Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2020
☐
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: 001-13349
BAR HARBOR BANKSHARES
(Exact name of registrant as specified in its charter)
Maine
01-0393663
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
PO Box 400
82 Main Street, Bar Harbor, ME
04609-0400
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (207) 288-3314
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
Common Stock, par value $2.00 per share
BHB
NYSE American
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definition of "large accelerated filer," "accelerated filer", "smaller reporting company", or "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ◻ Accelerated Filer ⌧ Non-Accelerated Filer Smaller Reporting Company ☐ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ☐ No ⌧
The Registrant had 15,533,659 shares of common stock, par value $2.00 per share, outstanding as of April 30, 2020.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
INDEX
Page
PART I.
FINANCIAL INFORMATION
Item 1.
Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019
4
Consolidated Statements of Income for the Three Months Ended March 31, 2020 and 2019
6
Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2020 and 2019
7
Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2020 and 2019
8
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2020 and 2019
9
Notes to Unaudited Consolidated Interim Financial Statements
Note 1
Basis of Presentation
11
Note 2
Securities Available for Sale
15
Note 3
Loans
18
Note 4
Allowance for Loan Losses
31
Note 5
Borrowed Funds
36
Note 6
Deposits
38
Note 7
Capital Ratios and Shareholders' Equity
39
Note 8
Earnings per Share
42
Note 9
Derivative Financial Instruments and Hedging Activities
43
Note 10
Fair Value Measurements
48
Note 11
Revenue from Contracts with Customers
54
Note 12
Leases
56
Note 13
Subsequent Events
58
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
59
Selected Financial Data
60
Consolidated Loan and Deposit Analysis
61
Average Balances and Average Yields/Rates
62
Non-GAAP Financial Measures
63
Reconciliation of Non-GAAP Financial Measures
64
Financial Summary
66
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
71
Item 4.
Controls and Procedures
73
PART II.
OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
74
Item 6.
Exhibits
75
Signatures
76
Bar Harbor Bankshares conducts business operations principally through Bar Harbor Bank & Trust, which may be referred to as the Bank and which is a subsidiary of Bar Harbor Bankshares. Unless the context requires otherwise, references in this report to “the Company” "our company, "our," "us," "we" and similar terms refer to Bar Harbor Bankshares and its subsidiaries, including the Bank, collectively.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this document that are not historical facts may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended ("Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended ("Exchange Act"), and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. When used in this Form 10-Q the words "may," "will," "should," "could," "would," "plan," "potential," "estimate," "project," "believe," "intend," "anticipate," "expect," "target" and similar expressions are intended to identify forward-looking statements, but these terms are not the exclusive means of identifying forward-looking statements. These forward-looking statements are subject to significant risks, assumptions and uncertainties, including among other things, changes in general economic and business conditions, increased competitive pressures, changes in the interest rate environment, legislative and regulatory change, changes in the financial markets, and other risks and uncertainties disclosed from time to time in documents that the Company files with the Securities and Exchange Commission, including but not limited to those discussed in the section titled "Risk Factors" in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019. Because of these and other uncertainties, the Company’s actual results, performance or achievements, or industry results, may be materially different from the results indicated by these forward-looking statements. In addition, the Company’s past results of operations do not necessarily indicate future results. You should not place undue reliance on any of the forward-looking statements, which speak only as of the dates on which they were made. The Company is not undertaking an obligation to update forward-looking statements, even though its situation may change in the future, except as required under federal securities law. The Company qualifies all of its forward-looking statements by these cautionary statements.
3
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31, 2020
December 31, 2019
Assets
Cash and due from banks
$
68,481
37,261
Interest-bearing deposit with the Federal Reserve Bank
17,174
19,649
Total cash and cash equivalents
85,655
56,910
Securities:
Securities available for sale, at fair value
626,341
663,230
Federal Home Loan Bank stock
19,897
20,679
Total securities
646,238
683,909
Loans:
Commercial real estate
948,178
930,661
Commercial and industrial
426,357
423,291
Residential real estate
1,132,328
1,151,857
Consumer
128,120
135,283
Total loans
2,634,983
2,641,092
Less: Allowance for loan losses
(15,297)
(15,353)
Net loans
2,619,686
2,625,739
Premises and equipment, net
49,978
51,205
Other real estate owned
2,205
2,236
Goodwill
119,477
118,649
Other intangible assets
8,398
8,641
Cash surrender value of bank-owned life insurance
76,400
75,863
Deferred tax assets, net
3,166
3,865
Other assets
66,139
42,111
Total assets
3,677,342
3,669,128
Liabilities
Deposits:
Demand
400,410
414,534
NOW
578,320
575,809
Savings
423,345
388,683
Money market
404,385
384,090
Time
844,097
932,635
Total deposits
2,650,557
2,695,751
Borrowings:
Senior
497,580
471,396
Subordinated
59,849
59,920
Total borrowings
557,429
531,316
Other liabilities
65,601
45,654
Total liabilities
3,273,587
3,272,721
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED BALANCE SHEETS (continued)
Shareholders’ equity
Capital stock, par value $2.00; authorized 20,000,000 shares; issued 16,428,388 shares at March 31, 2020 and December 31, 2019
32,857
Additional paid-in capital
189,314
188,536
Retained earnings
180,072
175,780
Accumulated other comprehensive income
6,190
3,911
Less: 841,029 and 870,257 shares of treasury stock at March 31, 2020 and December 31, 2019, respectively
(4,678)
(4,677)
Total shareholders’ equity
403,755
396,407
Total liabilities and shareholders’ equity
5
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
March 31,
(in thousands, except earnings per share data)
2020
2019
Interest and dividend income
27,987
26,864
Securities and other
5,507
6,363
Total interest and dividend income
33,494
33,227
Interest expense
6,020
6,307
Borrowings
2,911
5,155
Total interest expense
8,931
11,462
Net interest income
24,563
21,765
Provision for loan losses
1,111
324
Net interest income after provision for loan losses
23,452
21,441
Non-interest income
Trust and investment management fee income
3,369
2,757
Customer service fees
3,112
2,165
Gain on sales of securities, net
135
—
Bank-owned life insurance income
537
542
Customer derivative income
588
Other income
680
703
Total non-interest income
8,421
6,167
Non-interest expense
Salaries and employee benefits
11,884
10,519
Occupancy and equipment
4,420
3,386
Loss on premises and equipment, net
92
Outside services
534
411
Professional services
672
544
Communication
289
235
Marketing
388
295
Amortization of intangible assets
256
207
Acquisition, restructuring and other expenses
103
Other expenses
3,721
3,027
Total non-interest expense
22,359
18,624
Income before income taxes
9,514
8,984
Income tax expense
1,793
1,703
Net income
7,721
7,281
Earnings per share:
Basic
0.50
0.47
Diluted
Weighted average common shares outstanding:
15,558
15,523
15,593
15,587
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
Other comprehensive income, before tax:
Changes in unrealized gain on securities available-for-sale
5,357
8,900
Changes in unrealized loss on hedging derivatives
(2,382)
(845)
Changes in unrealized loss on pension
Income taxes related to other comprehensive income:
(1,346)
(2,079)
650
198
Total other comprehensive income
2,279
6,174
Total comprehensive income
10,000
13,455
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Accumulated
Common
Additional
other
stock
paid-in
Retained
comprehensive
Treasury
(in thousands, except per share data)
amount
capital
earnings
income (loss)
Total
Balance at December 31, 2018
187,653
166,526
(11,802)
(4,655)
370,579
Other comprehensive income
Cash dividends declared ($0.20 per share)
(3,105)
Net issuance (441 shares) to employee stock plans, including related tax effects
(173)
(169)
Recognition of stock based compensation
263
Balance at March 31, 2019
187,743
170,702
(5,628)
(4,651)
381,023
Balance at December 31, 2019
Cash dividends declared ($0.22 per share)
(3,429)
Treasury stock purchased (5,586 shares)
(130)
Net issuance (23,010 shares) to employee stock plans, including related tax effects
660
129
789
118
Balance at March 31, 2020
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31,
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of securities
686
693
Change in unamortized net loan costs and premiums
(132)
(85)
Premises and equipment depreciation
1,182
952
Stock-based compensation expense
90
Accretion of purchase accounting entries, net
(1,489)
(886)
Amortization of other intangibles
Income from cash surrender value of bank-owned life insurance policies
(537)
(542)
(135)
Loss on other real estate owned
Net change in other assets and liabilities
(5,900)
(3,757)
Net cash provided by operating activities
3,004
4,277
Cash flows from investing activities:
Proceeds from sales of securities available for sale
32,017
Proceeds from maturities, calls and prepayments of securities available for sale
24,899
21,709
Purchases of securities available for sale
(15,739)
(35,290)
Net change in loans
6,300
(36,209)
Purchase of FHLB stock
(3,161)
(5,567)
Proceeds from sale of FHLB stock
3,943
6,119
Purchase of premises and equipment, net
(628)
(1,809)
Acquisitions, net of cash acquired
(340)
Proceeds from sale of other real estate owned
51
Net cash provided by (used in) investing activities
47,342
(51,047)
Cash flows from financing activities:
Net decrease in deposits
(44,959)
(17,260)
Net change in short-term FHLB borrowings
(160,970)
59,716
Net change in short-term FRB borrowings
62,000
Proceeds from long-term borrowings from the FHLB
139,000
Repayments of long-term borrowings from the FHLB
(35,705)
Net change in short-term other borrowings
(13,831)
(1,531)
Repayments of subordinated debt
(32)
Payment of subordinated debt issuance costs
(39)
Net issuance to employee stock plans
Purchase of treasury stock
Cash dividends paid on common stock
Net cash (used in) provided by financing activities
(21,601)
2,119
Net change in cash and cash equivalents
28,745
(44,651)
Cash and cash equivalents at beginning of year
98,754
Cash and cash equivalents at end of year
54,103
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Supplemental cash flow information:
Interest paid
8,455
11,490
Income taxes paid, net
1,205
1,506
Acquisition of non-cash assets and liabilities:
Assets acquired
1,171
Liabilities acquired
(343)
10
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements (the “financial statements”) of Bar Harbor Bankshares and its subsidiaries (the “Company” or “Bar Harbor”) have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). Bar Harbor Bankshares is a Maine Financial Institution Holding Company for the purposes of the laws of the state of Maine, and as such is subject to the jurisdiction of the Superintendent of the Maine Bureau of Financial Institutions. These financial statements include the accounts of the Company, its wholly owned subsidiary Bar Harbor Bank & Trust (the "Bank") and the Bank’s consolidated subsidiaries. The results of operations of companies or assets acquired are included only from the dates of acquisition. All material wholly owned and majority owned subsidiaries are consolidated unless GAAP requires otherwise.
In addition, these interim financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X, and accordingly, certain information and footnote disclosures normally included in financial statements prepared according to GAAP have been omitted.
The results for any interim period are not necessarily indicative of results for the full year. These consolidated financial statements should be read in conjunction with the audited financial statements and note disclosures for the Company's Annual Report on Form 10-K for the year ended December 31, 2019 previously filed with the Securities and Exchange Commission (the "SEC"). In management's opinion, all adjustments necessary for a fair statement are reflected in the interim periods presented.
Reclassifications: Whenever necessary, amounts in the prior years’ financial statements are reclassified to conform to current presentation. The reclassifications had no impact on net income in the Company’s consolidated income statement.
Summary of Significant Accounting Policies
The disclosures below supplement the accounting policies in previously disclosed in NOTE 1 – Summary of Significant Accounting Policies of the Company’s 2019 Annual Report on Form 10-K.
Operating, Accounting and Reporting Considerations related to COVID-19:
The COVID-19 pandemic has negatively impacted the global economy. In response to this crisis, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was passed by Congress and signed into law on March 27, 2020. The CARES Act provides an estimated $2.2 trillion to fight the COVID-19 pandemic and stimulate the economy by supporting individuals and businesses through loans, grants, tax changes, and other types of relief. Some of the provisions applicable to the Company include, but are not limited to:
•
Accounting for Loan Modifications - The CARES Act provides that a financial institution may elect to suspend (1) the requirements under GAAP for certain loan modifications that would otherwise be categorized as a TDR and (2) any determination that such loan modifications would be considered a TDR, including the related impairment for accounting purposes.
Paycheck Protection Program - The CARES Act established the Paycheck Protection Program (“PPP”), an expansion of the Small Business Administration’s 7(a) loan program and the Economic Injury Disaster Loan Program (“EIDL”), administered directly by the SBA.
