )                             (1,822 )

Other comprehensive income, net of tax

                                            684       684  

Stock based compensation

            623                                       623  
                                                         

Balance September 30, 2019

  $ 594     $ 271,412     $ (9,731 )   $ (3,725 )   $ (183 )   $ (7,524 )   $ 250,843  
                                                         

Balance January 1, 2019

  $ 593     $ 269,147     $ (8,716 )   $ (3,725 )   $ (183 )   $ (11,927 )   $ 245,189  
                                                         

Net loss

                    (1,015 )                             (1,015 )

Other comprehensive income, net of tax

                                            4,403       4,403  

Stock based compensation

            2,005                                       2,005  

Options exercised (53,550 shares)

    1       260                                       261  
                                                         

Balance September 30, 2019

  $ 594     $ 271,412     $ (9,731 )   $ (3,725 )   $ (183 )   $ (7,524 )   $ 250,843  
                                                         

Balance July 1, 2018

  $ 593     $ 267,974     $ (13,195 )   $ (3,725 )   $ (183 )   $ (16,130 )   $ 235,334  
                                                         

Net income

                    2,322                               2,322  

Other comprehensive loss, net of tax

                                            (2,471 )     (2,471 )

Stock based compensation

            532                                       532  

Options exercised (28,750 shares)

            107                                       107  
                                                         

Balance September 30, 2018

  $ 593     $ 268,613     $ (10,873 )   $ (3,725 )   $ (183 )   $ (18,601 )   $ 235,824  
                                                         

Balance January 1, 2018

  $ 575     $ 256,285     $ (18,983 )   $ (3,725 )   $ (183 )   $ (7,509 )   $ 226,460  
                                                         

Reclassification due to the adoption of ASU 2018-02

                    1,640                       (1,640 )     -  

Net income

                    6,470                               6,470  

Other comprehensive loss, net of tax

                                            (9,452 )     (9,452 )

Stock based compensation

            1,584                                       1,584  

Conversion of subordinated debt to common stock (1,624,614 shares)

    16       10,078                                       10,094  

Options exercised (174,225 shares)

    2       666                                       668  
                                                         

Balance September 30, 2018

  $ 593     $ 268,613     $ (10,873 )   $ (3,725 )   $ (183 )   $ (18,601 )   $ 235,824  

 

(See notes to consolidated financial statements)

 

5

 

 

Republic First Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

 

 

Note 1: Basis of Presentation

 

Republic First Bancorp, Inc. (the “Company”) is a one-bank holding company organized and incorporated under the laws of the Commonwealth of Pennsylvania. It is comprised of one wholly-owned subsidiary, Republic First Bank, which does business under the name of Republic Bank (“Republic”). Republic is a Pennsylvania state chartered bank that offers a variety of banking services to individuals and businesses throughout the Greater Philadelphia, Southern New Jersey, and New York City markets through its offices and store locations in Philadelphia, Montgomery, Delaware, Bucks, Camden, Burlington, Atlantic, Gloucester, and New York Counties. On July 28, 2016, Republic acquired all of the issued and outstanding limited liability company interests of Oak Mortgage Company, LLC (“Oak Mortgage”) and, as a result, Oak Mortgage became a wholly owned subsidiary of Republic on that date. Oak Mortgage is headquartered in Marlton, NJ and is licensed to do business in Pennsylvania, Delaware, New Jersey, and Florida. On January 1, 2018, Oak Mortgage was merged into Republic and restructured as a division with Republic. The Oak Mortgage name is still utilized for marketing and branding purposes. The Company also has two unconsolidated subsidiaries, which are statutory trusts established by the Company in connection with its sponsorship of two separate issuances of trust preferred securities.

 

The Company and Republic encounter vigorous competition for market share in the geographic areas they serve from bank holding companies, national, regional and other community banks, thrift institutions, credit unions and other non-bank financial organizations, such as mutual fund companies, insurance companies and brokerage companies.

 

The Company and Republic are subject to federal and state regulations governing virtually all aspects of their activities, including but not limited to, lines of business, liquidity, investments, the payment of dividends and others. Such regulations and the cost of adherence to such regulations can have a significant impact on earnings and financial condition.

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Republic. The Company follows accounting standards set by the Financial Accounting Standards Board (“FASB”).  The FASB sets accounting principles generally accepted in the United States of America (“US GAAP”) that are followed to ensure consistent reporting of financial condition, results of operations, and cash flows. All material inter-company transactions have been eliminated. Events occurring subsequent to the date of the balance sheet have been evaluated for potential recognition or disclosure in the consolidated financial statements.  

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions to United States Securities and Exchange Commission (“SEC”) Form 10-Q and Article 10 of SEC Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for financial statements for a complete fiscal year. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine month period ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

 

6

 

 

 

Note 2: Summary of Significant Accounting Policies

 

Risks and Uncertainties

 

The earnings of the Company depend primarily on the earnings of Republic. The earnings of Republic are heavily dependent upon the level of net interest income, which is the difference between interest earned on its interest-earning assets, such as loans and investments, and the interest paid on its interest-bearing liabilities, such as deposits and borrowings. Accordingly, the Company’s results of operations are subject to risks and uncertainties surrounding Republic’s exposure to changes in the interest rate environment. Prepayments on residential real estate mortgage and other fixed rate loans and mortgage-backed securities vary significantly and may cause significant fluctuations in interest margins.

 

Mortgage Banking Activities and Mortgage Loans Held for Sale

 

Mortgage loans held for sale are originated and held until sold to permanent investors. Management has adopted the fair value option in accordance with FASB Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures, and record loans held for sale at fair value.

 

Mortgage loans held for sale originated on or subsequent to the election of the fair value option, are recorded on the balance sheet at fair value. The fair value is determined on a recurring basis by utilizing quoted prices from dealers in such securities. Changes in fair value are reflected in mortgage banking income in the statements of income. Direct loan origination costs are recognized when incurred and are included in non-interest expense in the statements of income.

 

Interest Rate Lock Commitments (“IRLCs”)

 

Mortgage loan commitments known as interest rate locks that relate to the origination of a mortgage that will be held for sale upon funding are considered derivative instruments under the derivatives and hedging accounting guidance FASB ASC 815, Derivatives and Hedging. Loan commitments that are classified as derivatives are recognized at fair value on the balance sheet as other assets and other liabilities with changes in their fair values recorded as mortgage banking income and included in non-interest income in the statements of income. Outstanding IRLCs are subject to interest rate risk and related price risk during the period from the date of issuance through the date of loan funding, cancellation or expiration. Loan commitments generally range between 30 and 90 days; however, the borrower is not obligated to obtain the loan. Republic is subject to fallout risk related to IRLCs, which is realized if approved borrowers choose not to close on the loans within the terms of the IRLCs. Republic uses best efforts commitments to substantially eliminate these risks. The valuation of the IRLCs issued by Republic includes the value of the servicing released premium. Republic sells loans where the servicing is released, and the servicing released premium is included in the market price. See Note 10 Derivatives and Risk Management Activities for further detail of IRLCs.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Significant estimates are made by management in determining the allowance for loan losses, carrying values of other real estate owned, assessment of other than temporary impairment (“OTTI”) of investment securities, fair value of financial instruments, and the realization of deferred income tax assets. Consideration is given to a variety of factors in establishing these estimates.

 

In estimating the allowance for loan losses, management considers current economic conditions, past loss experience, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews and regulatory examinations, borrowers’ perceived financial and managerial strengths, the adequacy of underlying collateral, if collateral dependent, or present value of future cash flows, and other relevant and qualitative risk factors. Subsequent to foreclosure, an estimate for the carrying value of other real estate owned is normally determined through valuations that are periodically performed by management and the assets are carried at the lower of carrying amount or fair value, less the cost to sell. Because the allowance for loan losses and carrying value of other real estate owned are dependent, to a great extent, on the general economy and other conditions that may be beyond the Company’s and Republic’s control, the estimates of the allowance for loan losses and the carrying values of other real estate owned could differ materially in the near term.

 

In estimating OTTI of investment securities, securities are evaluated on at least a quarterly basis and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. To determine whether a loss in value is other-than-temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline, the intent to hold the security and the likelihood of the Company not being required to sell the security prior to an anticipated recovery in the fair value. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the portion of the decline related to credit impairment is charged to earnings.

 

In evaluating the Company’s ability to recover deferred tax assets, management considers all available positive and negative evidence, including the past operating results and forecasts of future taxable income. In determining future taxable income, management makes assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require management to make judgments about the future taxable income and are consistent with the plans and estimates used to manage the business. A material reduction in estimated future taxable income may require management to record a valuation allowance against the deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on future earnings.

 

7

 

 

 Stock-Based Compensation

 

The Company has a Stock Option and Restricted Stock Plan (“the 2005 Plan”), under which the Company granted options, restricted stock or stock appreciation rights to the Company’s employees, directors, and certain consultants. The 2005 Plan became effective on November 14, 1995, and was amended and approved at the Company’s 2005 annual meeting of shareholders. Under the terms of the 2005 Plan, 1.5 million shares of common stock, plus an annual increase equal to the number of shares needed to restore the maximum number of shares that could be available for grant under the 2005 Plan to 1.5 million shares, were available for such grants. As of September 30, 2019, the only grants under the 2005 Plan were option grants. The 2005 Plan provided that the exercise price of each option granted equaled the market price of the Company’s stock on the date of the grant. Options granted pursuant to the 2005 Plan vest within one to four years and have a maximum term of 10 years. The 2005 Plan terminated on November 14, 2015 in accordance with the terms and conditions specified in the Plan agreement.

 

On April 29, 2014 the Company’s shareholders approved the 2014 Republic First Bancorp, Inc. Equity Incentive Plan (the “2014 Plan”), under which the Company may grant options, restricted stock, stock units, or stock appreciation rights to the Company’s employees, directors, independent contractors, and consultants. Under the terms of the 2014 Plan, 2.6 million shares of common stock, plus an annual adjustment to be no less than 10% of the outstanding shares or such lower number as the Board of Directors may determine, are available for such grants. At September 30, 2019, the maximum number of common shares issuable under the 2014 Plan was 6.3 million shares. During the nine months ended September 30, 2019, 1.3 million options were granted under the 2014 Plan with a fair value of $2,900,495.

 

The Company utilizes the Black-Scholes option pricing model to calculate the estimated fair value of each stock option granted on the date of the grant. A summary of the assumptions used in the Black-Scholes option pricing model for 2019 and 2018 are as follows:

 

   

2019

 

2018

Dividend yield(1)

  0.0%   0.0%

Expected volatility(2)

  28.81%   28.22%

Risk-free interest rate(3)

  1.42% to 2.78%   2.35% to 2.96%

Expected life(4) (years)

  6.25   6.25

Assumed forfeiture rate(5)

  4.0%   4.0%

 

(1) A dividend yield of 0.0% is utilized because cash dividends have never been paid.

(2) The expected volatility was based on the historical volatility of the Company’s common stock price as adjusted for certain historical periods of extraordinary volatility in order to provide a basis for a reasonable estimate of fair value.

(3) The risk-free interest rate is based on the five to seven year Treasury bond.

(4) The expected life reflects a 1 to 4 year vesting period, the maximum ten year term and review of historical behavior.

(5) Forfeiture rate is determined through forfeited and expired options as a percentage of options granted over the current three year period.

 

During the nine months ended September 30, 2019 and 2018, 842,898 shares and 753,864 shares vested, respectively. Expense is recognized ratably over the period required to vest. At September 30, 2019, the intrinsic value of the 5,007,725 options outstanding was $780,000, while the intrinsic value of the 2,645,960 exercisable (vested) options was $753,000. At September 30, 2018, the intrinsic value of the 3,841,275 options outstanding was $6.7 million, while the intrinsic value of the 1,905,112 exercisable (vested) options was $5.4 million. During the nine months ended September 30, 2019, 53,550 options were exercised resulting in cash receipts of $261,143 and 142,875 options were forfeited with a weighted average grant date fair value of $381,811. During the nine months ended September 30, 2018, 174,225 options were exercised resulting in cash receipts of $668,194 and 70,125 options were forfeited with a weighted average grant date fair value of $215,201.

 

Information regarding stock based compensation for the nine months ended September 30, 2019 and 2018 is set forth below:

 

   

2019

   

2018

 

Stock based compensation expense recognized

  $ 2,005,000     $ 1,584,000  

Number of unvested stock options

    2,361,765       1,936,163  

Fair value of unvested stock options

  $ 6,095,468     $ 5,499,104  

Amount remaining to be recognized as expense

  $ 4,183,148     $ 3,886,278  

 

The remaining unrecognized expense amount of $4,183,148 will be recognized ratably as expense through August 2023.

 

8

 

 

Earnings per Share

 

Earnings per share (“EPS”) consists of two separate components: basic EPS and diluted EPS. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding for each period presented. Diluted EPS is calculated by dividing net income by the weighted average number of common shares outstanding plus dilutive common stock equivalents (“CSEs”). CSEs consist of dilutive stock options granted through the Company’s stock option plans for the nine months ended September 30, 2019 and September 30, 2018.

 

The calculation of EPS for the three and nine months ended September 30, 2019 and 2018 is as follows (in thousands, except per share amounts):

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2019

   

2018

   

2019

   

2018

 
                                 

Net income (loss) -basic and diluted

  $ (1,822 )   $ 2,322     $ (1,015 )   $ 6,470  
                                 

Weighted average shares outstanding

    58,843       58,774       58,830       58,213  
                                 

Net income (loss) per share – basic

  $ (0.03 )   $ 0.04     $ (0.02 )   $ 0.11  
                                 

Weighted average shares outstanding (including dilutive CSEs)

    58,843       59,774       58,830       59,338  
                                 

Net income (loss) per share – diluted

  $ (0.03 )   $ 0.04     $ (0.02 )   $ 0.11  

 

The following is a summary of securities that could potentially dilute basic earnings per common share in future periods. These securities were not included in the computation of diluted earnings per common share because the effect would have been anti-dilutive for the periods presented.

 

(in thousands)

 

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2019

   

2018

   

2019

   

2018

 
                                 

Anti-dilutive securities

                               
                                 

Share based compensation awards

    -       2,845       -       2,720  

 

Recent Accounting Pronouncements

 

ASU 2014-09

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 660): Summary and Amendments that Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs – Contracts with Customers (Subtopic 340-40).” ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The guidance in this update supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance throughout the industry topics of the codification. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with The Company (Topic 606): Deferral of the Effective Date. The guidance in this ASU is now effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The Company’s revenue is comprised of net interest income and non-interest income. The scope of the guidance explicitly excludes interest income as well as many other revenues for financial assets and liabilities including revenue derived from loans, investment securities, and derivatives. This ASU was effective for the Company on January 1, 2018. The Company adopted this ASU on a modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary. The adoption of this ASU did not have a material impact to its financial condition, results of operations, and consolidated financial statements. Refer to Note 11: Revenue Recognition for further disclosure as to the impact of Topic 606.

 

9

 

 

ASU 2016-01

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall. The guidance in this ASU among other things, (1) requires equity investments with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (3) eliminates the requirement for public businesses entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (4) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (5) requires an entity to present separately in other comprehensive income the portion of the change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (6) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (7) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities. The guidance in this ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The guidance was effective for the Company on January 1, 2018 and was adopted using a modified retrospective approach. The adoption of ASU No. 2016-01 on January 1, 2018 did not have a material impact on the Company’s Consolidated Financial Statements. In accordance with (4) above, the Company measured the fair value of its loan portfolio as of December 31, 2018 using an exit price notion (see Note 7 Fair Value of Financial Instruments).

 

ASU 2016-02

 

In February 2016, the FASB issued ASU No. 2016-02, Leases. From the Company’s perspective, the new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases are classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for lessees. From the landlord perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease is treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing. If the lessor doesn’t convey risks and rewards or control, an operating lease results. The new standard was effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  

 

In July 2018, the FASB issued ASU 2018-11 “Leases (Topic 842): Targeted Improvements,” which provided lessees the option to apply the new leasing standard to all open leases as of the adoption date. Prior to this ASU issuance, a modified retrospective transition approach was required.

 

In December 2018, the FASB issued ASU 2018-20 "Leases (Topic 842): Narrow-Scope Improvements for Lessors," which provided lessors a policy election to not evaluate whether certain sales taxes and other similar taxes are lessor costs or lessee costs. Additionally, the update requires certain lessors to exclude from variable payments lessor costs paid by lessees directly to third parties.

 

The Company adopted this ASU on January 1, 2019. The Company recognized an ROU asset of $34.2 million and total operating lease liability obligations of $35.1 million at January 1, 2019. Capital ratios remained in compliance with the regulatory definition of well capitalized. There were no material changes to the recognition of operating lease expense in the consolidated statements of income. The Company adopted certain practical expedients available under the new guidance, which did not require it to (1) reassess whether any expired or existing contracts contain leases, (2) reassess the lease classification for any expired or existing leases, (3) reassess initial direct costs for any existing leases, and (4) evaluate whether certain sales taxes and other similar taxes are lessor costs. The Company elected the use-of-hindsight practical expedient. Additionally, the Company elected to apply the new lease guidance at the adoption date, rather than at the beginning of the earliest period presented.

 

ASU 2016-13

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The Company is currently evaluating the impact of this ASU, continuing its implementation efforts and reviewing the loss modeling requirements consistent with lifetime expected loss estimates. Calculations of expected losses under the new guidance are currently being run parallel to the calculations under existing guidance to assess and evaluate the potential impact to the Company’s financial statements. The Company expects that the new model will include different assumptions used in calculating credit losses, such as estimating losses over the estimated life of a financial asset and will consider expected future changes in macroeconomic conditions. The adoption of this ASU may result in an increase to the Company's allowance for loan losses which will depend upon the nature and characteristics of the Company's loan portfolio at the adoption date, as well as the macroeconomic conditions and forecasts at that date. For the Company, this update will be effective for interim and annual periods beginning after December 15, 2019.

 

ASU 2016-15

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). The ASU addresses classification of certain cash receipts and cash payments in the statement of cash flows. The new guidance was adopted on January 1, 2018, on a retrospective basis. The adoption of 2016-15 did not result any changes in classifications in the Consolidated Statement of Cash Flows.

 

10

 

 

ASU 2017-01

 

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805). The ASU clarifies the definition of a business in ASC 805. The FASB issued the ASU in response to stakeholder feedback that the definition of a business in ASC 805 is being applied too broadly. In addition, stakeholders said that analyzing transactions under the current definition is difficult and costly. Concerns about the definition of a business were among the primary issues raised in connection with the Financial Accounting Foundation’s post-implementation review report on FASB Statement No. 141(R), Business Combinations (codified in ASC 805). The amendments in the ASU are intended to make application of the guidance more consistent and cost-efficient. The ASU is effective for public business entities in annual periods beginning after December 15, 2017, including interim periods therein. For all other entities, the ASU is effective in annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019. The ASU must be applied prospectively on or after the effective date, and no disclosures for a change in accounting principle are required at transition. Early adoption is permitted for transactions (i.e., acquisitions or dispositions) that occurred before the issuance date or effective date of the standard if the transactions were not reported in financial statements that have been issued or made available for issuance. Unless the Company enters into a business combination, the impact of the ASU will not have a material impact on the consolidated financial statements.

