Bankwell Financial Group, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Unaudited)
4. Shareholders’ Equity
Common stock
On May 15, 2014, the Company priced 2,702,703 common shares in its initial public offering (“IPO”) at $18.00 per share, and on May 15, 2014, Bankwell common shares began trading on the Nasdaq Stock Market. The Company issued a total of 2,702,703 common shares in its IPO, which closed on May 20, 2014. The net proceeds from the IPO were approximately $44.7 million, after deducting the underwriting discount of approximately $2.5 million and approximately $1.3 million of expenses.
Between 2007 and 2013, four private placements for the sale of common stock were completed for the purpose of capitalizing the Company and allowing for continued growth. The private placement offerings were in addition to the initial and secondary offerings completed in 2002 and 2007, respectively. A total of 3,429,623 shares were issued and net proceeds of $47.8 million were received in connection with these offerings.
Preferred stock
In 2011, the Company elected to participate in the U.S. Treasury’s Small Business Lending Fund Program (“SBLF”). The SBLF is a $30 billion fund established under the Small Business Jobs Act of 2010 to encourage lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. The SBLF is intended to expand the ability to lend to small businesses, in order to help stimulate the economy and promote job growth. The transaction resulted in net capital proceeds to the Company of $5.9 million, of which at least 90% was invested in the Banks as Tier 1 Capital.
The Series C Preferred stock pays noncumulative dividends. The dividend rate on the Series C Preferred Stock for the initial ten quarterly dividend periods, commencing with the period ended September 30, 2011 and ending with the period ended December 31, 2013, was determined each quarter based on the increase in the Banks’ Qualified Small Business Lending over a baseline amount. The Company has paid dividends at a rate of 1.0% since issuance. For the eleventh quarterly dividend payment through four and one-half years after its issuance, the dividend rate on the Series C Preferred Stock will be fixed at the rate in effect at the end of the ninth quarterly dividend period, which is 1.0%. In the second quarter of 2016, four and one-half years from its issuance, the dividend rate will be fixed at 9.0% per annum.
The Series C Preferred Stock has no maturity date and ranks senior to the Company’s common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. The Series C Preferred Stock is non-voting, other than voting rights on matters that could adversely affect the Series C Preferred Stock, and is redeemable at any time by the Company, subject to the approval of its federal banking regulator. The redemption price is the aggregate liquidation preference of the SBLF Preferred Stock plus accrued but unpaid dividends and pro rata portion of any lending incentive fee. All redemptions must be in an amount at least equal to 25% of the number of originally issued shares of SBLF Preferred Stock, or 100% of the then-outstanding shares if less than 25% of the number of shares originally issued. In connection with the IPO, the U.S. Treasury exercised its piggyback registration rights under the SBLF and the Series C Preferred Stock held by the U.S. Treasury was registered under the Securities Act of 1933, as amended.
Warrants
The initial and secondary offerings completed in 2002 and 2007 each call for the issuance of Units. Each Unit issued pursuant to these two offerings represented one share of common stock and one non-transferable Warrant. The Warrants were exercisable at any time from and including October 1, 2009 and prior to or on November 30, 2009, unless extended or accelerated by the board of directors in their discretion. The board of directors has extended the exercise period to October 1, 2015 through December 1, 2015. Each Warrant allows a holder to purchase .3221 shares of common stock at an exercise price of $14.00 per share. None of the Warrants has been exercised as of March 31, 2015. Assuming that all of the Warrants issued are exercised in full during the exercise period, the Company would receive $4.3 million in gross capital and issue 304,640 shares of common stock.
As a result of the acquisition of Quinnipiac on October 1, 2014 the Company issued 68,600 warrants to former Quinnipiac warrant holders in accordance with the merger agreement. Each warrant was automatically converted into a warrant to purchase 0.56 shares of the Company’s common stock for an exercise price of $17.56. None of the warrants have been exercised as of March 31, 2015.
Dividends
The Company’s shareholders are entitled to dividends when and if declared by the board of directors, out of funds legally available. The ability of the Company to pay dividends depends, in part, on the ability of the Bank to pay dividends to the Company. In accordance with Connecticut statutes, regulatory approval is required to pay dividends in excess of the Bank’s profits retained in the current year plus retained profits from the previous two years. The bank is also prohibited from paying dividends that would reduce its capital ratios below minimum regulatory requirements.
The payment of dividends is subject to additional restrictions in connection with the SBLF preferred stock.
For the three months ended March 31, 2015 and 2014, the Company paid cash dividends on preferred stock of $27 thousand. To date, the Company has not declared or paid dividends on its common stock, nor has it repurchased any of its common stock.
5. Comprehensive Income
Comprehensive income represents the sum of net income and items of other comprehensive income or loss, including net unrealized gains or losses on securities available for sale and net gains or losses on derivatives accounted for as cash flow hedges. The Company’s total comprehensive income or loss for the three months ended March 31, 2015 and 2014 is reported in the Consolidated Statements of Comprehensive Income.