Mortgage Forbearance - Under the CARES Act, through the earlier of December 31, 2020, or the termination date of the COVID-19 national emergency, a borrower with a federally backed mortgage loan that is experiencing financial hardship due to COVID-19 may request a forbearance. A multifamily borrower with a federally backed multifamily mortgage loan that was current as of February 1, 2020, and is experiencing financial hardship due to COVID-19 may request forbearance on the loan for up to 30 days, with up to two additional 30-day periods at the borrower’s request.
Also in response to the COVID-19 pandemic, the Board of Governors of the Federal Reserve System (“FRB”), the Federal Deposit Insurance Corporation (“FDIC”), the National Credit Union Administration (“NCUA”), the Office of the Comptroller of the Currency (“OCC”), and the Consumer Financial Protection Bureau (“CFPB”), in consultation with the state financial regulators (collectively, the “agencies”) issued a joint interagency statement (issued March 22, 2020; revised statement issued April 7, 2020). Some of the provisions applicable to the Company include, but are not limited to:
Accounting for Loan Modifications - Loan modifications that do not meet the conditions of the CARES Act may still qualify as a modification that does not need to be accounted for as a TDR. The agencies confirmed with FASB staff that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or insignificant delays in payment.
Past Due Reporting - With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to COVID-19 as past due because of the deferral. A loan’s payment date is governed by the due date stipulated in the legal agreement. If a financial institution agrees to a payment deferral, these loans would not be considered past due during the period of the deferral.
Nonaccrual Status and Risk Rating - During short-term COVID-19 modifications, these loans generally should not be reported as nonaccrual or as having a classified risk rating.
12
Recent Accounting Pronouncements
The following table provides a brief description of recent accounting standards updates ("ASU") that could have a material impact to the Company’s consolidated financial statements upon adoption:
Standard
Description
Required Date of Adoption
Effect on financial statements
Standards Adopted in 2020
ASU 2017-04, Simplifying the Test for Goodwill Impairment
This ASU amends Topic 350, Intangibles-Goodwill and Other, and eliminates Step 2 from the goodwill impairment test. The Company still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary
January 1, 2020
The Company has adopted ASU 2017-04 effective January 1, 2020, as required, and the ASU did not have a material impact on its financial statements. Goodwill testing is normally scheduled to be completed during the fourth quarter, but was evaluated in the first quarter in light of the economic impacts of COVID-19. The Company recognized no impairments to goodwill in the first quarter of 2020. See management’s discussion and analysis for further details.
Early adoption is permitted
ASU 2018-13 Changes to Disclosure Requirements Fair Value Measurement, Topic 820
This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements.
The Company has adopted ASU 2018-13, as of January 1, 2020, as required, and the ASU did not have a material impact to the disclosures as a result of the adoption.
Early adoption is permitted.
Standards Not Yet Adopted
ASU 2016-13, Measurement of Credit Losses on Financial Instruments ASU 2018-19, Codification Improvements to ASU 2016-13
This ASU amends Topic 326, Financial Instruments- Credit Losses to replace the current incurred loss accounting model with a current expected credit loss approach (CECL) for financial instruments measured at amortized cost and other commitments to extend credit. The amendments require entities to consider all available relevant information when estimating current expected credit losses, including details about past events, current conditions, and reasonable and supportable forecasts. The resulting allowance for credit losses is to reflect the portion of the amortized cost basis that the entity does not expect to collect. The amendments also eliminate the current accounting model for purchased credit impaired loans and certain off-balance sheet exposures. Additional quantitative and qualitative disclosures are required upon adoption.
While the CECL model does not apply to available for sale debt securities, the ASU does require entities to record an allowance when recognizing credit losses for available for sale securities with unrealized losses, rather than reduce the amortized cost of the securities by direct write-offs. The guidance will require companies to recognize improvements to estimated credit losses immediately in earnings rather than interest income over time.
The ASU should be adopted on a modified retrospective basis. Entities that have loans accounted for under ASC 310-30 at the time of adoption should prospectively apply the guidance in this amendment for purchase credit deteriorated assets.
Adoption of this ASU is expected to primarily change how the Company estimates credit losses with the application of the expected credit loss model. The Company will apply the standard's provisions as a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). The Company's CECL implementation efforts in the first quarter focused on model validation, developing new disclosures, establishing formal policies and procedures and other governance and control documentation. Certain elements of the calculation were finalized in the first quarter, including refinement of the model assumptions, the qualitative framework, internal control design, model validation, and the operational control framework to support the new process. Furthermore, changes to the economic forecasts within the model could positively or negatively impact the actual results.
The ASU was effective for the Company beginning in the first quarter of 2020; however, the CARES Act, issued in 2020, provided temporary relief related to the implementation of this accounting guidance until the earlier of the date on which the national emergency concerning the COVID-19 virus terminates or December 31, 2020. The Company has elected to utilize this relief and has calculated the allowance for loan losses and the resulting provision for loan losses using the prior incurred loss method at March 31, 2020.
ASU 2018-14 Compensation- Disclosure Requirements for Defined Pension Plans Topic 715-20
This ASU makes minor changes to the disclosure requirements for employers that sponsor defined benefit pension and/or other post-retirement benefit plans.
January 1, 2021
Adoption of this ASU is not expected to have a material impact on the Company's consolidated financial statements.
13
ASU 2020-04 Facilitation of the Effects of Reference Rate Reform, Topic 848
This ASU provides temporary optional expedients and exceptions to GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as SOFR. For instance, companies can (1) elect not to apply certain modification accounting requirements to contracts affected by reference rate reform, if certain criteria are met. A company that makes this election would not have to re-measure the contracts at the modification date or reassess a previous accounting determination. Companies, can also (2) elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met. Finally, companies can (3) make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform.
May be elected between March 12, 2020 through December 31, 2022.
The Company is currently evaluating all of its contracts, hedging relationships and other transactions that will be effected by reference rates that are being discontinued and determining which elections that need to be made.
14
NOTE 2. SECURITIES AVAILABLE FOR SALE
The following is a summary of securities available for sale:
Gross
Unrealized
Amortized Cost
Gains
Losses
Fair Value
Debt securities:
Mortgage-backed securities:
US Government-sponsored enterprises
284,925
11,349
(617)
295,657
US Government agency
98,059
3,801
(191)
101,669
Private label
20,209
(1,772)
18,499
Obligations of states and political subdivisions thereof
134,258
3,636
(315)
137,579
Corporate bonds
76,191
1,497
(4,751)
72,937
Total securities available for sale
613,642
20,345
(7,646)
319,064
4,985
(2,080)
321,969
98,568
1,640
(547)
99,661
20,212
68
(747)
19,533
139,240
3,034
(268)
142,006
78,804
1,478
(221)
80,061
655,888
11,205
(3,863)
The amortized cost and estimated fair value of available for sale (“AFS”) securities segregated by contractual maturity at March 31, 2020 are presented below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Mortgage-backed securities are shown in total, as their maturities are highly variable.
Available for sale
Within 1 year
Over 1 year to 5 years
30,554
31,547
Over 5 years to 10 years
56,401
52,656
Over 10 years
123,494
126,313
Total bonds and obligations
210,449
210,516
Mortgage-backed securities
403,193
415,825
Securities with unrealized losses, segregated by the duration of their continuous unrealized loss positions, are summarized as follows:
Less Than Twelve Months
Over Twelve Months
Fair
(In thousands)
Value
165
9,548
452
6,608
617
16,156
180
11,899
4,122
191
16,021
124
1,762
18,234
1,772
18,358
315
17,862
3,831
29,977
920
5,330
4,751
35,307
4,501
69,410
3,145
34,294
7,646
103,704
1,074
43,429
1,006
49,712
2,080
93,141
432
19,717
115
9,120
547
28,837
380
9,843
367
9,411
747
19,254
137
29,355
131
1,682
268
31,037
142
9,888
79
12,276
221
22,164
112,232
1,698
82,201
3,863
194,433
Securities Impairment: As a part of the Company’s ongoing security monitoring process, the Company identifies securities in an unrealized loss position that could potentially be other-than-temporarily impaired. For the three months ended March 31, 2020 and 2019 the Company did not record any other-than-temporary impairment (“OTTI”) losses.
The following table presents the changes in estimated credit losses recognized by the Company for the periods presented:
Estimated credit losses as of prior year-end
1,697
Reductions for securities paid off during the period
Estimated credit losses at end of the period
The Company expects to recover its amortized cost basis on all securities in its AFS portfolio. Furthermore, the Company does not intend to sell nor does it anticipate that it will be required to sell any of its securities in an unrealized loss position as of March 31, 2020, prior to this recovery. The Company’s ability and intent to hold these securities until recovery is supported by the Company’s strong capital and liquidity positions as well as its historically low portfolio turnover.
16
The following summarizes, by investment security type, the basis for the conclusion that securities in an unrealized loss position were not other-than-temporarily impaired at March 31, 2020:
43 out of the total 675 securities in the Company’s portfolios of AFS US Government-sponsored enterprises were in unrealized loss positions. Aggregate unrealized losses represented 3.83% of the amortized cost of securities in unrealized loss positions. The FNMA and FHLMC guarantee the contractual cash flows of all of the Company’s US Government-sponsored enterprises. The securities are investment grade rated and there were no material underlying credit downgrades during the quarter. All securities are performing.
22 out of the total 179 securities in the Company’s portfolios of AFS US Government agency securities were in unrealized loss positions. Aggregate unrealized losses represented 1.18% of the amortized cost of securities in unrealized loss positions. The Government National Mortgage Association (“GNMA”) guarantees the contractual cash flows of all of the Company’s US Government agency securities. The securities are investment grade rated and there were no material underlying credit downgrades during the quarter. All securities are performing.
12 of the total 19 securities in the Company’s portfolio of AFS private label mortgage-backed securities were in unrealized loss positions. Aggregate unrealized losses represented 8.80% of the amortized cost of securities in unrealized loss positions. Based upon the expectation that the Company will receive all of the future contractual cash flows related to the amortized cost on these securities, the Company does not consider there to be any additional other-than-temporary impairment with respect to these securities.
10 of the total 210 securities in the Company’s portfolio of AFS municipal bonds and obligations were in unrealized loss positions. Aggregate unrealized losses represented 0.91% of the amortized cost of securities in unrealized loss positions. The Company continually monitors the municipal bond sector of the market carefully and periodically evaluates the appropriate level of exposure to the market. At this time, the Company feels the bonds in this portfolio carry minimal risk of default and the Company is appropriately compensated for the risk. There were no material underlying credit downgrades during the quarter. All securities are performing.
12 out of the total 27 securities in the Company’s portfolio of AFS corporate bonds were in an unrealized loss position. The aggregate unrealized loss represents 12.13% of the amortized cost of bonds in unrealized loss positions. The Company reviews the financial strength of all of these bonds and has concluded that the amortized cost remains supported by the expected future cash flows of these securities.
17
NOTE 3. LOANS
The Company’s loan portfolio is comprised of the following segments: commercial real estate, commercial and industrial, residential real estate, and consumer loans. Commercial real estate loans include multi-family, commercial construction and land development, and other commercial real estate classes. Commercial and industrial loans include loans to commercial and agricultural businesses and tax exempt entities. Residential real estate loans consist of mortgages for 1-to-4 family housing. Consumer loans include home equity loans, auto and other installment loans.
The Company’s lending activities are principally conducted in Maine, New Hampshire, and Vermont.
Total loans include business activity loans and acquired loans. Acquired loans are those loans previously acquired from other institutions. The following is a summary of total loans:
Business
Activities
Acquired
Commercial real estate:
Construction and land development
49,157
2,422
51,579
31,387
2,903
34,290
Other commercial real estate
680,578
216,021
896,599
666,051
230,320
896,371
Total commercial real estate
729,735
218,443
697,438
233,223
Commercial and industrial:
Commercial
288,082
52,713
340,795
239,692
59,072
298,764
Agricultural
18,597
200
18,797
20,018
206
20,224
Tax exempt
55,694
11,071
66,765
66,860
37,443
104,303
Total commercial and industrial
362,373
63,984
326,570
96,721
Total commercial loans
1,092,108
282,427
1,374,535
1,024,008
329,944
1,353,952
Residential real estate:
Residential mortgages
742,710
389,618
740,687
411,170
Total residential real estate
Consumer:
Home equity
64,514
53,030
117,544
59,368
63,033
122,401
Other consumer
9,226
1,350
10,576
11,167
1,715
12,882
Total consumer
73,740
54,380
70,535
64,748
1,908,558
726,425
1,835,230
805,862
The carrying amount of the acquired loans at March 31, 2020 totaled $726.4 million. A subset of these loans was determined to have evidence of credit deterioration at acquisition date, which is accounted for in accordance with ASC 310-30, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. These purchased credit-impaired loans presently maintain a carrying value of $15.2 million (and total note balances of $19.3 million). These loans are evaluated for impairment through the periodic reforecasting of expected cash flows. Acquired loans considered not impaired at the acquisition date had a carrying amount of $711.2 million as of March 31, 2020.
