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: September 30, 2021
☐
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 14,986,786 shares of common stock, par value $2.00 per share, outstanding as of November 5, 2021.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
INDEX
Page
PART I.
FINANCIAL INFORMATION
Item 1.
Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets as of September 30, 2021 and December 31, 2020
4
Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2021 and 2020
6
Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2021 and 2020
7
Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months Ended September 30, 2021 and 2020
8
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2021 and 2020
9
Notes to Unaudited Consolidated Interim Financial Statements
Note 1
Basis of Presentation
11
Note 2
Securities Available for Sale
21
Note 3
Loans and Allowance for Credit Losses
24
Note 4
Borrowed Funds
36
Note 5
Deposits
38
Note 6
Capital Ratios and Shareholders' Equity
39
Note 7
Earnings per Share
44
Note 8
Derivative Financial Instruments and Hedging Activities
45
Note 9
Fair Value Measurements
54
Note 10
Revenue from Contracts with Customers
61
Note 11
Leases
63
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
65
Selected Financial Data
66
Consolidated Loan and Deposit Analysis
67
Average Balances and Average Yields/Rates
68
Non-GAAP Financial Measures
70
Reconciliation of Non-GAAP Financial Measures
71
Financial Summary
73
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
79
Item 4.
Controls and Procedures
81
PART II.
OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
82
Item 6.
Exhibits
83
Signatures
84
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," 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, 2020. 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
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share data)
September 30, 2021
December 31, 2020
Assets
Cash and cash equivalents:
Cash and due from banks
$
39,081
27,566
Interest-bearing deposits with other banks
302,118
198,441
Total cash and cash equivalents
341,199
226,007
Securities:
Securities available for sale
545,327
585,046
Federal Home Loan Bank stock
10,192
14,036
Total securities
555,519
599,082
Loans held for sale
7,505
23,988
Total loans
2,534,154
2,562,885
Less: Allowance for credit losses
(22,448)
(19,082)
Net loans
2,511,706
2,543,803
Premises and equipment, net
50,070
52,458
Goodwill
119,477
Other intangible assets
6,966
7,670
Cash surrender value of bank-owned life insurance
79,380
77,870
Deferred tax assets, net(1)
5,811
3,047
Other assets(1)
60,712
70,873
Total assets(1)
3,738,345
3,724,275
Liabilities
Deposits:
Demand
664,395
544,636
NOW
888,021
738,849
Savings
605,977
521,638
Money market
379,651
402,731
Time
469,221
698,361
Total deposits
3,007,265
2,906,215
Borrowings:
Senior
190,267
276,062
Subordinated
60,083
59,961
Total borrowings
250,350
336,023
Other liabilities(1)
62,295
74,972
Total liabilities(1)
3,319,910
3,317,210
(continued)
CONSOLIDATED BALANCE SHEETS (UNAUDITED) (continued)
Shareholders’ equity
Capital stock, par value $2.00; authorized 20,000,000 shares; issued 16,428,388 shares at September 30, 2021 and December 31, 2020
32,857
Additional paid-in capital
190,892
190,084
Retained earnings
209,426
195,607
Accumulated other comprehensive income(1)
2,888
6,740
Less: 1,441,763 and 1,512,465 shares of treasury stock at September 30, 2021 and December 31, 2020, respectively
(17,628)
(18,223)
Total shareholders’ equity(1)
418,435
407,065
Total liabilities and shareholders’ equity(1)
The accompanying notes are an integral part of these consolidated financial statements.
5
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended
Nine Months Ended
September 30,
(in thousands, except earnings per share data)
2021
2020
Interest and dividend income
Loans
25,094
25,918
72,490
80,398
Securities and other
3,821
4,557
11,792
15,006
Total interest and dividend income
28,915
30,475
84,282
95,404
Interest expense
1,555
3,869
7,109
14,437
Borrowings
1,778
1,941
5,415
7,149
Total interest expense
3,333
5,810
12,524
21,586
Net interest income
25,582
24,665
71,758
73,818
Provision for credit losses
(174)
1,800
(1,428)
4,265
Net interest income after provision for loan losses
25,756
22,865
73,186
69,553
Non-interest income
Trust and investment management fee income
3,868
3,532
11,335
10,060
Customer service fees
3,515
2,886
9,742
8,437
Gain on sales of securities, net
1,930
—
1,980
1,486
Mortgage banking income
850
2,649
4,973
4,230
Bank-owned life insurance income
494
492
1,510
1,525
Customer derivative income
341
316
837
1,417
Other income
352
227
726
1,078
Total non-interest income
11,350
10,102
31,103
28,233
Non-interest expense
Salaries and employee benefits
11,743
11,809
35,275
35,602
Occupancy and equipment
4,029
4,279
12,251
12,559
Loss (gain) on sales of premises and equipment, net
(146)
(137)
90
Outside services
547
438
1,512
1,414
Professional services
491
479
1,200
1,488
Communication
188
215
707
698
Marketing
339
300
1,163
970
Amortization of intangible assets
233
256
768
Loss on debt extinguishment
1,768
1,351
Acquisition, conversion and other expenses
318
691
1,759
952
Other expenses
3,862
3,952
11,382
11,152
Total non-interest expense
23,372
22,419
67,587
67,044
Income before income taxes
13,734
10,548
36,702
30,742
Income tax expense
2,706
2,146
7,169
6,138
Net income
11,028
8,402
29,533
24,604
Earnings per share:
Basic
0.74
0.56
1.97
1.60
Diluted
0.73
1.96
Weighted average common shares outstanding:
14,983
15,079
14,961
15,359
15,051
15,103
15,035
15,382
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in thousands)
Other comprehensive income, before tax:
Changes in unrealized (loss) gain on securities available for sale
(3,700)
351
(7,328)
7,922
Changes in unrealized (loss) gain on hedging derivatives(1)
(203)
1,302
2,311
(7,568)
Changes in unrealized loss on pension
Income taxes related to other comprehensive income:
Changes in unrealized loss (gain) on securities available for sale
861
(82)
1,703
(1,791)
Changes in unrealized loss (gain) on hedging derivatives(1)
48
(308)
(538)
1,776
Total other comprehensive (loss) income(1)
(2,994)
1,263
(3,852)
Total comprehensive income(1)
8,034
9,665
25,681
24,943
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)
Accumulated
Common
Additional
other
stock
paid-in
Retained
comprehensive
Treasury
(in thousands, except per share data)
amount
capital
earnings
income (loss)(1)
Total(1)
Balance at December 31, 2019
188,536
175,780
3,792
(4,677)
396,288
16,202
Other comprehensive income
(924)
Cash dividends declared ($0.44 per share)
(6,819)
Treasury stock purchased (405,208 shares)
(7,467)
Net issuance (61,025 shares) to employee stock plans, including related tax effects
406
251
657
Recognition of stock based compensation
584
Balance at June 30, 2020
189,526
185,163
2,868
(11,893)
398,521
Cash dividends declared ($0.22 per share)
(3,316)
Common stock purchased (297,658 shares)
(6,003)
Net issuance (12,275 shares) to employee stock plans, including related tax effects
(199)
224
25
279
Balance at September 30, 2020
189,606
190,249
4,131
(17,672)
399,171