The following table presents the changes in accumulated other comprehensive income (loss) by component, net of tax for the three months ended March 31, 2015 and 2014:
6. Earnings Per Share
Basic earnings per share (“EPS”) is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock options) were exercised or converted into common stock or resulted in the issuance of common stock that then shared in earnings. Unvested share-based payment awards, which include the right to receive non-forfeitable dividends, are considered to participate with common stock in undistributed earnings for purposes of computing EPS.
The Company’s unvested restricted stock awards are participating securities, and therefore, are included in the computation of both basic and diluted earnings per common share. EPS is calculated using the two-class method, under which calculations (1) exclude from the numerator any dividends paid or owed on participating securities and any undistributed earnings considered to be attributable to participating securities and (2) exclude from the denominator the dilutive impact of the participating securities.
The following is a reconciliation of earnings available to common shareholders and basic weighted-average common shares outstanding to diluted weighted average common shares outstanding, reflecting the application of the two-class method:
7. Regulatory Matters
The Federal Reserve, the FDIC and the other federal and state bank regulatory agencies establish regulatory capital guidelines for U.S. banking organizations.
As of January 1, 2015, the Company and the Bank became subject to new capital rules set forth by the Federal Reserve, the FDIC and the other federal and state bank regulatory agencies. The new capital rules revise the banking agencies’ leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (the Basel III Capital Rules).
The Basel III Capital Rules establish a new minimum common equity Tier 1 capital requirement of 4.5% of risk-weighted assets; set the minimum leverage ratio at 4% of total assets; increased the minimum Tier 1 capital to risk-weighted assets requirement from 4% to 6%; and retained the minimum total capital to risk-weighted assets requirement at 8.0%. A “well-capitalized” institution must generally maintain capital ratios 200 basis points higher than the minimum guidelines.
The Basel III Capital Rules also change the risk weights assigned to certain assets. The Basel III Capital Rules assigned a higher risk weight (150%) to loans that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The Basel III Capital Rules also alter the risk weighting for other assets, including marketable equity securities that are risk weighted generally at 300%. The Basel III Capital Rules require certain components of accumulated other comprehensive income (loss) to be included for purposes of calculating regulatory capital requirements unless a one-time opt-out is exercised. The Bank did exercise its opt-out option and will exclude the unrealized gain (loss) on investment securities component of accumulated other comprehensive income (loss) from regulatory capital.
The Basel III Capital Rules limit a banking organization’s capital distributions and certain discretionary bonus payments to executive officers if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The “capital conservation buffer” is being phased in from January 1, 2016 to January 1, 2019, when the full capital conservation buffer will be effective.
Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements.
Management believes, as of March 31, 2015, the Bank and Company meet all capital adequacy requirements to which they are subject. There are no conditions or events since then that management believes have changed this conclusion.
The capital amounts and ratios for the Bank and the Company at March 31, 2015 were as follows:
As of December 31, 2014, the Bank and Company were subject to different regulatory capital requirements administered by federal and state banking agencies. Quantitative measures established by regulation to ensure capital adequacy required the Bank and Company to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets, as defined by regulation.
BankwellFinancial Group, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Unaudited)
The capital amounts and ratios for the Bank and Company at December 31, 2014, were as follows:
Restrictions on dividends
The ability of the Company to pay dividends depends, in part, on the ability of the Bank to pay dividends to the Company. In accordance with Connecticut statutes, regulatory approval is required to pay dividends in excess of the Bank’s profits retained in the current year plus retained profits from the previous two years. The Bank is also prohibited from paying dividends that would reduce its capital ratios below minimum regulatory requirements.
8. STOCK-BASED COMPENSATION
Equity award plans
The Company has five equity award plans, which are collectively referred to as the “Plan.” The current plan under which any future issuances of equity awards will be made is the 2012 BNC Financial Group, Inc. Stock Plan, or the “2012 Plan,” amended on June 26, 2013. All equity awards made under the 2012 Plan are made by means of an award agreement, which contains the specific terms and conditions of the grant. To date, all equity awards have been in the form of share options or restricted stock. At March 31, 2015, there were 464,189 shares reserved for future issuance under the 2012 Plan.
Share Options: The Company accounts for stock options based on the fair value at the date of grant over the vesting period of such awards on a straight line basis. For the three months ended March 31, 2015 and 2014, the Company recorded expense related to options granted under the various share option plans of approximately $4 thousand and $8 thousand, respectively.
There were no options granted during the three months ended March 31, 2015.
A summary of the status of outstanding share options as of and for the three months ended March 31, 2015 is presented below:
Intrinsic value is the amount by which the fair value of the underlying stock exceeds the exercise price of an option on the exercise date. The total intrinsic value of share options exercised during the three months ended March 31, 2015 was $89 thousand.
Restricted Stock: Restricted stock provides grantees with rights to shares of common stock upon completion of a service period and certain performance goals. Shares of unvested restricted stock are considered participating securities. Restricted stock awards generally vest over one to five years.
The following table presents the activity for restricted stock for the three months ended March 31, 2015:
The Company’s restricted stock expense for the three months ended March 31, 2015 and 2014 was $238 thousand and $142 thousand, respectively.