The following table summarizes activity in the accretable yield for the acquired loan portfolio that falls under the purview of ASC 310-30, Accounting for Certain Loans or Debt Securities Acquired in a Transfer:
Balance at beginning of period
7,367
3,509
Reclassification from nonaccretable difference for loans with improved cash flows
2,031
Accretion
(528)
(1,063)
Balance at end of period
6,839
4,477
The following is a summary of past due loans at March 31, 2020 and December 31, 2019:
Business Activities Loans
90 Days or
Past Due >
30-59 Days
60-89 Days
Greater
Total Past
90 days and
Past Due
Due
Current
Total Loans
Accruing
276
418
48,739
1,521
533
1,010
3,064
677,514
1,663
1,286
3,482
726,253
1,108
1,515
1,251
3,874
284,208
381
169
18,390
1,146
1,420
4,081
358,292
2,809
2,048
2,706
7,563
1,084,545
8,824
69
1,207
10,100
732,610
293
471
20
412
903
63,611
19
2
26
9,200
490
25
414
929
72,811
12,123
2,142
4,327
18,592
1,889,966
946
Acquired Loans
Credit
Impaired
245
1,843
1,024
3,123
7,275
737
7,520
97
1,752
1,952
1,940
3,220
9,472
5,043
99
834
5,976
4,856
401
626
199
825
1
627
826
847
7,610
355
2,057
10,022
15,175
1,181
205
53
258
31,129
40
1,534
1,810
3,384
662,667
1,587
3,642
693,796
50
894
1,396
238,296
34
96
192
19,826
514
84
990
1,588
324,982
759
1,671
2,800
5,230
1,018,778
7,293
1,243
668
9,204
731,483
597
429
1,069
58,299
11,119
633
55
1,117
69,418
8,685
2,969
3,897
15,551
1,819,679
21
384
2,029
231
2,505
8,289
257
2,517
8,673
440
335
140
915
2,723
173
2,932
2,469
592
371
3,432
11,605
3,185
864
1,015
5,064
5,591
208
548
217
973
1,291
210
557
984
1,357
5,864
2,013
1,603
9,480
18,553
22
Non-Accrual Loans
The following is summary information pertaining to non-accrual loans at March 31, 2020 and December 31, 2019:
1,664
287
1,951
2,888
343
3,231
2,227
3,146
3,489
1,282
89
1,371
932
1,558
625
278
1,907
1,996
1,210
1,836
3,847
376
4,223
4,356
969
5,325
4,077
1,012
5,089
3,362
1,973
5,335
284
724
615
254
869
460
744
636
890
8,384
1,672
10,056
8,354
3,196
11,550
Loans evaluated for impairment as of March 31, 2020 and December 31, 2019 are, as follows:
Residential
real estate
and industrial
Individually evaluated for impairment
2,638
1,733
3,586
7,970
Collectively evaluated
727,097
360,640
739,124
73,727
1,900,588
70
296
366
Purchased credit impaired
210,853
62,032
384,466
53,533
710,884
23
3,964
1,353
2,620
7,950
693,474
325,217
738,067
70,522
1,827,280
385
1,032
1,675
224,292
93,404
404,547
63,391
785,634
The following is a summary of impaired loans at March 31, 2020 and December 31, 2019:
Recorded
Unpaid Principal
Related
Investment
Balance
Allowance
With no related allowance:
1,341
2,060
1,075
1,242
67
Tax exempt loans
2,603
2,794
With an allowance recorded:
265
266
213
1,082
462
230
236
47
361
91
983
126
3,408
675
138
3,905
Total impaired loans
9,233
939
24
134
308
162
185
493
564
27
1,911
1,957
710
773
261
2,067
1,795
1,026
282
164
553
590
57
4,155
1,231
1,423
2,817
8,408
1,452
481
678
938
168
354
49
1,314
2,053
The following is a summary of the average recorded investment and interest income recognized on impaired loans for the three months ended March 31, 2020 and 2019:
Three Months Ended March 31, 2020
Three Months Ended March 31, 2019
Average Recorded
Interest
Income Recognized
1,728
7,773
1,071
527
2,589
1,965
1,021
1,203
233
979
652
3,010
8,981
1,304
1,417
3,568
2,617
7,894
13,028
45
28
479
195
436
163
358
803
428
1,408
Troubled Debt Restructuring Loans
The Company’s loan portfolio also includes certain loans that have been modified in a Troubled Debt Restructuring ("TDR"), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are classified as non-performing at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months. TDRs are evaluated individually for impairment and may result in a specific allowance amount allocated to an individual loan.
The following tables include the recorded investment and number of modifications identified during the three months ended March 31, 2020 and 2019, respectively. The table includes the recorded investment in the loans prior to a modification and also the recorded investment in the loans after the loans were restructured. Modifications may include adjustments to interest rates, payment amounts, extensions of maturity, court ordered concessions or other actions intended to minimize economic loss and avoid foreclosure or repossession of collateral.
29
Pre-Modification
Post-Modification
Number of
Outstanding Recorded
Modifications
Troubled Debt Restructurings
259
Other commercial
41
130
501
113
530
674
671
The following tables summarize the types of loan concessions made for the periods presented:
Outstanding
outstanding
(in thousands, except modifications)
Interest rate and maturity concession
Interest rate, forbearance and maturity concession
467
Amortization and maturity concession
314
Amortization concession
156
Amortization, interest rate and maturity concession
77
Forbearance and interest only payments
112
Maturity concession
For the three months ended March 31, 2020, there were no loans that were restructured that had subsequently defaulted during the period. The evaluation of certain loans individually for specific impairment includes loans that were previously classified as TDRs or continue to be classified as TDRs.
Modifications in response to COVID-19
The Company began offering short-term loan modifications to assist borrowers during the COVID-19 national emergency. The CARES Act along with a joint agency statement issued by banking agencies, provides that short-term modifications made in response to COVID-19 do not need to be accounted for as a TDR. Accordingly, the Company does not account for such loan modifications as TDRs. See Note 1 - Basis of Presentation for more information.
Foreclosure
As of March 31, 2020 and December 31, 2019, the Company maintained bank-owned residential real estate with a fair value of $2.2 million. Additionally, residential mortgage loans collateralized by real estate that are in the process of foreclosure as of March 31, 2020 and December 31, 2019 totaled $931 thousand and $810 thousand, respectively.
Mortgage Banking
Total residential loans included held for sale loans of $11.7 million and $6.5 million at March 31, 2020 and December 31, 2019, respectively.
30
NOTE 4. ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level considered adequate to provide for an estimate of probable credit losses inherent in the loan portfolio. The allowance is increased by the provision charged to operating expense and reduced by net charge-offs. Loans are charged against the allowance for loan losses when the Company believes collectability has declined to a point where there is a distinct possibility of some loss of principal and interest. While the Company uses the best information available to make the evaluation, future adjustments may be necessary if there are significant changes in conditions.
The allowance is comprised of four distinct reserve components: (1) specific reserves related to loans individually evaluated; (2) quantitative reserves related to loans collectively evaluated; (3) qualitative reserves related to loans collectively evaluated; and (4) a temporal estimate is made for incurred loss emergence period for each loan category within the collectively evaluated pools.
A summary of the methodology employed on a quarterly basis with respect to each of these components in order to evaluate the overall adequacy of the Company's allowance for loan losses is as follows:
Specific Reserve for Loans Individually Evaluated
First, the Company identifies loan relationships having aggregate balances in excess of $150 thousand with potential credit weaknesses. Such loan relationships are identified primarily through the Company's analysis of internal loan evaluations, past due loan reports, TDRs and loans adversely classified. Each loan so identified is then individually evaluated for impairment. Loans are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement. Substantially all impaired loans have historically been collateral dependent, meaning repayment of the loan is expected or is considered to be provided solely from the sale of the loan's underlying collateral. For such loans, the Company measures impairment based on the fair value of the loan's collateral, which is generally determined utilizing current appraisals. A specific reserve is established in an amount equal to the excess, if any, of the recorded investment in each impaired loan over the fair value of its underlying collateral, less estimated costs to sell. The Company's policy is to re-evaluate the fair value of collateral dependent loans at least every twelve months unless there is a known deterioration in the collateral's value, in which case a new appraisal is obtained.
Purchase credit impaired (“PCI”) loans are collectively evaluated, but are not included in the general reserve as described below. The evaluation of the PCI loans requires continued quarterly assessment of key assumptions and estimates similar to the initial fair value estimate, including changes in the severity of loss, timing and speed of payments, collateral value changes, expected cash flows and other relevant factors. The quarterly assessment is compared to the initial fair value estimate and a determination is made if an adjustment to the allowance for loan loss is deemed necessary.
Quantitative Reserve for Loans Collectively Evaluated
Second, the Company stratifies the loan portfolio into two general business loan pools: substandard (7 risk-rated) and pass-rated (0 to 6 risk-rated) by loan type. Substandard rated loans are subject to higher credit loss rates in the allowance for loan loss calculation. The Company utilizes historical loss rates for commercial real estate and commercial and industrial loans assessed by internal risk rating. Historical loss rates on residential real estate and consumer loans are not risk graded. Residential real estate and consumer loans are considered as part of the pass-rated portfolio unless removed due to specific reserve evaluation based on past due status and/or other indications of credit deterioration. Quantitative reserves relative to each loan pool are established as follows: for all loan segments an allocation equaling 100% of the respective pool's average 3-year historical net loan charge-off rate (determined based upon the most recent 12 quarters) is applied to the aggregate recorded investment in the pool of loans. Purchased performing loans are collectively evaluated as their own separate category within each loan pool.
Qualitative Reserve for Loans Collectively Evaluated
Third, the Company considers the necessity to adjust the average historical net loan charge-off rates relative to each of the above two loan pools for potential risks factors that could result in actual losses deviating from prior loss experience. Such qualitative risk factors considered are: (1) lending policies and procedures, (2) business conditions, (3) volume and nature of the loan portfolio, (4) experience, ability and depth of lending management, (5) problem loan trends, (6) quality of the Company’s loan review system, (7) concentrations in the loan portfolio, (8) competition, legal, and regulatory environment and (9) collateral coverage and loan-to-value.
Loss Emergence Period for Loans Collectively Evaluated
Fourth, the general allowance related to loans collectively evaluated includes an estimate of incurred losses over an estimated loss emergence period ("LEP"). The LEP is generated utilizing a charge-off look-back analysis, which evaluates the time from the first indication of elevated risk of repayment (or other early event indicating a problem) to eventual charge-off to support the LEP considered in the allowance calculation. This reserving methodology establishes the approximate number of months of LEP that represents incurred losses for each loan portfolio within each portfolio segment in addition to the qualitative reserves.
Activity in the allowance for loan losses for the three months ended March 31, 2020 and 2019 are, as follows:
At or for the Three Months Ended March 31, 2020
7,668
3,608
3,402
379
15,057
Charged-off loans
(770)
(150)
(148)
(1,068)
Recoveries on charged-off loans
738
111
150
1,083
7,661
3,543
3,513
15,101
6,986
3,405
3,387
14,162
147
143
(101)
(29)
(8)
(5)
(143)
(Releases) provision for loan losses
(12)
196
32
At or for the Three Months Ended March 31, 2019
6,811
2,380
3,982
408
13,581
(57)
(53)
(110)
(195)
397
(47)
193
6,575
2,778
3,953
396
13,702
83
6,179
2,725
3,870
395
13,169
35
285
(16)
(104)
(1)
(121)
Provision (releases) for loan losses
132
161
105
145
Loan Origination/Risk Management: The Company has certain lending policies and procedures in place designed to maximize loan income within an acceptable level of risk. The Company’s Board of Directors reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management and the Company's Board of Directors with frequent reports related to loan production, loan quality, concentration of credit, loan delinquencies, non-performing loans and potential problem loans. The Company seeks to diversify the loan portfolio as a means of managing risk associated with fluctuations in economic conditions.
Credit Quality Indicators/Classified Loans: In monitoring the credit quality of the portfolio, management applies a credit quality indicator and uses an internal risk rating system to categorize commercial loans. These credit quality indicators range from one through nine, with a higher number correlating to increasing risk of loss. These ratings are used as inputs to the calculation of the allowance for loan losses. Consistent with regulatory guidelines, the Company provides for the classification of loans which are considered to be of lesser quality as special mention, substandard, doubtful, or loss (i.e. risk-rated 6, 7, 8 and 9, respectively).