 

ASU 2017-04

 

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test For Goodwill Impairment. The ASU simplifies the accounting for goodwill impairments by eliminating step 2 from the goodwill impairment test. Instead, if “the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.” For public business entities that are SEC filers, the ASU is effective for annual and any interim impairment tests for periods beginning after December 15, 2019. The Company early adopted this ASU on July 1, 2018 using the simplified method. The adoption of ASU 2017-04 did not have a material impact on the consolidated financial statements.

 

ASU 2017-08

 

In March 2017, the FASB issued ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities, which amends the amortization period for certain purchased callable debt securities held at a premium, shortening such period to the earliest call date. The ASU is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Earlier application is permitted for all entities, including adoption in an interim period. If an entity early adopts the ASU in an interim period, any adjustments must be reflected as of the beginning of the fiscal year that includes that interim period. The adoption of ASU 2017-08 did not have a material impact on the consolidated financial statements.

 

ASU 2017-09

 

In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation: Scope of Modification Accounting, which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification in ASC 718. The ASU also provides that modification accounting is only required if the fair value, vesting conditions, or the classification of the award as equity or a liability changes as a result of the change in terms or conditions. The amendments in this ASU are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for (1) public business entities for reporting periods for which financial statements have not yet been issued and (2) all other entities for reporting periods for which financial statements have not yet been made available for issuance. The ASU became effective January 1, 2018 on a prospective basis for awards modified on or after the adoption date. The adoption of ASU-2017-09 did not have a material impact on the consolidated financial statements.

 

11

 

 

ASU 2018-02

 

In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows for reclassification from accumulated other comprehensive income (loss) to retained earnings for stranded tax effects resulting from the 2017 Tax Cuts and Jobs Act described in the "Income Taxes" section below. The amount of the reclassification should include the effect of the change in the federal corporate income tax rate related to items remaining in accumulated other comprehensive income (loss). The ASU would require an entity to disclose whether it elects to reclassify stranded tax effects from accumulated other comprehensive income (loss) to retained earnings in the period of adoption and, more generally, a description of the accounting policy for releasing income tax effects from accumulated other comprehensive income (loss). The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption of the amendments in this update is permitted for periods for which financial statements have not yet been issued or made available for issuance, including in the period the Act was enacted. The Company adopted this ASU on January 1, 2018, by recording the reclassification adjustment to its beginning retained earnings in the amount of $1.6 million. The Company utilized the portfolio approach when releasing tax effects from AOCI for its investment securities.

 

ASU 2018-03

 

In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10). The ASU was issued to clarify certain aspects of ASU 2016-01 such as treatment for discontinuations and adjustments for equity securities without a readily determinable market value, forward contracts and purchased options, presentation requirements for certain fair value option liabilities, fair value option liabilities denominated in a foreign currency, and transition guidance for equity securities without a readily determinable fair value. The Company adopted this ASU on January 1, 2018. The adoption of this ASU did not have a significant impact on the Company’s financial condition, results of operations and consolidated financial statements.

 

ASU 2018-07

 

In June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 718). The ASU simplifies the accounting for share based payments granted to non-employees for goods and services. The ASU applies to all share based payment transactions in which a grantor acquires goods or services from non-employees to be used or consumed in a grantor’s own operations by issuing share based payment awards. With the amended guidance from ASU 2018-07, non-employees share based payments are measured with an estimate of the fair value of the equity of the business is obligated to issue at the grant date (the date that the business and the stock award recipient agree to the terms of the award). Compensation would be recognized in the same period and in the same manner as if the entity had paid cash for goods and services instead of stock. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The Company adopted this ASU on January 1, 2019. The adoption of this ASU did not have a significant impact on the Company’s financial condition, results of operations, and consolidated financial statements.

 

 

Note 3: Legal Proceedings

 

The Company and Republic are from time to time parties (plaintiff or defendant) to lawsuits in the normal course of business. While any litigation involves an element of uncertainty, management is of the opinion that the liability of the Company and Republic, if any, resulting from such actions will not have a material effect on the financial condition or results of operations of the Company and Republic.

 

 

Note 4: Segment Reporting

 

The Company has one reportable segment: community banking. The community banking segment primarily encompasses the commercial loan and deposit activities of Republic, as well as, residential mortgage and consumer loan products in the area surrounding its stores. Mortgage loans in Delaware and Florida are primarily made to local customers that have second homes (vacation) in Delaware and Florida. We do not have loan production offices in those states.

 

12

 

 

 

Note 5: Investment Securities

 

A summary of the amortized cost and market value of securities available for sale and securities held to maturity at September 30, 2019 and December 31, 2018 is as follows:

 

   

At September 30, 2019

 

(dollars in thousands)

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair

Value

 
                                 

U.S. Government agencies

  $ 29,404     $ 16     $ -     $ 29,420  

Collateralized mortgage obligations

    254,439       2,641       (691 )     256,389  

Agency mortgage-backed securities

    23,889       93       (81 )     23,901  

Municipal securities

    4,065       17       -       4,082  

Corporate bonds

    69,499       9       (3,338 )     66,170  

Total securities available for sale

  $ 381,296     $ 2,776     $ (4,110 )   $ 379,962  
                                 

U.S. Government agencies

  $ 98,481     $ 1,192     $ (97 )   $ 99,576  

Collateralized mortgage obligations

    448,807       9,962       (620 )     458,149  

Agency mortgage-backed securities

    140,137       1,768       (576 )     141,329  

Total securities held to maturity

  $ 687,425     $ 12,922     $ (1,293 )   $ 699,054  

 

   

At December 31, 2018

 

(dollars in thousands)

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair

Value

 
                                 

Collateralized mortgage obligations

  $ 197,812     $ 567     $ (2,120 )   $ 196,259  

Agency mortgage-backed securities

    39,105       5       (611 )     38,499  

Municipal securities

    20,807       64       (232 )     20,639  

Corporate bonds

    62,583       87       (3,396 )     59,274  

Asset-backed securities

    6,433       -       (90 )     6,343  

Total securities available for sale

  $ 326,740     $ 723     $ (6,449 )   $ 321,014  
                                 

U.S. Government agencies

  $ 107,390     $ -     $ (3,772 )   $ 103,618  

Collateralized mortgage obligations

    500,690       570       (5,793 )     495,467  

Agency mortgage-backed securities

    153,483       -       (5,245 )     148,238  

Total securities held to maturity

  $ 761,563     $ 570     $ (14,810 )   $ 747,323  

 

The following table presents investment securities by stated maturity at September 30, 2019. Collateralized mortgage obligations and agency mortgage-backed securities have expected maturities that differ from contractual maturities because borrowers have the right to call or prepay with or without prepayment penalties and, therefore, these securities are classified separately with no specific maturity date.

 

   

Available for Sale

   

Held to Maturity

 

 

(dollars in thousands)

 

Amortized

Cost

   

Fair

Value

   

Amortized

Cost

   

Fair

Value

 

Due in 1 year or less

  $ 3,439     $ 3,448     $ -     $ -  

After 1 year to 5 years

    20,839       20,855       11,487       11,617  

After 5 years to 10 years

    75,690       72,478       86,994       87,959  

After 10 years

    3,000       2,891       -       -  

Collateralized mortgage obligations

    254,439       256,389       448,807       458,149  

Agency mortgage-backed securities

    23,889       23,901       140,137       141,329  

Total

  $ 381,296     $ 379,962     $ 687,425     $ 699,054  

 

The Company’s investment securities portfolio consists primarily of debt securities issued by U.S. government agencies, U.S. government-sponsored agencies, state governments, local municipalities and certain corporate entities. There were no private label mortgage-backed securities (“MBS”) or collateralized mortgage obligations (“CMO”) held in the investment securities portfolio as of September 30, 2019 and December 31, 2018. There were also no MBS or CMO securities that were rated “Alt-A” or “sub-prime” as of those dates.

 

       The fair value of investment securities is impacted by interest rates, credit spreads, market volatility and liquidity conditions. Net unrealized gains and losses in the available for sale portfolio are included in shareholders’ equity as a component of accumulated other comprehensive income or loss, net of tax. Securities classified as held to maturity are carried at amortized cost. An unrealized loss exists when the current fair value of an individual security is less than the amortized cost basis.

 

13

 

 

The Company regularly evaluates investment securities that are in an unrealized loss position in order to determine if the decline in fair value is other than temporary. Factors considered in the evaluation include the current economic climate, the length of time and the extent to which the fair value has been below cost, the current interest rate environment and the rating of each security. An OTTI loss must be recognized for a debt security in an unrealized loss position if the Company intends to sell the security or it is more likely than not that it will be required to sell the security prior to recovery of the amortized cost basis. The amount of OTTI loss recognized is equal to the difference between the fair value and the amortized cost basis of the security that is attributed to credit deterioration. Accounting standards require the evaluation of the expected cash flows to be received to determine if a credit loss has occurred. In the event of a credit loss, that amount must be recognized against income in the current period. The portion of the unrealized loss related to other factors, such as liquidity conditions in the market or the current interest rate environment, is recorded in accumulated other comprehensive income (loss) for investment securities classified available for sale.

 

There were no impairment charges (credit losses) on any securities held in the portfolio for the three and nine months ended September 30, 2019 and September 30, 2018.

 

The following table presents a roll-forward of the balance of credit-related impairment losses on securities held at September 30, 2019 and 2018 for which a portion of OTTI was recognized in other comprehensive income:

 

(dollars in thousands)

 

2019

   

2018

 

Beginning Balance, January 1st

  $ -     $ 274  

Additional credit-related impairment loss on securities for which an other-than-temporary impairment was previously recognized

    -       -  

Reductions for securities sold during the period

    -       -  

Ending Balance, September 30th

  $ -     $ 274  

 

The following tables show the fair value and gross unrealized losses associated with the investment portfolio, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position in the available for sale and held to maturity section:

 

   

At September 30, 2019

 
   

Less than 12 months

   

12 months or more

   

Total

 

(dollars in thousands)

 

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

 

Collateralized mortgage obligations

  $ 55,237     $ 623     $ 9,339     $ 68     $ 64,576     $ 691  

Agency mortgage-backed securities

    2,716       8       8,742       73       11,458       81  

Corporate bonds

    11,390       110       51,772       3,228       63,162       3,338  

Total Available for Sale

  $ 69,343     $ 741     $ 69,853     $ 3,369     $ 139,196     $ 4,110  

 

   

At September 30, 2019

 
   

Less than 12 months

   

12 months or more

   

Total

 

(dollars in thousands)

 

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

 

U.S. Government agencies

  $ 13,938     $ 70     $ 3,750     $ 27     $ 17,688     $ 97  

Collateralized mortgage obligations

    2,575       11       68,023       609       70,598       620  

Agency mortgage-backed securities

    -       -       69,551       576       69,551       576  

Total Held to Maturity

  $ 16,513     $ 81     $ 141,324     $ 1,212     $ 157,837     $ 1,293  

 

   

At December 31, 2018

 
   

Less than 12 months

   

12 months or more

   

Total

 

(dollars in thousands)

 

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

 

Collateralized mortgage obligations

  $ 58,883     $ 270     $ 83,377     $ 1,850     $ 142,260     $ 2,120  

Agency mortgage-backed securities

    1,134       10       16,768       601       17,902       611  

Municipal securities

    1,549       7       12,154       225       13,703       232  

Corporate bonds

    -       -       53,189       3,396       53,189       3,396  

Asset backed securities

    6,343       90       -       -       6,343       90  

Total Available for Sale

  $ 67,909     $ 377     $ 165,488     $ 6,072     $ 233,397     $ 6,449  

 

   

At December 31, 2018

 
   

Less than 12 months

   

12 months or more

   

Total

 

(dollars in thousands)

 

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

 

U.S. Government agencies

  $ 5,351     $ 26     $ 98,267     $ 3,746     $ 103,618     $ 3,772  

Collateralized mortgage obligations

    44,574       475       173,467       5,318       218,041       5,793  

Agency mortgage-backed securities

    -       -       119,243       5,245       119,243       5,245  

Total Held to Maturity

  $ 49,925     $ 501     $ 390,977     $ 14,309     $ 440,902     $ 14,810  

 

 

 

 

Unrealized losses on securities in the investment portfolio amounted to $5.4 million with a total fair value of $297.0 million as of September 30, 2019 compared to unrealized losses of $21.3 million with a total fair value of $674.3 million as of December 31, 2018. The Company believes the unrealized losses presented in the tables above are temporary in nature and primarily related to market interest rates or limited trading activity in particular type of security rather than the underlying credit quality of the issuers. The Company does not believe that these losses are other than temporary and does not currently intend to sell or believe it will be required to sell securities in an unrealized loss position prior to maturity or recovery of the amortized cost bases.

 

The Company held four U.S. Government agency securities, twenty-nine collateralized mortgage obligations and seventeen agency mortgage-backed securities that were in an unrealized loss position at September 30, 2019. Principal and interest payments of the underlying collateral for each of these securities are backed by U.S. Government sponsored agencies and carry minimal credit risk. Management found no evidence of OTTI on any of these securities and believes the unrealized losses are due to fluctuations in fair values resulting from changes in market interest rates and are considered temporary as of September 30, 2019.

 

All municipal securities held in the investment portfolio are reviewed on least a quarterly basis for impairment. Each bond carries an investment grade rating by either Moody’s or Standard & Poor’s. In addition, the Company periodically conducts its own independent review on each issuer to ensure the financial stability of the municipal entity. The largest geographic concentration was in Pennsylvania and New Jersey and consisted of either general obligation or revenue bonds backed by the taxing power of the issuing municipality. At September 30, 2019, the investment portfolio included no municipal securities that were in an unrealized loss position.

 

At September 30, 2019, the investment portfolio included eight corporate bonds that were in an unrealized loss position. Management believes the unrealized losses on these securities were also driven by changes in market interest rates and not a result of credit deterioration.

 

       The unrealized loss on the trust preferred security at September 30, 2018 was primarily the result of the secondary market becoming inactive for such a security and was considered temporary at that time. During 2018, management received several inquiries regarding the availability of the remaining trust preferred CDO security and noted an increased level of trading in this type of security. As a result of the increased activity and the level of bids received, management elected to sell the remaining CDO security in December 2018.

 

Proceeds associated with the sale of securities available for sale during the three months ended September 30, 2019 were $11.5 million. The tax provision applicable to the net gains of $520,000 for the three months ended September 30, 2019 amounted to $132,000. Proceeds associated with the sale of securities available for sale during the nine months ended September 30, 2019 were $54.7 million. Gross gains of $1.2 million and gross losses of $67,000 were realized on these sales. The tax provision applicable to the net gains of $1.1 million for the nine months ended September 30, 2019 amounted to $280,000. 

 

There were no proceeds from the sale of investments securities for the three months ended September 30, 2018. During the nine months ended September 30, 2018, the proceeds from the sale of investment securities were $5.7 million. A gross loss of $1,000 was realized on the sale of investment securities for the nine months ended September 30, 2018.

 

 

Note 6: Loans Receivable and Allowance for Loan Losses

 

      The following table sets forth the Company’s gross loans by major category as of September 30, 2019 and December 31, 2018:

 

 

(dollars in thousands)

 

September 30,

2019

   

December 31,

2018

 
                 

Commercial real estate

  $ 570,327     $ 515,738  

Construction and land development

    109,582       121,042  

Commercial and industrial

    187,837       200,423  

Owner occupied real estate

    397,843       367,895  

Consumer and other

    98,034       91,152  

Residential mortgage

    205,498       140,364  

Total loans receivable

    1,569,121       1,436,614  

Deferred costs (fees)

    259       (16 )

Allowance for loan losses

    (8,467 )     (8,615 )

Net loans receivable

  $ 1,560,913     $ 1,427,983  

 

15

 

 

The Company disaggregates its loan portfolio into groups of loans with similar risk characteristics for purposes of estimating the allowance for loan losses. The Company’s loan groups include commercial real estate, construction and land development, commercial and industrial, owner occupied real estate, consumer, and residential mortgages. The loan groups are also considered classes for purposes of monitoring and assessing credit quality based on certain risk characteristics.