Market Conditions Restricted Stock: On December 9, 2014 the Company issued restricted stock with market and service conditions pursuant to the Company’s 2012 Stock Plan. The maximum number of shares that can vest is 49,400. The actual number of shares to be vested will be based on market criteria over a five-year period ending on December 1, 2019 based on the Company’s stock price being at or above $25.00, $27.00 and $29.00 per share over a 60-day consecutive period. These shares may vest over a period from December 1, 2017 to December 1, 2019 based on meeting the price targets. In addition, the grantees must be employed with the Company on the vesting date to receive the shares. The Company determined the fair value of these market condition awards in accordance with ASC 718 Stock Compensationusing the Monte Carlo simulation model deemed appropriate for this type of grant. The grant date fair value for these grants was $11.63 for the awards that vest at the $25 stock price, $10.30 for the awards that vest at the $27 stock price and $9.10 for the awards that vest at the $29 stock price. The grant date fair value for the Company’s stock was $18.99 per share. The Company recognized $43 thousand in stock compensation expense for the three months ended March 31, 2015 for these restricted stock awards.
9. Derivative Instruments
Information about derivative instruments at March 31, 2015 and December 31, 2014 is as follows:
March 31, 2015:
December 31, 2014:
The effective portion of unrealized changes in the fair value of derivatives accounted for as cash flow hedges is reported in other comprehensive income and subsequently reclassified to earnings in the same period or periods during which the hedged forecasted transaction affects earnings. The Bank assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged item or transaction. The ineffective portion of changes in the fair value of the derivatives is recognized directly in earnings.
The Bank’s cash flow hedge positions are all forward starting interest rate swap transactions. The Bank entered into the following forward starting interest rate swap transactions:
This hedge strategy converts the LIBOR based rate of interest on certain FHLB advances to fixed interest rates, thereby protecting the Bank from floating interest rate variability.
Changes in the consolidated statements of comprehensive income related to interest rate derivatives designated as hedges of cash flows were as follows for the three months ended March 31, 2015 and 2014:
10. Fair Value of Financial Instruments
GAAP requires disclosure of fair value information about financial instruments, whether or not recognized in the statements of condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparisons to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.
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 presented herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction at either March 31, 2015 or December 31, 2014. The estimated fair value amounts have been measured as of the respective period-ends, and have not been reevaluated or updated for purposes of these consolidated 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 period-end.
The carrying values, fair values and placement in the fair value hierarchy of the Company’s financial instruments at March 31, 2015 and December 31, 2014 were as follows:
The following methods and assumptions were used by management in estimating the fair value of its financial instruments:
11. FairValue Measurements
The Company is required to account for certain assets and liabilities at fair value on a recurring or non-recurring basis. As discussed in Note 1, the Company determines fair value in accordance with GAAP, which defines fair value and establishes a framework for measuring fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. GAAP establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair values:
Valuation techniques based on unobservable inputs are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows and the selection of discount rates that may appropriately reflect market and credit risks. Changes in these judgments often have a material impact on the fair value estimates. In addition, since these estimates are as of a specific point in time they are susceptible to material near-term changes.
Financial instruments measured at fair value on a recurring basis
The following tables detail the financial instruments carried at fair value on a recurring basis at March 31, 2015 and December 31, 2014, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value. The Company had no transfers into or out of Levels 1, 2 or 3 during the three months ended March 31, 2015 and the year ended December 31, 2014.
Available for sale investment securities: The fair value of the Company’s investment securities are estimated by using pricing models or quoted prices of securities with similar characteristics (i.e. matrix pricing) and are classified within Level 2 of the valuation hierarchy.
Derivative liabilities: The Company’s derivative liabilities consist of an interest rate swap initiated in February 2014 and an interest rate swap initiated in December 2014 as part of management’s strategy to manage interest rate risk. The valuation of the Company’s interest rate swaps is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. The Company has determined that the majority of the inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy.
Financial instruments measured at fair value on a nonrecurring basis
Certain assets are measured at fair value on a non-recurring basis in accordance with GAAP. These include assets that are measured at the-lower-of-cost-or-market that were recognized at fair value below cost at the end of the period as well as assets that are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.
The following table details the financial instruments carried at fair value on a nonrecurring basis at March 31, 2015 and December 31, 2014, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value:
The following table presents information about quantitative inputs and assumptions for Level 3 financial instruments carried at fair value on a nonrecurring basis at March 31, 2015 and December 31, 2014:
Impaired loans: Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records nonrecurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Nonrecurring adjustments also include certain impairment amounts for collateral-dependent loans calculated in accordance with ASC 310-10 when establishing the allowance for credit losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan. Collateral is typically valued using appraisals or other indications of value based on recent comparable sales of similar properties or other assumptions. Estimates of fair value based on collateral are generally based on assumptions not observable in the marketplace and therefore such valuations have been classified as Level 3. For those loans where the primary source of repayment is cash flow from operations, adjustments include impairment amounts calculated based on the perceived collectability of interest payments on the basis of a discounted cash flow analysis utilizing a discount rate equivalent to the original note rate.