The following are the definitions of the Company’s credit quality indicators:
Pass: Loans the Company considers in the commercial portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. Management believes there is a low risk of loss related to these loans considered pass-rated.
Special Mention: Loans the Company considers having some potential weaknesses, but are deemed to not carry levels of risk inherent in one of the subsequent categories, are designated as special mention. A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. This might include loans which may require a higher level of supervision or internal reporting because of: (i) declining industry trends; (ii) increasing reliance on secondary sources of repayment; (iii) the poor condition of or lack of control over collateral; or (iv) failure to obtain proper documentation or any other deviations from prudent lending practices. Economic or market conditions which may, in the future, affect the obligor may warrant special mention of the asset. Loans for which an adverse trend in the borrower's operations or an imbalanced position in the balance sheet which has not reached a point
33
where the liquidation is jeopardized may be included in this classification. Special mention loans are not adversely classified and do not expose the Company to sufficient risks to warrant classification.
Substandard: Loans the Company considers as substandard are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard loans have a well-defined weakness that jeopardizes liquidation of the debt. Substandard loans include those loans where there is the distinct possibility of some loss of principal, if the deficiencies are not corrected.
Doubtful: Loans the Company considers as doubtful have all of the weaknesses inherent in those loans that are classified as substandard. These loans have the added characteristic of a well-defined weakness which is inadequately protected by the current sound worth and paying capacity of borrower or of the collateral pledged, if any, and calls into question the collectability of the full balance of the loan. The possibility of loss is high but because of certain important and reasonably specific pending factors which may work to the advantage and strengthening of the loan, its classification as loss is deferred until its more exact status is determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans. The entire amount of the loan might not be classified as doubtful when collection of a specific portion appears highly probable. Loans are generally not classified doubtful for an extended period of time (i.e., over a year).
Loss: Loans the Company considers as losses are those considered uncollectible and of such little value that their continuance as an asset is not warranted and the uncollectible amounts are charged-off. This classification does not mean the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this worthless asset even though partial recovery may be affected in the future. Losses are taken in the period in which they are determined to be uncollectible.
The following tables present the Company’s loans by risk rating at March 31, 2020 and December 31, 2019:
Commercial Real Estate
Commercial construction
and land development
Commercial real estate other
Mar 31, 2020
Dec 31, 2019
Grade:
Pass
48,881
31,057
659,494
646,886
708,375
677,943
Special mention
8,133
5,483
Substandard
330
11,824
11,974
11,835
12,304
Doubtful
1,127
1,708
1,392
2,083
2,412
205,309
218,491
207,392
220,903
1,742
2,261
2,273
339
9,400
9,239
9,879
Commercial and Industrial
268,287
221,329
17,559
18,940
341,540
307,129
3,641
2,744
298
3,862
3,042
15,195
14,866
456
780
15,651
15,646
959
753
1,320
50,663
51,184
37,407
61,934
88,649
882
5,432
944
2,115
148
2,299
224
341
Residential Real Estate and Consumer Loans
Total residential real estate and consumer
Performing
738,633
737,325
64,074
58,753
9,206
11,146
811,913
807,224
Nonperforming
4,537
3,998
816,450
811,222
387,304
407,811
52,619
62,504
1,343
1,707
441,266
472,022
2,314
3,359
529
2,732
3,896
443,998
475,918
The following table summarizes total classified and criticized loans as of March 31, 2020 and December 31, 2019:
Activities Loans
Non-accrual
Substandard accruing
26,351
11,537
37,888
26,055
13,387
39,442
Total classified
34,735
13,209
47,944
34,409
16,583
50,992
11,995
2,624
14,619
8,525
7,705
16,230
Total Criticized
46,730
15,833
62,563
42,934
24,288
67,222
NOTE 5. BORROWED FUNDS
Borrowed funds at March 31, 2020 and December 31, 2019 are summarized, as follows:
(dollars in thousands)
Carrying Value
Weighted Average Rate
Short-term borrowings
Advances from the FHLB
172,643
1.27
%
303,286
1.83
Advances from the FRB
0.25
Other borrowings
31,001
1.21
44,832
0.99
Total short-term borrowings
265,644
1.03
348,118
1.73
Long-term borrowings
231,936
1.80
123,278
1.93
Subordinated borrowings
4.97
5.53
Total long-term borrowings
291,785
2.45
183,198
2.87
1.77
2.11
Short-term debt includes Federal Home Loan Bank of Boston (“FHLB”) advances with a maturity of less than one year. The Company also maintains a $1.0 million secured line of credit with the FHLB that bears a daily adjustable rate calculated by the FHLB. There was no outstanding balance on the FHLB line of credit for the periods ended March 31, 2020 and December 31, 2019.
The Company has the capacity to borrow funds on a secured basis utilizing the Borrower in Custody program and the Discount Window at the Federal Reserve Bank of Boston (the “FRB”). At March 31, 2020, the Company’s available secured line of credit at the FRB was $142.1 million. The Company has pledged certain loans and securities to the FRB to support this arrangement. There were $62.0 million of outstanding advances with the FRB for the period ended March 31, 2020 and no borrowings with the FRB as of December 31, 2019.
The Company maintains, with a correspondent bank, an unused unsecured federal funds line of credit that has an aggregate overnight borrowing capacity of $50.0 million as of March 31, 2020 and December 31, 2019. There was no outstanding balance on the line of credit as of March 31, 2020 and December 31, 2019.
Long-term FHLB advances consist of advances with a maturity of more than one year. The advances outstanding at March 31, 2020 and December 31, 2019 include no callable advances and $314 thousand of amortizing advances. All FHLB borrowings, including the line of credit, are secured by a blanket security agreement on certain qualified collateral, principally all residential first mortgage loans and certain securities.
A summary of maturities of FHLB advances as of March 31, 2020 is, as follows:
Weighted Average
(in thousands, except rates)
Rate
Fixed rate advances maturing:
142,300
1.19
2021
50,665
2022
104,000
1.97
2023
80,000
2024
7,300
1.16
2025 and thereafter
20,314
1.22
Total FHLB advances
404,579
1.58
On November 26, 2019, the Company executed a Subordinated Note Purchase Agreement with an aggregate of $40.0 million of subordinated notes (the "Notes") to accredited investors. The Notes have a maturity date of December 1, 2029 and bear a fixed interest rate of 4.625% through December 1, 2024 payable semi-annually in arrears. From December 1, 2024 and thereafter the interest rate shall be reset quarterly to an interest rate per annum equal to the then current three-month SOFR plus 3.27%. The Company has the option beginning with the interest payment date of December 1, 2024, and on any scheduled payment date thereafter, to redeem the Notes, in whole or in part upon prior approval of the Federal Reserve. Netted with subordinated borrowings is amortized subordinated debt issuance costs of $739 thousand.
The Company also has $20.6 million in floating Junior Subordinated Deferrable Interest Debentures ("Debentures") issued by NHTB Capital Trust II ("Trust II") and NHTB Capital Trust III ("Trust III"), which are both Connecticut statutory trusts. The Debentures were issued on March 30, 2004, carry a variable interest rate of 3-month LIBOR plus 2.79%, and mature in 2034. The debt is callable by the Company at the time when any interest payment is made. Trust II and Trust III are considered variable interest entities for which the Company is not the primary beneficiary. Accordingly, Trust II and Trust III are not consolidated into the Company’s financial statements.
37
NOTE 6. DEPOSITS
A summary of time deposits is, as follows:
Time less than $100,000
559,255
600,747
Time $100,000 through $250,000
173,305
225,505
Time $250,000 or more
111,537
106,383
Total time deposits
At March 31, 2020 and December 31, 2019, the scheduled maturities by year for time deposits are, as follows:
479,983
555,074
Over 1 year to 2 years
295,939
287,934
Over 2 years to 3 years
31,909
51,444
Over 3 years to 4 years
27,811
31,262
Over 4 years to 5 years
8,438
6,883
Over 5 years
Included in time deposits are brokered deposits of $378.7 million and $526.9 million at March 31, 2020 and December 31, 2019, respectively. Also included in time deposits are reciprocal deposits of $79.3 million and $64.1 million at March 31, 2020 and December 31, 2019, respectively.
NOTE 7. CAPITAL RATIOS AND SHAREHOLDERS’ EQUITY
The actual and required capital ratios are, as follows:
Regulatory
Minimum to be
December 31,
"Well Capitalized"
Company (consolidated)
Total capital to risk-weighted assets
13.61
10.50
Common equity tier 1 capital to risk-weighted assets
10.61
7.00
10.57
Tier 1 capital to risk-weighted assets
11.42
8.50
11.39
Tier 1 capital to average assets
8.25
5.00
8.13
Bank
12.58
12.42
11.96
11.79
8.64
8.39
At each date shown, the Company and the Bank met the conditions to be classified as “well-capitalized” under the relevant regulatory framework. To be categorized as "well-capitalized," an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table above.
The Company and the Bank are subject to the Basel III rule that requires the Company and the Bank to assess their Common equity tier 1 capital to risk-weighted assets and the Company and the Bank each exceed the minimum to be "well-capitalized." Effective January 1, 2019 all banking organizations must maintain a minimum Common equity tier 1 risk-based capital ratio of 7.0%, a minimum Tier 1 risk-based capital ratio of 8.5% and a minimum Total risk-based capital ratio of 10.5%.
At March 31, 2020, the capital levels of both the Company and the Bank exceeded all regulatory capital requirements and their regulatory capital ratios were above the minimum levels required to be considered "well-capitalized" for regulatory purposes.
Accumulated other comprehensive income (loss)
Components of accumulated other comprehensive income is, as follows:
Other accumulated comprehensive income, before tax:
Net unrealized gain on AFS securities
12,699
7,342
Net unrealized loss on hedging derivatives
(3,099)
(718)
Net unrealized loss on post-retirement plans
(1,512)
Income taxes related to items of accumulated other comprehensive income:
(3,139)
(1,793)
886
237
The following table presents the components of other comprehensive income (loss) for the three months ended March 31, 2020 and 2019:
Before Tax
Tax Effect
Net of Tax
Net unrealized gain on AFS securities:
Net unrealized gain arising during the period
5,492
(1,378)
4,114
Less: reclassification adjustment for gains (losses) realized in net income
4,011
Net unrealized loss on derivative hedges:
Net unrealized loss arising during the period
(1,732)
Net unrealized loss on derivative hedges
Net unrealized gain on post-retirement plans:
Net unrealized gain on post-retirement plans
2,975
(696)
6,821
Less: reclassification adjustment for gains realized in net income
Net unrealized loss on cash flow hedging derivatives:
(647)
Net unrealized gain on cash flow hedging derivatives
8,055
(1,881)
The following table presents the changes in each component of accumulated other comprehensive income (loss), net of tax impacts, for the three months ended March 31, 2020 and 2019:
Net unrealized
Net loss on
gain (loss)
effective cash
loss
on AFS
flow hedging
on pension
Securities
derivatives
plans
5,549
(481)
(1,157)
Other comprehensive gain (loss) before reclassifications
2,382
Less: amounts reclassified from accumulated other comprehensive income
Total other comprehensive income (loss)
9,560
(2,213)
(8,665)
(2,249)
(888)
(1,844)
(2,896)
The following tables presents the amounts reclassified out of each component of accumulated other comprehensive income for the three months ended March 31, 2020 and 2019:
Affected Line Item where
Net Income is Presented
Net realized gains on AFS securities:
Before tax(1)
Tax effect
Tax expense
Total reclassifications for the period
Net of tax
..
NOTE 8. EARNINGS PER SHARE
The following table presents the calculation of earnings per share:
(in thousands, except per share and share data)
Average number of basic common shares outstanding
15,558,132
15,523,423
Plus: dilutive effect of stock options and awards outstanding (1)
34,463
63,226
Average number of diluted common shares outstanding (1)
15,592,595
15,586,649
Anti-dilutive options excluded from earnings calculation
NOTE 9. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
As part of its overall asset and liability management strategy, the Company uses derivative instruments to minimize fluctuations in earnings and cash flows caused by interest rate volatility. The Company’s interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets or liabilities so the changes in interest rates do not have a significant effect on net interest income. Thus, all of the Company's derivative contracts are considered to be interest rate contracts.