 

The following tables provide the activity in and ending balances of the allowance for loan losses by loan portfolio class at and for the three months ended September 30, 2019 and 2018:

 

(dollars in thousands)

 

Commercial

Real Estate

   

Construction

and Land

Development

   

Commercial

and Industrial

   

Owner

Occupied

Real Estate

   

Consumer

and Other

   

Residential Mortgage

   

Unallocated

   

Total

 
                                                                 

Three months ended September 30, 2019

                                                               

Allowance for loan losses:

                                                               
                                                                 

Beginning balance:

  $ 2,673     $ 631     $ 875     $ 2,158     $ 562     $ 1,124     $ 33     $ 8,056  

Charge-offs

    -       -       (72 )     -       (29 )     -       -       (101 )

Recoveries

    -       -       59       1       2       -       -       62  

Provisions (credits)

    198       (10 )     (79 )     31       36       205       69       450  
                                                                 

Ending balance

  $ 2,871     $ 621     $ 783     $ 2,190     $ 571     $ 1,329     $ 102     $ 8,467  
                                                                 

Three months ended September 30, 2018

                                                               

Allowance for loan losses:

                                                               
                                                                 

Beginning balance:

  $ 2,039     $ 772     $ 1,449     $ 1,856     $ 509     $ 638     $ 303     $ 7,566  

Charge-offs

    -       -       -       -       (1 )     -       -       (1 )

Recoveries

    17       -       1       -       1       -       -       19  

Provisions (credits)

    202       34       193       156       38       103       (226 )     500  
                                                                 

Ending balance

  $ 2,258     $ 806     $ 1,643     $ 2,012     $ 547     $ 741     $ 77     $ 8,084  

 

The following tables provide the activity in and ending balances of the allowance for loan losses by loan portfolio class at and for the nine months ended September 30, 2019 and 2018:

 

(dollars in thousands)

 

Commercial

Real Estate

   

Construction

and Land

Development

   

Commercial

and Industrial

   

Owner

Occupied

Real Estate

   

Consumer

and Other

   

Residential

Mortgage

   

Unallocated

   

Total

 
                                                                 

Nine months ended September 30, 2019

                                                               

Allowance for loan losses:

                                                               
                                                                 

Beginning balance:

  $ 2,462     $ 777     $ 1,754     $ 2,033     $ 577     $ 894     $ 118     $ 8,615  

Charge-offs

    -       -       (1,002 )     -       (117 )     -       -       (1,119 )

Recoveries

    -       -       213       1       7       -       -       221  

Provisions (credits)

    409       (156 )     (182 )     156       104       435       (16 )     750  
                                                                 

Ending balance

  $ 2,871     $ 621     $ 783     $ 2,190     $ 571     $ 1,329     $ 102     $ 8,467  
                                                                 

Nine months ended September 30, 2018

                                                               

Allowance for loan losses:

                                                               
                                                                 

Beginning balance:

  $ 3,774     $ 725     $ 1,317     $ 1,737     $ 573     $ 392     $ 81     $ 8,599  

Charge-offs

    (1,535 )     -       (151 )     (465 )     (213 )     -       -       (2,364 )

Recoveries

    50       -       77       20       2       -       -       149  

Provisions (credits)

    (31 )     81       400       720       185       349       (4 )     1,700  
                                                                 

Ending balance

  $ 2,258     $ 806     $ 1,643     $ 2,012     $ 547     $ 741     $ 77     $ 8,084  

 

16

 

 

The following tables provide a summary of the allowance for loan losses and balance of loans receivable by loan class and by impairment method as of September 30, 2019 and December 31, 2018:

 

 

 

(dollars in thousands)

 

Commercial

Real Estate

   

Construction

and Land

Development

   

Commercial

and Industrial

   

Owner

Occupied

Real Estate

   

 

Consumer

and Other

   

Residential

Mortgage

   

Unallocated

   

Total

 
                                                                 

September 30, 2019

                                                               

Allowance for loan losses:

                                                               

Individually evaluated for impairment

  $ 262     $ -     $ 35     $ 291     $ -     $ -     $ -     $ 588  

Collectively evaluated for impairment

    2,609       621       748       1,899       571       1,329       102       7,879  

Total allowance for loan losses

  $ 2,871     $ 621     $ 783     $ 2,190     $ 571     $ 1,329     $ 102     $ 8,467  
                                                                 

Loans receivable:

                                                               

Loans evaluated individually

  $ 11,257     $ -     $ 3,608     $ 3,532     $ 961     $ 768     $ -     $ 20,126  

Loans evaluated collectively

    559,070       109,582       184,229       394,311       97,073       204,730       -       1,548,995  

Total loans receivable

  $ 570,327     $ 109,582     $ 187,837     $ 397,843     $ 98,034     $ 205,498     $ -     $ 1,569,121  

 

 

 

(dollars in thousands)

 

Commercial

Real Estate

   

Construction

and Land

Development

   

Commercial

and Industrial

   

Owner

Occupied

Real Estate

   

Consumer

and Other

   

Residential

Mortgage

   

Unallocated

   

Total

 
                                                                 

December 31, 2018

                                                               

Allowance for loan losses:

                                                               

Individually evaluated for impairment

  $ 295     $ -     $ 867     $ 217     $ 94     $ -     $ -     $ 1,473  

Collectively evaluated for impairment

    2,167       777       887       1,816       483       894       118       7,142  

Total allowance for loan losses

  $ 2,462     $ 777     $ 1,754     $ 2,033     $ 577     $ 894     $ 118     $ 8,615  
                                                                 

Loans receivable:

                                                               

Loans evaluated individually

  $ 10,947     $ -     $ 3,662     $ 2,560     $ 861     $ -     $ -     $ 18,030  

Loans evaluated collectively

    504,791       121,042       196,761       365,335       90,291       140,364       -       1,418,584  

Total loans receivable

  $ 515,738     $ 121,042     $ 200,423     $ 367,895     $ 91,152     $ 140,364     $ -     $ 1,436,614  

 

17

 

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan.  Impaired loans include nonperforming loans, but also include internally classified accruing loans.  The following table summarizes information with regard to impaired loans by loan portfolio class as of September 30, 2019 and December 31, 2018:

 

   

September 30, 2019

   

December 31, 2018

 

(dollars in thousands)

 

Recorded Investment

   

Unpaid Principal Balance

   

Related Allowance

   

Recorded Investment

   

Unpaid Principal Balance

   

Related Allowance

 

With no related allowance recorded:

                                               

Commercial real estate

  $ 7,243     $ 7,248     $ -     $ 6,332     $ 6,337     $ -  

Construction and land development

    -       -       -       -       -       -  

Commercial and industrial

    3,229       6,589       -       1,655       5,418       -  

Owner occupied real estate

    1,775       1,924       -       1,905       2,013       -  

Consumer and other

    961       1,256       -       710       1,082       -  

Residential mortgage

    768       768       -       -       -       -  

Total

  $ 13,976     $ 17,785     $ -     $ 10,602     $ 14,850     $ -  
                                                 

With an allowance recorded:

                                               

Commercial real estate

  $ 4,014     $ 4,536     $ 262     $ 4,615     $ 5,498     $ 295  

Construction and land development

    -       -       -       -       -       -  

Commercial and industrial

    379       394       35       2,007       2,195       867  

Owner occupied real estate

    1,757       1,757       291       655       704       217  

Consumer and other

    -       -       -       151       158       94  

Residential mortgage

    -       -       -       -       -       -  

Total

  $ 6,150     $ 6,687     $ 588     $ 7,428     $ 8,555     $ 1,473  
                                                 

Total:

                                               

Commercial real estate

  $ 11,257     $ 11,784     $ 262     $ 10,947     $ 11,835     $ 295  

Construction and land development

    -       -       -       -       -       -  

Commercial and industrial

    3,608       6,983       35       3,662       7,613       867  

Owner occupied real estate

    3,532       3,681       291       2,560       2,717       217  

Consumer and other

    961       1,256       -       861       1,240       94  

Residential mortgage

    768       768       -       -       -       -  

Total

  $ 20,126     $ 24,472     $ 588     $ 18,030     $ 23,405     $ 1,473  

 

18

 

 

The following table presents additional information regarding the Company’s impaired loans for the three months ended September 30, 2019 and September 30, 2018:

 

   

Three Months Ended September 30,

 
   

2019

   

2018

 

(dollars in thousands)

 

Average

Recorded

Investment

   

Interest

Income

Recognized

   

Average

Recorded

Investment

   

Interest

Income

Recognized

 

With no related allowance recorded:

                               

Commercial real estate

  $ 7,004     $ 80     $ 9,748     $ 72  

Construction and land development

    -       -       -       -  

Commercial and industrial

    2,821       19       2,566       12  

Owner occupied real estate

    1,801       12       2,255       15  

Consumer and other

    931       4       647       10  

Residential mortgage

    640       1       -       -  

Total

  $ 13,197     $ 116     $ 15,216     $ 109  
                                 
With an allowance recorded:                                

Commercial real estate

  $ 4,114     $ -     $ 3,976     $ -  

Construction and land development

    -       -       -       -  

Commercial and industrial

    572       -       1,948       1  

Owner occupied real estate

    1,492       12       905       6  

Consumer and other

    12       -       169       -  

Residential mortgage

    -       -       -       -  

Total

  $ 6,190     $ 12     $ 6,998     $ 7  
                                 
Total:                                

Commercial real estate

  $ 11,118     $ 80     $ 13,724     $ 72  

Construction and land development

    -       -       -       -  

Commercial and industrial

    3,393       19       4,514       13  

Owner occupied real estate

    3,293       24       3,160       21  

Consumer and other

    943       4       816       10  

Residential mortgage

    640       1       -       -  

Total

  $ 19,387     $ 128     $ 22,214     $ 116  

 

19

 

 

The following table presents additional information regarding the Company’s impaired loans for the nine months ended September 30, 2019 and September 30, 2018:

 

   

Nine Months Ended September 30,

 
   

2019

   

2018

 

(dollars in thousands)

 

Average

Recorded

Investment

   

Interest

Income

Recognized

   

Average

Recorded

Investment

   

Interest

Income

Recognized

 

With no related allowance recorded:

                               

Commercial real estate

  $ 6,532     $ 220     $ 11,454     $ 216  

Construction and land development

    -       -       -       -  

Commercial and industrial

    2,001       19       3,762       45  

Owner occupied real estate

    1,853       40       2,367       43  

Consumer and other

    871       12       645       12  

Residential mortgage

    384       2       -       -  

Total

  $ 11,641     $ 293     $ 18,228     $ 316  
                                 
With an allowance recorded:                                

Commercial real estate

  $ 4,314     $ -     $ 2,692     $ -  

Construction and land development

    -       -       -       -  

Commercial and industrial

    956       -       1,826       4  

Owner occupied real estate

    962       24       1,047       18  

Consumer and other

    38       -       201       1  

Residential mortgage

    -       -       -       -  

Total

  $ 6,270     $ 24     $ 5,766     $ 23  
                                 
Total:                                

Commercial real estate

  $ 10,846     $ 220     $ 14,146     $ 216  

Construction and land development

    -       -       -       -  

Commercial and industrial

    2,957       19       5,588       49  

Owner occupied real estate

    2,815       64       3,414       61  

Consumer and other

    909       12       846       13  

Residential mortgage

    384       2       -       -  

Total

  $ 17,911     $ 317     $ 23,994     $ 339  

 

The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the past due status as of September 30, 2019 and December 31, 2018:

 

 

 

 

(dollars in thousands)

 

30-59 Days

Past Due

   

60-89 Days

Past Due

   

Greater

than 90

Days

   

Total

Past Due

   

Current

   

Total

Loans

Receivable

   

Loans

Receivable >

90 Days and

Accruing

 

At September 30, 2019

                                                       

Commercial real estate

  $ 93     $ -     $ 4,269     $ 4,362     $ 565,965     $ 570,327     $ -  

Construction and land development

    -       -       -       -       109,582       109,582       -  

Commercial and industrial

    -       -       3,608       3,608       184,229       187,837       -  

Owner occupied real estate

    -       28       2,317       2,345       395,498       397,843       -  

Consumer and other

    83       9       1,090       1,182       96,852       98,034       129  

Residential mortgage

    -       -       768       768       204,730       205,498       -  

Total

  $ 176     $ 37     $ 12,052     $ 12,265     $ 1,556,856     $ 1,569,121     $ 129  

 

 

 

 

(dollars in thousands)

 

30-59 Days

Past Due

   

60-89 Days

Past Due

   

Greater

than 90

Days

   

Total

Past Due

   

Current

   

Total

Loans Receivable

   

Loans Receivable >

90 Days and Accruing

 

At December 31, 2018

                                                       

Commercial real estate

  $ 339     $ 921     $ 4,631     $ 5,891     $ 509,847     $ 515,738     $ -  

Construction and land development

    -       -       -       -       121,042       121,042       -  

Commercial and industrial

    280       -       3,661       3,941       196,482       200,423       -  

Owner occupied real estate

    -       653       1,188       1,841       366,054       367,895       -  

Consumer and other

    214       -       861       1,075       90,077       91,152       -  

Residential mortgage

    302       -       -       302       140,062       140,364       -  

Total

  $ 1,135     $ 1,574     $ 10,341     $ 13,050     $ 1,423,564     $ 1,436,614     $ -  

 

20

 

 

The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system as of September 30, 2019 and December 31, 2018:

 

 

(dollars in thousands)

 

 

Pass

   

 

Special Mention

   

 

Substandard

   

 

Doubtful

   

 

Total

 

At September 30, 2019:

                                       

Commercial real estate

  $ 565,187     $ 92     $ 5,048     $ -     $ 570,327  

Construction and land development

    109,582       -       -       -       109,582  

Commercial and industrial

    184,229       -       3,328       280       187,837  

Owner occupied real estate

    392,245       2,066       3,532       -       397,843  

Consumer and other

    97,073       -       961       -       98,034  

Residential mortgage

    204,608       122       768       -       205,498  

Total

  $ 1,552,924     $ 2,280     $ 13,637     $ 280     $ 1,569,121  

 

 

(dollars in thousands)

 

 

Pass

   

 

Special Mention

   

 

Substandard

   

 

Doubtful

   

 

Total

 

At December 31, 2018:

                                       

Commercial real estate

  $ 510,186     $ 921     $ 4,631     $ -     $ 515,738  

Construction and land development

    121,042       -       -       -       121,042  

Commercial and industrial

    196,751       10       3,382       280       200,423  

Owner occupied real estate

    364,032       1,303       2,560       -       367,895  

Consumer and other

    90,291       -       861       -       91,152  

Residential mortgage

    140,240       124       -       -       140,364  

Total

  $ 1,422,542     $ 2,358     $ 11,434     $ 280     $ 1,436,614  

 

The following table shows non-accrual loans by class as of September 30, 2019 and December 31, 2018:

 

(dollars in thousands)

 

September 30,

2019

   

December 31,

2018

 
                 

Commercial real estate

  $ 4,269     $ 4,631  

Construction and land development

    -       -  

Commercial and industrial

    3,608       3,661  

Owner occupied real estate

    2,317       1,188  

Consumer and other

    961       861  

Residential mortgage

    768       -  

Total

  $ 11,923     $ 10,341  

 

If these loans were performing under their original contractual rate, interest income on such loans would have increased approximately $145,000 and $378,000 for the three and nine months ended September 30, 2019, respectively, and $156,000 and $519,000 for the three and nine months ended September 30, 2018, respectively.    

 

21

 

 

Troubled Debt Restructurings

 

A modification to the contractual terms of a loan which results in a concession to a borrower that is experiencing financial difficulty is classified as a troubled debt restructuring (“TDR”). The concessions made in a TDR are those that would not otherwise be considered for a borrower or collateral with similar risk characteristics. A TDR is typically the result of efforts to minimize potential losses that may be incurred during loan workouts, foreclosure, or repossession of collateral at a time when collateral values are declining. Concessions include a reduction in interest rate below current market rates, a material extension of time to the loan term or amortization period, partial forgiveness of the outstanding principal balance, acceptance of interest only payments for a period of time, or a combination of any of these conditions.

 

The following table summarizes information with regard to outstanding troubled debt restructurings at September 30, 2019 and December 31, 2018:

 

 

(dollars in thousands)

 

Number

of Loans

   

Accrual

Status

   

Non-

Accrual

Status

   

Total

TDRs

 

September 30, 2019

                               

Commercial real estate

    1     $ 6,209     $ -     $ 6,209  

Construction and land development

    -       -       -       -  

Commercial and industrial

    -       -       -       -  

Owner occupied real estate

    -       -       -       -  

Consumer and other

    -       -       -       -  

Residential mortgage

    -       -       -       -  

Total

    1     $ 6,209     $ -     $ 6,209  
                                 

December 31, 2018

                               

Commercial real estate

    1     $ 6,316     $ -     $ 6,316  

Construction and land development

    -       -       -       -  

Commercial and industrial

    3       -       1,224       1,224  

Owner occupied real estate

    1       -       242       242  

Consumer and other

    -       -       -       -  

Residential mortgage

    -       -       -       -  

Total

    5     $ 6,316     $ 1,466     $ 7,782  

 

All TDRs are considered impaired and are therefore individually evaluated for impairment in the calculation of the allowance for loan losses. Some TDRs may not ultimately result in the full collection of principal and interest as restructured and could lead to potential incremental losses. These potential incremental losses would be factored into our estimate of the allowance for loan losses. The level of any subsequent defaults will likely be affected by future economic conditions.

 

There were no loan modifications made during the three and nine months ended September 30, 2019 that met the criteria of a TDR.

 

After a loan is determined to be a TDR, the Company continues to track its performance under the most recent restructured terms. There were no TDRs that subsequently defaulted during the three and nine months ended September 30, 2019. There were three TDRs that subsequently defaulted during the year ended December 31, 2018.

 

There was one residential mortgage in the process of foreclosure as of September 30, 2019. There were no residential mortgages in the process of foreclosure as of December 31, 2018. There was no other real estate owned relating to residential real estate at September 30, 2019 and December 31, 2018.

 

 

Note 7: Fair Value of Financial Instruments

 

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique.  Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated.  The estimated fair value amounts have been measured as of their respective year-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates.  As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year-end.

 

22

 

 

The Company follows the guidance issued under ASC 820, Fair Value Measurement, which defines fair value, establishes a framework for measuring fair value under GAAP, and identifies required disclosures on fair value measurements.

 

ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  The three levels of the fair value hierarchy under ASC 820 are as follows:

 

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

 

Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.

 

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported with little or no market activity).

 

An asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2019 and December 31, 2018 were as follows:

 

 

 

 

 

(dollars in thousands)

 

 

 

 

 

Total

   

(Level 1)

Quoted Prices

in Active

Markets for

Identical Assets

   

(Level 2)

Significant

Other

Observable

Inputs

   

 

(Level 3)

Significant

Unobservable

Inputs

 
                                 

September 30, 2019

                               

Assets:

                               
                                 

U.S. Government agencies

  $ 29,420     $ -     $ 29,420     $ -  

Collateralized mortgage obligations

    256,389       -       256,389       -  

Agency mortgage-backed securities

    23,901       -       23,901       -  

Municipal securities

    4,082       -       4,082       -  

Corporate bonds

    66,170       -       63,279       2,891  

Securities Available for Sale

  $ 379,962     $ -     $ 377,071     $ 2,891  
                                 

Mortgage Loans Held for Sale

  $ 18,734     $ -     $ 18,734     $ -  

SBA Servicing Assets

    4,504       -       -       4,504  

Interest Rate Lock Commitments

    506       -       506       -  

Best Efforts Forward Loan Sales Commitments

    43       -       43       -  

Mandatory Forward Loan Sales Commitments

    27       -       27       -  
                                 

Liabilities:

                               
                                 

Interest Rate Lock Commitments

    2       -       2       -  

Best Efforts Forward Loan Sales Commitments

    126       -       126       -  

Mandatory Forward Loan Sales Commitments

    79       -       79       -  
                                 

December 31, 2018

                               

Assets:

                               
                                 

Collateralized mortgage obligations

  $ 196,259     $ -     $ 196,259     $ -  

Agency mortgage-backed securities

    38,499       -       38,499       -  

Municipal securities

    20,639       -       20,639       -  

Corporate bonds

    59,274       -       56,205       3,069  

Asset-backed securities

    6,343       -       6,343       -  

Securities Available for Sale

  $ 321,014     $ -     $ 317,945     $ 3,069  
                                 

Mortgage Loans Held for Sale

  $ 20,887     $ -     $ 20,887     $ -  

SBA Servicing Assets

    4,785       -       -       4,785  

Interest Rate Lock Commitments

    410       -       410       -  

Best Efforts Forward Loan Sales Commitments

    5       -       5       -  

Mandatory Forward Loan Sales Commitments

    10       -       10       -  
                                 

Liabilities:

                               
                                 

Interest Rate Lock Commitments

    -       -       -       -  

Best Efforts Forward Loan Sales Commitments

    138       -       138       -  

Mandatory Forward Loan Sales Commitments

    230       -       230       -  

 

23

 

 

The following tables present an analysis of the activity in the SBA servicing assets for the three and nine months ended September 30, 2019 and 2018:

 

   

Three Months Ended

September 30,

 

(dollars in thousands)

 

2019

   

2018

 

Beginning balance, July 1st

  $ 4,593     $ 4,977  

Additions

    272       297  

Fair value adjustments

    (361 )     (419 )

Ending balance, September 30th

  $ 4,504     $ 4,855  

 

   

Nine Months Ended

September 30,

 

(dollars in thousands)

 

2019

   

2018

 

Beginning balance, January 1st

  $ 4,785     $ 5,243  

Additions

    825       864  

Fair value adjustments

    (1,106 )     (1,252 )

Ending balance, September 30th

  $ 4,504     $ 4,855  

 

Fair value adjustments are recorded as loan and servicing fees on the statement of income. Servicing fee income, not including fair value adjustments, totaled $498,000 and $486,000 for the three months ended September 30, 2019 and 2018, respectively. Servicing fee income, not including fair value adjustments, totaled $1.4 million and $1.5 million for the nine months ended September 30, 2019 and 2018, respectively. Total loans in the amount of $204.3 million at September 30, 2019 and $204.4 million at December 31, 2018 were serviced for others.