Balance at December 31, 2020
Allowance for credit losses cumulative-effect adjustment - ASU 2016-13 (Note 1)
(5,242)
18,505
Other comprehensive loss
(858)
Cash dividends declared ($0.46 per share)
(6,876)
Net issuance (56,290 shares) to employee stock plans, including related tax effects
(280)
449
169
997
Balance at June 30, 2021
190,801
201,994
5,882
(17,774)
413,760
Cash dividends declared ($0.24 per share)
(3,596)
Net issuance (14,412 shares) to employee stock plans, including related tax effects
(276)
146
(130)
367
Balance at September 30, 2021
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30,
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of securities
3,788
2,472
Change in unamortized net loan costs and premiums
(2,739)
1,923
Premises and equipment depreciation
3,466
3,571
Stock-based compensation expense
1,364
863
Accretion of purchase accounting entries, net
10
Amortization of other intangibles
704
Income from cash surrender value of bank-owned life insurance policies
(1,510)
(1,525)
(1,980)
(1,486)
Decrease (increase) in right-of-use lease assets
851
(578)
(Decrease) increase in lease liabilities
(786)
625
Loss on other real estate owned
366
(Gain) loss on premises and equipment, net
Net change in other assets and liabilities
(373)
(3,978)
Net cash provided by operating activities
30,763
31,987
Cash flows from investing activities:
Proceeds from sales of securities available for sale
54,388
87,521
Proceeds from maturities, calls and prepayments of securities available for sale
99,580
109,314
Purchases of securities available for sale
(123,335)
(131,107)
Net change in loans
47,519
(71,233)
Purchase of FHLB stock
(790)
(4,044)
Proceeds from sale of FHLB stock
4,634
10,748
Purchase of premises and equipment, net
(1,216)
(4,449)
Net investment in community limited partnerships
(1,112)
Acquisitions, net of cash acquired
(340)
Proceeds from sale of other real estate owned
(113)
Net cash provided by (used in) investing activities
79,668
(3,703)
Cash flows from financing activities:
Net change in deposits
101,050
239,164
Net change in short-term senior borrowings
9,324
(273,268)
Proceeds from long-term senior borrowings
273,342
Repayments of long-term senior borrowings
(89,018)
(71,187)
Net change in short-term other borrowings
(6,112)
(14,784)
Net change subordinated debt issuance costs
119
Exercise of stock options
682
Purchase of treasury and common stock
(13,470)
Cash dividends paid on common stock
(10,472)
(10,135)
Net cash provided by financing activities
4,811
130,463
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (continued)
Net change in cash and cash equivalents
115,242
158,747
Cash and cash equivalents at beginning of year
56,910
Cash and cash equivalents at end of period
341,249
215,657
Supplemental cash flow information:
Interest paid
13,052
22,085
Income taxes paid, net
7,755
4,806
Acquisition of non-cash assets and liabilities:
Assets acquired
1,171
Liabilities acquired
(343)
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, 2020 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 updates the accounting policies previously disclosed in NOTE 1 – Summary of Significant Accounting Policies of the Company’s Annual Report on Form 10-K for the year ended December 31, 2020. The updates reflect the adoption of the Financial Accounting Standards Board (FASB) Accounting Standards Updates (ASU) 2016-13, “Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments”, referred to as ASC 326 or, more commonly, referred to as Current Expected Credit Losses (CECL).
Allowance for Credit Loss on AFS Debt Securities: Upon adoption of CECL, effective January 1, 2021, the Company monitors the credit quality of available for sale (AFS) debt securities through credit ratings from various rating agencies and substantial price changes. Credit ratings express opinions about the credit quality of a security and are utilized by the Company to make informed decisions. Securities are triggered for further review in the quarter if the security has significant fluctuations in ratings, drops below investment grade, or significant pricing changes. For securities without credit ratings, the Company utilizes other financial information indicating the financial health of the underlying municipality, agency, or organization associated with the underlying security. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance on AFS debt securities is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. When assessing an AFS debt security for credit loss, securities with identical CUSIPs are pooled together to assess for impairment using the average cost basis. Any impairment that has not been recorded through an allowance is recognized in other comprehensive income.
A change in the allowance on AFS debt securities may be in full or a portion thereof, is recorded as expense (credit) within provision for credit losses on the consolidated statements of income. Losses are charged against the allowance when management believes the uncollectibility of an AFS debt security is confirmed based on the above described analysis. As
of September 30, 2021 and January 1, 2021 (i.e. ASU 2016-13 adoption), there was no allowance carried on the Company's AFS debt securities. Refer to Note 2 of the consolidated financial statements for further discussion.
Loans: Loans held for investment by the Company are reported at amortized cost. Amortized cost is the principal balance outstanding net of the unamortized balance of any deferred fees or costs and the unamortized balance of any premiums or discounts on loans purchased or acquired through mergers.
For originated loans, loan fees and certain direct origination costs are deferred and amortized into interest income over the contractual term of the loan using the level-yield method over the estimated lives of the related loans. When a loan is paid off, the unamortized portion of deferred fees or costs are recognized in interest income. Interest income on originated loans is accrued based upon the daily principal amount outstanding except for loans on non-accrual status.
For acquired loans, interest income is accrued based upon the daily principal amount outstanding and is then further adjusted by the accretion of any discount or amortization of any premium associated with the loan that was recognized based on the acquisition date fair value. When a loan is paid off, the unamortized portion of any premiums or discounts on loans are recognized in interest income.
Purchase Credit Deteriorated (PCD) Loans: Loans that the Company acquired in acquisitions include some loans that have experienced more than insignificant credit deterioration since origination. The initial allowance for credit losses is determined on a collective basis and allocated to the individual loans. The sum of the loan’s purchase price and allowance for credit losses becomes its initial amortized cost. The difference between the initial amortized cost and the par value of the loan is a discount or premium, which is amortized into interest income over the life of the loan. Subsequent changes to the allowance for credit losses are recorded through provision expense.