The Company recognizes its derivative instruments on the consolidated balance sheet at fair value. On the date the derivative instrument is entered into, the Company designates whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). The Company formally documents relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking hedge transactions. The Company also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting the changes in cash flows or fair values of hedged items. Changes in fair value of derivative instruments that are highly effective and qualify as cash flow hedges are recorded in other comprehensive income or loss.
The Company offers derivative products in the form of interest rate swaps, to commercial loan customers to facilitate their risk management strategies. These instruments are executed through Master Netting Arrangements ("MNA") with financial institution counterparties or Risk Participation Agreements ("RPA") with commercial bank counterparties, for which the Company assumes a pro rata share of the credit exposure associated with a borrower's performance related to the derivative contract with the counterparty.
The following tables present information about derivative assets and liabilities at March 31, 2020 and December 31, 2019:
Weighted
Location Fair
Notional
Average
Value Asset
Amount
Maturity
Asset (Liability)
(Liability)
(in years)
Cash flow hedges:
Interest rate swap on wholesale funding
100,000
4.3
(6,467)
Total cash flow hedges
Fair value hedges:
Interest rate swap on securities
37,190
9.3
3,368
Total fair value hedges
Economic hedges:
Forward sale commitments
53,751
0.2
(73)
Customer Loan Swaps-MNA Counterparty
150,490
7.8
(15,463)
Other liabilities (1)
Customer Loan Swaps-RPA Counterparty
78,505
8.7
(9,470)
Customer Loan Swaps-Customer
228,995
8.1
24,933
Total economic hedges
511,741
Non-hedging derivatives:
Interest rate lock commitments
23,146
0.1
93
Total non-hedging derivatives
672,077
(3,079)
4.6
(1,311)
9.6
593
11,228
(84)
135,598
7.5
(4,669)
69,505
8.8
(3,377)
205,103
8,046
421,434
21,748
580,372
(743)
As of March 31, 2020 and December 31, 2019, the following amounts were recorded on the balance sheet related to cumulative basis adjustments for fair value hedges:
Cumulative Amount of Fair
Location of Hedged Item on
Carrying Amount of Hedged
Value Hedging Adjustment in
Balance Sheet
Assets (Liabilities)
Carrying Amount
38,710
39,026
523
44
Information about derivative assets and liabilities for March 31, 2020 and December 31, 2019, follows:
Amount of
Gain (Loss)
Recognized in
Reclassified
Location of
Other
Location of Gain (Loss)
from Other
Comprehensive
Reclassified from Other
Recognized
Income
Comprehensive Income
Income(1)
in Income
4,949
(2,736)
Interest income
Forward commitments
Other Income
2,213
402
Interest rate cap agreements
2,494
Acquisition, restructuring, and other expenses
2,896
(65)
Cash flow hedges
In 2014, interest rate cap agreements were purchased to limit the Company’s exposure to rising interest rates on four rolling, three-month borrowings indexed to three-month LIBOR. Under the terms of the agreements, the Company paid total premiums of $4.6 million for the right to receive cash flow payments if three-month LIBOR rises above the caps of 3.00%, thus effectively ensuring interest expense on the borrowings at maximum rates of 3.00% for the duration of the agreements. The interest rate cap agreements were designated as cash flow hedges, however the caps were terminated in the fourth quarter of 2019, with $3.2 million recognized in acquisition, restructuring and other expenses. The caps were terminated because it was probable that the original forecasted transaction would not occur by the end of the original specified period.
Interest rate swap on deposits
In March and November 2019, the Company entered into interest rate swaps on brokered deposits (the "SWAPS") to limit its exposure to rising interest rates over a five year term. Under the terms of the agreement, the Company has two swaps each with a $50.0 million notional amount and pays a fixed interest rate of 2.46% and 1.55% respectively, and the financial institution counterparty pays the Company interest on the three-month LIBOR rate. The Company designated the swap as a cash flow hedge.
Economic hedges
The Company utilizes forward sale commitments on residential mortgage loans to hedge interest rate risk and the associated effects on the fair value of interest rate lock commitments and loans originated for sale. The forward sale commitments are accounted for as derivatives. The Company typically uses a combination of best efforts and mandatory delivery contracts. The contracts are loan sale agreements where the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. Generally, the Company may enter into contracts just prior to the loan closing with a customer.
Customer loan derivatives
The Company enters into customer loan derivatives to facilitate the risk management strategies for commercial banking customers. The Company mitigates this risk by entering into equal and offsetting loan swap agreements with highly rated third-party financial institutions. The loan swap agreements are free-standing derivatives and are recorded at fair value in the Company's consolidated balance sheet. The Company is party to master netting arrangements with its financial institutional counterparties; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes.
The master netting arrangements provide for a single net settlement of all loan swap agreements, as well as collateral or cash funds, in the event of default on, or termination of, any one contract. Collateral is provided by cash or securities received or posted by the counterparty with net liability positions, respectively, in accordance with contract thresholds. Currently, the Company has posted cash of $26.2 million with counterparties.
Gross Amounts Offset in the Consolidated Balance Sheet
Derivative
Cash Collateral
Derivative Assets
Pledged
Net Amount
As of March 31, 2020
Customer Loan Derivatives:
MNA counterparty
15,463
26,200
RPA counterparty
9,470
(24,933)
46
As of December 31, 2019
4,669
10,700
3,377
(8,046)
Non-hedging derivatives
The Company enters into interest rate lock commitments (“IRLCs”) for residential mortgage loans, which commit the Company to lend funds to a potential borrower at a specific interest rate and within a specified period of time. IRLCs relate to the origination of residential mortgage loans that are held for sale are considered derivative financial instruments under applicable accounting guidance. Outstanding IRLCs expose the Company to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. The IRLCs are free-standing derivatives which are carried at fair value with changes recorded in non-interest income in the Company’s Consolidated Statements of Income. Changes in the fair value of IRLCs subsequent to inception are based on; (i) changes in the fair value of the underlying loan resulting from the fulfillment of the commitment and (ii) changes in the probability when the loan will fund within the terms of the commitment, which is affected primarily by changes in interest rates and the passage of time.
NOTE 10. FAIR VALUE MEASUREMENTS
A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities that are carried at fair value.
Recurring Fair Value Measurements
The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of March 31, 2020 and December 31, 2019, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
Level 1
Level 2
Level 3
Inputs
Available for sale securities:
Derivative assets
25,026
Derivative liabilities
(28,032)
(28,105)
6,791
6,850
(8,102)
(8,186)
Securities Available for Sale: All securities and major categories of securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from independent pricing providers. The fair value measurements used by the pricing providers consider observable data that may include dealer quotes, market maker quotes and live trading systems. If quoted prices are not readily available, fair values are determined using matrix pricing models, or other model-based valuation techniques requiring observable inputs other than quoted prices such as market pricing spreads, credit information, callable features, cash flows, the U.S. Treasury yield curve, trade execution data, market consensus prepayment speeds, default rates, and the securities’ terms and conditions, among other things.
Derivative Assets and Liabilities
Cash Flow and Fair Value Hedges. The valuation of the Company's cash flow hedges are obtained from a third party. 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 inputs used to value the Company's cash flow hedges are all classified as Level 2 measurements.
Interest Rate Lock Commitments. The Company enters into IRLCs for residential mortgage loans, which commit the Company to lend funds to a potential borrower at a specific interest rate and within a specified period of time. The estimated
fair value of commitments to originate residential mortgage loans for sale is based on quoted prices for similar loans in active markets. However, this value is adjusted by a factor which considers the likelihood of a loan in a lock position will ultimately close. The closing ratio is derived from the Company’s internal data and is adjusted using significant management judgment. As such, IRLCs are classified as Level 3 measurements.
Forward Sale Commitments. The Company utilizes forward sale commitments as economic hedges against potential changes in the values of the IRLCs and loans originated for sale. The fair values of the Company’s mandatory delivery loan sale commitments are determined similarly to the IRLCs using quoted prices in the market place that are observable. However, closing ratios included in the calculation are internally generated and are based on management’s judgment and prior experience, which are not considered observable factors. As such, mandatory delivery forward commitments are classified as Level 3 measurements.
Customer Loan Derivatives. The valuation of the Company’s customer loan derivatives 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 incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of master netting arrangements and any applicable credit enhancements, such as collateral postings.
Although the Company has determined that the majority of the inputs used to value its customer loan derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of March 31, 2020, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
The table below presents the changes in Level 3 assets and liabilities that were measured at fair value on a recurring basis for the three months ended March 31, 2020:
Interest Rate Lock
Forward
Commitments
Realized gain recognized in non-interest income
Quantitative information about the significant unobservable inputs within Level 3 recurring assets and liabilities is, as follows:
Valuation
Unobservable
(in thousands, except ratios)
Techniques
Input Value
Interest Rate Lock Commitment
Historical trend
Closing Ratio
Pricing Model
Origination Costs, per loan
1.7
Forward Commitments
Quoted prices for similar loans in active markets.
Freddie Mac pricing system
Pair-off contract price
(25)
Non-Recurring Fair Value Measurements
The Company is required, on a non-recurring basis, to adjust the carrying value or provide valuation allowances for certain assets using fair value measurements in accordance with GAAP. The following is a summary of applicable non-recurring fair value measurements:
Measurement Date as of
Gains (Losses)
Impaired loans
8,335
9,625
1,290
March 2020
Capitalized servicing rights
4,301
(31)
August 2019
Premises held for sale
1,764
September 2019
16,201
17,926
1,259
There are no liabilities measured at fair value on a non-recurring basis in 2020 and 2019.
Quantitative information about the significant unobservable inputs within Level 3 non-recurring assets is, as follows:
Range
Valuation Techniques
Unobservable Inputs
(Weighted Average)(a)
4,947
Fair value of collateral -appraised value
Loss severity
0% to 70%
Appraised value
$0 to $975
3,388
Discount cash flow
Discount rate
3.50% to 9.50%
Cash flows
$21 to $1,002
Discounted cash flow
Constant prepayment rate (CPR)
11.91
11.33
Fair value of collateral less selling costs
2,695
Selling Costs
6% to 10%
Premises held for sale(b)
Fair value of asset less selling costs
$136 to $527
6,137
0% to 55.00%
$0 to $6,915
3,488
2.88% to 9.50%
$22 to $1,002
9.95
10.07
10% to 20%
6.00
There were no Level 1 or Level 2 non-recurring fair value measurements for the periods ended March 31, 2020 and December 31, 2019.
Impaired loans. Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records non-recurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Non-recurring adjustments can also include certain impairment amounts for collateral-dependent loans calculated when establishing the allowance for credit losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the calculated valuation amount does not necessarily represent the fair value of the loan. Real estate collateral is typically valued using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace. However, the choice of observable data is subject to significant judgment, and there are often adjustments based on judgment in order to make observable data comparable and to consider the impact of time, the condition of properties, interest rates, and other market factors on current values. Additionally, commercial real estate appraisals frequently involve discounting of projected cash flows, which relies inherently on unobservable data. Therefore, non-recurring fair value measurement adjustments relating to real estate collateral have generally been classified as Level 3. Estimates of fair value for other collateral supporting commercial loans are generally based on assumptions not observable in the marketplace and therefore such valuations have been classified as Level 3.
Capitalized loan servicing rights. A loan servicing right asset represents the amount by which the present value of the estimated future net cash flows to be received from servicing loans exceed adequate compensation for performing the servicing. The fair value of loan servicing rights is estimated using a present value cash flow model. The most important assumptions used in the valuation model are the anticipated rate of the loan prepayments and discount rates. Adjustments are only recorded when the discounted cash flows derived from the valuation model are less than the carrying value of the asset. Although some assumptions in determining fair value are based on standards used by market participants, some are based on unobservable inputs and therefore are classified in Level 3 of the valuation hierarchy.
Other real estate owned (“OREO”). OREO results from the foreclosure process on residential or commercial loans issued by the Company. Upon assuming the real estate, the Company records the property at the fair value of the asset less the
estimated sales costs. Thereafter, OREO properties are recorded at the lower of cost or fair value less the estimated sales costs. OREO fair values are primarily determined based on Level 3 data including sales comparables and appraisals.
Premises held for sale. Assets held for sale, identified as part of the Company’s strategic review and branch optimization exercise, were transferred from premises and equipment at the lower of amortized cost or fair value less the estimated sales costs. Assets held for sale fair values are primarily determined based on Level 3 data including sales comparables and appraisals.
Summary of Estimated Fair Values of Financial Instruments
The estimated fair values, and related carrying amounts, of the Company’s financial instruments are included in the table below. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company.