 

The following table presents a reconciliation of the securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2019 and 2018:

 

   

Three Months Ended

September 30, 2019

   

Three Months Ended

September 30, 2018

 

Level 3 Investments Only

(dollars in thousands)

 

Trust

Preferred

Securities

   

Corporate

Bonds

   

Trust

Preferred

Securities

   

Corporate

Bonds

 

Balance, July 1st

  $ -     $ 2,999     $ 547     $ 3,083  

Unrealized gains (losses)

    -       (108 )     -       102  

Proceeds from sales

    -       -       -       -  

Realized losses

    -       -       -       -  

Balance, September 30th

  $ -     $ 2,891     $ 547     $ 3,185  

 

   

Nine Months Ended

September 30, 2019

   

Nine Months Ended

September 30, 2018

 

Level 3 Investments Only

(dollars in thousands)

 

Trust

Preferred

Securities

   

Corporate

Bonds

   

Trust

Preferred

Securities

   

Corporate

Bonds

 

Balance, January 1st

  $ -     $ 3,069     $ 489     $ 3,086  

Unrealized gains (losses)

    -       (178 )     58       99  

Proceeds from sales

    -       -       -       -  

Realized losses

    -       -       -       -  

Balance, September 30th

  $ -     $ 2,891     $ 547     $ 3,185  

 

24

 

 

For assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2019 and December 31, 2018 were as follows:

 

 

 

(dollars in thousands)

 

 

 

 

 

Total

   

(Level 1)

Quoted Prices

in Active

Markets for

Identical Assets

   

(Level 2)

Significant

Other

Observable

Inputs

   

 

(Level 3)

Significant

Unobservable

Inputs

 

September 30, 2019

                               

Impaired loans

  $ 5,823     $ -     $ -     $ 5,823  

Other real estate owned

    5,726       -       -       5,726  
                                 

December 31, 2018

                               

Impaired loans

  $ 5,955     $ -     $ -     $ 5,955  

Other real estate owned

    1,114       -       -       1,114  

 

The table below presents additional quantitative information about Level 3 assets measured at fair value on a nonrecurring basis (dollars in thousands):

 

   

Quantitative Information about Level 3 Fair Value Measurements

Asset Description

 

Fair Value

 

Valuation Technique

 

Unobservable Input

 

Range

(Weighted Average)

September 30, 2019

                       

Corporate bonds

  $ 2,891  

Discounted Cash Flows

 

Discount Rate

 

(7.14%)

                         

SBA servicing assets

  $ 4,504  

Discounted Cash Flows

 

Conditional Prepayment Rate

 

(13.28%)

                         
              Discount Rate   (11.00%)
                         

Impaired loans

  $ 5,823  

Appraised Value of Collateral (1)

 

Liquidation expenses (2)

  9% - 20%

(12%) (3)

                         

Other real estate owned

  $ 5,726  

Appraised Value of Collateral (1)

 

Liquidation expenses (2)

  7% - 25%

(14%) (3)

                         
          Sales Price   Liquidation expenses (2)   (22%) (3)

December 31, 2018

                       

Corporate bonds

  $ 3,069  

Discounted Cash Flows

 

Discount Rate

 

(8.24%)

                         

SBA servicing assets

  $ 4,785  

Discounted Cash Flows

 

Conditional Prepayment Rate

 

(10.31%)

                         
              Discount Rate   (11.50%)
                         

Impaired loans

  $ 5,955  

Appraised Value of Collateral (1)

 

Liquidation expenses (2)

  11% - 24%

(13%) (3)

                         

Other real estate owned

  $ 1,114  

Appraised Value of Collateral (1)

 

Liquidation expenses (2)

 

(7%) (3)

 

(1)

Fair value is generally determined through independent appraisals of the underlying collateral, which include Level 3 inputs that are not identifiable.

(2)

Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.

(3)

The range and weighted average of qualitative factors such as economic conditions and estimated liquidation expenses are presented as a percent of the appraised value.

 

The significant unobservable inputs for impaired loans and other real estate owned are the appraised value or an agreed upon sales price. These values are adjusted for estimated costs to sell which are incremental direct costs to transact a sale such as broker commissions, legal fees, closing costs and title transfer fees. The costs must be considered essential to the sale and would not have been incurred if the decision to sell had not been made. The costs to sell are based on costs associated with the Company’s actual sales of other real estate owned which are assessed annually.

 

25

 

 

Fair Value Assumptions

 

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities.  Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.  The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at September 30, 2019 and December 31, 2018.

 

Investment Securities

 

The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.  For certain securities, which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3).  In the absence of such evidence, management’s best estimate is used.  Management’s best estimate consists of both internal and external support on certain Level 3 investments.  Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support fair values of certain Level 3 investments.

 

The types of instruments valued based on matrix pricing in active markets include all of the Company’s U.S. government and agency securities, corporate bonds, asset backed securities, and municipal obligations held in the investment securities portfolio. Such instruments are generally classified within Level 2 of the fair value hierarchy. As required by ASC 820-10, the Company does not adjust the matrix pricing for such instruments.

 

Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, and may be adjusted to reflect illiquidity and/or non-transferability, with such adjustment generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Subsequent to inception, management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows. Republic has one Level 3 investment classified as available for sale which is a single corporate bond.

 

The corporate bond included in Level 3 was transferred from Level 2 in 2010 and is not actively traded. Impairment would depend on the repayment ability of the underlying issuer, which is assessed through a detailed quarterly review of the issuer’s financial statements. The issuer is a “well capitalized” financial institution as defined by federal banking regulations and has demonstrated the ability to raise additional capital, when necessary, through the public capital markets. The fair value of this corporate bond is estimated by obtaining a price of a comparable floating rate debt instrument through Bloomberg.

 

26

 

 

Mortgage Loans Held for Sale (Carried at Fair Value)

 

The fair value of mortgage loans held for sale is determined by obtaining prices at which they could be sold in the principal market at the measurement date and are classified within Level 2 of the fair value hierarchy. Republic elected to adopt the fair value option for its mortgage loans held for sale portfolio in order to more accurately reflect their economic value. Interest income on loans held for sale, which totaled $142,000 and $398,000 for three and nine months ended September 30, 2019, respectively, and $389,000 and $914,000 for the three and nine months ended September 30, 2018, respectively, are included in interest and fees in the statements of income.

 

The following table reflects the difference between the carrying amount of mortgage loans held for sale, measured at fair value and the aggregate unpaid principal amount that Republic is contractually entitled to receive at maturity as of September 30, 2019 and December 31, 2018.

 

(dollars in thousands)

 

September 30,

2019

   

December 31,

2018

 
                 

Carrying Amount

  $ 18,734     $ 20,887  
                 

Aggregate Unpaid Principal Balance

  $ 18,203     $ 20,071  
                 

Excess Carrying Amount Over Aggregate Unpaid Principal Balance

  $ 531     $ 816  

 

Changes in the excess carrying amount over aggregate unpaid principal balance are recorded in the statement of income in mortgage banking income. Republic did not have any mortgage loans held for sale recorded at fair value that were 90 or more days past due and on non-accrual at September 30, 2019 and December 31, 2018.

 

Interest Rate Lock Commitments (“IRLC”)

 

The Company determines the value of IRLCs by comparing the market price to the price locked in with the customer, adding fees or points to be collected at closing, subtracting commissions to be paid at closing, and subtracting estimated remaining loan origination costs to the bank based on the processing status of the loan. The Company also considers pull-through as it determines the fair value of IRLCs. Factors that affect pull-through rates include the origination channel, current mortgage interest rates in the market versus the interest rate incorporated in the IRLC, the purpose of the mortgage (purchase versus financing), the stage of completion of the underlying application and underwriting process, and the time remaining until the IRLC expires. IRLCs are classified within Level 2 of the valuation hierarchy.

 

Best Efforts Forward Loan Sales Commitments

 

Best efforts forward loan sales commitments are classified within Level 2 of the valuation hierarchy. Best efforts forward loan sales commitments fix the forward sales price that will be realized upon the sale of mortgage loans into the secondary market. Best efforts forward loan sales commitments are entered into for loans at the time the borrower commitment is made. These best efforts forward loan sales commitments are valued using the committed price to the counterparty against the current market price of the interest rate lock commitment or mortgage loan held for sale.

 

27

 

 

Mandatory Forward Loan Sales Commitments

 

Fair values for mandatory forward loan sales commitments are based on fair values of the underlying mortgage loans and the probability of such commitments being exercised. Due to the observable inputs used by Republic, best efforts mandatory loan sales commitments are classified within Level 2 of the valuation hierarchy.

 

Impaired Loans (Carried at Lower of Cost or Fair Value)

 

Impaired loans are those that the Company has measured impairment based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements. The fair value consists of the loan balances less any valuation allowance. The valuation allowance amount is calculated as the difference between the recorded investment in a loan and the present value of expected future cash flows or it is calculated based on discounted collateral values if the loans are collateral dependent.

 

Other Real Estate Owned (Carried at Lower of Cost or Fair Value)

 

These assets are carried at the lower of cost or fair value. Fair value is determined through valuations periodically performed by third-party appraisers, and the real estate is carried at the lower of its carrying amount or fair value less estimated costs to sell. Any declines in the fair value of the real estate properties below the initial cost basis are recorded through a valuation expense. At September 30, 2019 and December 31, 2018, these assets are carried at current fair value and classified within Level 3 of the fair value hierarchy.

 

SBA Servicing Asset (Carried at Fair Value)

 

The SBA servicing asset is initially recorded when loans are sold and the servicing rights are retained and recorded on the balance sheet. An updated fair value is obtained from an independent third party on a quarterly basis and adjustments are presented as loan and servicing fees on the statement of income. The valuation begins with the projection of future cash flows for each asset based on their unique characteristics, the Company’s market-based assumptions for prepayment speeds and estimated losses and recoveries. The present value of the future cash flows are then calculated utilizing the Company’s market-based discount ratio assumptions. In all cases, the Company models expected payments for every loan for each quarterly period in order to create the most detailed cash flow stream possible.

 

The Company uses assumptions and estimates in determining the impairment of the SBA servicing asset. These assumptions include prepayment speeds and discount rates commensurate with the risks involved and comparable to assumptions used by participants to value and bid serving rights available for sale in the market. At September 30, 2019 and December 31, 2018, the sensitivity of the current fair value of the SBA loan servicing rights to immediate 10% and 20% adverse changes in key assumptions are included in the accompanying table.

 

(dollars in thousands)

 

September 30,

2019

   

December 31,

2018

 
                 

SBA Servicing Asset

               
                 

Fair Value of SBA Servicing Asset

  $ 4,504     $ 4,785  
                 

Composition of SBA Loans Serviced for Others

               

Fixed-rate SBA loans

    2 %     2 %

Adjustable-rate SBA loans

    98 %     98 %

Total

    100 %     100 %
                 

Weighted Average Remaining Term (years)

 

20.7

   

20.4

 
                 

Prepayment Speed

    13.28 %     10.31 %

Effect on fair value of a 10% increase

  $ (175 )   $ (170 )

Effect on fair value of a 20% increase

    (338 )     (330 )
                 

Weighted Average Discount Rate

    11.00 %     11.50 %

Effect on fair value of a 10% increase

  $ (160 )   $ (186 )

Effect on fair value of a 20% increase

    (309 )     (359 )

 

The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in value may not be linear. Also in this table, the effect of an adverse variation in a particular assumption on the value of the SBA servicing rights is calculated without changing any other assumption. While in reality, changes in one factor may magnify or counteract the effect of the change.

 

28

 

 

Off-Balance Sheet Financial Instruments (Disclosed at notional amounts)

 

Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing.

 

The estimated fair values of the Company’s financial instruments at September 30, 2019 were as follows.

 

   

Fair Value Measurements at September 30, 2019

 

 

(dollars in thousands)

 

Carrying

Amount

   

Fair

Value

   

Quoted Prices

in Active

Markets for

Identical Assets

(Level 1)

   

Significant

Other

Observable

Inputs

(Level 2)

   

Significant Unobservable Inputs

(Level 3)

 

Balance Sheet Data

                                       

Financial assets:

                                       

Cash and cash equivalents

  $ 201,477     $ 201,477     $ 201,477     $ -     $ -  

Investment securities available for sale

    379,962       379,962       -       377,071       2,891  

Investment securities held to maturity

    687,425       699,054       -       699,054       -  

Restricted stock

    2,371       2,371       -       2,371       -  

Loans held for sale

    21,210       21,210       -       18,734       2,476  

Loans receivable, net

    1,560,913       1,530,738       -       -       1,530,738  

SBA servicing assets

    4,504       4,504       -       -       4,504  

Accrued interest receivable

    9,277       9,277       -       9,277       -  

Interest rate lock commitments

    506       506       -       506       -  

Best efforts forward loan sales commitments

    43       43       -       43       -  

Mandatory forward loan sales commitments

    27       27       -       27       -  

Financial liabilities:

                                       

Deposits

                                       

Demand, savings and money market

  $ 2,522,829     $ 2,522,829     $ -     $ 2,522,829     $ -  

Time

    217,203       217,325       -       217,325       -  

Subordinated debt

    11,263       8,109       -       -       8,109  

Accrued interest payable

    1,655       1,655       -       1,655       -  

Interest rate lock commitments

    2       2       -       2       -  

Best efforts forward loan sales commitments

    126       126       -       126       -  

Mandatory forward loan sales commitments

    79       79       -       79       -  
                                         

Off-Balance Sheet Data

                                       

Commitments to extend credit

    -       -       -       -       -  

Standby letters-of-credit

    -       -       -       -       -  

 

29

 

 

The estimated fair values of the Company’s financial instruments at December 31, 2018 were as follows:

 

   

Fair Value Measurements at December 31, 2018

 
(dollars in thousands)  

Carrying

Amount

   

Fair

Value

   

Quoted Prices

in Active

Markets for I

dentical Assets

(Level 1)

   

Significant

Other

Observable

Inputs

(Level 2)

   

Significant Unobservable Inputs

(Level 3)

 
Balance Sheet Data                                        
Financial assets:                                        

Cash and cash equivalents

  $ 72,473     $ 72,473     $ 72,473     $ -     $ -  

Investment securities available for sale

    321,014       321,014       -       317,945       3,069  

Investment securities held to maturity

    761,563       747,323       -       747,323       -  

Restricted stock

    5,754       5,754       -       5,754       -  

Loans held for sale

    26,291       26,291       -       20,887       5,404  

Loans receivable, net

    1,427,983       1,410,945       -       -       1,410,945  

SBA servicing assets

    4,785       4,785       -       -       4,785  

Accrued interest receivable

    9,025       9,025       -       9,025       -  

Interest rate lock commitments

    410       410       -       410       -  

Best efforts forward loan sales commitments

    5       5       -       5       -  

Mandatory forward loan sales commitments

    10       10       -       10       -  

Financial liabilities:

                                       
                                         

Deposits

                                       

Demand, savings and money market

  $ 2,238,610     $ 2,238,610     $ -     $ 2,238,610     $ -  

Time

    154,257       152,989       -       152,989       -  

Subordinated debt

    11,259       8,279       -       -       8,279  

Accrued interest payable

    558       558       -       558       -  

Interest rate lock commitments

    -       -       -       -       -  

Best efforts forward loan sales commitments

    138       138       -       138       -  

Mandatory forward loan sales commitments

    230       230       -       230       -  
                                         

Off-Balance Sheet Data

                                       

Commitments to extend credit

    -       -       -       -       -  

Standby letters-of-credit

    -       -       -       -       -  

  

30

 

 

 

Note 8: Changes in Accumulated Other Comprehensive Income (Loss) By Component (1)

 

The following table presents the changes in accumulated other comprehensive loss by component for the nine months ended September 30, 2019 and 2018, and the year ended December 31, 2018.

 

   

 

Unrealized Gains

(Losses) on Available-

For-Sale Securities

   

Unrealized Holding

Losses on Securities

Transferred From

Available-For-Sale To

Held-To-Maturity

   

 

Total

 

(dollars in thousands)

                       

Balance January 1, 2019

  $ (4,736 )   $ (7,191 )   $ (11,927 )

Unrealized gain on securities

    4,456       -       4,456  

Amounts reclassified from accumulated other comprehensive income to net income (2)

    (894 )     841       (53 )

Net current-period other comprehensive income

    3,562       841       4,403  

Total change in accumulated other comprehensive income

    3,562       841       4,403  

Balance September 30, 2019

  $ (1,174 )   $ (6,350 )   $ (7,524 )
                         

Balance January 1, 2018

  $ (7,150 )   $ (359 )   $ (7,509 )

Reclassification due to the adoption of ASU 2018-02

    (1,562 )     (78 )     (1,640 )

Unrealized loss on securities

    (9,536 )     -       (9,536 )

Amounts reclassified from accumulated other comprehensive income to net income (2)

    1       83       84  

Net current-period other comprehensive income (loss)

    (9,535 )     83       (9,452 )

Total change in accumulated other comprehensive income (loss)

    (11,097 )     5       (11,092 )

Balance September 30, 2018

  $ (18,247 )   $ (354 )   $ (18,601 )
                         

Balance January 1, 2018

  $ (7,150 )   $ (359 )   $ (7,509 )

Reclassification due to the adoption of ASU 2018-02

    (1,562 )     (78 )     (1,640 )

Unrealized gain on securities

    3,927       -       3,927  

Net unrealized holding losses on securities transferred from available-for-sale to held-to-maturity

    -       (6,855 )     (6,855 )

Amounts reclassified from accumulated other comprehensive income to net income (2)

    49       101       150  

Net current-period other comprehensive income (loss)

    3,976       (6,754 )     (2,778 )

Total change in accumulated other comprehensive income (loss)

    2,414       (6,832 )     (4,418 )

Balance December 31, 2018

  $ (4,736 )   $ (7,191 )   $ (11,927 )

 

 

(1)

All amounts are net of tax. Amounts in parentheses indicate reductions to other comprehensive income.

 

(2)

Reclassification amounts are reported as gains on sales of investment securities, impairment losses, and amortization of net unrealized losses on the Consolidated Statement of Operations.

 

 

Note 9: Goodwill and Other Intangibles

 

The Company completed an annual impairment test for goodwill as of July 31, 2019. Future impairment testing will be conducted each year as of July 31, unless a triggering event occurs in the interim that would suggest impairment, in which case it would be tested as of the date of the triggering event. During the nine months ended September 30, 2019 and 2018, there was no goodwill impairment recorded. There can be no assurance that future impairment assessments or tests will not result in a charge to earnings.