The Company adopted CECL using the prospective transition approach for financial assets purchased with credit deterioration that were previously classified as purchased credit impaired (PCI) and accounted for under ASC 310-30. In accordance with the standard, the Company did not reassess whether PCI assets met the definition of PCD assets as of the date of adoption. On January 1, 2021, the amortized cost basis of the PCD assets representing the noncredit discount will be accreted into interest income using the level-yield method over the estimated lives of the related loans. The converted PCD assets of $12.5 million were then pooled by call report coding and an additional allowance was calculated on the pooled assets separately from other loan pools totaling $524 thousand.
Non-performing loans: Residential real estate and consumer loans are generally placed on non-accrual status when reaching 90 days past due, or in process of foreclosure, or sooner if considered appropriate by management. Secured consumer loans are written down to net realizable value and unsecured consumer loans are charged-off upon reaching 120 days past due. Commercial real estate loans and commercial business loans that are 90 days or more past due are generally placed on non-accrual status, unless secured by sufficient cash or other assets immediately convertible to cash, and the loan is in the process of collection. Commercial real estate and commercial business loans may be placed on non-accrual status prior to the 90 days delinquency date if considered appropriate by management.
When a loan has been placed on non-accrual status, previously accrued and uncollected interest is reversed against interest on the loan. The interest on non-accrual loans is accounted for using the cash-basis or cost-recovery method depending on corresponding credit risk, until qualifying for return to accrual status. A loan can be returned to accrual status when collectability of principal is reasonably assured and the loan has performed for a period of time, generally six months.
Previously, acquired loans that met the criteria for non-accrual of interest prior to the acquisition were considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if the Company could reasonably estimate the timing and amount of the expected cash flows on such loans and if the Company expects to fully collect the new carrying value of the loans and any change in performance would have impacted accretable yield. After adoption of ASC 326 on January 1, 2021 the Company now treats these non-performing acquired loans that meet the criteria for non-accrual consistent with originated loans.
Allowance for Credit Losses: The allowance for credit losses (the “allowance”) is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The Allowance is comprised of the allowance for
12
loan losses and the allowance for off-balance sheet credit exposures, which is accounted for as a separate liability in other liabilities on the balance sheet. The level of the allowance represents management’s estimate of expected credit losses over the expected life of the loans at the balance sheet date.
Upon adoption of ASC 326 or CECL on January 1, 2021, the Company replaced the incurred loss impairment model that recognizes losses when it became probable that a credit loss will be incurred, with a requirement to recognize lifetime expected credit losses immediately when a financial asset is originated or purchased. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged off against the allowance when they are deemed uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged- off. The allowance is comprised of reserves measured on a collective (pool) basis based on a lifetime loss-rate model when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated on an individual basis, generally larger non-accruing commercial loans and TDRs.
The Company uses the discounted cash flow (DCF) method to estimate expected credit losses for all loan portfolio segments measured on a collective (pool) basis. For each loan segment, the Company generates cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speeds, probability of default, and loss given default. The modeling of prepayment speeds is based on historical internal data.
The Company uses regression analysis of historical internal and peer data to determine suitable loss drivers to utilize when modeling lifetime probability of default. This analysis also determines how expected probability of default and loss given default will react to forecasted levels of the loss drivers. For all loan pools utilizing the DCF method, management utilizes various economic indicators such as changes in unemployment rates, gross domestic product, property values, housing starts, and other relevant factors as loss drivers. For all DCF models, management has determined that due to historic volatility in economic data, two quarters currently represents a reasonable and supportable forecast period, followed by a six-period reversion to historical mean levels for each of the various economic indicators.
The combination of adjustments for credit expectations (default and loss) and timing expectations (prepayment, curtailment, and time to recovery) produces an expected cash flow stream at the instrument level. Specific instrument effective yields are calculated, net of the impacts of prepayment assumptions, and the instrument expected cash flows are then discounted at that effective yield to produce an instrument-level Net Present Value (NPV). An allowance is established for the difference between the instrument’s NPV and amortized cost basis.
The allowance evaluation also considers various qualitative factors, such as: (i) changes to lending policies, underwriting standards and/or management personnel performing such functions, (ii) delinquency and other credit quality trends, (iii) credit risk concentrations, if any, (iv) changes to the nature of the Company's business impacting the loan portfolio, (v) and other external factors, that may include, but are not limited to, results of internal loan reviews, stress testing, examinations by bank regulatory agencies, or other events such as a natural disaster.
Arriving at an appropriate level of allowance involves a high degree of judgment. The determination of the adequacy of the allowance and provisioning for estimated losses is evaluated regularly based on review of loans, with particular emphasis on non-performing and other loans that management believes warrant special consideration. While management uses available information to recognize losses on loans, changing economic conditions and the economic prospects of the borrowers may necessitate future additions or reductions to the allowance.
Individually Evaluated Loans: Prior to the adoption of CECL on January 1, 2021, a loan was individually evaluated when the loan was considered impaired. Impaired loans were based on current information and events, it is probable that the Company will not be able to collect all amounts due from the borrower in accordance with the contractual terms of the loan, including scheduled interest payments.
With the adoption of CECL, loans that do not share risk characteristics with existing pools are evaluated on an individual basis. For loans that are individually evaluated and collateral dependent, financial loans where the Company has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the financial asset to be provided substantially through the operation or sale of the collateral, the ACL is measured
13
based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. When repayment is expected to be from the operation of the collateral, the specific credit loss reserve is calculated as the amount by which the amortized cost basis of the financial asset exceeds the NPV from the operation of the collateral. When repayment is expected to be from the sale of the collateral, the specific credit loss reserve is calculated as the amount by which the amortized costs basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The allowance may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of the financial asset.
Accrued Interest. Upon adoption of CECL, effective as of January 1, 2021, the Company made the following elections regarding accrued interest receivable: (i) present accrued interest receivable balances within other assets on the consolidated statements of condition; (ii) exclude accrued interest from the measurement of the allowance for credit losses, including investments and loans; and (iii) continue to write-off accrued interest receivable by reversing interest income. The Company has a policy in place to write-off accrued interest when a loan is placed on non-accrual. Historically, the Company has not experienced uncollectible accrued interest receivable on investment debt securities.