Foreclosed real estate: The Company classifies property acquired through foreclosure or acceptance of deed-in-lieu of foreclosure as foreclosed real estate and repossessed assets in its financial statements. Upon foreclosure, the property securing the loan is written down to fair value less selling costs. The write-down is based upon differences between the appraised value and the book value. Appraisals are based on observable market data such as comparable sales, however assumptions made in determining comparability are unobservable and therefore these assets are classified as Level 3 within the valuation hierarchy.
12. Mergers And Acquisitions
On October 1, 2014, the Company acquired all of the outstanding common shares of Quinnipiac Bank & Trust Company (“Quinnipiac”). Quinnipiac had two banking offices primarily serving south-central Connecticut and has merged with and into Bankwell Bank.
Quinnipiac shareholders received 510,122 shares of the Company common stock and $3.6 million in cash. As of September 30, 2014, Quinnipiac had assets with a carrying value of approximately $117.8 million, including loans outstanding with a carrying value of approximately $97.1 million, as well as deposits with a carrying value of approximately $100.4 million and a book value of $10.1 million. The results of Quinnipiac’s operations are included in the Company’s Consolidated Statement of Income from the date of acquisition.
The assets and liabilities in the Quinnipiac acquisition were recorded at their fair value based on management’s best estimate using information available at the date of acquisition. Consideration paid and fair values of Quinnipiac’s assets acquired and liabilities assumed are summarized in the following tables:
Explanation of fair value adjustments:
Except for collateral dependent loans with deteriorated credit quality, the fair values for loans acquired from Quinnipiac were estimated using cash flow projections based on the remaining maturity and repricing terms. Cash flows were adjusted by estimating future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value using a risk-adjusted market rate for similar loans. For collateral dependent loans with deteriorated credit quality, to estimate the fair value, the Company analyzed the value of the underlying collateral of the loans, assuming the fair values of the loans were derived from the eventual sale of the collateral. Those values were discounted using market derived rates of return, with consideration given to the period of time and costs associated with the foreclosure and disposition of the collateral. There was no carryover of Quinnipiac’s allowance for credit losses associated with the loans that were acquired as the loans were initially recorded at fair value.
Information about the acquired loan portfolio subject to purchased credit impaired accounting guidance (ASC 310-30) as of October 1, 2014 was as follows:
13. Subsequent events
Management has evaluated subsequent events for potential recognition or disclosure in the consolidated financial statements through May 11, 2015, the date upon which the Company’s consolidated financial statements were available to be issued. No subsequent events were identified that would have required a change to the consolidated financial statements or disclosure in the notes to the consolidated financial statements.
Item 2. Management’sDiscussion and Analysis of FinancialCondition and Results of Operations
This section presents management’s perspective on our financial condition and results of operations. The following discussion and analysis should be read in conjunction with the unaudited interim consolidated financial statements and related notes contained elsewhere in this report on Form 10-Q. To the extent that this discussion describes prior performance, the descriptions relate only to the periods listed, which may not be indicative of future financial outcomes. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management’s expectations. Factors that could cause such differences are discussed in Company’s Form 10-K filed for the year ended December 31, 2014 in the sections titled “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors” We assume no obligation to update any of these forward-looking statements.
General
Bankwell Financial Group, Inc. is a bank holding company headquartered in New Canaan, Connecticut. Through our wholly owned subsidiary, Bankwell Bank, or the Bank, we serve small and medium-sized businesses and retail customers in greater Fairfield County, Connecticut. We also serve similar customers in greater New Haven County, Connecticut as a result of the merger with Quinnipiac Bank and Trust Company. We have a history of building long-term customer relationships and attracting new customers through what we believe is our strong customer service and our ability to deliver a diverse product offering.
The following discussion and analysis presents our results of operations and financial condition on a consolidated basis. However, because we conduct all of our material business operations through the Bank, the discussion and analysis relates to activities primarily conducted at the Bank.
As a bank holding company, we generate most of our revenue from interest on loans and investments and fee-based revenues. Our primary source of funding for our loans is deposits. Our largest expenses are interest on these deposits and salaries and related employee benefits. We measure our performance primarily through our net interest margin, efficiency ratio, ratio of allowance for loan losses to total loans, return on average assets and return on average equity, among other metrics, while maintaining appropriate regulatory leverage and risk-based capital ratios.
Critical Accounting Policies and Estimates
The discussion and analysis of our results of operations and financial condition are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires us to make significant estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from our current estimates, as a result of changing conditions and future events. The current economic environment has increased the degree of uncertainty inherent in these significant estimates.
We believe that accounting estimates for the fair value of acquired assets, the allowance for loan losses, stock-based compensation and derivative instrument valuation are particularly critical and susceptible to significant near-term change. These accounting estimates are discussed further in the Company’s Form 10-K filed for the year ended December 31, 2014 in the section “Critical Accounting Policies and Estimates” under Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Executive Overview
We are focused on becoming the “Hometown” bank and the banking provider of choice in our highly attractive market area, and to serve as a locally based alternative to our larger competitors. We aim to do this through:
On November 5, 2013 we completed the merger of Wilton into Bankwell Bank.