 

The Company’s goodwill and intangible assets related to the acquisition of Oak Mortgage in July 2016 is detailed below:

 

   

Three Months Ended

September 30,

 

(dollars in thousands)

 

2019

   

2018

 

Balance, July 1st

  $ 5,011     $ 5,011  

Additions/Adjustments

    -       -  

Amortization

    -       -  

Balance, September 30th

  $ 5,011     $ 5,011  

Amortization Period (in years)

 

Indefinite

   

Indefinite

 

 

   

Nine Months Ended

September 30,

 

(dollars in thousands)

 

2019

   

2018

 

Balance, January 1st

  $ 5,011     $ 5,011  

Additions/Adjustments

    -       -  

Amortization

    -       -  

Balance, September 30th

  $ 5,011     $ 5,011  

Amortization Period (in years)

 

Indefinite

   

Indefinite

 

 

31

 

 

 

Note 10: Derivatives and Risk Management Activities

 

Republic did not have any derivative instruments designated as hedging instruments, or subject to master netting and collateral agreements for the nine months ended September 30, 2019 and September 30, 2018. The following table summarizes the amounts recorded in Republic’s statement of financial condition for derivatives not designated as hedging instruments as of September 30, 2019 and December 31, 2018 (in thousands):

 

 

September 30, 2019

Balance Sheet

Presentation

 

Fair

Value

   

Notional

Amount

 

Asset derivatives:

                 

IRLCs

Other Assets

  $ 506     $ 29,205  

Best efforts forward loan sales commitments

Other Assets

    43       10,622  

Mandatory forward loan sales commitments

Other Assets

    27       6,948  
                   

Liability derivatives:

                 

IRLCs

Other Liabilities

  $ 2     $ 810  

Best efforts forward loan sales commitments

Other Liabilities

    126       19,393  

Mandatory forward loan sales commitments

Other Liabilities

    79       11,132  

 

 

December 31, 2018

Balance Sheet

Presentation

 

Fair

Value

   

Notional

Amount

 

Asset derivatives:

                 

IRLCs

Other Assets

  $ 410     $ 16,966  

Best efforts forward loan sales commitments

Other Assets

    5       1,639  

Mandatory forward loan sales commitments

Other Assets

    10       865  
                   

Liability derivatives:

                 

IRLCs

Other Liabilities

  $ -     $ -  

Best efforts forward loan sales commitments

Other Liabilities

    138       15,327  

Mandatory forward loan sales commitments

Other Liabilities

    230       18,980  

 

32

 

 

The following tables summarize the amounts recorded in Republic’s statement of operations for derivative instruments not designated as hedging instruments for the three and nine months ended September 30, 2019 and 2018 (in thousands):

 

 

Statement of Operations

Presentation

 

Three Months Ended

September 30, 2019

Gain/(Loss)

   

Nine Months Ended

September 30, 2019

Gain/(Loss)

 

Asset derivatives:

                 

IRLCs

Mortgage banking income

  $ (201 )   $ 96  

Best efforts forward loan sales commitments

Mortgage banking income

    26       38  

Mandatory forward loan sales commitments

Mortgage banking income

    27       17  
                   

Liability derivatives:

                 

IRLCs

Mortgage banking income

  $ (2 )   $ (2 )

Best efforts forward loan sales commitments

Mortgage banking income

    81       12  

Mandatory forward loan sales commitments

Mortgage banking income

    148       151  

 

 

Statement of Operations

Presentation

 

Three Months Ended

September 30, 2018

Gain/(Loss)

   

Nine Months Ended

September 30, 2018

Gain/(Loss)

 
                   

Asset derivatives:

                 

IRLCs

Mortgage banking income

  $ (297 )   $ 54  

Best efforts forward loan sales commitments

Mortgage banking income

    7       3  

Mandatory forward loan sales commitments

Mortgage banking income

    13       -  
                   

Liability derivatives:

                 

IRLCs

Mortgage banking income

  $ 3     $ 1  

Best efforts forward loan sales commitments

Mortgage banking income

    120       3  

Mandatory forward loan sales commitments

Mortgage banking income

    198       92  

 

The fair value of Republic’s IRLCs, best efforts forward loan sales commitments, and mandatory forward loan sales commitments are based upon the estimated value of the underlying mortgage loan (determined consistent with “Loans Held for Sale”), adjusted for (1) estimated costs to complete and originate the loan, and (2) the estimated percentage of IRLCs that will result in a closed mortgage loan. The valuation of the IRLCs issued by Republic includes the value of the servicing released premium. Republic sells loans servicing released, and the servicing released premium is included in the market price.

 

33

 

 

 

Note 11: Revenue Recognition

 

On January 1, 2018, the Company adopted ASU 2014-09 “Revenue from Contracts with Customers(Topic 606) and all subsequent ASUs that modified Topic 606. As stated in Note 2 Summary of Significant Accounting Policies, the implementation of the new standard did not have a material impact on the measurement of recognition of revenue. Management determined that a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

 

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and investments. In addition, certain non-interest income streams such as gains on sales of residential mortgage and SBA loans, income associated with servicing assets, and loan fees, including residential mortgage originations to be sold and prepayment and late fees charged across all loan categories are also not in scope of the new guidance. Topic 606 is applicable to non-interest revenue streams such as service charges on deposit accounts. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Non-interest revenue streams in-scope of Topic 606 are discussed below.

 

Service Charges on Deposit Accounts

 

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), ATM fees, NSF fees, and other deposit related fees.

 

The Company’s performance obligation for account analysis fees and monthly services fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided, which is typically one month. Revenue is recognized at month end after the completion of the service period and payment for these service charges on deposit accounts is primarily received through a direct charge to customers’ accounts.

 

ATM fees, NSF fees, and other deposit related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and the related revenue recognized, at a point in time. Payment for these service charges are received immediately through a direct charge to customers’ accounts.

 

For the Company, there are no other material revenue streams within the scope of Topic 606.

 

The following tables present non-interest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three and nine months ended September 30, 2019 and 2018.

 

   

Three Months Ended

September 30,

 

(dollars in thousands)

 

2019

   

2018

 

Non-interest income

               

In-scope of Topic 606

               

Service charges on deposit accounts

  $ 1,990     $ 1,386  

Other non-interest income

    46       29  

Non-interest income (in-scope of Topic 606)

    2,036       1,415  

Non-interest income (out-of-scope of Topic 606)

    4,518       3,716  

Total non-interest income

  $ 6,554     $ 5,131  

 

   

Nine Months Ended

September 30,

 

(dollars in thousands)

 

2019

   

2018

 

Non-interest income

               

In-scope of Topic 606

               

Service charges on deposit accounts

  $ 5,450     $ 3,887  

Other non-interest income

    175       107  

Non-interest income (in-scope of Topic 606)

    5,625       3,994  

Non-interest income (out-of-scope of Topic 606)

    12,900       11,440  

Total non-interest income

  $ 18,525     $ 15,434  

 

34

 

 

Contract Balances

 

A contract assets balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s non-interest revenue streams are largely based on transaction activity, or standard month-end revenue accruals. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term contracts with customers, and therefore, does not experience significant contract balances. As of September 30, 2019 and December 31, 2018, the Company did not have any significant contract balances.

 

Contract Acquisition Costs

 

In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize as an expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the assets that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Company did not capitalize any contract acquisition cost.

 

 

Note 12: Leases

 

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). The FASB issued this ASU to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet by lessees for those leases classified as operating leases under current U.S. GAAP and disclosing key information about leasing arrangements. The new standard was adopted by the Company on January 1, 2019. ASU 2016-02 provides for a modified retrospective transition approach requiring lessees to recognize and measure leases on the balance sheet at the beginning of either the earliest period presented or as of the beginning of the period of adoption. The Company elected to apply ASU 2016-02 as of the beginning of the period of adoption (January 1, 2019) and will not restate comparative periods. Adoption of ASU 2016-02 resulted in the recognition of total operating lease liability obligations totaling $35.1 million and the recognition of operating lease right-of-use assets totaling $34.2 million at the date of adoption. The initial balance sheet gross up upon adoption was related to operating leases on land and buildings for twenty-three lease agreements. The Company has no finance leases or material subleases for which it is the lessor of property or equipment. The Company has elected to apply the package of practical expedients allowed by the new standard under which the Company need not reassess whether any expired or existing contracts are leases or contain leases, the Company need not reassess the lease classification for any expired or existing lease, and the Company need not reassess initial direct costs for any existing leases.

 

At January 1, 2019, the Company had thirty-four operating leases for real property, which includes operating leases for fifteen branch stores, eight offices that are used for general office space, and eleven operating leases for equipment. All of the real property operating leases include one of more options to extend the lease term. Five of the operating leases for branch stores are a lease for the land under the building and the Company owns the leasehold improvements.

 

At September 30, 2019, the Company had thirty-seven operating lease agreements, which include operating leases for seventeen branch stores, eight offices that are used for general office space, and twelve operating leases for equipment. Sixteen of the real property operating leases did not include one of more options to extend the lease term. Five of the operating leases for branch stores are a lease for the land under the building and the Company owns the leasehold improvements. The thirty-nine operating leases have maturity dates ranging from December 2019 to December 2058 which includes options for multiple five and ten year extensions which the Company is reasonably certain to exercise. The weighted average remaining operating lease term for these leases is 19.1 years as of September 30, 2019.

 

35

 

 

The discount rate used in determining the operating lease liability obligation for each individual lease was the assumed incremental borrowing rate for the Company that corresponded with the remaining lease term as of January 1, 2019 for leases that existed at adoption and as of the lease commencement date for leases subsequently entered in to. The weighted average operating lease discount rate was 3.58% as of September 30, 2019.

 

The following table presents operating lease costs net of sublease income for the three and nine months ended September 30, 2019.

 

   

Three Months Ended

September 30, 2019

   

Nine Months Ended

September 30, 2019

 

(dollars in thousands)

               

Operating lease cost

  $ 1,890     $ 4,920  

Sublease income

    (80 )     (241 )

Total lease cost

  $ 1,810     $ 4,679  

 

The following table presents a maturity analysis of total operating lease liability obligations and reconciliation of the undiscounted cash flows to total operating lease liability obligations at September 30, 2019.

 

   

September 30, 2019

 

(dollars in thousands)

       

Operating lease payments due:

       

Within one year

  $ 6,962  

One to three years

    11,806  

Three to five years

    10,106  

More than five years

    72,030  

Total undiscounted cash flows

    100,904  

Discount on cash flows

    (31,258 )

Total operating lease liability obligations

  $ 69,646  

 

The following table presents cash and non-cash activities for the three and nine months ended September 30, 2019.

 

   

Three Months Ended

September 30, 2019

   

Nine Months Ended

September 30, 2019

 

(dollars in thousands)

               

Cash paid for amounts included in the measurement of lease liabilities

               

Operating cash flows from operating leases

  $ 1,706     $ 3,755  
                 

Non-cash investing and financing activities

               

Additions to Operating leases – right of use asset

               

New operating lease liability obligation

  $ 101     $ 72,457  

 

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ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following is management’s discussion and analysis of our financial condition, changes in financial condition, and results of operations in the accompanying consolidated financial statements. This discussion should be read in conjunction with the accompanying notes to the consolidated financial statements.

 

We may from time to time make written or oral "forward-looking statements", including statements contained in this quarterly report. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements.  For example, risks and uncertainties can arise with changes in: general economic conditions, including turmoil in the financial markets and related efforts of government agencies to stabilize the financial system; the adequacy of our allowance for loan losses and our methodology for determining such allowance; adverse changes in our loan portfolio and credit risk-related losses and expenses; concentrations within our loan portfolio, including our exposure to commercial real estate loans, and to our primary service area; changes in interest rates; our ability to identify, negotiate, secure and develop new store locations and renew, modify, or terminate leases or dispose of properties for existing store locations effectively; business conditions in the financial services industry, including competitive pressure among financial services companies, new service and product offerings by competitors, price pressures and similar items; deposit flows; loan demand; the regulatory environment, including evolving banking industry standards, changes in legislation or regulation; our securities portfolio and the valuation of our securities; accounting principles, policies and guidelines as well as estimates and assumptions used in the preparation of our financial statements; rapidly changing technology; litigation liabilities, including costs, expenses, settlements and judgments; and other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services.  You should carefully review the risk factors described in the Annual Report on Form 10-K for the year ended December 31, 2018 and other documents we file from time to time with the Securities and Exchange Commission. The words "would be," "could be," "should be," "probability," "risk," "target," "objective," "may," "will," "estimate," "project," "believe," "intend," "anticipate," "plan," "seek," "expect" and similar expressions or variations on such expressions are intended to identify forward-looking statements. All such statements are made in good faith by us pursuant to the "safe harbor" provisions of the U.S. Private Securities Litigation Reform Act of 1995. We do not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of us, except as may be required by applicable law or regulations.

 

Financial Condition

 

Assets

 

Total assets increased by $332.6 million to $3.09 billion at September 30, 2019, compared to $2.75 billion at December 31, 2018.

 

Cash and Cash Equivalents

 

Cash and due from banks and interest bearing deposits comprise this category, which consists of our most liquid assets. The aggregate amount of these two categories increased by $129.0 million to $201.5 million at September 30, 2019, from $72.5 million at December 31, 2018 primarily as a result of an increase in deposit balances.

 

Loans Held for Sale

 

Loans held for sale are comprised of loans guaranteed by the U.S. Small Business Administration (“SBA”) which we usually originate with the intention of selling in the future and residential mortgage loans originated which we also intend to sell in the future. Total SBA loans held for sale were $2.5 million at September 30, 2019 as compared to $5.4 million at December 31, 2018. Residential mortgage loans held for sale were $18.7 million at September 30, 2019 compared to $20.9 million at December 31, 2018. Loans held for sale, as a percentage of total Company assets, were less than 1% at September 30, 2019.

 

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Loans Receivable

 

The loan portfolio represents our largest asset category and is our most significant source of interest income. Our lending strategy is focused on small and medium sized businesses and professionals that seek highly personalized banking services. The loan portfolio consists of secured and unsecured commercial loans including commercial real estate, construction loans, residential mortgages, home improvement loans, home equity loans and lines of credit, overdraft lines of credit, and others. Commercial loans typically range between $250,000 and $5,000,000 but customers may borrow significantly larger amounts up to our legal lending limit to a customer, which was approximately $34.4 million at September 30, 2019. Loans made to one individual customer, even if secured by different collateral, are aggregated for purposes of the lending limit.

 

Loans increased $132.9 million, or 9%, to $1.6 billion at September 30, 2019, versus $1.4 billion at December 31, 2018. This growth was the result of an increase in loan demand across our residential mortgage, commercial real estate, owner occupied real estate, and consumer and other categories driven by the successful execution of our relationship banking strategy which focuses on delivering high levels of customer service.

 

Investment Securities

 

Investment securities considered available-for-sale are investments that may be sold in response to changing market and interest rate conditions, and for liquidity and other purposes. Our investment securities classified as available-for-sale consist primarily of U.S. Government agency Small Business Administration (“SBA”) bonds, U.S. Government agency collateralized mortgage obligations (“CMO”), agency mortgage-backed securities (“MBS”), municipal securities, and corporate bonds. Available-for-sale securities totaled $380.0 million at September 30, 2019, compared to $321.0 million at December 31, 2018. The increase was primarily due to the purchase of securities totaling $150.7 million partially offset by proceeds from the sale of securities totaling $53.6 million and paydowns of securities totaling $41.6 million during the first nine months of 2019. At September 30, 2019, the portfolio had a net unrealized loss of $1.3 million compared to a net unrealized loss of $5.7 million at December 31, 2018. The change in value of the investment portfolio was driven by a decrease in market interest rates which drove an increase in value of the securities classified as available-for-sale in our portfolio during the first nine months of 2019.

 

Investment securities held-to-maturity are investments for which there is the intent and ability to hold the investment to maturity. These investments are carried at amortized cost. The held-to-maturity portfolio consists primarily of U.S. Government agency Small Business Investment Company bonds (“SBIC”) and SBA bonds, CMOs and MBSs. The fair value of securities held-to-maturity totaled $699.1 million and $747.3 million at September 30, 2019 and December 31, 2018, respectively. The decrease was primarily due to paydowns of securities totaling $73.9 million partially offset by an increase of $25.8 million in the value of securities held in the portfolio during the first nine months of 2019. The change in value of the investment portfolio was driven by a decrease in market interest rates which drove an increase in value of the securities classified as held-to-maturity in our portfolio during the first nine months of 2019.

 

Restricted Stock

 

Restricted stock, which represents a required investment in the capital stock of correspondent banks related to available credit facilities, is carried at cost as of September 30, 2019 and December 31, 2018. As of those dates, restricted stock consisted of investments in the capital stock of the Federal Home Loan Bank of Pittsburgh (“FHLB”) and Atlantic Community Bankers Bank (“ACBB”).

 

38

 

 

At September 30, 2019 and December 31, 2018, the investment in FHLB capital stock totaled $2.2 million and $5.6 million, respectively. The decrease was due to a lower required investment in FHLB stock during the first nine months of 2019. At both September 30, 2019 and December 31, 2018, ACBB capital stock totaled $143,000. Both the FHLB and ACBB have issued dividend payments in 2019.

 

Premises and Equipment

 

The balance of premises and equipment increased to $111.6 million at September 30, 2019 from $87.7 million at December 31, 2018. The increase was primarily due to premises and equipment expenditures of $28.6 million less depreciation and amortization expenses of $4.7 million during the first nine months of 2019. A new store was opened in New York City during the third quarter of 2019 bringing the total store count to twenty-eight as of September 30, 2019. There are also multiple sites in various stages of development for future store locations.

 

Expansion into New York City began in 2019. The Company opened its first store located at 14th Street & 5th Avenue in Manhattan in July 2019. A second store location at 51st Street & 3rd Avenue in Manhattan opened in November 2019.

 

Other Real Estate Owned

 

The balance of other real estate owned was $6.7 million at September 30, 2019 and $6.2 million at December 31, 2018. The increase was primarily due to additions of $1.1 million partially offset by sales and writedowns totaling $640,000.

 

Operating Leases – Right of Use Asset

 

Accounting Standards Codification Topic 842, also known as ASC 842 and ASU 2016-02, is the new lease accounting standard published by the FASB. ASC 842 represents a significant modification to the accounting treatment for leases, with the most significant change being that most leases, including operating leases, will now be capitalized on the balance sheet. Under the previous guidance (ASC 840), FASB permitted operating leases to be reported only in the footnotes of corporate financial statements. Under ASC 842, the only leases that are exempt from the capitalization requirement are short-term leases less than or equal to twelve months in length.

 

The right-of-use asset is valued as the initial amount of the lease liability obligation adjusted for any initial direct costs, prepaid or accrued rent, and any lease incentives. At September 30, 2019, the balance of the operating lease right-of-use asset was $65.9 million.

 

Goodwill

 

Goodwill is reviewed for impairment annually as of July 31 and between annual tests when events and circumstances indicate that impairment may have occurred. Impairment is a condition that exists when the carrying amount of goodwill exceeds the reporting unit’s fair value.

 

We early adopted Accounting Standards Update ("ASU") 2017-04, Simplifying the Test for Goodwill Impairment during our annual goodwill impairment review in 2018. The new rules under this guidance provide that the goodwill impairment charge will be the amount by which the reporting unit's carrying amount exceeds its fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.