Allowance for off-balance sheet credit exposures: The exposure is a component of other liabilities on the Company’s Consolidated Balance Sheet and represents the estimate for probable credit losses inherent in unfunded commitments to extend credit. Unfunded commitments to extend credit include unused portions of lines of credit and standby and commercial letters of credit. The process used to determine the allowance for these exposures is consistent with the process for determining the allowance for loans, as adjusted for estimated funding probabilities or loan equivalency factors. A charge (credit) to provision for credit losses on the consolidated statements of income is made to account for the change in the allowance on off-balance sheet exposures between reporting periods.
14
Impact of Adoption
The following table illustrates the adoption of CECL on January 1, 2021:
Reclassification
Pre-CECL
Post-CECL
to CECL
Adoption
Impact of
Portfolio
CECL
Segmentation
Assets:
Loans:
Commercial construction
131,123
(13,241)
117,882
Commercial real estate
953,258
(953,258)
Commercial real estate owner occupied
219,217
Commercial real estate non-owner occupied
716,776
Tax exempt
63,431
(15,569)
47,862
Commercial and industrial
377,638
(21,954)
355,684
Residential real estate
923,891
71,325
995,216
Home equity
102,464
(2,368)
100,096
Consumer other
11,080
(928)
10,152
Allowance for credit losses on loans
1,044
(220)
824
2,020
1,196
10,199
(10,199)
1,783
2,491
708
7,864
5,856
(2,008)
80
(22)
58
98
40
3,302
(165)
3,137
6,133
2,996
4,078
932
5,010
6,742
1,732
258
27
285
888
603
121
(39)
Total allowance for credit losses on loans
19,082
24,310
5,228
Liabilities:
Allowance for credit losses on unfunded commitments
359
1,975
1,616
Total allowance for credit losses
19,441
26,285
6,844
Retained earnings:
Total increase in Allowance for credit losses
Tax effect
(1,602)
Decrease to retained earnings
5,242
15
Revision of Previously Issued Financial Statements
The Company has revised amounts reported in previously issued financial statements for the periods presented in this Quarterly Report on Form 10-Q related to errors. The revised amounts relate to derivatives that were incorrectly presented as assets instead of liabilities and related equity effects net of tax and the related effects on comprehensive income and shareholders’ equity.
The following tables present the revisions to the line items of our previously issued financial statements to reflect the correction of errors:
Consolidated Balance Sheets
As Reported
Adjustment
As Revised
Deferred tax assets, net
1,745
Other assets
73,662
(2,789)
Total assets
3,725,762
(1,487)
Other liabilities
72,183
2,789
Total liabilities
3,314,421
Total shareholders' equity
411,341
(4,276)
Total liabilities and shareholders' equity
Consolidated Statements of Comprehensive Income (Unaudited)
Three months ended September 30, 2020
Changes in unrealized gain (loss) on hedging derivatives
805
497
Changes in unrealized (gain) loss on hedging derivatives
(190)
(118)
Total other comphrensive income
884
379
Total comphrensive income
9,286
Nine months ended September 30, 2020
(833)
(6,735)
195
1,580
5,494
(5,155)
30,098
16
Consolidated Statements of Changes in Shareholder's Equity (Unaudited)
396,407
(119)
Beginning accumulated other comprehensive income
3,911
4,610
(5,534)
Ending accumulated other comprehensive income
8,521
(5,653)
404,174
9,405
(5,274)
404,445
11,016
(3,322)
2,464
7,694
(1,812)
415,572
17
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 2021
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, such as of balance sheet credit exposures (loan comitments, unused line of credit and stand-by letters of 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.
January 1, 2022
Adoption of this ASU primarily changed how the Company estimates credit losses with the application of the expected credit loss model. The Company applied 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 has finalized its CECL implementation, recieved board approval of the final CECL model, completed modelling of off-balance sheet credit risks, completed formal governance and control documentation, and developed and presented revised disclosures for board approval.The ASU was originally effective for the Company beginning in the first quarter of 2020; however, after the The Coronavirus Aid, Relief, and Economic Security Act, or CARES CARES Act Act, was enacted on March 27, 2020, the Securities and Exchange Commission (SEC) staff clarified that once the deferral was elected by a registrant, Dec. 31, 2020, adoption of CECL was required, retrospective to Jan. 1, 2020 (ignoring an early termination of the national emergency). Under the amendments, a registrant electing the delay under the CARES Act is further delayed until Jan. 1, 2022, effective as of Jan. 1, 2022 (absent an early termination of the national emergency). With regard to the amendments to Section 4014, the SEC staff indicated it would not object to a registrant early adopting on Dec. 31, 2020, retrospective to Jan. 1, 2020, or Jan. 1, 2021, effective as of Jan. 1, 2021.The Company adopted CECL effective January 1, 2021, which increased its allowance for credit losses (ACL) by $5.2 million and reserve for unfunded commitments by $1.6 million. Equity was reduced by $5.2 million, net of deferred tax of $1.6 million on the date of adoption.
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, 2021Early adoption is permitted.
Adoption of this ASU did not have a material impact on the Company's consolidated financial statements. The impact will be reflected in the Company’s annual 10-K disclosures of employee benefit plans.
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ASU 2020-01, Investments—Equity Securities, Investments Equity Method and Joint Ventures, and Derivatives and Hedging
In January 2016, the FASB issued Accounting Standards Update No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which added Topic 321, Investments – Equity Securities, and made targeted improvements to address certain aspects of accounting for financial instruments. The amendments in this Update affect all entities that apply the guidance in Topics 321, 323, and 815 and (1) elect to apply the measurement alternative or (2) enter into a forward contract or purchase an option to purchase securities that, upon settlement of the forward contract or exercise of the purchased option, would be accounted for under the equity method of accounting. The amendments in this Update clarify certain interactions between the guidance to account for certain equity securities under Topic 321, the guidance to account for investments under the equity method of accounting in Topic 323, and the guidance in Topic 815, which could change how an entity accounts for an equity security under the measurement alternative or a forward contract or purchased option to purchase securities that, upon settlement of the forward contract or exercise of the purchased option, would be accounted for under the equity method of accounting or the fair value option in accordance with Topic 825, Financial Instruments. The amendments in this Update should be applied prospectively.
December 15, 2020
The adoption had no material impact on the Company's consolidated financial statements. The Company’s equity method investments which primarily consist of community limited partnership investments are in compliance with the new guidance prospectively in 2021.