On May 15, 2014, Bankwell Financial Group, Inc. priced 2,702,703 common shares in its IPO at $18.00 per share, and on May 15, 2014, Bankwell common shares began trading on the Nasdaq Stock Market. The net proceeds from the IPO were approximately $44.7 million, after deducting the underwriting discount of approximately $2.5 million and approximately $1.3 million of expenses. We intend to use the net proceeds for general corporate purposes, which may include maintaining liquidity at the holding company, providing equity capital to the Bank to fund balance sheet growth, our working capital needs, and funding acquisitions of branches, whole financial institutions and related lines of businesses in or around our existing market that further our objectives.
On October 1, 2014 Quinnipiac merged with and into Bankwell Bank. Quinnipiac had one branch located in Hamden, Connecticut and a second branch located in the neighboring town of North Haven, Connecticut. The results discussed below for the three months ended March 31, 2014 do not reflect any results from Quinnipiac.
Earnings Overview
Net income available to common shareholders was $1.8 million, or $0.26 per diluted share, and $1.1 million, or $0.28 per diluted share, for the three months ended March 31, 2015 and 2014, respectively. Returns on average equity and average assets for the three months ended March 31, 2015 were 5.81% and 0.70%, respectively, compared to 6.48% and 0.59%, respectively, for the three months ended March 31, 2014.
For the three months ended March 31, 2015, we had net interest income of $9.9 million, an increase of $2.7 million, or 38.46%, over the three months ended March 31, 2014. Our net interest margin (fully taxable equivalent basis) for the three months ended March 31, 2015 and 2014 was 3.89% and 3.97%, respectively. We experienced a decline in our non-interest income, which totaled $599 thousand for the three months ended March 31, 2015 representing 5.71% of our total revenue, down from $769 thousand, or 9.72% of total revenue, for the three months ended March 31, 2014. The decline in our non-interest income was driven by a reduction in gains and fees from sales of loans of $339 thousand.
Results of Operations Net Interest Income
Net interest income is the difference between interest earned on loans and securities and interest paid on deposits and other borrowings, and is the primary source of our operating income. Net interest income is affected by the level of interest rates, changes in interest rates and changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Included in interest income are certain loan fees, such as deferred origination fees and late charges. The following tables and discussion present net interest income on a fully taxable equivalent, or FTE basis, by adjusting income and yields on tax-exempt loans and securities to be comparable to taxable loans and securities. We convert tax-exempt income to a FTE basis using the statutory federal income tax rate adjusted for applicable state income taxes net of the related federal tax benefit. The average balances are principally daily averages. Interest income on loans includes the effect of deferred loan fees and costs accounted for as yield adjustments. Premium amortization and discount accretion are included in the respective interest income and interest expense amounts.
FTE net interest income for the three months ended March 31, 2015 and 2014 was $10.0 million and $7.3 million, respectively. Our net interest margin declined 8 basis points to 3.89% for the three months ended March 31, 2015, compared to the three months ended March 31, 2014 due primarily to the effects of the low interest rate environment and increases in interest rates for funding liabilities.
FTE basis interest income for the three months ended March 31, 2015 increased by $3.4 million, or 42.87%, to $11.4 million, compared to FTE basis interest income for the three months ended March 31, 2014 due primarily to loan growth in our commercial real estate and commercial business portfolios and growth in our securities portfolio, offset by lower discount accretion. Average interest-earning assets were $1.0 billion for the three months ended March 31, 2015, up by $296.2 million from the three months ended March 31, 2014. The average balance of total loans increased $289.7 million, or 44.87%, contributing $3.3 million to the increase in interest income. Commercial real estate and commercial business loan average balances grew by $200.1 million and $48.0 million, respectively. The average yield on interest earning assets increased from 4.36% from the three months ended March 31, 2014 to 4.43% for the three months ended March 31, 2015.
Interest expense for the three months ended March 31, 2015, increased by $664 thousand, or 92.87%, compared to interest expense for the three months ended March 31, 2014 due to a $223.9 million increase in the average balances of interest-bearing liabilities due to higher average balances in money market, time accounts and borrowed money and increased rates on time deposits and borrowed money.
Average Balance Sheet, FTE basis Interest and Average Yields/Rates
The following tables present the average balances and yields earned on interest-earning assets and average balances and weighted average rates paid on our funding liabilities for the three months ended March 31, 2015 and 2014.
Effect of changes in interest rates and volume of average earning assets and average interest-bearing liabilities
The following table shows the extent to which changes in interest rates and changes in the volume of average earning assets and average interest-bearing liabilities have affected net interest income. For each category of earning assets and interest-bearing liabilities, information is provided relating to: changes in volume (changes in average balances multiplied by the prior year’s average interest rates); changes in rates (changes in average interest rates multiplied by the prior year’s average balances); and the total change. Changes attributable to both volume and rate have been allocated proportionately based on the relationship of the absolute dollar amount of change in each.