 

At July 31, 2019, the Company elected to perform a Step One analysis to review goodwill for impairment. The results of the Step One analysis indicated that the carrying value of the reporting unit did not exceed its fair value. Based on our quantitative assessment, we determined that there was no evidence of impairment on the balance of goodwill. As of September 30, 2019 and December 31, 2018, goodwill totaled $5.0 million.

 

39

 

 

Deposits

 

Deposits, which include non-interest and interest-bearing demand deposits, money market, savings and time deposits, are Republic’s major source of funding. Deposits are generally solicited from our market area through the offering of a variety of products to attract and retain customers, with a primary focus on multi-product relationships.

 

Total deposits increased by $347.2 million to $2.7 billion at September 30, 2019 from $2.4 billion at December 31, 2018. The increase was the result of significant growth in all deposit categories, led by strong growth in demand deposit balances. We constantly focus our efforts on the growth of deposit balances through the successful execution of our relationship banking model which is based upon a high level of customer service and satisfaction. This strategy has also allowed us to build a stable core-deposit base and nearly eliminate our dependence upon the more volatile sources of funding found in brokered and wholesale deposits.

 

We are also in the midst of an aggressive expansion plan which we refer to as “The Power of Red is Back”. During 2018, we opened new stores in Gloucester Township, Evesboro, and Somers Point in NJ and Fairless Hills in PA. In the current year, we have opened stores in Lumberton, NJ, Feasterville, PA, and at 14th Street & 5th Avenue and 51st Street & 3rd Avenue in Manhattan. We have several more in various stages of construction and development including sites in New York City.

 

Short-term Borrowings

 

As of September 30, 2019, we had no short-term borrowings with the FHLB compared to $91.4 million at December 31, 2018. The short-term borrowings were paid off in 2019 as a result of growth in deposit balances.

 

Operating Lease Liability Obligation

 

Accounting Standards Codification Topic 842, also known as ASC 842 and ASU 2016-02, is the new lease accounting standard published by the FASB. ASC 842 represents a significant modification to the accounting treatment for leases, with the most significant change being that most leases, including operating leases, will now be capitalized on the balance sheet. Under the previous guidance (ASC 840), FASB permitted operating leases to be reported only in the footnotes of corporate financial statements. Under ASC 842, the only leases that are exempt from the capitalization requirement are short-term leases less than or equal to twelve months in length.

 

The operating lease liability obligation is calculated as the present value of the lease payments, using the discount rate specified in the lease, or if that is not available, our incremental borrowing rate. At September 30, 2019, the balance of the operating lease liability obligation was $69.6 million.

 

Shareholders’ Equity

 

Total shareholders’ equity increased $5.7 million to $250.8 million at September 30, 2019 compared to $245.2 million at December 31, 2018. The increase during the first nine months of 2019 was primarily due to a $4.4 million decrease in accumulated other comprehensive losses associated with an increase in the market value of the investment securities portfolio, an adjustment for stock based compensation in the amount of $2.0 million, and stock option exercises of $261,000 partially offset by a net loss of $1.0 million. The shift in market value of the securities portfolio was primarily driven by a decrease in market interest rates which drove an increase in the market value of the securities held in our portfolio.

 

40

 

 

Results of Operations

 

Three Months Ended September 30, 2019 Compared to Three Months Ended September 30, 2018

 

We reported a net loss of $1.8 million, or ($0.03) per diluted share, for the three months ended September 30, 2019 and compared to net income of $2.3 million, or $0.04 per diluted share for the three months ended September 30, 2018. The decrease in net income of $4.1 million was primarily driven by the growth in non-interest expense year over year. The increase in expense was driven by the addition of five new store locations over the last twelve months, including our first store located in New York City. The expansion into New York City has also required us to hire a lending and management team and support group in this new market. During 2019 we have also experienced a flat and, at times, an inverted yield curve which has resulted in minimal growth in net interest income despite the addition of more than $300 million in interest earning assets.

 

Net interest income was $19.4 million for the three month period ended September 30, 2019 compared to $19.1 million for the three months ended September 30, 2018. Interest income increased $2.7 million, or 11%, due to an increase in average loans receivable and federal funds sold and other interest earning assets. Interest expense increased $2.4 million, or 55%, primarily due to an increase in average deposit balances and the average rate paid on deposit balances. The net interest margin decreased by 32 basis points to 2.82% during the third quarter of 2019 compared to 3.14% during the third quarter of 2018. Compression in the net interest margin was driven by flattening of the yield curve resulting in a rapid increase in our cost of funds and a decline in the yield on interest earning assets.

 

We recorded a provision for loan losses in the amount of $450,000 for the three months ended September 30, 2019 and a provision for loan losses in the amount of $500,000 for the three months ended September 30, 2018. This decrease was primarily due to a decline in the allowance required for loans individually evaluated for impairment.

 

Non-interest income increased by $1.4 million to $6.6 million during the three months ended September 30, 2019 compared to $5.1 million during the three months ended September 30, 2018. The increase during the three months ended September 30, 2019 was primarily due to increases in service fees on deposit accounts and gains on the sale of investment securities.

 

Non-interest expenses increased $7.0 million to $27.8 million during the three months ended September 30, 2019 compared to $20.8 million during the three months ended September 30, 2018. This increase was primarily driven by higher salaries, employee benefits, and occupancy and equipment expenses associated with the addition of new stores related to our expansion strategy which we refer to as “The Power of Red is Back”. Annual merit increases contributed to the increase in salaries and employee benefit costs. We have also incurred costs related to our expansion into New York City as we hire a management and lending team and commence rent payments for our store locations. Our first store in New York City opened at 14th Street & 5th Avenue in Manhattan in July 2019. Construction was completed on a second store location at 51st Street & 3rd Avenue in November 2019.

 

We recorded a benefit for income taxes in the amount of $516,000 during the three months ended September 30, 2019 compared to a $622,000 provision for income taxes during the three months ended September 30, 2018.

 

Return on average assets and average equity from continuing operations was (0.24%) and (2.88%), respectively, during the three months ended September 30, 2019 compared to 0.36% and 3.90%, respectively, for the three months ended September 30, 2018.

 

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Nine Months Ended September 30, 2019 Compared to Nine Months Ended September 30, 2018

 

We reported a net loss of $1.0 million, or ($0.02) per diluted share, for the nine months ended September 30, 2019 compared to net income of $6.5 million, or $0.11 per diluted share, for the nine months ended September 30, 2018. The decrease in net income of $7.5 million was primarily driven by the growth in non-interest expense year over year. The increase in expense was driven by the addition of five new store locations over the last twelve months, including our first store located in New York City. The expansion into New York City has also required us to hire a lending and management team and support group in this new market. During 2019 we have also experienced a flat and, at times, an inverted yield curve which has resulted in minimal growth in net interest income despite the addition of more than $300 million in interest earning assets.

 

Net interest income for the nine months ended September 30, 2019 was $57.9 million as compared to $55.9 million for the nine months ended September 30, 2018. Interest income increased $11.2 million, or 17%, due to an increase in average loans receivable and the average yield earned on loan balances. Interest expense increased $9.2 million, or 85%, primarily due to an increase in average deposit balances and the average rate paid on deposit balances. The net interest margin decreased by 26 basis points to 2.92% during nine months ended September 30, 2019 compared to 3.18% during the nine months ended September 30, 2018. Compression in the net interest margin was driven by flattening of the yield curve resulting in a more rapid increase in our cost of funds compared to the yield on interest earning assets.

 

We recorded a provision for loan losses of $750,000 for the nine months ended September 30, 2019 compared to a provision for loan losses of $1.7 million for the nine months ended September 30, 2018. This decrease was primarily due to a decline in the allowance required for loans individually evaluated for impairment.

 

Non-interest income increased $3.1 million to $18.5 million during the nine months ended September 30, 2019 compared to $15.4 million during the nine months ended September 30, 2018. The increase during the nine months ended September 30, 2019 was primarily due to increases in service fees on deposit accounts and gains on the sales of investment securities.

 

Non-interest expenses increased $15.3 million to $77.0 million during the nine months ended September 30, 2019 as compared to $61.7 million during the nine months ended September 30, 2018. This increase was primarily driven by higher salaries, employee benefits, and occupancy and equipment expenses associated with the addition of new stores related to our expansion strategy which we refer to as “The Power of Red is Back”. Annual merit increases contributed to the increase in salaries and employee benefit costs. We have incurred costs related to our expansion into New York City as we hire a management and lending team and commence rent payments for our store locations. Our first store in New York City opened at 14th Street & 5th Avenue in Manhattan in July 2019. Construction was completed on a second store location at 51st Street & 3rd Avenue in November 2019.

 

We recorded a benefit for income taxes in the amount of $319,000 during the nine months ended September 30, 2019 compared to a $1.5 million provision for income taxes during the nine months ended September 30, 2018.

 

Return on average assets and average equity from continuing operations were (0.05%) and (0.55%), respectively, during the nine months ended September 30, 2019 compared to 0.35% and 3.73%, respectively, for the nine months ended September 30, 2018.

 

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Analysis of Net Interest Income

 

Historically, our earnings have depended primarily upon Republic’s net interest income, which is the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is affected by changes in the mix of the volume and rates of interest-earning assets and interest-bearing liabilities. The following table provides an analysis of net interest income on an annualized basis, setting forth for the periods average assets, liabilities, and shareholders’ equity, interest income earned on interest-earning assets and interest expense on interest-bearing liabilities, average yields earned on interest-earning assets and average rates on interest-bearing liabilities, and Republic’s net interest margin (net interest income as a percentage of average total interest-earning assets). Averages are computed based on daily balances. Non-accrual loans are included in average loans receivable. Yields are adjusted for tax equivalency, a non-GAAP measure, using a rate of 21% in 2019 and 21% in 2018.

 

Average Balances and Net Interest Income

 

   

For the three months ended

September 30, 2019

   

For the three months ended

September 30, 2018

 

 

(dollars in thousands)

 

Average

Balance

   

 

Interest

   

Yield/

Rate(1)

   

Average

Balance

   

 

Interest

   

Yield/

Rate(1)

 

Interest-earning assets:

                                               

Federal funds sold and other interest-earning assets

  $ 146,446     $ 777       2.10

%

  $ 29,163     $ 153       2.08

%

Investment securities and restricted stock (2)

    1,055,154       6,743       2.56

%

    1,018,910       6,676       2.62

%

Loans receivable (2)

    1,540,834       18,816       4.84

%

    1,390,894       16,873       4.81

%

Total interest-earning assets

    2,742,434       26,336       3.81

%

    2,438,967       23,702       3.86

%

Other assets

    247,682                       135,139                  

Total assets

  $ 2,990,116                     $ 2,574,106                  
                                                 

Interest-earning liabilities:

                                               

Demand – non-interest bearing

  $ 563,691                     $ 513,292                  

Demand – interest bearing

    1,168,404       3,752       1.27

%

    861,607       1,948       0.90

%

Money market & savings

    702,547       1,814       1.02

%

    699,081       1,308       0.74

%

Time deposits

    208,624       1,123       2.14

%

    126,378       386       1.21

%

Total deposits

    2,643,266       6,689       1.00

%

    2,200,358       3,642       0.66

%

Total interest-bearing deposits

    2,079,575       6,689       1.28

%

    1,687,066       3,642       0.86

%

Other borrowings

    14,037       137       3.87

%

    127,150       770       2.40

%

Total interest-bearing liabilities

    2,093,612       6,826       1.29

%

    1,814,216       4,412       0.96

%

Total deposits and other borrowings

    2,657,303       6,826       1.02

%

    2,327,508       4,412       0.75

%

Non-interest bearing other liabilities

    81,872                       10,363                  

Shareholders’ equity

    250,941                       236,235                  

Total liabilities and shareholders’ equity

  $ 2,990,116                     $ 2,574,106                  
Net interest income (2)           $ 19,510                     $ 19,290          
Net interest spread                     2.52 %                     2.90 %
Net interest margin (2)                     2.82 %                     3.14 %

 

(1)Yields on investments are calculated based on amortized cost.

(2)Net interest income and net interest margin are presented on a tax equivalent basis, a Non-GAAP measure. Net interest income has been increased over the financial statement amount by $128 and $144 for the three months ended September 30, 2019 and 2018, respectively, to adjust for tax equivalency. The tax equivalent net interest margin is calculated by dividing tax equivalent net interest income by average total interest earning assets.

 

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Average Balances and Net Interest Income

 

   

For the nine months ended

September 30, 2019

   

For the nine months ended

September 30, 2018

 

 

(dollars in thousands)

 

Average

Balance

   

 

Interest

   

Yield/

Rate(1)

   

Average

Balance

   

 

Interest

   

Yield/

Rate(1)

 

Interest-earning assets:

                                               

Federal funds sold and other interest-earning assets

  $ 96,245     $ 1,631       2.27

%

  $ 27,625     $ 388       1.88

%

Investment securities and restricted stock (2)

    1,069,304       21,347       2.66

%

    1,027,614       20,001       2.60

%

Loans receivable (2)

    1,506,482       55,408       4.92

%

    1,310,750       46,795       4.77

%

Total interest-earning assets

    2,672,031       78,386       3.92

%

    2,365,989       67,184       3.80

%

Other assets

    218,947                       130,344                  

Total assets

  $ 2,890,978                     $ 2,496,333                  
                                                 

Interest-earning liabilities:

                                               

Demand – non-interest bearing

  $ 533,922                     $ 475,659                  

Demand – interest bearing

    1,142,515       11,896       1.39

%

    866,397       4,754       0.73

%

Money market & savings

    691,876       4,894       0.95

%

    695,386       3,454       0.66

%

Time deposits

    179,936       2,608       1.94

%

    127,281       1,121       1.18

%

Total deposits

    2,548,249       19,398       1.02

%

    2,164,723       9,329       0.58

%

Total interest-bearing deposits

    2,014,327       19,398       1.29

%

    1,689,064       9,329       0.74

%

Other borrowings

    26,836       681       3.39

%

    90,160       1,528       2.27

%

Total interest-bearing liabilities

    2,041,163       20,079       1.32

%

    1,779,224       10,857       0.82

%

Total deposits and other borrowings

    2,575,085       20,079       1.04

%

    2,254,883       10,857       0.64

%

Non-interest bearing other liabilities

    67,182                       9,534                  

Shareholders’ equity

    248,711                       231,916                  

Total liabilities and shareholders’ equity

  $ 2,890,978                     $ 2,496,333                  

Net interest income (2)

          $ 58,307                     $ 56,327          

Net interest spread

                    2.60

%

                    2.98

%

Net interest margin (2)

                    2.92

%

                    3.18

%

 

(1)Yields on investments are calculated based on amortized cost.

(2)Net interest income and net interest margin are presented on a tax equivalent basis, a Non-GAAP measure. Net interest income has been increased over the financial statement amount by $414 and $403 for the nine months ended September 30, 2019 and 2018, respectively, to adjust for tax equivalency. The tax equivalent net interest margin is calculated by dividing tax equivalent net interest income by average total interest earning assets.

 

44

 

 

Rate/Volume Analysis of Changes in Net Interest Income

 

Net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The following table sets forth an analysis of volume and rate changes in net interest income for the three and nine months ended September 30, 2019, as compared to the three and nine months ended September 30, 2018. For purposes of this table, changes in interest income and expense are allocated to volume and rate categories based upon the respective changes in average balances and average rates.

 

   

For the three months ended

September 30, 2019 vs. 2018

   

For the nine months ended

September 30, 2019 vs. 2018

 
   

Changes due to:

           

Changes due to:

         

(dollars in thousands)

 

Average

Volume

   

Average

Rate

   

Total

Change

   

Average

Volume

   

Average

Rate

   

Total

Change

 

Interest earned:

                                               

Federal funds sold and other interest-earning assets

  $ 633     $ (9 )   $ 624     $ 1,163     $ 80     $ 1,243  

Securities

    229       (162 )     67       832       514       1,346  

Loans

    1,696       247       1,943       6,873       1,740       8,613  

Total interest-earning assets

    2,558       76       2,634       8,868       2,334       11,202  
                                                 

Interest expense:

                                               

Deposits

                                               

Interest-bearing demand deposits

    996       808       1,804       2,875       4,267       7,142  

Money market and savings

    (9 )     515       506       (60 )     1,500       1,440  

Time deposits

    425       312       737       763       724       1,487  

Total deposit interest expense

    1,412       1,635       3,047       3,578       6,491       10,069  

Other borrowings

    (765 )     132       (633 )     (1,317 )     470       (847 )

Total interest expense

    647       1,767       2,414       2,261       6,961       9,222  

Net interest income

  $ 1,911     $ (1,691 )   $ 220     $ 6,607     $ (4,627 )   $ 1,980  

 

Net Interest Income and Net Interest Margin

 

Net interest income, on a fully tax-equivalent basis, a non-GAAP measure, for the three months ended September 30, 2019 increased $220,000, or 1%, over the same period in 2018. Interest income on interest-earning assets totaled $26.3 million and $23.7 million for the three months ended September 30, 2019 and 2018, respectively. The increase in interest income earned was primarily the result of an increase in the average balances of loans receivable and federal funds sold and other interest-bearing deposits. Total interest expense for the three months ended September 30, 2019 increased by $2.4 million, or 55%, to $6.8 million from $4.4 million for the same period in 2018. Interest expense on deposits increased by $3.0 million, or 84%, for the three months ended September 30, 2019 versus the same period in 2018 due to increases in average deposit balances and higher rates. Interest expense on other borrowings decreased by $633,000 for the three months ended September 30, 2019 as compared to the three months ended September 30, 2018 due to a decrease in overnight borrowings. The flattening of the yield curve has resulted in a rapid increase in the cost of interest bearing liabilities and a decline in the yield on interest earning assets. The Federal Reserve increased the Fed Funds borrowing rate by 25 basis points on three separate occasions during 2018 which has impacted rates on the short end of the yield curve which typically impacts deposit rates. During the third quarter of 2019, the Fed Funds rate was reduced by 25 basis points on two occasions which has resulted in a decline in the cost of interest bearing liabilities on a linked quarter basis.

 

45

 

 

Net interest income, on a fully tax-equivalent basis, a non-GAAP measure, for the nine months ended September 30, 2019 increased $2.0 million, or 4%, over the same period in 2018. Interest income on interest-earning assets totaled $78.4 million and $67.2 million for the nine months ended September 30, 2019 and 2018, respectively. The increase in interest income earned was primarily the result of an increase in the average balances of loans receivable and the average yield earned on loan balances. Total interest expense for the nine months ended September 30, 2019 increased by $9.2 million, or 85%, to $20.1 million from $10.9 million for the same period in 2018. Interest expense on deposits increased by $10.1 million, or 108%, for the nine months ended September 30, 2019 versus the same period in 2018 due to both increases in average deposit balances and the average rate paid on deposit balances. Interest expense on other borrowings decreased by $847,000 for the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018 due to a decrease in average overnight borrowings. The flattening of the yield curve has resulted in a more rapid increase in the cost of interest bearing liabilities when compared to the yield on interest earning assets. The Federal Reserve increased the Fed Funds borrowing rate by 25 basis points on three separate occasions during 2018 which has impacted rates on the short end of the yield curve which typically impacts deposit rates. During the third quarter of 2019, the Fed Funds rate was reduced by 25 basis points on two occasions which has resulted in a decline in the cost of interest bearing liabilities on a linked quarter basis.