Carrying
Financial Assets
Cash and cash equivalents
Securities available for sale
FHLB stock
2,604,406
Accrued interest receivable
3,268
Cash surrender value of bank-owned life insurance policies
Financial Liabilities
Non-maturity deposits
1,806,460
1,861,960
Time deposits
852,346
Short-term other borrowings
31,000
FHLB advances
410,065
FRB advances
28,105
28,032
52
2,634,147
3,294
1,763,116
1,751,481
932,886
44,831
426,564
425,989
8,186
8,102
Other than as discussed above, the following methods and assumptions were used by management to estimate the fair value of significant classes of financial instruments for which the estimate of fair value goes beyond the carrying value approximating fair value.
Loans, net. The fair value of loans are calculated on an individual basis with consideration given to the loans' underlying characteristics, including account types, remaining terms, annual interest rates or coupons, interest types, timing of principal and interest payments, current market rates, risk ratings, credit ratings and remaining balances. A discounted cash flow model is used to estimate the fair value of the loans using assumptions for the coupon rates, remaining maturities, prepayment speeds, liquidity premiums, projected default probabilities, loss given defaults, and estimates of prevailing discount rates.
Deposits. The fair value of demand, non-interest bearing checking, savings and money market deposits is determined as the amount payable on demand at the reporting date. The fair value of time deposits is estimated by discounting the estimated future cash flows using market rates offered for deposits of similar remaining maturities.
Borrowed funds. The fair value of borrowed funds is estimated by discounting the future cash flows using market rates for similar borrowings. Such funds include all categories of debt and debentures in the table above.
Subordinated borrowings. The Company utilizes a pricing service along with internal models to estimate the valuation of its junior subordinated debentures. The junior subordinated debentures re-price every 90 days.
Off-balance-sheet financial instruments. Off-balance-sheet financial instruments including standby letters of credit and other financial guarantees and commitments are considered immaterial to the Company’s financial statements.
NOTE 11. REVENUE FROM CONTRACTS WITH CUSTOMER
The Company has accounted for the various non-interest revenue streams and related contracts under ASC 606.
Disaggregation of Revenue
The following tables present disaggregation of the Company’s non-interest revenue by major business line and timing of revenue recognition for the transfer of products or services:
Major Products/Service Lines
Trust management fees
3,046
2,525
Financial services fees
323
Interchange fees
1,738
1,031
Customer deposit fees
1,110
907
Other customer service fees
264
226
6,481
4,922
Timing of Revenue Recognition
Products and services transferred at a point in time
3,273
2,267
Products and services transferred over time
3,208
2,655
Trust Management Fees.
The trust management business generates revenue through a range of fiduciary services including trust and estate administration, wealth advisory, and investment management to individuals, businesses, not-for-profit organizations, and municipalities. Revenue from these services are generally recognized over time and is typically based on a time elapsed measure of service. Certain fees, such as bill paying fees, distribution fees, real estate sale fees, and supplemental tax service fees, are recorded as revenue at a point in time upon the completion of the service.
Financial Services Fees.
Bar Harbor Financial Services is a branch office of Infinex, an independent registered broker dealer offering securities and insurance products not affiliated with the Company or its subsidiaries. The Company has a revenue sharing agreement with Infinex for any financial service fee income generated. Financial services fees are recognized at a point in time upon the completion of service requirements.
Interchange Fees.
The Company earns interchange fees from transaction fees that merchants pay whenever a customer uses a debit card to make a purchase from their store. The fees are paid to the card-issuing bank to cover handling costs, fraud, bad debt costs and the risk involved in approving the payment. Interchange fees are generally recognized as revenue at a point in time upon the completion of a debit card transaction.
Customer Deposit Fees.
The Customer Deposit business offers a variety of deposit accounts with a range of interest rates, fee schedules and other terms, which are designed to meet the customer's financial needs. Additional depositor-related services provided to
customers include ATM, bank-by-phone, internet banking, internet bill pay, mobile banking, and other cash management services which include remote deposit capture, ACH origination, and wire transfers. These customer deposit fees are generally recognized by the Company at a point in time upon the completion of the service.
Other Customer Service Fees.
The Company has certain incentive and referral fee arrangements with independent third parties in which fees are earned for new account activity, product sales, or transaction volume generated for the respective third parties. The Company also earns a percentage of the fees generated from third-party credit card plans promoted through the Bank. Revenue from these incentive and referral fee arrangements are recognized over time using the right to invoice measure of progress.
Contract Balances from Contracts with Customers
The following table provides information about contract assets or receivables and contract liabilities or deferred revenues from contracts with customers:
Balance at
Balances from contracts with customers only:
Other Assets
1,336
Other Liabilities
3,014
3,114
The timing of revenue recognition, billings and cash collections results in contract assets or receivables and contract liabilities or deferred revenue on the consolidated balance sheets. For most customer contracts, fees are deducted directly from customer accounts and, therefore, there is no associated impact on the accounts receivable balance. For certain types of service contracts, the Company has an unconditional right to consideration under the service contract and an accounts receivable balance is recorded for services completed. When consideration is received, or such consideration is unconditionally due, from a customer prior to transferring goods or services to the customer under the terms of a contract, a contract liability is recorded. Contract liabilities are recognized as revenue after control of the products or services is transferred to the customer and all revenue recognition criteria have been met.
Costs to Obtain and Fulfill a Contract
The Company currently expenses contract costs for processing and administrative fees for debit card transactions. The Company also expenses custody fees and transactional costs associated with securities transactions as well as third party tax preparation fees. The Company has elected the practical expedient in ASC 340-40-25-4, whereby the Company recognizes the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets the Company otherwise would have recognized is one year or less.
NOTE 12. LEASES
A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. On January 1, 2019, the Company adopted ASU No. 2016-02 “Leases” and all subsequent ASUs modifying ASC 842. Substantially all of the leases pursuant to which the Company is the lessee are comprised of real estate property for branches, ATM locations, and office space with terms extending through 2040. All leases are classified as operating leases, and therefore, were previously not recognized on the Company’s consolidated balance sheets. With the adoption of ASC 842, operating lease agreements are required to be recognized on the consolidated balance sheets as a right-of-use (“ROU”) asset with a corresponding lease liability using the modified retrospective approach.
The Company elected the following practical expedients in conjunction with implementation of ASC 842 as follows:
The following table presents the consolidated statements of condition classification of the Company’s ROU assets and lease liabilities as of March 31, 2020:
Lease Right-of-Use Assets
Classification
Operating lease right-of-use assets
10,129
9,623
Lease Liabilities
Operating lease liabilities
10,205
9,651
The calculated amount of the ROU assets and lease liabilities in the table above are impacted by the length of the lease term and the discount rate used for the present value of the minimum lease payments. The Company’s lease agreements often include one or more options to renew at the Company’s discretion. If at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company will include the extended term in the calculation of the ROU asset and lease liability. If there are multiple renewals typically only the next lease renewal is considered. Regarding the discount rate, ASC 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, the Company utilizes its incremental borrowing rate at lease inception, on a collateralized basis, over a similar term.
The following table presents the weighted average lease term and discount rate of the Company’s leases:
Weighted-average remaining lease term (in years)
Operating leases
9.52
8.96
Weighted-average discount rate
3.30
3.27
The following table represents lease costs and other lease information. As the Company elected, for all classes of underlying assets, not to separate lease and non-lease components and instead to account for them as a single lease component, the variable lease cost primarily represents variable payments such as real estate taxes, common area maintenance and utilities.
March 31, 2019
Lease Costs
Operating lease cost
234
Variable lease cost
144
Total lease cost
378
Future minimum payments for operating leases with initial or remaining terms of one year or more as of March 31, 2020 are, as follows:
Operating Leases
Twelve Months Ended:
March 31, 2021
1,285
March 31, 2022
1,300
March 31, 2023
1,319
March 31, 2024
1,323
March 31, 2025
1,240
Thereafter
6,495
Total future minimum lease payments
12,962
Amounts representing interest
(2,757)
Present value of net future minimum lease payments
NOTE 13. SUBSEQUENT EVENTS
There were no significant subsequent events between March 31, 2020 and through the date the financial statements are available to be issued.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Management’s discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of the Company. The following discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and the notes thereto appearing in Part I, Item 1 of this document and with the Company’s consolidated financial statements and the notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company's Annual Report on Form 10-K for the year ended December 31, 2019. In the following discussion, income statement comparisons are against the same period of the previous year and balance sheet comparisons are against the previous fiscal year-end, unless otherwise noted. Operating results discussed herein are not necessarily indicative of the results for the full year 2020 or any future period. In management’s discussion and analysis of financial condition and results of operations, certain reclassifications have been made to make prior periods comparable.
Bar Harbor Bankshares (the “Company”) is the parent of Bar Harbor Bank & Trust (the “Bank”), which is the only community bank headquartered in Northern New England with branches in Maine, New Hampshire and Vermont. The Bank is a true community bank providing exceptional commercial, retail, and wealth management banking services from over 50 locations. The Company’s corporate goal is to be among the most profitable banks in New England, and its business model is centered on the following:
Shown below is a profile of the Company as of March 31, 2020:
SELECTED FINANCIAL DATA
The following summary data is based in part on the consolidated financial statements and accompanying notes and other information appearing elsewhere in this or prior Forms 10-Q.
PER SHARE DATA
Net earnings, diluted
Adjusted earnings, diluted(1)
Total book value
25.90
24.54
Tangible book value(1)
17.70
17.63
Market price at period end
17.28
25.87
Dividends
0.22
0.20
PERFORMANCE RATIOS(2)
Return on assets
0.85
0.83
Adjusted return on assets(1)
0.86
Return on equity
7.64
7.83
Adjusted return on equity(1)
7.71
Adjusted return on tangible equity(1)
11.54
11.19
Net interest margin, fully taxable equivalent (FTE)(1) (3)
3.06
2.77
Net interest margin (FTE), excluding purchased loan accretion(3)
2.99
2.67
Efficiency ratio(1)
64.82
63.94
GROWTH (Year-to-date)(1)
6.4
(3.3)
(0.9)
5.9
(6.7)
(2.8)
FINANCIAL DATA (In millions)
3,677
3,629
Total earning assets(4)
3,269
3,312
Total investments
646
782
2,635
2,527
Allowance for loan losses
Total goodwill and intangible assets
107
2,651
2,466
Total shareholders' equity
404
Adjusted income(1)
ASSET QUALITY AND CONDITION RATIOS
Net charge-offs (current quarter annualized)/average loans
0.18
0.03
Allowance for loan losses/total loans
0.58
0.55
Loans/deposits
102
Shareholders' equity to total assets
10.98
Tangible shareholders' equity to tangible assets(1)
7.77
CONSOLIDATED LOAN AND DEPOSIT ANALYSIS
The following tables present the quarterly trend in loan and deposit data and accompanying quarterly growth rates as of March 31, 2020 on an annualized basis:
LOAN ANALYSIS
Annualized
Growth %
September 30,
June 30,
923,773
881,479
821,567
321,605
318,988
301,590
312,029
305,185
3.3
1,269,783
1,249,649
1,225,363
1,193,508
1,126,752
1,143,452
1,167,759
1,184,053
(6.8)
107,375
112,275
111,402
(21.2)
Tax exempt and other
104,752
101,116
104,696
2,577,306
2,578,238
2,526,959
DEPOSIT ANALYSIS
380,707
354,125
342,030
(13.6)
490,315
472,576
470,277
360,570
352,657
346,813
35.7
359,328
305,506
349,833
21.1
Total non-maturity deposits
1,590,920
1,484,864
1,508,953
9.8
902,665
996,512
956,818
(38.0)
2,493,585
2,481,376
2,465,771
AVERAGE BALANCES AND AVERAGE YIELDS/RATES
The following tables present average balances and average yields and rates on an annualized fully taxable equivalent basis for the periods included:
Interest(3)
Yield/Rate(3)
945,851
10,484
4.46
825,596
9,721
4.78
423,393
5,151
4.89
405,107
4,786
4.79
1,141,908
10,909
3.84
1,143,862
11,126
3.94
130,471
1,688
5.20
113,060
1,464
5.25
Total loans (1)
2,641,623
28,232
4.30
2,487,625
27,097
4.42
Securities and other (2)
661,848
5,813
3.53
777,458
6,645
3.47
Total earning assets
3,303,471
34,045
4.14
3,265,083
33,742
4.19
358,288
295,957
3,661,759
3,561,040
570,127
565
0.40
468,392
583
0.51
410,931
346,707
0.19
373,650
934
1.01
335,882
1,141
1.38
892,654
4,263
1.92
894,160
4,416
2.00
Total interest bearing deposits
2,247,362
1.08
2,045,141
6,303
1.25
556,824
2.10
761,885
2.74
Total interest bearing liabilities
2,804,186
1.28
2,807,026
11,458
1.66
Non-interest bearing demand deposits
406,951
351,362
44,343
25,520
3,255,480
3,183,908
406,279
377,132
Total liabilities and shareholders' equity
Net interest spread
2.86
2.53
Net interest margin
NON-GAAP FINANCIAL MEASURES
This document contains certain non-GAAP financial measures in addition to results presented in accordance with accounting principles generally accepted in the United States of America ("GAAP"). These non-GAAP measures are intended to provide the reader with additional supplemental perspectives on operating results, performance trends, and financial condition. Non-GAAP financial measures are not a substitute for GAAP measures; they should be read and used in conjunction with the Company's GAAP financial information. A reconciliation of non-GAAP financial measures to GAAP measures is provided below. In all cases, it should be understood that non-GAAP measures do not depict amounts that accrue directly to the benefit of shareholders. An item that management excludes when computing non-GAAP adjusted earnings can be of substantial importance to the Company's results for any particular quarter or year. The Company's non-GAAP adjusted earnings information set forth is not necessarily comparable to non- GAAP information that may be presented by other companies. Each non-GAAP measure used by the Company in this report as supplemental financial data should be considered in conjunction with the Company's GAAP financial information.