Standards Not Yet Adopted
ASU 2020-04 Facilitation of the Effects of Reference Rate Reform, Topic 848, as amended in ASU 2021-01
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 the London Interbank Offered Rate (LIBOR) and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate (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 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 are being discontinued. The following elections have been made in regards to our cash flow hedges as outlined on the next page.
19
Rate Reform Elections
Adherence to ISDA Fallback Protocol
The ISDA 2020 IBOR Fallbacks Protocol (the “ISDA Fallback Protocol”) was made available for adherence on October 23, 2020 with an effective date of January 25, 2021. Once adhered to by both counterparties in a bilateral relationship and the effective date is reached, the ISDA Fallback Protocol represents a change to the contractual terms of derivatives governed by each respective ISDA agreement between the Company and a derivative counterparty. The change relates to reference rate reform and represents the potential for addition of or changes to contractual terms and was developed by a private-sector working group convened by a regulator as referenced in 848-20-15-5(g). For all of the Company’s interest rate swaps that meet the scope requirements of 848-10-15-3 and 848-10-15-3A and for which the Company adhered to the ISDA Fallback Protocol, the Company makes the following elections:
Cash flow hedges
The Company amends the hedge documentation, without dedesignating and redesignating, for all outstanding cash flow hedging relationships for the following elections:
New hedging activity
The Company makes the same elections for each hedging relationship designated subsequent to March 31, 2021. Any hedging relationship-specific elections beyond the elections noted above will be documented in the respective inception hedge documentation. Subsequent election of optional expedients and exceptions after the March 31, 2021 will be documented in accordance with the elections being made here.
20
NOTE 2. SECURITIES AVAILABLE FOR SALE
The following is a summary of securities available for sale:
Gross
Unrealized
Amortized Cost
Gains
Losses
Fair Value
Mortgage-backed securities:
US Government-sponsored enterprises
181,821
3,386
(1,939)
183,268
US Government agency
53,475
1,470
(239)
54,706
Private label
62,843
185
(114)
62,914
Obligations of states and political subdivisions thereof
158,914
2,090
(827)
160,177
Corporate bonds
82,533
2,376
(647)
84,262
Total securities available for sale
539,586
9,507
(3,766)
206,834
6,018
(462)
212,390
82,878
2,870
(116)
85,632
19,810
(141)
19,709
164,766
4,244
(6)
169,004
97,689
1,465
(843)
98,311
571,977
14,637
(1,568)
Credit Quality Information
The Company monitors the credit quality of available for sale debt securities through credit ratings from various rating agencies and substantial price changes. Credit ratings express opinions about the credit quality of a security and are utilized by the Company to make informed decisions. Securities are triggered for further review in the quarter if the security has significant fluctuations in ratings, drops below investment grade, or significant pricing changes. For securities without credit ratings, the Company utilizes other financial information indicating the financial health of the underlying municipality, agency, or organization associated with the underlying security.
As of September 30, 2021 the Company carried no allowance on available for sale debt securities in accordance with ASU 2016-13.
The amortized cost and estimated fair value of available for sale securities segregated by contractual maturity at September 30, 2021 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
11,755
11,664
Over 1 year to 5 years
23,313
23,863
Over 5 years to 10 years
48,500
47,493
Over 10 years
157,879
161,419
Total bonds and obligations
241,447
244,439
Mortgage-backed securities
298,139
300,888
The following table presents the gains and losses from the sale of AFS securities for the periods presented:
Gross gains on sales of available for sale securities
2,030
1,508
Gross losses on sales of available for sale securities
(50)
Net gains on sale of available for sale securities
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
Total
Fair
Value
1,408
77,412
531
16,618
1,939
94,030
130
10,488
109
4,729
239
15,217
42,852
114
42,869
827
48,355
2,486
633
11,617
647
14,103
2,488
181,593
1,278
32,981
3,766
214,574
209
40,285
253
4,323
462
44,608
6,776
3,297
116
10,073
141
19,514
5,577
555
21,774
288
11,712
843
33,486
815
74,412
753
38,846
1,568
113,258
22
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 September 30, 2021, 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.
The following summarizes, by investment security type, the impact of securities in an unrealized loss position for greater than 12 months at September 30, 2021:
49 out of the total 528 securities in the Company’s portfolios of AFS US Government-sponsored enterprises were in unrealized loss positions. Aggregate unrealized losses represented 1.07% of the amortized cost of securities in unrealized loss positions. The Federal National Mortgage Association and Federal Home Loan Mortgage Corporation 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.
11 out of the total 150 securities in the Company’s portfolios of AFS US Government agency securities were in unrealized loss positions. Aggregate unrealized losses represented 0.45% of the amortized cost of securities in unrealized loss positions. The Government National Mortgage Association 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.
14 of the total 31 securities in the Company’s portfolio of AFS private label mortgage-backed securities were in unrealized loss positions. Aggregate unrealized losses represented 0.18% 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.
12 of the total 119 securities in the Company’s portfolio of AFS municipal bonds and obligations were in unrealized loss positions. Aggregate unrealized losses represented 0.52% 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.
4 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 0.78% 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. The most recent review includes all bond issuers and their current credit ratings, financial performance and capitalization.
23
NOTE 3. LOANS AND ALLOWANCE FOR CREDIT LOSSES
Upon adoption of ASC 326 or CECL, at January 1, 2021, the Company evaluates its risk characteristics of loans based on regulatory call report code with segmentation based on the underlying collateral for certain loan types. Prior to the adoption of ASC 326, under the incurred loss model, the Company evaluated its risk characteristics of loans based on purpose of the loans.
The following is a summary of total loans by regulatory call report code segmentation based on underlying collateral for certain loan types:
December 31,
152,700
253,792
733,353
42,448
336,989
917,301
88,002
9,569
Allowance for credit losses
22,448
Total unamortized net costs and premiums included in loan totals were as follows:
Unamortized net loan origination costs
4,015
5,157
Unamortized net premium on purchased loans
(65)
(85)
Total unamortized net costs and premiums
3,950
5,072
The Company elected to exclude accrued interest receivable from the amortized cost basis of loans disclosed throughout this footnote. As of September 30, 2021 and December 31, 2020, accrued interest receivable for loans totaled $8.7 million and $11.4 million, respectively, and is included in the “other assets” line item on the Company’s consolidated balance sheets.
The CARES Act and subsequent legislation established the Payroll Protection Program (PPP), administered directly by the Small Business Administration (SBA). The Company has participated in both 2020 and 2021 rounds of funding. As of September 30, 2021 and December 31, 2020, the Company had 404 and 746 PPP loans outstanding, with an outstanding principal balance of $24.2 million and $53.8 million, respectively. The PPP loans are fully guaranteed by the SBA and may be eligible for forgiveness by the SBA to the extent that the proceeds are used to cover eligible costs. PPP loans are included in the commercial and industrial portfolio segment.