 

     Changes in net interest income are frequently measured by two statistics: net interest rate spread and net interest margin. Net interest rate spread is the difference between the average rate earned on interest-earning assets and the average rate incurred on interest-bearing liabilities. Our net interest rate spread on a fully tax-equivalent basis was 2.52% during the three months ended September 30, 2019 compared to 2.90% during the three months ended September 30, 2018 and was 2.60% during the nine months ended September 30, 2019 compared to 2.98% during nine months ended September 30, 2018. Net interest margin represents the difference between interest income, including net loan fees earned, and interest expense, reflected as a percentage of average interest-earning assets. For the three months ended September 30, 2019 and September 30, 2018, the fully tax-equivalent net interest margin was 2.82% and 3.14%, respectively. The net interest margin for the three months ended September 30, 2019 decreased primarily due to a rate increase of 27 basis points in total deposits and other borrowings compared to a decrease of 5 basis points in the yield on total interest earning assets. For the nine months ended September 30, 2019 and September 30, 2018, the fully tax-equivalent net interest margin was 2.92% and 3.18%, respectively. The net interest margin for the nine months ended September 30, 2019 decreased primarily due to a rate increase of 40 basis points in total deposits and other borrowings offset by an increase of 12 basis points in the yield on total interest earning assets.

 

Provision for Loan Losses

 

We recorded a $450,000 provision for loan losses for the three months ended September 30, 2019 as compared to $500,000 provision for the three months ended September 30, 2018. We recorded a $750,000 provision for loan losses for the nine months ended September 30, 2019 as compared to $1.7 million for the nine months ended September 30, 2018. During the three and nine months ended September 30, 2019, there was a decrease in the allowance required for loans individually evaluated for impairment.

 

Non-Interest Income

 

Total non-interest income for the three months ended September 30, 2019 increased $1.4 million, or 28%, compared to the three months ended September 30, 2018. Service fees on deposit accounts totaled $2.0 million for the three months ended September 30, 2019 which represents an increase of $604,000 over the same period in 2018. This increase was due to the growth in the number of customer accounts and transaction volume. Gains of $520,000 were recognized on the sale of investment securities during the three months ended September 30, 2019 compared to no gains on the sale of investment securities during the three months ended September 30, 2018. Mortgage banking income totaled $2.8 million during the three months ended September 30, 2019 which represents an increase of $217,000 from the same period in 2018. Gains on the sale of SBA loans totaled $944,000 for the three months ended September 30, 2019, an increase of $128,000, compared to $816,000 for the same period in 2018. Loan advisory and servicing fees totaled $257,000 for the three months ended September 30, 2019 which represents a decrease of $63,000 from the same period in 2018.

 

46

 

 

Total non-interest income for the nine months ended September 30, 2019 increased $3.1 million, or 20%, compared to the nine months ended September 30, 2018. Service fees on deposit accounts totaled $5.5 million for the nine months ended September 30, 2019 which represents an increase of $1.6 million over the same period in 2018. This increase was due to the growth in the number of customer accounts and transaction volume. Gains of $1.1 million were recognized on the sale of investment securities during the nine months ended September 30, 2019 compared to a $1,000 loss on the sale of investment securities during the nine months ended September 30, 2018. Loan and servicing fees totaled $1.2 million for the nine months ended September 30, 2019 which represents an increase of $317,000 from the same period in 2018. Mortgage banking income totaled $8.0 million for the nine months ended September 30, 2019, an increase of $100,000, compared to $7.9 million during the nine months ended September 30, 2018.

 

Non-Interest Expenses

 

Three Months Ended September 30, 2019 Compared to Three Months Ended September 30, 2018

 

Non-interest expenses increased $7.0 million, or 34%, for the three months ended September 30, 2019 compared to the same period in 2018. An explanation of changes in non-interest expenses for certain categories is presented in the following paragraphs.

 

Salaries and employee benefits increased by $3.1 million, or 28%, for the three months ended September 30, 2019 compared to the same period in 2018 which was primarily driven by annual merit increases along with increased staffing levels related to our growth strategy of adding and relocating stores, which we refer to as “The Power of Red is Back”. There were twenty-eight stores open as of September 30, 2019 compared to twenty-three stores at September 30, 2018. Our first store in New York City opened in July 2019.

 

Occupancy expense, including depreciation and amortization expenses, increased by $1.5 million, or 45%, for the three months ended September 30, 2019 compared to the same period last year, also as a result of our continuing growth and expansion strategy.

 

Other real estate expenses totaled $799,000 during the three months ended September 30, 2019, an increase of $421,000, or 111%, compared to the same period in 2018. This increase was a result of higher costs to carry foreclosed properties and higher writedowns on foreclosed assets in the current period.

 

All other non-interest expenses increased by $2.0 million, or 33%, for the three months ended September 30, 2019 compared to the same period last year. Increases in data processing, advertising, legal, professional fees, insurance, other taxes, automated teller machine expenses, and other expenses resulting from our expansion strategy also contributed to the growth in other operating expenses.

 

Nine Months Ended September 30, 2019 Compared to Nine Months Ended September 30, 2018

 

Non-interest expenses increased $15.3 million, or 25%, for the nine months ended September 30, 2019 compared to the same period in 2018. An explanation of changes in non-interest expenses for certain categories is presented in the following paragraphs.

 

Salaries and employee benefits increased by $7.6 million, or 23%, for the nine months ended September 30, 2019 compared to the same period in 2018 which was primarily driven by annual merit increases along with increased staffing levels related to our growth strategy of adding and relocating stores, which we refer to as “The Power of Red is Back”. There were twenty-eight stores open as of September 30, 2019 compared to twenty-three stores at September 30, 2018. Our first store in New York City opened in July 2019.

 

47

 

 

Occupancy expense, including depreciation and amortization expenses, increased by $2.9 million, or 29%, for the nine months ended September 30, 2019 compared to the same period last year, also as a result of our continuing growth and expansion strategy.

 

Other real estate expenses totaled $1.7 million during the nine months ended September 30, 2019, an increase of $772,000, or 88%, compared to the same period in 2018. This increase was a result of higher costs to carry foreclosed properties and higher writedowns on foreclosed assets in the current period.

 

All other non-interest expenses increased by $4.0 million, or 22%, for the nine months ended September 30, 2019 compared to the same period last year. Increases in data processing, advertising, professional fees, automated teller machine expenses, legal, insurance, other taxes, appraisal and other loan expenses, and other expenses resulting from our expansion strategy also contributed to the growth in other operating expenses.

 

One key measure that management utilizes to monitor progress in controlling overhead expenses is the ratio of annualized net non-interest expenses to average assets, a non-GAAP measure. For the purposes of this calculation, net non-interest expenses equal non-interest expenses less non-interest income. For the three months ended September 30, 2019, this ratio was 2.82% compared to 2.42% for the three months ended September 30, 2018. For the nine months ended September 30, 2019, the ratio was 2.70% compared to 2.48% for the nine months ended September 30, 2018, respectively. The increase in this ratio was mainly due to our growth and expansion strategy which drives the addition of new stores.

 

       Another productivity measure utilized by management is the operating efficiency ratio, a non-GAAP measure. This ratio expresses the relationship of non-interest expenses to net interest income plus non-interest income. For the three months ended September 30, 2019, the operating efficiency ratio was 107.3% compared to 85.8% for the three months ended September 30, 2018. The efficiency ratio was 100.8% for the nine months ended September 30, 2019 compared to 86.4% for the nine months ended September 30, 2018. The increase in this ratio for three and nine months ended September 30, 2019 was due to non-interest expenses increasing at a faster rate than net interest income and non-interest income.

 

Provision (Benefit) for Income Taxes

 

We recorded a benefit for income taxes in the amount of $516,000 for the three months ended September 30, 2019, compared to a $622,000 provision for the three months ended September 30, 2018. For the nine months ended September 30, 2019, we recorded a benefit for income taxes of $319,000 compared to a $1.5 million provision for the nine months ended September 30, 2018. The effective tax rates for the three months ended September 30, 2019 and 2018 were (22%) and 21%, respectively. For the nine months ended September 30, 2019 and 2018, the effective tax rates were (24%) and 19%, respectively.

 

We evaluate the carrying amount of our deferred tax assets on a quarterly basis or more frequently, if necessary, in accordance with the guidance provided in FASB Accounting Standards Codification Topic 740 (ASC 740), in particular, applying the criteria set forth therein to determine whether it is more likely than not (i.e. a likelihood of more than 50%) that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight of available evidence. If management makes a determination based on the available evidence that it is more likely than not that some portion or all of the deferred tax assets will not be realized in future periods, a valuation allowance is calculated and recorded. These determinations are inherently subjective and dependent upon estimates and judgments concerning management’s evaluation of both positive and negative evidence.

 

       In conducting the deferred tax asset analysis, we believe it is important to consider the unique characteristics of an industry or business. In particular, characteristics such as business model, level of capital and reserves held by a financial institution and the ability to absorb potential losses are important distinctions to be considered for bank holding companies like us. In addition, it is also important to consider that net operating loss carryforwards (“NOLs”) calculated for federal income tax purposes can generally be carried back two years and carried forward for a period of twenty years, for NOLs created prior to January 1, 2018. Federal NOLs generated after December 31, 2017 can be carried forward indefinitely. In order to realize our deferred tax assets, we must generate sufficient taxable income in such future years.

 

48

 

 

       In assessing the need for a valuation allowance, we carefully weighed both positive and negative evidence currently available. Judgment is required when considering the relative impact of such evidence. The weight given to the potential effect of positive and negative evidence must be commensurate with the extent to which it can be objectively verified. Based on the guidance provided in ASC 740, we believed that the positive evidence considered at September 30, 2019 and December 31, 2018 outweighed the negative evidence and that it was more likely than not that all of our deferred tax assets would be realized within their life cycle. Therefore, a valuation allowance is not required.

 

The net deferred tax asset balance was $11.7 million as of September 30, 2019 and $12.3 million as of December 31, 2018. The deferred tax asset will continue to be analyzed on a quarterly basis for changes affecting realizability.

 

Net Income and Net Income per Common Share

 

       The net loss for the three months ended September 30, 2019 was $1.8 million, a decrease of $4.1 million, compared to net income of $2.3 million recorded for the three months ended September 30, 2018. The decrease in net income for the three months ended September 30, 2019 was due to non-interest expense driven by our expansion strategy and limited growth in net interest income caused by the flattening of the yield curve.

 

The net loss for the nine months ended September 30, 2019 was $1.0 million, a decrease of $7.5 million, compared to net income of $6.5 million recorded for the nine months ended September 30, 2018. The decrease in net income for the nine months ended September 30, 2019 was due to non-interest expense driven by our expansion strategy and limited growth in net interest income caused by the flattening of the yield curve.

 

      The changes in interest income and interest expense were primarily caused by a decline in the net interest margin for the three and nine months ended September 30, 2019. We have experienced a flat and at times an inverted yield curve which has caused the interest rates paid on deposit balances to increase more rapidly than rates on interest earning assets. In addition, non-interest expenses have grown as a result of the costs incurred to initiate our expansion into New York City.

 

For the three month period ended September 30, 2019, basic and fully-diluted net loss per common share was ($0.03) and for the three month period ended September 30, 2018, basic and fully-diluted net income per common share was $0.04. For the nine month period ended September 30, 2019, basic and fully-diluted net loss per common share was ($0.02) and for the nine month period ended September 30, 2018, basic and fully-diluted net income per common share was $0.11.

 

Return on Average Assets and Average Equity

 

       Return on average assets (ROA) measures our net income in relation to our total average assets. The ROA for the three months ended September 30, 2019 was (0.24%), compared to 0.36% for the three months ended September 30, 2018. The ROA for the nine months ended September 30, 2019 and 2018 was (0.05%) and 0.35%, respectively. Return on average equity (ROE) indicates how effectively we can generate net income on the capital invested by our shareholders. ROE is calculated by dividing annualized net income by average stockholders' equity. The ROE was (2.88%) for the three months September 30, 2019, compared to 3.90% for the three months ended September 30, 2018. The ROE for the nine months ended September 30, 2019 and 2018 was (0.55%) and 3.73%, respectively.

 

49

 

 

Commitments, Contingencies and Concentrations

 

Financial instruments with contract amounts representing potential credit risk were commitments to extend credit of approximately $316.8 million and $286.4 million, and standby letters of credit of approximately $14.6 million and $13.9 million, at September 30, 2019 and December 31, 2018, respectively. These financial instruments constitute off-balance sheet arrangements. Commitments often expire without being drawn upon. Substantially all of the $316.8 million of commitments to extend credit at September 30, 2019 were committed as variable rate credit facilities.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and many require the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management’s credit evaluation of the customer. Collateral held varies but may include real estate, marketable securities, pledged deposits, equipment and accounts receivable.

 

Standby letters of credit are conditional commitments issued that guarantee the performance of a customer to a third party. The credit risk and collateral policy involved in issuing letters of credit is essentially the same as that involved in extending loan commitments. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies but may include real estate, marketable securities, pledged deposits, equipment and accounts receivable. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees.  The current amount of liability as of September 30, 2019 and December 31, 2018 for guarantees under standby letters of credit issued is not material. 

 

Regulatory Matters 

 

We are required to comply with certain “risk-based” capital adequacy guidelines issued by the bank regulatory agencies. The risk-based capital guidelines assign varying risk weights to the individual assets held by a bank. The guidelines also assign weights to the “credit-equivalent” amounts of certain off-balance sheet items, such as letters of credit and interest rate and currency swap contracts.

 

Under the capital rules, risk-based capital ratios are calculated by dividing common equity Tier 1, Tier 1, and total risk-based capital, respectively, by risk-weighted assets. Assets and off-balance sheet credit equivalents are assigned to one of several categories of risk-weights, based primarily on relative risk. Under applicable capital rules, Republic is required to maintain a minimum common equity Tier 1 capital ratio requirement of 4.5%, a minimum Tier 1 capital ratio requirement of 6%, a minimum total capital requirement of 8% and a minimum leverage ratio requirement of 4%. Under the rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity Tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The capital conservation buffer, which is composed of common equity Tier 1 capital, began on January 1, 2016 at the 0.625% level and was phased in over a three year period (increasing by that amount on each January 1, until it reached 2.5% on January 1, 2019). Implementation of the deductions and other adjustments to common equity Tier 1 capital began on January 1, 2015 and were phased-in over a three-year period.

 

50

 

 

The following table shows the required capital ratios with the conversation buffer over the phase-in period.

 

   

Basel III Community Banks

Minimum Capital Ratio Requirements

 
   

2016

   

2017

   

2018

   

2019

 
                                 

Common equity Tier 1 capital (CET1)

    5.125 %     5.750 %     6.375 %     7.000 %

Tier 1 capital (to risk-weighted assets)

    6.625 %     7.250 %     7.875 %     8.500 %

Total capital (to risk-weighted assets)

    8.625 %     9.250 %     9.875 %     10.500 %

 

The risk-based capital ratios measure the adequacy of a bank’s capital against the riskiness of its assets and off-balance sheet activities. Failure to maintain adequate capital is a basis for “prompt corrective action” or other regulatory enforcement action. In assessing a bank’s capital adequacy, regulators also consider other factors such as interest rate risk exposure; liquidity, funding and market risks; quality and level or earnings; concentrations of credit, quality of loans and investments; risks of any nontraditional activities; effectiveness of bank policies; and management’s overall ability to monitor and control risks.

 

Management believes that the Company and Republic met, as of September 30, 2019 and December 31, 2018, all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis as if all such requirements were currently in effect. In the current year, the FDIC categorized Republic as well capitalized under the regulatory framework for prompt corrective action provisions of the Federal Deposit Insurance Act. There are no calculations or events since that notification which management believes would have changed Republic’s category.

 

The Company and Republic’s ability to maintain the required levels of capital is substantially dependent upon the success of their capital and business plans, the impact of future economic events on Republic’s loan customers and Republic’s ability to manage its interest rate risk, growth and other operating expenses.

 

51

 

 

The following table presents the capital regulatory ratios for both Republic and the Company as of September 30, 2019, and December 31, 2018 (dollars in thousands):

 

(dollars in thousands)

 

 

 

Actual

   

Minimum Capital

Adequacy

   

 

Minimum Capital

Adequacy with

Capital Buffer

   

To Be Well

Capitalized Under

Prompt Corrective

Action Provisions

 
   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 

At September 30, 2019:

                                                               
                                                                 

Total risk-based capital

                                                               

Republic

  $ 253,326       12.98

%

  $ 156,113       8.00

%

  $ 204,898       10.50

%

  $ 195,141       10.00

%

Company

    264,626       13.53

%

    156,472       8.00

%

    205,369       10.50

%

    -       -

%

Tier 1 risk-based capital

                                                               

Republic

    244,859       12.55

%

    117,085       6.00

%

    165,870       8.50

%

    156,113       8.00

%

Company

    256,159       13.10

%

    117,354       6.00

%

    166,251       8.50

%

    -       -

%

CET 1 risk-based capital

                                                               

Republic

    244,859       12.55

%

    87,813       4.50

%

    136,599       7.00

%

    126,842       6.50

%

Company

    245,159       12.53

%

    88,015       4.50

%

    136,913       7.00

%

    -       -

%

Tier 1 leveraged capital

                                                               

Republic

    246,850       8.23

%

    118,946       4.00

%

    118,946       4.00

%

    148,683       5.00

%

Company

    250,843       8.60

%

    119,134       4.00

%

    119,134       4.00

%

    -       -

%

                                                                 
At December 31, 2018:                                                                
                                                                 
Total risk-based capital                                                                

Republic

  $ 231,610       13.26

%

  $ 139,722       8.00

%

  $ 172,489       9.875

%

  $ 174,652       10.00

%

Company

    262,964       15.03

%

    140,009       8.00

%

    172,824       9.875

%

    -       -

%

Tier 1 risk-based capital

                                                               

Republic

    222,995       12.77

%

    104,791       6.00

%

    137,539       7.875

%

    139,722       8.00

%

Company

    254,349       14.53

%

    105,007       6.00

%

    137,821       7.875

%

    -       -

%

CET 1 risk-based capital

                                                               

Republic

    222,995       12.77

%

    78,594       4.50

%

    111,341       6.375

%

    113,524       6.50

%

Company

    243,349       13.90

%

    78,755       4.50

%

    111,570       6.375

%

    -       -

%

Tier 1 leveraged capital

                                                               

Republic

    222,995       8.21

%

    108,685       4.00

%

    108,685       4.00

%

    135,857       5.00

%

Company

    254,349       9.35

%

    108,800       4.00

%

    108,800       4.00

%

    -       -

%

  

Dividend Policy

 

We have not paid any cash dividends on our common stock. We have no plans to pay cash dividends in 2019. Our ability to pay dividends depends primarily on receipt of dividends from our subsidiary, Republic. Dividend payments from Republic are subject to legal and regulatory limitations. The ability of Republic to pay dividends is also subject to profitability, financial condition, capital expenditures and other cash flow requirements.