The Company utilizes the non-GAAP measure of adjusted earnings in evaluating operating trends, including components for adjusted revenue and expense. These measures exclude amounts that the Company views as unrelated to its normalized operations, including gains/losses on securities, premises, equipment and other real estate owned, acquisition costs, restructuring costs, legal settlements, and systems conversion costs. Non-GAAP adjustments are presented net of an adjustment for income tax expense.
The Company also calculates adjusted earnings per share based on its measure of adjusted earnings. The Company views these amounts as important to understanding its operating trends, particularly due to the impact of accounting standards related to acquisition activity. Analysts also rely on these measures in estimating and evaluating the Company's performance. Management also believes that the computation of non-GAAP adjusted earnings and adjusted earnings per share may facilitate the comparison of the Company to other companies in the financial services industry. The Company also adjusts certain equity related measures to exclude intangible assets due to the importance of these measures to the investment community.
RECONCILIATION OF NON-GAAP FINANCIAL MEASURES
The following table summarizes the reconciliation of non-GAAP items for the time periods presented:
GAAP net income
Plus (less):
Gain on sale of securities, net
Loss on sale of premises and equipment, net
Income tax expense(1)
(22)
Total adjusted income(2)
(A)
7,790
GAAP net interest income
(B)
Plus: Non-interest income
Total Revenue
32,984
27,932
Less: Gain on sale of securities, net
Total adjusted revenue(2)
(C)
32,849
GAAP total non-interest expense
Less: Loss on sale of premises and equipment, net
(92)
Less: Loss on other real estate owned
Less: Acquisition, restructuring and other expenses
(103)
Adjusted non-interest expense(2)
(D)
22,133
(in millions)
Total average earning assets
(E)
3,306
3,265
Total average assets
(F)
3,662
3,561
Total average shareholders' equity
(G)
406
377
Total average tangible shareholders' equity(2)(3)
(H)
270
Total tangible shareholders' equity, period-end(2)(3)
(I)
274
Total tangible assets, period-end(2)(3)
(J)
3,549
3,522
Total common shares outstanding, period-end
(K)
15,524
Average diluted shares outstanding
(L)
Adjusted earnings per share, diluted
(A/L)
Tangible book value per share, period-end(2)
(I/K)
Securities adjustment, net of tax(1)(4)
(M)
(1,842)
Tangible book value per share, excluding securities adjustment(2)(4)
(I+M)/K
17.09
17.75
Total tangible shareholders' equity/total tangible assets(2)
(I/J)
Performance ratios(5)
Adjusted return on assets(2)
(A/F)
Adjusted return on equity(2)
(A/G)
Adjusted return on tangible equity(2)(6)
(A+Q)/H
Efficiency ratio(2)(7)
(D-O-Q)/(C+N)
Net interest margin(2)
(B+P)/E
Supplementary data (in thousands)
Taxable equivalent adjustment for efficiency ratio
(N)
719
684
Franchise taxes included in non-interest expense
(O)
119
120
Tax equivalent adjustment for net interest margin
(P)
551
515
Intangible amortization
(Q)
65
FINANCIAL SUMMARY
The Company reported first quarter 2020 net income of $7.7 million or $0.50 per share, a 6% increase in net income over the same quarter of 2019 of $7.3 million or $0.47 per share. Financial highlights for the first quarter 2020 include the following (compared to the first quarter of 2019, unless otherwise noted):
The Company’s financial performance in the first quarter 2020 was strong while quickly shifting efforts to address COVID-19 developments. The Company is fully dedicated to supporting customers and employees during these difficult times and is confident in the strength of its operating model.
While focusing on the challenges posed by the health crisis in the first quarter, the Company remains committed to its cornerstone of business operations: Risk management, ranging from underwriting practices to what is now at the forefront, crisis management and business continuity planning. From the onset of the crisis, the Company has maintained open communication with customers and employees alike, and transitioned to a mostly remote working environment. This transition was smooth given the readiness of the Company’s information technology and operations departments. The Company modified its branch model providing safety to customers and employees while balancing a personalized touch to meet the needs of its customers. These modifications include transitioning to mostly drive-up and walk-up windows along with in person meetings by appointment when necessary. The investments the Company has made in the past few years in online and mobile banking platforms have been essential with the current environment while helping to accelerate adoption rates.
The Company recognizes the importance of liquidity, especially in the current economic environment. Therefore, the Company has opportunistically and appropriately utilized many of the various federal programs in an effort to insulate from potential risk and uncertainty. Further supporting capital levels and the balance sheet the Company recently refinanced and upsized its subordinated debt in the fourth quarter 2019. Loan volumes were significant this quarter as originations offset elevated payoff levels as typically seen with the lower rate environment. Growth in commercial loans offset the decrease in the residential portfolio as the Company strategically moved most of production to the secondary market. The Company also successfully rolled out the Small Business Administration (SBA) Paycheck Protection Program (PPP) in an effort to help its business partners and communities. As of April 30, 2020, the Company has over 1,500 PPP loans approved by the SBA with a total balance of $127 million. In addition, the Company has modified close to 500 existing loans, representing $271 million in balances. The loans modified under these deferment plans are still accruing interest and all contractual principal and interest is expected to be collected.
The Company’s loan portfolio remains diverse with over 80 different industries and several geographies limiting concentration risk, which is further mitigated by the specific type and strength of the borrowers. These credit relationships are proven successful operators in their industry and have weathered difficult economic times in the past. The Company continues to carefully review opportunities with proven borrowers while also stress testing the portfolio regularly.
Given the recently passed CARES Act, the Company has elected to defer the new accounting for the allowance for loan losses known as “CECL” to prioritize resources around customers and communities. At the same time, the Company increased the allowance for loan losses during the quarter due to elevated qualitative economic factors at quarter end. Overall, the Company’s liquidity, capital ratios and overall balance sheet position are strong. Additionally, the Company’s reliance on wholesale borrowing is further declining and the ability to access such funding sources at fair pricing is significant.
The Company continues to execute strategies that will benefit long-term profitability while being mindful of the short-term challenges and operating environment. Lower interest rates and the divergence in FHLB borrowings and brokered
deposit spreads has provided the Company with an opportunity to lock into favorable rates with longer maturities. The benefits of these activities, along with the balance sheet strategies executed last year, are unveiled as the Company’s net interest margin expanded nearly 30 basis points during the quarter. Non-interest income has also improved for the quarter as the Company continues to provide hedging transactions to help meet customers’ needs. While trust and investment management fee income is up significantly over prior year, it is also sensitive to market conditions and could vary as market dynamics persist with the pandemic. In summary, the Company is focused on activities that create value for long-term shareholders as it continues to build tangible book value at a quarterly annualized rate of close to 10%.
COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 2020 AND DECEMBER 31, 2019
Summary
Total assets were $3.7 billion at the end of the first quarter 2020 and at year-end 2019. Asset quality metrics remain strong with an allowance for credit losses to total loans ratio of 0.58% with a coverage ratio to non-accruing loans at 152%, up from 133% as of year-end 2019. The loan to deposit ratio was 99% compared to 98% at year-end 2019 due to lower deposits in the first quarter. The Company's tangible book value per share increased 9%, on annualized basis, in the first quarter 2020.
Securities totaled $646.2 million in the first quarter 2020 and $683.9 million at year-end 2019 representing 18% and 19% of total assets, respectively. The decrease in the first quarter is consistent with the Company strategy to de-lever and remix the investment portfolio resulting in a higher year-over-year yield along with lower borrowing levels. Securities purchased in the first quarter 2020 included $13.2 million of mortgage-backed securities guaranteed by US Government-sponsored enterprises, $2.5 million of corporate bonds, and a net $782 thousand decrease in FHLB stock. The purchases were offset by $58.0 million of sales, maturities, calls and pay-downs of amortizing securities. Fair value adjustments increased the security portfolio by $12.7 million at the end of the first quarter 2020 and $7.3 million at year-end 2019. The improvement in the fair value continues to be the result of lower long-term interest rates. The weighted average yield on the Company's securities profile as of March 31, 2020 was 3.20% for the quarter compared to 3.42% at year-end 2019. At the end of the first quarter 2020 securities held by the Company had an average life of 5.1 years and a duration of 2.7 years compared to 5.0 years and 3.6 years at the end of 2019, respectively.
Loan balances in the first quarter 2020 were $2.6 billion, flat with year-end 2019. Total commercial loans grew at an annualized rate of 6% led by commercial real estate with an annualized growth rate of 8% as the Company executed on an expanded pipeline. Residential real estate loans were relatively flat with the fourth quarter as originations maintained, but were offset by secondary market sales and payoff activity. Payoff activity was experienced across all products lines as seasoned borrowers refinanced given the lower rate environment. Although the commercial portfolio grows each quarter, the product mix of total commercial loans remains diversified among 80 industries throughout many geographic regions. Average yields from loans were 4.30% in the first quarter 2020 as variable rate loans repriced compared with 4.33% in the fourth quarter 2019.
Asset Quality
The allowance for loan losses totaled $15.3 million at the end of the first quarter 2020 and $14.4 at year-end 2019. In the first quarter 2020, the Company elected to defer implementation of CECL as allowed under the CARES Act. As result, the Company continues to operate its incurred loss model, which has been adjusted higher to reflect current economic conditions. Increases to the allowance associated with those adjustments were offset by improvements in other credit quality factors including several specifically reserved loans that were settled at approximate book value. Past due accounts between 30 to 89 days as a percentage of total loans was 0.84% for the first quarter compared to 0.74% at year-end 2019. The majority of the customers in that range have a history of making payments on a cycle that is about 30 days overdue and is not likely an indication of deteriorated credit quality.
Given current events and the economic situation associated with COVID-19 along with the variation of the Company’s stock price, the fair value of the Company’s business and test for goodwill impairment is required under accounting standards. The Company’s models suggest that the fair value of the business is greater than the book value or market
capitalization based on the price at which the stock is currently trading. While the Company concluded there is no goodwill impairment in the first quarter 2020, it will continue to evaluate its position as economic conditions change.
Deposits and Borrowings
Total deposits were $2.7 billion at the end of the first quarter 2020 and year-end 2019. Non-maturity deposits increased to $1.8 billion, 10% on annualized basis, during the first quarter 2020. The Company's expanding branch model has helped to increase new accounts, which totaled 3,071 in the first quarter 2020 compared to 2,918 in the fourth quarter 2019 excluding acquired balances. Time deposits decreased $88.6 million, due to the Company's strategy to target lower rate and longer duration funding sources. The average cost of deposits decreased to 1.08% from 1.19% in the fourth quarter 2019 reflecting the Federal Reserve Bank short-term rate cuts in current and prior quarters. Total borrowings increased by $26.1 million as the Company took advantage of lower FRB and FHLB rates opposed to other funding sources. Borrowing costs improved to 2.10% from 2.30% in the fourth 2019 as a result of cuts in short-term interest rates.
Derivative Financial Instruments
The notional balance of derivative financial instruments increased to $672.1 million at the end of the first quarter 2020 from $580.4 million at year-end 2019. The increase is principally due to a $47.8 million increase in customer loan derivatives sold on commercial loans with matching hedges using national bank counterparties and a $42.5 million in forward commitments to sell mortgages in the secondary market. The net fair value of all derivatives was a liability of $3.1 at the end of the first quarter 2020 compared to $743 thousand at year-end 2019. The increase in the net derivative liability primarily reflects the valuation of the Company’s interest rate swaps on wholesale funding based on lower market rates at the end of the first quarter 2020.