Characteristics of each loan portfolio segment are as follows:
Commercial construction - Loans in this segment primarily include raw land, land development and construction of commercial and multifamily residential properties. Collateral values are determined based upon appraisals and evaluations of the completed structure in accordance with established policy guidelines. Maximum loan-to-value ratios at origination are governed by established policy guidelines that are more restrictive than existing structures. Construction loans are primarily paid by the cash flow generated from the completed structure, such as operating leases, rents, or other operating cash flows from the borrower.
Commercial real estate owner occupied and non-owner occupied - Loans in these segments are primarily owner-occupied or income-producing properties. Loans to Real Estate Investment Trusts (REITs) and unsecured loans to developers that closely correlate to the inherent risk in commercial real estate markets are also included. Commercial real estate loans are typically written with amortizing payment structures. Collateral values are determined based upon appraisals and evaluations in accordance with established policy guidelines. Maximum loan-to-value ratios at origination are governed by established policy and regulatory guidelines. Commercial real estate loans are primarily paid by the cash flow generated from the real property, such as operating leases, rents, or other operating cash flows from the borrower.
Tax Exempt - Loans in this segment primarily include loans to various state and municipal government entities. Loans made in these borrowers may provide the Company with tax-exempt income. While governed and underwritten similar to commercial loans they do have unique requirements based on established polices. Almost all state and municipal loans are considered a general obligation of the issuing entity. Given the size of many municipal borrowers, borrowings are normally not rated by major rating agencies.
Commercial and industrial loans - Loans consist of revolving and term loan obligations extended to business and corporate enterprises for the purpose of financing working capital and/or capital investment in this segment. Generally loans are secured by assets of the business such as accounts receivable, inventory, marketable securities, other liquid collateral, equipment and other business assets. Some loans in this category may be unsecured or guaranteed by government agencies such as the SBA. Loans are primarily paid by the operating cash flow of the borrower.
Residential real estate - All loans in this segment are collateralized by one-to-four family homes. Residential real estate loans held in the Company's loan portfolio are made to borrowers who demonstrate the ability to make scheduled payments with full consideration to various underwriting factors. Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan-to-value ratios within established policy guidelines.
Home equity - All loans and lines of credit are made to qualified individuals and are secured by senior or junior mortgage liens on owner-occupied one- to four-family homes, condominiums, or vacation homes. The home equity loan has a fixed rate and is billed as equal payments comprised of principal and interest. The home equity line of credit has a variable rate and is billed as interest-only payments during the draw period. At the end of the draw period, the home equity line of credit is billed as a percentage of the principal balance plus all accrued interest. Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan-to-value ratios within established policy guidelines.
Consumer other - Loans in this segment include personal lines of credit and amortizing loans made to qualified individuals for various purposes such as auto loans, recreational equipment, overdraft protection or other consumer loans. Borrower qualifications include favorable credit history combined with supportive income and collateral requirements within established policy guidelines, as applicable.
Allowance for Credit Losses
The Allowance for Credit Losses (ACL) is comprised of the allowance for loan losses and the allowance for unfunded commitments which is accounted for as a separate liability in other liabilities on the balance sheet. The level of the ACL represents management’s estimate of expected credit losses over the expected life of the loans at the balance sheet date.
Upon adoption of CECL on January 1, 2021, the Company replaced the incurred loss impairment model that recognizes losses when it becomes probable that a credit loss will be incurred, with a requirement to recognize lifetime expected credit losses immediately when a financial asset is originated or purchased. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged off against the allowance when they are deemed uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged off. The ACL is comprised of reserves measured on a collective (pool) basis based on a lifetime loss-rate model when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated on an individual basis, generally larger non-accruing commercial loans and TDRs.
The Company’s activity in the allowance for credit losses for the periods ended are as follows:
Three Months Ended September 30, 2021
Balance at
Beginning of
Period
Charge Offs
Recoveries
Provision
End of Period
2,372
(286)
2,086
2,552
(142)
72
237
2,719
5,604
5,582
91
85
5,225
(24)
105
5,306
6,069
(290)
5,792
822
(49)
1
30
804
74
22,815
93
Nine Months Ended September 30, 2021
Impact of ASC
326
(403)
559
(278)
(13)
(44)
(797)
(67)
(1,024)
(108)
101
(741)
307
Three Months Ended September 30, 2020
532
717
1,524
370
1,894
5,926
(266)
783
6,457
64
3,056
236
3,282
4,991
86
5,078
(4)
314
(149)
140
97
16,509
(439)
37
17,907
26
Nine Months Ended September 30, 2020
317
400
2,368
(474)
4,695
(1,137)
2,790
3,262
(360)
355
4,213
(32)
885
320
111
(341)
15,353
(1,870)
159
Unfunded Commitments
The Company’s allowance for credit losses on unfunded commitments is recognized as a liability (other liabilities on the consolidated balance sheet), with adjustments to the reserve recognized in other non-interest expense in the consolidated statement of operations. The Company’s activity in the allowance for credit losses on unfunded commitments for the periods ended was as follows:
Begininng Balance
1,921
Impact of CECL adoption
280
226
Ending Balance
2,201
319
2
321
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, and 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: 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. 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 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.