 

Liquidity

 

A financial institution must maintain and manage liquidity to ensure it has the ability to meet its financial obligations. These obligations include the payment of deposits on demand or at their contractual maturity; the repayment of borrowings as they mature; the payment of lease obligations as they become due; the ability to fund new and existing loans and other funding commitments; and the ability to take advantage of new business opportunities. Liquidity needs can be met by either reducing assets or increasing liabilities. Our most liquid assets consist of cash, amounts due from banks and federal funds sold.

 

52

 

 

Regulatory authorities require us to maintain certain liquidity ratios in order for funds to be available to satisfy commitments to borrowers and the demands of depositors. In response to these requirements, we have formed an asset/liability committee (ALCO), comprised of certain members of Republic’s Board of Directors and senior management to monitor such ratios. The ALCO committee is responsible for managing the liquidity position and interest sensitivity. That committee’s primary objective is to maximize net interest income while configuring Republic’s interest-sensitive assets and liabilities to manage interest rate risk and provide adequate liquidity for projected needs. The ALCO committee meets on a quarterly basis or more frequently if deemed necessary.

 

Our target and actual liquidity levels are determined by comparisons of the estimated repayment and marketability of interest-earning assets with projected future outflows of deposits and other liabilities. Our most liquid assets, comprised of cash and cash equivalents on the balance sheet, totaled $201.5 million at September 30, 2019, compared to $72.5 million at December 31, 2018. Loan maturities and repayments are another source of asset liquidity. At September 30, 2019, Republic estimated that more than $105.0 million of loans would mature or repay in the six-month period ending March 31, 2020. Additionally, a significant portion of our investment securities are available to satisfy liquidity requirements through sales on the open market or by pledging as collateral to access credit facilities. At September 30, 2019, we had outstanding commitments (including unused lines of credit and letters of credit) of $316.8 million. Certificates of deposit scheduled to mature in one year totaled $152.0 million at September 30, 2019. We anticipate that we will have sufficient funds available to meet all current commitments.

 

Daily funding requirements have historically been satisfied by generating core deposits and certificates of deposit with competitive rates, buying federal funds or utilizing the credit facilities of the FHLB. We have established a line of credit with the FHLB of Pittsburgh. Our maximum borrowing capacity with the FHLB was $815.1 million at September 30, 2019. At September 30, 2019 and December 31, 2018, we had no outstanding term borrowings with the FHLB. At September 30, 2019, we had no overnight borrowings with the FHLB and at December 31, 2018, we had outstanding overnight borrowings of $91.4 million with the FHLB. As of September 30, 2019 and December 31, 2018, FHLB had issued letters of credit, on Republic’s behalf, totaling $100.0 million against our available credit line. We also established a contingency line of credit of $10.0 million with ACBB and a Fed Funds line of credit with Zions Bank in the amount of $15.0 million to assist in managing our liquidity position. We had no amounts outstanding against the ACBB line of credit or the Zions Fed Funds line at both September 30, 2019 and December 31, 2018.

 

Investment Securities Portfolio

 

At September 30, 2019, we identified certain investment securities that were being held for indefinite periods of time, including securities that will be used as part of our asset/liability management strategy and that may be sold in response to changes in interest rates, prepayments and similar factors. These securities are classified as available-for-sale and are intended to increase the flexibility of our asset/liability management. Our investment securities classified as available for sale consist primarily of U.S. Government agency securities, CMOs, MBSs, municipal securities, and corporate bonds. Available for sale securities totaled $380.0 million and $321.0 million as of September 30, 2019 and December 31, 2018, respectively. At September 30, 2019, securities classified as available for sale had a net unrealized loss of $1.3 million and a net unrealized loss of $5.7 million at December 31, 2018.

 

Loan Portfolio

 

Our loan portfolio consists of secured and unsecured commercial loans including commercial real estate loans, construction and land development loans, commercial and industrial loans, owner occupied real estate loans, consumer and other loans, and residential mortgages. Commercial loans are primarily secured term loans made to small to medium-sized businesses and professionals for working capital, asset acquisition and other purposes. Commercial loans are originated as either fixed or variable rate loans with typical terms of 1 to 5 years. Republic’s commercial loans typically range between $250,000 and $5.0 million, but customers may borrow significantly larger amounts up to Republic’s legal lending limit of approximately $34.4 million at September 30, 2019. Individual customers may have several loans often secured by different collateral.

 

53

 

 

Credit Quality

 

Republic’s written lending policies require specified underwriting, loan documentation and credit analysis standards to be met prior to funding, with independent credit department approval for the majority of new loan balances. A committee consisting of senior management and certain members of the Board of Directors oversees the loan approval process to monitor that proper standards are maintained, while approving the majority of commercial loans.

 

Loans, including impaired loans, are generally classified as non-accrual if they are past due as to maturity or payment of interest or principal for a period of more than 90 days, unless such loans are well-secured and in the process of collection. Loans that are on a current payment status or past due less than 90 days may also be classified as non-accrual if repayment in full of principal and/or interest is in doubt. Loans may be returned to accrual status when all principal and interest amounts contractually due are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower, in accordance with the contractual terms.

 

While a loan is classified as non-accrual, any collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. For non-accrual loans, which have been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.

 

The following table shows information concerning loan delinquency and non-performing assets as of the dates indicated (dollars in thousands):

 

   

September 30,

2019

   

December 31,

2018

 

Loans accruing, but past due 90 days or more

  $ 129     $ -  

Non-accrual loans

    11,923       10,341  

Total non-performing loans

    12,052       10,341  

Other real estate owned

    6,653       6,223  

Total non-performing assets

  $ 18,705     $ 16,564  
                 

Non-performing loans as a percentage of total loans, net of unearned income

    0.77 %     0.72 %

Non-performing assets as a percentage of total assets

    0.61 %     0.60 %

 

Non-performing asset balances increased by $2.1 million to $18.7 million as of September 30, 2019 from $16.6 million at December 31, 2018. Loans accruing, but past due 90 days or more, totaled $129,000 at September 30, 2019. There were no loans accruing, but past due 90 days or more at December 31, 2018. At September 30, 2019 and December 31, 2018, all identified impaired loans are internally classified and individually evaluated for impairment in accordance with the guidance under ASC 310.

 

54

 

 

The following table presents our 30 to 89 days past due loans at September 30, 2019 and December 31, 2018.  

 

(dollars in thousands)

 

September 30,

   

December 31,

 
   

2019

   

2018

 

30 to 59 days past due

  $ 176     $ 1,135  

60 to 89 days past due

    37       1,574  

Total loans 30 to 89 days past due

  $ 213     $ 2,709  

 

Other Real Estate Owned

 

The balance of other real estate owned was $6.7 million at September 30, 2019 and $6.2 million at December 31, 2018. The following table presents a reconciliation of other real estate owned for the nine months ended September 30, 2019 and the year ended December 31, 2018:

 

(dollars in thousands)

 

September 30,

2019

   

December 31,

2018

 

Beginning Balance, January 1st

  $ 6,223     $ 6,966  

Additions

    1,071       315  

Valuation adjustments

    (240 )     (563 )

Dispositions

    (401 )     (495 )

Ending Balance

  $ 6,653     $ 6,223  

 

At September 30, 2019, we had no credit exposure to “highly leveraged transactions” as defined by the FDIC.

 

Allowance for Loan Losses

 

The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish an allowance against loan losses on a quarterly basis. When an increase in this allowance is necessary, a provision for loan losses is charged to earnings. The allowance for loan losses consists of three components. The first component is allocated to individually evaluated loans found to be impaired and is calculated in accordance with ASC 310 Receivables. The second component is allocated to all other loans that are not individually identified as impaired. This component is calculated for all non-impaired loans on a collective basis in accordance with ASC 450 Contingencies. The third component is an unallocated allowance to account for a level of imprecision in management’s estimation process.

 

We evaluate loans for impairment and potential charge-off on a quarterly basis. Management regularly monitors the condition of borrowers and assesses both internal and external factors in determining whether any loan relationships have deteriorated. Any loan rated as substandard or lower will have an individual collateral evaluation analysis prepared to determine if a deficiency exists. We first evaluate the primary repayment source. If the primary repayment source is determined to be insufficient and unlikely to repay the debt, we then look to the secondary repayment sources. Secondary sources are conservatively reviewed for liquidation values. Updated appraisals and financial data are obtained to substantiate current values. If the reviewed sources are deemed to be inadequate to cover the outstanding principal and any costs associated with the resolution of the troubled loan, an estimate of the deficient amount will be calculated and a specific allocation of loan loss reserve is recorded.

 

Factors considered in the calculation of the allowance for non-impaired loans include several qualitative and quantitative factors such as historical loss experience, trends in delinquency and nonperforming loan balances, changes in risk composition and underwriting standards, experience and ability of management, and general economic conditions along with other external factors. Historical loss experience is analyzed by reviewing charge-offs over a three year period to determine loss rates consistent with the loan categories depicted in the allowance for loan loss table below.

 

55

 

 

The factors supporting the allowance for loan losses do not diminish the fact that the entire allowance for loan losses is available to absorb losses in the loan portfolio and related commitment portfolio, respectively. Our principal focus, therefore, is on the adequacy of the total allowance for loan losses. The allowance for loan losses is subject to review by banking regulators. Our primary bank regulators regularly conduct examinations of the allowance for loan losses and make assessments regarding the adequacy and the methodology employed in their determination.

 

An analysis of the allowance for loan losses for the nine months ended September 30, 2019 and 2018, and the twelve months ended December 31, 2018 is as follows:

 

(dollars in thousands)

 

For the nine

months ended

September 30,

2019

   

For the twelve

months ended

December 31,

2018

   

For the nine

months ended

September 30,

2018

 
                         

Balance at beginning of period

  $ 8,615     $ 8,599     $ 8,599  

Charge-offs:

                       

Commercial real estate

    -       1,603       1,535  

Construction and land development

    -       -       -  

Commercial and industrial

    1,002       151       151  

Owner occupied real estate

    -       465       465  

Consumer and other

    117       219       213  

Residential mortgage

    -       -       -  

Total charge-offs

    1,119       2,438       2,364  

Recoveries:

                       

Commercial real estate

    -       50       50  

Construction and land development

    -       -       -  

Commercial and industrial

    213       81       77  

Owner occupied real estate

    1       20       20  

Consumer and other

    7       3       2  

Residential mortgage

    -       -       -  

Total recoveries

    221       154       149  

Net charge-offs/(recoveries)

    898       2,284       2,215  

Provision for loan losses

    750       2,300       1,700  

Balance at end of period

  $ 8,467     $ 8,615     $ 8,084  
                         

Average loans outstanding(1)

  $ 1,506,482     $ 1,340,117     $ 1,310,750  

As a percent of average loans:(1)

                       

Net charge-offs (annualized)

    0.08 %     0.17 %     0.23 %

Provision for loan losses (annualized)

    0.07 %     0.17 %     0.17 %

Allowance for loan losses

    0.56 %     0.64 %     0.62 %

Allowance for loan losses to:

                       

Total loans, net of unearned income

    0.54 %     0.60 %     0.59 %

Total non-performing loans

    70.25 %     83.31 %     59.97 %

 

(1)Includes non-accruing loans.

 

We recorded a provision for loan losses of $450,000 for the three month period ended September 30, 2019 and $750,000 for the nine months ended September 30, 2019. We recorded a provision for loan losses of $500,000 for the three month period ended September 30, 2018 and $1.7 million for the nine months ended September 30, 2018. During the first nine months of 2019, there was a decrease in the allowance required for loans individually evaluated for impairment partially offset by an increase in the allowance required for loans collectively evaluated for impairment.

 

The allowance for loan losses as a percentage of non-performing loans (coverage ratio) was 70.3% at September 30, 2019, compared to 83.3% at December 31, 2018 and 60.0% at September 30, 2018. Total non-performing loans were $12.1 million, $10.3 million, and $13.5 million at September 30, 2019, December 31, 2018 and September 30, 2018, respectively.

 

56

 

 

Management makes at least a quarterly determination as to an appropriate provision from earnings to maintain an allowance for loan losses that it determines is adequate to absorb inherent losses in the loan portfolio. The Board of Directors periodically reviews the status of all non-accrual and impaired loans and loans classified by the management team. The Board of Directors also considers specific loans, pools of similar loans, historical charge-off activity, economic conditions and other relevant factors in reviewing the adequacy of the allowance for loan losses. Any additions deemed necessary to the allowance for loan losses are charged to operating expenses.

 

We evaluate loans for impairment and potential charge-offs on a quarterly basis. Any loan rated as substandard or lower will have a collateral evaluation analysis completed in accordance with the guidance under GAAP on impaired loans to determine if a deficiency exists. Our credit monitoring process assesses the ultimate collectability of an outstanding loan balance from all potential sources. When a loan is determined to be uncollectible it is charged-off against the allowance for loan losses. Unsecured commercial loans and all consumer loans are charged-off immediately upon reaching the 90-day delinquency mark unless they are well-secured and in the process of collection. The timing on charge-offs of all other loan types is subjective and will be recognized when management determines that full repayment, either from the cash flow of the borrower, collateral sources, and/or guarantors, will not be sufficient and that repayment is unlikely. A full or partial charge-off is recognized equal to the amount of the estimated deficiency calculation.

 

Serious delinquency is often the first indicator of a potential charge-off. Reductions in appraised collateral values and deteriorating financial condition of borrowers and guarantors are factors considered when evaluating potential charge-offs. The likelihood of possible recoveries or improvements in a borrower’s financial condition is also assessed when considering a charge-off.

 

Partial charge-offs of non-performing and impaired loans can significantly reduce the coverage ratio and other credit loss statistics due to the fact that the balance of the allowance for loan losses will be reduced while still carrying the remainder of a non-performing loan balance in the impaired loan category. The amount of non-performing loans for which partial charge-offs have been recorded amounted to $3.9 million at September 30, 2019 and $4.4 million at December 31, 2018.

 

The following table provides additional analysis of partially charged-off loans.

 

(dollars in thousands)

 

September 30,

2019

   

December 31,

2018

 

Total nonperforming loans

  $ 12,052     $ 10,341  

Nonperforming and impaired loans with partial charge-offs

    3,927       4,387  
                 

Ratio of nonperforming loans with partial charge-offs to total loans

    0.25

%

    0.31

%

Ratio of nonperforming loans with partial charge-offs to total nonperforming loans

    32.58

%

    42.42

%

Coverage ratio net of nonperforming loans with partial charge-offs

    215.61

%

    196.38

%

 

Our charge-off policy is reviewed on an annual basis and updated as necessary. During the nine month period ended September 30, 2019, there were no changes made to this policy.

 

Effects of Inflation

 

The majority of assets and liabilities of a financial institution are monetary in nature. Therefore, a financial institution differs greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. Management believes that the most significant impact of inflation on its financial results is through our need and ability to react to changes in interest rates. Management attempts to maintain an essentially balanced position between rate sensitive assets and liabilities over a one-year time horizon in order to protect net interest income from being affected by wide interest rate fluctuations.

 

57

 

 

ITEM 3: QUANTITATIVE AND QUALITATIVE INFORMATION ABOUT MARKET RISK

 

There has been no material change in the Company’s assessment of its sensitivity to market risk since its presentation in the Annual Report on Form 10-K for the fiscal year ended December 31, 2018 filed with the SEC on March 14, 2019.

 

ITEM 4: CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures  

 

The Company maintains disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and accumulated and communicated to the Company’s management, including the Company’s principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

 The Company’s management, with the participation of the principal executive officer and the principal financial officer, conducted an evaluation, as of the end of the period covered by this report, of the effectiveness of the Company’s disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a-15(e). Based on this evaluation, the principal executive officer and the principal financial officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e), were effective at the reasonable assurance level.

 

Changes in Internal Controls

 

The principal executive officer and principal financial officer also conducted an evaluation of the Company’s internal control over financial reporting (“Internal Control”) to determine whether any changes in Internal Control occurred during the quarter ended September 30, 2019 that have materially affected or which are reasonably likely to materially affect Internal Control. Based on that evaluation, there has been no such change during the quarter ended September 30, 2019.

 

Limitations on the Effectiveness of Controls

 

Control systems, no matter how well designed and operated, can provide only reasonable, not an absolute, level of assurance that the objectives of the control system are met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

 

58

 

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

The Company and Republic are from time to time parties (plaintiff or defendant) to lawsuits in the normal course of business. While any litigation involves an element of uncertainty, management is of the opinion that the liability of the Company and Republic, if any, resulting from such actions will not have a material effect on the financial condition or results of operations of the Company and Republic.

 

ITEM 1A. RISK FACTORS

 

Significant risk factors could adversely affect the Company’s business, financial condition and results of operation. Risk factors discussing these risks can be found in Part I, “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 and Form 10-Q for the quarter ended June 30, 2019. The risk factors in the Company’s Annual Report on Form 10-K have not materially changed. You should carefully consider these risk factors. The risks described in the Company’s Form 10-K and Form 10-Q are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

       Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

59

 

 

ITEM 6. EXHIBITS

 

The following Exhibits are filed as part of this report. (Exhibit numbers correspond to the exhibits required by Item 601 of Regulation S-K for quarterly reports on Form 10-Q).

 

Exhibit

Number

 

 

Description

 

 

Location

         

3.1

 

Amended and Restated Articles of Incorporation of Republic First Bancorp, Inc.

 

Incorporated by reference to Form 10-K filed March 10, 2017

         

3.2

 

Amended and Restated By-Laws of Republic First Bancorp, Inc.

 

Incorporated by reference to Form S-1 filed April 23, 2010 (333-166286)

         

31.1

 

Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer of Republic First Bancorp, Inc.

 

Filed herewith

         

31.2

 

Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer of Republic First Bancorp, Inc.

 

Filed herewith

         

32.1

 

Section 1350 Certification of Harry D. Madonna

 

Furnished herewith

         

32.2

 

Section 1350 Certification of Frank A. Cavallaro

 

Furnished herewith

         

101

 

The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2019, formatted in XBRL (eXtensible Business Reporting Language); (i) Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018, (ii) Consolidated Statements of Operations for the three and nine months ended September 30, 2019 and 2018, (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2019 and 2018, (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018, (v) Consolidated Statements of Changes in Shareholders’ Equity for the three and nine months ended September 30, 2019 and 2018, and (vi) Notes to Consolidated Financial Statements.

   

 

60

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

   

REPUBLIC FIRST BANCORP, INC.

 
       

Date: November 12, 2019

By:

/s/ Harry D. Madonna

 
   

Harry D. Madonna

 
   

President and Chief Executive Officer

(principal executive officer)

 
       

Date: November 12, 2019

By:

/s/ Frank A. Cavallaro

 
   

Frank A. Cavallaro

 
   

Executive Vice President and Chief Financial Officer

(principal financial and accounting officer)

 

 

61