Equity
Total equity was $403.8 million, compared with $396.4 million at year-end 2019. The Company's book value per share increased to $25.90 at the end of the first quarter 2020 from $25.48 at year-end 2019. The increase includes a $4.0 million improvement in fair value of securities, net of tax, along with strong net income of $7.7 million offset by $3.4 million in dividends. The Company evaluates changes in tangible book value, a non-GAAP financial measure that is a commonly used valuation metric in the investment community, which parallels some regulatory capital measures. Tangible book value per share (non-GAAP measure) increased to $17.70 per share at year-end 2019 up from $17.30 per share at year-end 2019; an increase of 9% on annualized basis.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019
Net income in the first quarter 2020 was $7.7 million, or $0.50 per diluted share, compared with $7.3 million, or $0.47 per diluted share, in the same quarter 2019. Noteworthy improvements in net income include a lower cost of funds and increased non-interest income offset in part by higher operational expenses. The Company's return on assets ratio was 0.85% during the first quarter of 2020 and 0.83% in the same quarter of 2019 and the return on equity ratio was 7.64% and 7.83% for the same respective periods.
Net Interest Income
Net interest income was $24.6 million compared with $21.8 million in the same quarter of 2019 and net interest margin was 3.06% and 2.77% for the same respective periods. The increase is primarily driven by lower borrowing levels as the average balance decreased to $557 million in the first quarter 2020 from $762 million in the first quarter of 2019 due to deleveraging strategies executed in late 2019 and a lower cost of funds. The balance sheet strategies executed during the second half of last year along with the rate cuts experienced in the first quarter reduced borrowing rates to 2.10% from 2.74% and interest-bearing deposits rates to 1.08% from 1.25% in the first quarter 2019. The Company continues to optimize its funding sources to take advantage of this lower rate environment through a mixture of various debt and derivative instruments. Yields from earning assets declined to 4.14% from 4.19% in the first quarter 2019 reflecting loan originations and repricing of variable rate products in a lower interest rate environment. Purchase loan accretion contributed 0.08% to net interest margin in the first quarter 2020 compared to 0.10% in the first quarter 2019. The loan to deposit ratio was 99% in the first quarter 2020 as the Company maintained its fourth quarter 2019 deposit levels, which is due to strong customer relationships within its branch model.
Loan Loss Provision
The first quarter 2020 provision for loan losses increased to $1.1 million from $324 thousand in the same quarter 2019. As noted above, the Company is maintaining its incurred loss model for calculating the allowance for loan losses. The year-over-year increase in the provision for loan losses is due to qualitative adjustments made to reflect a downward economic trend in the first quarter 2020. Those downward adjustments were offset in part by improvements in other credit quality factors such as charge-off history and underwriting practices. While the impact of the health crisis is uncertain, we believe the existing allowance for loan losses is sufficient to absorb inherent losses based on a disciplined credit approach, experienced losses and methodology, and current review of the portfolio.
Non-Interest Income
Non-interest income in the first quarter 2020 increased 37% to $8.4 million from $6.2 million in the same quarter in 2019. Trust income was $3.4 million in the first quarter 2020, up 22% from the same quarter of 2019 based on higher assets under management within an expanded footprint given the branch acquisition which closed in October 2019. Customer service fees also increased significantly to $3.1 million compared to $2.2 million from the same quarter of 2019 due to transaction growth from a higher customer base. Customer loan derivative income also contributed $588 thousand to non-interest income in the first quarter 2020 as demand for these products remains strong within the commercial loan pipeline.
Non-Interest Expense
Non-interest expense was $22.4 million in the first quarter 2020 compared to $18.6 million in the same quarter of 2019. The increase is primarily due to higher salary and benefit and occupancy and equipment costs to support the Company’s expanded branch model and wealth management business.
Income Tax Expense
The first quarter effective tax rate decreased to 18.8% in 2020 compared with 19.0% in the same quarter of 2019, reflecting a higher level of tax-advantaged income.
Liquidity and Cash Flows
Liquidity is measured by the Company's ability to meet short-term cash needs at a reasonable cost or minimal loss. The Company seeks to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. Besides serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer-initiated needs. Many factors affect the Company's ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and credit standing in the marketplace, and general economic conditions.
The Bank actively manages its liquidity position through target ratios established under its Asset-Liability Management Policy. Continual monitoring of these ratios, by using historical data and through forecasts under multiple rate and stress scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity. The Bank's policy is to maintain a liquidity position of at least 4% of total assets. A portion of the Bank's deposit base has been historically seasonal in nature, with balances typically declining in the winter months through late spring, during which period the Bank's liquidity position tightens.
At March 31, 2020, same day available liquidity totaled approximately $1.2 billion, including cash, borrowing capacity at the Federal Home Loan Bank of Boston (“FHLB”) and the Federal Reserve Discount Window and various lines of credit. Additional sources of liquidity include cash flows from operations, wholesale deposits, cash flow from the Bank's amortizing securities and loan portfolios. At March 31, 2020, the Company had unused borrowing capacity at the FHLB of $539.0 million, unused borrowing capacity at the Federal Reserve of $27.0 million and unused lines of credit totaling $51.0 million.
The Bank maintains a liquidity contingency plan approved by the Bank's Board of Directors. This plan addresses the steps that would be taken in the event of a liquidity crisis, and identifies other sources of liquidity available to the Company. Company management believes the level of liquidity is sufficient to meet current and future funding requirements. However, changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on the Company's liquidity position.
Off-Balance Sheet Arrangements
The Company is, from time to time, a party to certain off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, that may be material to investors.
The Company’s off-balance sheet arrangements are limited to standby letters of credit whereby the Bank guarantees the obligations or performance of certain customers. These letters of credit are sometimes issued in support of third-party debt. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same origination, portfolio maintenance and management procedures in effect to monitor other credit products. The amount of collateral obtained, if deemed necessary by the Bank upon issuance of a standby letter of credit, is based upon management's credit evaluation of the customer.
The Company’s off-balance sheet arrangements have not changed materially since previously reported in our Annual Report on Form 10-K for the year ended December 31, 2019.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ACCOUNTING ESTIMATES, AND RECENT ACCOUNTING PRONOUNCEMENTS
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements in this Form 10-Q and in the most recent Form 10-K. Please see those policies in conjunction with this discussion. The accounting and reporting policies followed by the Company conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.
Management has identified the Company's most critical accounting policies as related to:
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk do not arise in the normal course of the Company’s business activities.
The responsibility for interest rate risk management oversight is the function of the Bank’s Asset and Liability Committee (“ALCO”), chaired by the Chief Financial Officer and composed of various members of senior management. ALCO meets regularly to review balance sheet structure, formulate strategies in light of current and expected economic conditions, adjust product prices as necessary, implement policy, monitor liquidity, and review performance against guidelines established to control exposure to the various types of inherent risk.
Interest Rate Risk: Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank's net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and or cash flow characteristics of assets and liabilities. Management's objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank's balance sheet. The objectives in managing the Bank's balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promote sufficient reward for understood and controlled risk.
The Bank's interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off-balance sheet instruments as each relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by ALCO and the Company’s Board of Directors.
The Bank's Asset Liability Management Policy, approved annually by the Bank’s Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat, and decreasing rate scenarios. It is the role of the ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.
Interest Rate Sensitivity Modeling: The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The model simulates the behavior of interest income and expense for all balance sheet and off-balance sheet instruments, under different interest rate scenarios together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.
The interest rate risk sensitivity model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates, as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. The model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. The model uses contractual re-pricing dates for variable products, contractual maturities for fixed rate products, and product-specific assumptions for deposit accounts, such as money market accounts, that are subject to re-pricing based on current market conditions. Re-pricing margins are also determined for adjustable rate assets and incorporated in the model. Investment securities and borrowings with call provisions are examined on an individual basis in each rate environment to estimate the likelihood of a call. Prepayment assumptions for mortgage loans and mortgage-backed securities are developed from industry median estimates of prepayment speeds, based upon similar coupon ranges and degree of seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different interest rate scenarios. Interest income and interest expense are then simulated under several hypothetical interest rate conditions including:
Changes in net interest income based upon the foregoing simulations are measured against the flat interest rate scenario and actions are taken to maintain the balance sheet interest rate risk within established policy guidelines.
As of March 31, 2020 interest rate sensitivity modeling results indicate that the Bank’s balance sheet in years 1 and 2 were slightly asset sensitive.
Assuming short-term and long-term interest rates decline 100 basis points from current levels (i.e., a parallel yield curve shift) and the Bank’s balance sheet structure and size remain at current levels, management believes net interest income will deteriorate over the one year horizon (-2.2% versus the base case) while deteriorating further from that level over the two-year horizon (-6.4% versus the base case).
Assuming the Bank’s balance sheet structure and size remain at current levels and the Federal Reserve increases short-term interest rates by 200 basis points with the balance of the yield curve shifting in parallel with these increases, management believes net interest income will improve slightly over the one and two-year horizons (1.2% and 3.6%, respectively).
As compared to December 31, 2019, the year-one sensitivity in the down 100 basis points scenario was down slightly for the three months ended March 31, 2020 (-1.0% prior, versus -2.2% current). The year-two sensitivities in the down 100 basis points scenario changed going from -3.7% to -6.4%. In the year-one up 200 basis points scenario, results improved going from .7% to 1.2%. Year-two, up 200 basis points was flat (3.3% prior, versus 3.6% current).
The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels and yield curve shape, prepayment speeds on loans and securities, deposit rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows, and renegotiated loan terms with borrowers. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.
As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment and refinancing levels deviating from those assumed; the impact of interest rate changes, caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other such variables. The sensitivity analysis also does not reflect additional actions that the Bank’s Senior Executive Team and Board of Directors might take in responding to or anticipating changes in interest rates, and the anticipated impact on the Bank’s net interest income.
72
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our senior management, consisting of the Company’s principal executive officer and our principal financial officer, the Company conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, the Company’s management, including its principal executive officer and principal financial officer, concluded that as of March 31, 2020 the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. The Company’s disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in its Exchange Act reports is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
There were no changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and its subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of their respective businesses, which in the opinion of management based upon currently available information will have no material effect on the Company's consolidated financial statements.
ITEM 1A. RISK FACTORS
The disclosures below supplement the risk factors previously disclosed under Item 1A. of the Company’s 2019 Annual Report on Form 10-K.
The COVID-19 pandemic may adversely impact our business and financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.
The COVID-19 pandemic is creating extensive disruptions to the economy and to the lives of individuals. Governments, businesses, and the public are taking unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief. While the scope, duration, and full effects of COVID-19 are rapidly evolving and not fully known, the pandemic and related efforts to contain it have disrupted economic activity, adversely affected the functioning of financial markets, impacted interest rates, increased economic and market uncertainty, and disrupted trade and supply chains. If these effects continue for a prolonged period or result in sustained economic stress or recession, many of the risk factors identified in our Form 10-K could be exacerbated and such effects could have an adverse impact on us in a number of ways related to credit quality, collateral values, customer demand, funding, operations, interest rate risk, and human capital.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Total number of shares
Maximum number of
purchased as a part of
shares that may yet be
Total number of
Average price
publicly announced
purchased under
Period
shares purchased
paid per share
plans or programs
the plans or programs(1)
January 1-31, 2020
776,000
February 1-29, 2020
March 1-31, 2020
781,000
ITEM 6. EXHIBITS
31.1
Certification of Chief Executive Officer under Rule 13a-14(a)/15d-14(a)
Filed herewith
31.2
Certification of Chief Financial Officer under Rule 13a-14(a)/15d-14(a)
32.1
Certification of Chief Executive Officer under 18 U.S.C. Sec. 1350.
Furnished herewith
32.2
Certification of Chief Financial Officer under 18 U.S.C. Sec. 1350.
101
The following financial information from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 is formatted in Inline Extensible Business Reporting Language (iXBRL): (i) Consolidated Condensed Statements of Income, (ii) the Condensed Consolidated Balance Sheets, (iii) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, (iv) Consolidated Statements of Cash Flows and (v) Notes to the Consolidated Condensed Financial Statements
104
Cover Page Interactive Data File (the cover page XBRL tags are embedded within the Inline XBRL document).
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.
Dated: May 8, 2020
By:
/s/ Curtis C. Simard
Curtis C. Simard
President & Chief Executive Officer
/s/ Josephine Iannelli
Josephine Iannelli
Executive Vice President & Chief Financial Officer