Provision for Loan Losses
The provision for loan losses is based on management’s periodic assessment of the adequacy of the allowance for loan losses which, in turn, is based on such interrelated factors as the composition of the loan portfolio and its inherent risk characteristics, the level of nonperforming loans and net charge-offs, both current and historic, local economic and credit conditions, the direction of real estate values, and regulatory guidelines. The provision for loan losses is charged against earnings in order to maintain our allowance for loan losses and reflects management’s best estimate of probable losses inherent in our loan portfolio at the balance sheet date.
Under accounting standards for business combinations, acquired loans are recorded at fair value with no loan loss allowance on the date of acquisition. A provision for loan losses will be recorded for the emergence of new probable and estimable losses on acquired loans which were not impaired as of the acquisition date. As of and for the three months ended March 31, 2015, there was a $15 thousand provision or allowance for loan losses related to the loan portfolios that we acquired.
The provision for loan losses for the three months ended March 31, 2015 was $733 thousand compared to $211 thousand provision for loan losses for the three months ended March 31, 2014. For further information, see sections titled Asset Quality and Allowance for Loan Losses.
Noninterest Income
The following tables compare noninterest income for the three months ended March 31, 2015 and 2014:
Noninterest income decreased $170 thousand to $599 thousand for the three months ended March 31, 2015 compared to the three months ended March 31, 2014, reflecting a decrease in gains recorded on sales of loans. During the three months ended March 31, 2015, the Company recorded $31 thousand in gains on the sale of $3.3 million of residential real estate loans and $58 thousand of gains on the sale of $0.5 million of SBA loans. During the three months ended March 31, 2014, the Company recorded income of $413 thousand on the sale of $14.9 million of commercial real estate loans and $15 thousand on the sale of $1.1 million of residential real estate loans. The cash surrender value of bank owned life insurance increased by $98 thousand due to the purchase of an additional tranche of $12.5 million in the third quarter of 2014. Other income decreased $31 thousand from $132 thousand for the three months ended March 31, 2014 to $101 thousand for the three months ended March 31, 2015, primarily driven by decreases in investment services income.
Noninterest Expense
The following tables compare noninterest expense for the three months ended March 31, 2015, and 2014:
Noninterest expense increased $931 thousand to $7.0 million for the three months ended March 31, 2015 compared to the three months ended March 31, 2014. The increase was primarily driven by a $620 thousand increase in salaries and employee benefits. The increase in salaries and employee benefits was driven by higher staffing levels and incentive accruals. In addition, the increase was driven by a $284 thousand increase in occupancy and equipment. The increase in occupancy and equipment was driven by increased costs associated with the addition of the two branches added as a result of the Quinnipiac Bank acquisition and the opening of a branch in Norwalk Connecticut.
Income Tax Expense
Income tax expense for the three months ended March 31, 2015 and 2014 totaled $915 thousand and $540 thousand, respectively. The effective tax rates for the three months ended March 31, 2015 and 2014 were 32.8%, and 32.5%, respectively. The slight increase in the effective tax rate reflects decreases in nontaxable income.
Financial Condition
Summary
At March 31, 2015, total assets were $1.1 billion, a $4.9 million, or 0.45%, increase over December 31, 2014. Total loans outstanding and total deposits totaled $964.0 million and $834.7 million, respectively at March 31, 2015. Our credit quality remained strong, with nonperforming assets to total assets of 0.30% and the allowance for loan losses to total loans was 1.18%. Total shareholders’ equity at March 31, 2015 and December 31, 2014 was $131.4 million and $129.2 million, respectively. Tangible book value was $16.62 per share at March 31, 2015 compared to $16.35 per share at December 31, 2014.
Loan Portfolio
We originate commercial and residential real estate loans, including construction loans, commercial business loans, home equity and other consumer loans. Lending activities are primarily conducted within our market of Fairfield and New Haven Counties and the surrounding Connecticut region. Our loan portfolio is the largest category of our earning assets. Loans acquired in connection with the Wilton acquisition in November 2013 and the Quinnipiac acquisition in October 2014 are referred to as “acquired” loans as a result of the manner in which they are accounted for. All other loans are referred to as “originated” loans. Accordingly, selected disclosures that follow are presented separately for the originated loan portfolio and the acquired loan portfolio.
Total loans before deferred loan fees and the allowance for loan losses were $978.6 million at March 31, 2015, up by $48.9 million, or 5.2%, from December 31, 2014. Commercial real estate loans have experienced the most significant growth, up by $44.9 million.
The following table compares the composition of our loan portfolio for the dates indicated:
Asset Quality
Asset quality metrics remained strong through the first quarter of 2015. Nonperforming assets totaled $3.3 million and represented 0.30% of total assets at March 31, 2015, compared to $4.3 million and 0.39% of total assets at December 31, 2014. Nonaccrual loans totaled $2.5 million at March 31, 2015, a decrease of $0.9 million from December 31, 2014. The balance of foreclosed real estate decreased $120 thousand and totaled $830 thousand at March 31, 2015 when compared to December 31, 2014.