28
The following tables present the Company’s loans by year of origination, loan segmentation and risk indicator as of September 30, 2021:
2019
2018
2017
Prior
Risk rating:
Pass
22,192
76,226
44,453
9,829
Special mention
Substandard
9,937
16,003
35,366
47,026
20,038
110,663
239,033
767
3,125
3,892
248
10,030
10,526
Doubtful
172
36,133
47,446
20,286
123,987
101,706
147,754
90,963
40,545
147,197
186,056
714,221
15,612
131
3,086
3,348
40,676
147,328
204,926
1,511
604
975
14,453
5,387
19,518
104,179
64,303
36,010
17,635
35,407
73,972
331,506
619
222
596
202
1,429
3,785
549
50
677
1,388
122
310
104,896
64,525
37,276
18,245
35,781
76,266
29
Performing
143,071
126,171
95,942
70,062
69,486
404,395
909,127
Nonperforming
576
183
7,415
8,174
70,638
69,669
411,810
8,227
10,946
9,775
7,647
6,975
43,133
86,703
1,299
44,432
3,037
1,942
1,023
803
329
2,429
9,563
2,435
Total Loans
394,577
444,171
316,540
209,737
285,755
883,374
The following table summarizes credit risk exposure indicators by portfolio segment, under the incurred loss methodology, as of the period indicated:
Commercial
Residential
Real Estate
and Industrial
Consumer
Grade:
1,053,773
422,016
1,475,789
914,749
112,190
1,026,939
6,075
2,771
8,846
22,267
15,180
37,447
2,265
1,100
3,365
Loss
Non-performing
9,142
1,354
10,496
1,084,381
441,069
113,544
Past Dues
The following is a summary of past due loans for the periods ended:
30-59
60-89
90+
Total Past Due
Current
627
637
253,155
117
431
732,922
35
313
392
336,597
414
1,007
2,796
4,217
913,084
344
95
62
501
87,501
32
34
9,535
1,148
1,149
3,915
6,212
2,527,942
75
117,807
1,309
464
2,211
217,006
503
674
624
1,801
714,975
161
193
354
355,330
9,178
2,511
3,200
14,889
980,327
1,062
614
375
2,051
98,045
10,130
12,307
4,263
4,833
21,403
2,541,482
Non-Accrual Loans
The following is a summary of non-accrual loans for the periods ended:
Nonaccrual With No
90+ Days Past
Nonaccrual
Related Allowance
Due and Accruing
1,184
808
770
775
629
149
3,217
1,298
12,207
5,284
620
3,038
929
383
118
1,223
1,065
5,883
4,948
1,345
1,346
267
12,188
8,464
31
Collateral Dependent Loans
Loans that do not share risk characteristics are evaluated on an individual basis. For loans that are individually evaluated and collateral dependent, financial loans where the Company has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the financial asset to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date.
The following table presents the amortized cost basis of collateral-dependent loans by loan portfolio segment for the periods ended.
Other
259
3,441
436
607
7,432
1,493
60
11,868
13,693
Pre Adoption of ASC 326 – Impaired Loans
For periods prior to the adoption of CECL, loans were considered impaired when, based on current information and events, it was probable the Company would be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. The Company identified loan relationships having aggregate balances in excess of $150 thousand with potential credit weaknesses. Such loan relationships were identified primarily through the Company's analysis of internal loan evaluations, past due loan reports, TDRs and loans adversely classified. Each loan so identified was then individually evaluated for impairment. Substantially all impaired loans have historically been collateral dependent, meaning repayment of the loan was expected or was considered to be provided solely from the sale of the loan's underlying collateral. For such loans, the Company measured impairment based on the fair value of the loan's collateral, which is generally determined utilizing current appraisals. A specific reserve was 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 was 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.
The tables reflects the activity associated with impaired loans in 2020 prior to the adoption of CECL.
Recorded
Unpaid Principal
Related
Average Recorded
Interest
Investment
Balance
Allowance
Income Recognized
With no related allowance:
Construction and land development
Other commercial real estate
2,001
2,047
1,610
1,095
1,254
1,140
Agricultural
361
150
Tax exempt loans
2,745
3,165
1,077
Other consumer
With an allowance recorded:
205
203
1,963
2,108
1,038
1,973
282
289
164
887
944
106
1,865
4,222
4,413
1,243
3,786
1,738
1,693
1,327
3,632
4,109
2,942
Total impaired loans
9,605
10,228
1,513
8,067
78
33
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 periods ended. 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. There were no modifications qualifying as TDR’s for the three and nine months ended September 30, 2021.
Pre-Modification
Post-Modification
Number of
Outstanding
Modifications
Reserve
247
127
216
528
The following tables summarize the types of loan concessions made for the periods presented:
September 30, 2020
Interest rate, forbearance and maturity concession
409
Forbearance and interest only payments
Maturity concession
For the three months ended September 30, 2021 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 in December 31, 2020 10-K for more information.
Foreclosure
Residential mortgage loans collateralized by real estate that are in the process of foreclosure as of September 30, 2021 and December 31, 2020 totaled $734 thousand and $917 thousand, respectively.
Mortgage Banking
The Company had identified and designated loans with an unpaid principal balance of $7.5 million and $24.0 million as residential loans held for sale at September 30, 2021 and December 31, 2020, respectively. The interest rate exposure on loans held for sale are mitigated through forward delivery commitments with certain approved secondary market investors. Forward delivery commitments were $14.5 million, and $50.6 million, respectively. Refer to Note 8 for further discussion of the Company's forward delivery commitments.
For the three months ended September 30, 2021 and 2020, the Company sold $28.5 million and $86.2 million, respectively, of residential mortgage loans on the secondary market, which resulted in a net gain on sale of loans (net of costs, including direct and indirect origination costs) of $682 thousand and $2.2 million, respectively. For the nine months ended September 30, 2021 and 2020, the Company sold $153.9 million and $156.0 million, respectively, of residential mortgage loans on the secondary market, which resulted in a net gain on sale of loans (net of costs, including direct and indirect origination costs) of $3.6 million and $3.1 million, respectively.
The Company sells residential loans on the secondary market with the Company primarily retaining the servicing of these loans. Servicing sold loans helps to maintain customer relationships and the Company earns fees over the servicing period. Loans serviced for others are not included in the accompanying consolidated balance sheets. The risks inherent in servicing assets relate primarily to level of prepayments that result from shifts in interest rates. The Company obtains third party valuations of its servicing assets portfolio quarterly, which assumptions are reflected in Fair Value disclosures.
NOTE 4. BORROWED FUNDS
Borrowed funds at September 30, 2021 and December 31, 2020 are summarized, as follows:
Weighted
(dollars in thousands)
Carrying Value
Average Rate
Short-term borrowings
Advances from the FHLB
75,000
0.30
%
65,676
1.19
Other borrowings
21,667
0.13
27,779
0.15
Total short-term borrowings
96,667
0.18
93,455
0.44
Long-term borrowings
93,600
1.57
182,607
1.73
Subordinated borrowings
4.34
Total long-term borrowings
153,683
2.65
242,568
2.37
1.06
1.41
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 September 30, 2021 and December 31, 2020.
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 September 30, 2021, the Company’s available secured line of credit at the FRB was $72.0 million. The Company has pledged certain loans and securities to the FRB to support this arrangement. There were no outstanding advances with the FRB for the periods ended September 30, 2021 and December 31, 2020.
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 September 30, 2021 and December 31, 2020. There was no outstanding balance on the line of credit as of September 30, 2021 and December 31, 2020.