The following table presents nonperforming assets and additional asset quality data for the dates indicated:
Allowance for Loan Losses
Establishing an appropriate level of allowance for loan losses, or the allowance, involves a high degree of judgment. We use a methodology to systematically measure the amount of estimated loan loss exposure inherent in our loan portfolio for purposes of establishing a sufficient allowance for loan losses. We evaluate the adequacy of the allowance at least quarterly. Our allowance for loan losses is our best estimate of the probable loan losses inherent in our loan portfolio as of the balance sheet date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by charge-offs on loans.
At March 31, 2015, our allowance for loan losses was $11.6 million and represented 1.18% of total loans, compared to $10.9 million, or 1.17% of total loans, at December 31, 2014. The net increase in the allowance primarily reflects a provision of $733 thousand. The carrying amount of total impaired loans at March 31, 2015 and December 31, 2014 was $9.0 million and $8.3 million, respectively and the amount of related allowance totaled $40 thousand and $33 thousand, respectively. At March 31, 2015 impaired loans consisted of 1 residential real estate loan, 7 commercial real estate loans, 2 home equity loan, 9 commercial business loans and 2 consumer loans and at December 31, 2014 impaired loans consisted of 8 commercial business loans, 5 commercial real estate loans, 1 residential real estate loan and 1 home equity loan.
The following tables present the activity in our allowance for loan losses and related ratios for the dates indicated, and include both originated and acquired allowance activity:
The following tables present the allocation of the allowance for loan losses and the percentage of these loans to total loans for the dates indicated:
The allocation of the allowance for loan losses at March 31, 2015 reflects our assessment of credit risk and probable loss within each portfolio. We believe that the level of the allowance for loan losses at March 31, 2015 is appropriate to cover probable losses.
Investment Securities
At March 31, 2015, the carrying value of our investment securities portfolio totaled $62.1 million and represented 6% of total assets, compared to $76.5 million and 7% of total assets at December 31, 2014. The decrease of $14.4 million, or 23%, primarily reflects early calls and scheduled maturities of U.S. Government agency obligations. We purchase investment grade securities with a focus on earnings, duration exposure and for use as collateral for public funds. There were no purchases or sales of available-for-sale investment securities during the first quarter of 2015.
The net unrealized gain position on our investment portfolio at March 31, 2015 and December 31, 2014 was $1.4 million and $1.1 million, respectively and included gross unrealized losses of $215 thousand and $290 thousand, respectively. The gross unrealized losses were concentrated in U.S. Government, agency obligations and State agency and municipal obligations, reflecting interest rate fluctuation. At March 31, 2015, we determined that there had been no deterioration in credit quality subsequent to purchase and believe that all unrealized losses are temporary. All of our investment securities are investment grade.
Sources of Funds
Total deposits were $834.7 million at March 31, 2015, a decrease of $0.7 million, from the balance at December 31, 2014 reflecting declines in noninterest bearing deposits.
We utilize advances from the Federal Home Loan Bank of Boston, or FHLBB, as part of our overall funding strategy and to meet short-term liquidity needs. Total FHLBB advances were $133.0 million at March 31, 2015 compared to $129.0 million at December 31, 2014. The increase of $4.0 million, or 3%, reflects normal operating fluctuation in our borrowings.
Liquidity
The Company is required to maintain levels of liquid assets sufficient to ensure the Company’s safe and sound operation. Liquidity is defined as the ability to generate sufficient cash flows to meet all present and future funding requirements at reasonable costs. Our primary source of liquidity is deposits. Other sources of funding include discretionary use of FHLBB term advances and other borrowings, cash flows from our investment securities portfolios, loan repayments and earnings. Investment securities designated as available-for-sale may also be sold in response to short-term or long-term liquidity needs.
The Company anticipates that it will have sufficient funds available to meet its current loan and other commitments. As of March 31, 2015, the Company had cash and cash equivalents of $19.4 million and available-for-sale securities of $50.7 million. At March 31, 2015, outstanding commitments to originate loans totaled $41.3 million and undisbursed funds from approved lines of credit, home equity lines of credit and secured commercial lines of credit totaled $122.1 million. Time deposits scheduled to mature in one year or less at March 31, 2015 totaled $253.8 million. Historically, the Company’s deposit flow history has been that a significant portion of such deposits remain with the Company.
Capital Resources
Total shareholders’ equity was $131.4 million at March 31, 2015 compared to $129.2 million at December 31, 2014. The increase of $2.2 million primarily reflected net income of $1.9 million for the three months ended March 31, 2015. The ratio of total equity to total assets was 11.90% at March 31, 2015, which compares to 11.75% at December 31, 2014.
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. At March 31, 2015, the Bank, met all capital adequacy requirements to which it was subject and exceeded the regulatory minimum capital levels to be considered well-capitalized under the regulatory framework for prompt corrective action. At March 31, 2015, the Bank’s ratio of total common equity tier 1 capital to risk-weighted assets was 12.08%, total capital to risk-weighted assets was 13.26%, Tier 1 capital to risk-weighted assets was 12.08% and Tier 1 capital to average assets was 10.99%.
In July 2013, the Federal Reserve published Basel III rules establishing a new comprehensive capital framework of U.S. banking organizations. Under the rules, effective January 1, 2015 for the Company and Bank, the minimum capital ratios will be a) 4.5% “Common Equity Tier 1” to risk-weighted assets, b) 6.0% Tier 1 capital to risk weighted assets and c) 8.0% total capital to risk-weighted assets. In addition, the new regulations will impose certain limitations on dividends, share buy-backs, discretionary payments on Tier 1 instruments and discretionary bonuses to executive officers if the organization does not maintain a capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of its risk-weighted assets, in addition to the amount needed to meet its minimum risk-based capital requirements, phased in over a 5 year period until January 1, 2019. Accordingly, while these proposed rules are slated for phase in commencing January 1, 2015 (and the capital conservation buffer beginning January 1, 2016), the Company believes it is well positioned to meet the requirements as they become effective.
On May 15, 2014, Bankwell Financial Group, Inc. priced 2,702,703 common shares in its initial public offering at $18.00 per share, and on May 15, 2014, Bankwell common shares began trading on the Nasdaq Stock Market. The net proceeds from the IPO were approximately $44.7 million, after deducting the underwriting discount of approximately $2.5 million and approximately $1.3 million of expenses.
Interest Rate Sensitivity Analysis
We measure interest rate risk using simulation analysis to calculate earnings and equity at risk. These risk measures are quantified using simulation software from one of the leading firms in the field of asset/liability modeling. Key assumptions relate to the behavior of interest rates and spreads, prepayment speeds and the run-off of deposits. From such simulations, interest rate risk, or IRR, is quantified and appropriate strategies are formulated and implemented. We manage IRR by using two primary risk measurement techniques: simulation of net interest income and simulation of economic value of equity. These two measurements are complementary and provide both short-term and long-term risk profiles for the Company. Because income simulations assume that our balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that the Asset and Liability Committee could implement in response to rate shifts.
We use two sets of standard scenarios to measure net interest income at risk. For the Parallel Ramp scenario, rate changes are ramped over a twelve-month horizon based upon a parallel yield curve shift and then maintained at those levels over the remainder of the simulation horizon. The Parallel shock scenario assumes instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Simulation analysis involves projecting a future balance sheet structure and interest income and expense under the various rate scenarios. Internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net income at risk for the subsequent one-year period should not decline by more than: 6% for a 100 basis point shift; 12% for a 200 basis point shift and 18% for a 300 basis point shift.
The following tables set forth the estimated percentage change in our net interest income at risk over one-year simulation periods beginning March 31, 2015 and December 31, 2014:
We conduct economic value of equity at risk simulation in tandem with net interest income simulations, to ascertain a longer term view of our interest rate risk position by capturing longer-term re-pricing risk and options risk embedded in the balance sheet. It measures the sensitivity of economic value of equity to changes in interest rates. Economic value of equity at risk simulation values only the current balance sheet and does not incorporate the growth assumptions used in income simulation. As with the net interest income simulation, this simulation captures product characteristics such as loan resets, re-pricing terms, maturity dates, rate caps and floors. Key assumptions include loan prepayment speeds, deposit pricing elasticity and non-maturity deposit attrition rates. These assumptions can have significant impacts on valuation results as the assumptions remain in effect for the entire life of each asset and liability. We conduct non-maturity deposit behavior studies on a periodic basis to support deposit assumptions used in the valuation process. All key assumptions are subject to a periodic review.
Base case economic value of equity at risk is calculated by estimating the net present value of all future cash flows from existing assets and liabilities using current interest rates. The base case scenario assumes that future interest rates remain unchanged.
The following table sets forth the estimated percentage change in our economic value of equity at risk, assuming various shifts in interest rates:
The interest rate risk position remains liability sensitive. The sensitivity has slightly lessened this quarter due to the extension of FHLB borrowings, partially offset by the inflow of rate sensitive short term deposits. The Bank remains within all internally established policies for interest rate risk and the economic value of equity calculation.
Item3. Quantitative and QualitativeDisclosures About MarketRisk
Interest Rate Risk Management
Interest rate risk management is our primary market risk. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate Sensitivity Analysis” herein for a discussion of our management of our interest rate risk.
Inflation Risk Management
Inflation has an important impact on the growth of total assets in the banking industry and causes a need to increase equity capital higher than normal levels in order to maintain an appropriate equity-to-assets ratio. We cope with the effects of inflation by managing our interest rate sensitivity position through our asset/liability management program, and by periodically adjusting our pricing of services and banking products to take into consideration current costs.
Item4. Controls and Procedures
PART II – OTHER INFORMATION
Item1. Legal Proceedings
The Company and the Bank are periodically involved in various legal proceedings as normal incident to their businesses. In the opinion of management, no material loss is expected from any such pending lawsuit.
Item1A. Risk Factors
There has been no material changes in risk factors previously disclosed in the Company’s Form 10-K dated March 16, 2015, filed with the SEC.
Item2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item3. Defaults UponSenior Securities
Item4. Mine Safety Disclosures
Item5. Other Information
Item6. Exhibits
The following exhibits are filed herewith:
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.