Long-term FHLB advances consist of advances with a maturity of more than one year. The advances outstanding at September 30, 2021 include callable advances of $20.0 million and amortizing advances of $300 thousand. The advances outstanding at December 31, 2020 included $20.0 million of callable advances and $307 million 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 September 30, 2021 is, as follows:
Weighted Average
(in thousands, except rates)
Amount
Rate
2022
15,000
1.76
2023
51,000
1.71
2024
7,300
1.16
2025
20,000
1.21
2026 and thereafter
3.39
Total FHLB advances
168,600
1.01
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 $537 thousand as of September 30, 2021 and issuance costs of $659 thousand net of amortization as of December 31, 2020.
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.
NOTE 5. DEPOSITS
A summary of time deposits is, as follows:
Time less than $100,000
199,312
325,646
Time $100,000 through $250,000
192,497
278,940
Time $250,000 or more
93,775
At September 30, 2021 and December 31, 2020, the scheduled maturities by year for time deposits are, as follows:
362,774
574,007
Over 1 year to 2 years
56,926
61,584
Over 2 years to 3 years
31,888
41,145
Over 3 years to 4 years
9,182
12,875
Over 4 years to 5 years
6,272
8,728
Over 5 years
2,179
Included in time deposits are brokered deposits of $31.4 million and $193.7 million at September 30, 2021 and December 31, 2020, respectively. Also included in time deposits are reciprocal deposits of $238.5 million and $125.0 million at September 30, 2021 and December 31, 2020, respectively.
NOTE 6. CAPITAL RATIOS AND SHAREHOLDERS’ EQUITY
The actual and required capital ratios are, as follows:
Regulatory
Minimum to be
"Well-Capitalized"
Company (consolidated)
Total capital to risk-weighted assets(1)
14.12
10.50
13.57
Common equity tier 1 capital to risk-weighted assets(1)
10.92
7.00
10.49
Tier 1 capital to risk-weighted assets(1)
11.70
8.50
11.29
Tier 1 capital to average assets
8.54
5.00
8.12
Bank
13.92
13.27
13.02
12.53
12.52
9.50
9.02
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%.
Accumulated other comprehensive income (loss)
Components of accumulated other comprehensive income is, as follows:
Accumulated other comprehensive income, before tax:
Net unrealized gain on AFS securities
5,741
13,069
Net unrealized gain on hedging derivatives(1)
(121)
(2,432)
Net unrealized loss on post-retirement plans
(1,850)
Income taxes related to items of accumulated other comprehensive income:
(1,343)
(3,046)
567
432
The following table presents the components of other comprehensive income (loss) for the three and nine months ended September 30, 2021 and 2020:
Before Tax
Tax Effect
Net of Tax
Net unrealized gain on AFS securities:
Net unrealized gain arising during the period
(1,770)
403
(1,367)
Less: reclassification adjustment for gains (losses) realized in net income
(458)
1,472
(2,839)
Net unrealized gain on hedging derivatives:
(155)
Net unrealized gain on cash flow hedging derivatives
Net unrealized loss on post-retirement plans:
Net unrealized loss arising during the period
(3,903)
909
269
Net unrealized gain on derivative hedgess:
Net unrealized gain arising during the period(1)
994
Net unrealized gain on cash flow derivative hedges(1)
Other comprehensive income(1)
1,653
(390)
Net unrealized loss on AFS securities:
(5,348)
1,234
(4,114)
(469)
Net unrealized loss on AFS securities
(5,625)
Net unrealized loss on derivative hedges:
1,773
Less: reclassification adjustment for (losses) gains realized in net income
Net unrealized loss on derivative hedges
(5,017)
1,165
9,408
(2,143)
7,265
Less: reclassification adjustment for gains realized in net income
(352)
1,134
6,131
Net unrealized loss on cash flow hedging derivatives:
Net unrealized loss arising during the period(1)
(5,792)
Net unrealized loss on cash flow hedging derivatives(1)
Net unrealized gain on post-retirement plans:
Net unrealized gain on post-retirement plans
(15)
41
The following table presents the changes in each component of accumulated other comprehensive income (loss), net of tax impacts, for the three and nine months ended September 30, 2021 and 2020:
Net unrealized
Net loss on
gain
effective cash
loss
on AFS
flow hedging
on pension
Securities
derivatives(1)
plans
Balance at beginning of period
7,237
(1,418)
Other comprehensive gain before reclassifications
(1,522)
Less: amounts reclassified from accumulated other comprehensive income
Total other comprehensive income
Balance at end of period
4,398
(92)
11,412
(7,387)
(1,157)
11,681
(6,393)
10,023
(1,865)
Other comprehensive loss before reclassifications
(2,341)
Total other comprehensive loss
5,550
(601)
Other comprehensive gain (loss) before reclassifications
1,473
Total other comprehensive income (loss)
42
The following tables presents the amounts reclassified out of each component of accumulated other comprehensive income for three and nine months ended September 30, 2021 and 2020:
Three Months Ended September 30,
Affected Line Item where
Net Income is Presented
Net realized gains on AFS securities:
Before tax (1)
Tax expense
Total reclassifications for the period
43
NOTE 7. 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
14,982,766
15,079,413
14,960,753
15,358,803
Plus: dilutive effect of stock options and awards outstanding
67,990
23,421
73,829
23,063
Average number of diluted common shares outstanding(1)
15,050,756
15,102,834
15,034,582
15,381,866
NOTE 8. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
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 September 30, 2021 and December 31, 2020:
Notional
Average
Location Fair
Maturity
Asset (Liability)
Value Asset
(in years)
(Liability)
Cash flow hedges:
Interest rate swap on wholesale fundings
3.3
(1,168)
Interest rate swap on variable rate loans
50,000
4.5
Total cash flow hedges
125,000
(1,289)
Fair value hedges:
Interest rate swap on securities
37,190
7.8
(841)
Total fair value hedges
Economic hedges:
Forward sale commitments
14,533
0.1
(140)
Customer Loan Swaps-MNA Counterparty
250,852
6.4
(10,258)
Customer Loan Swaps-RPA Counterparty
119,285
7.1
(5,892)
Customer Loan Swaps-Customer
370,137
6.6
16,150
Total economic hedges
754,807
Non-hedging derivatives:
Interest rate lock commitments
12,885
47
Total non-hedging derivatives
929,882
(2,223)
4.0
(2,664)
Interest rate swap on securities(1)
8.6
50,629
0.2
(95)
235,947
6.8
(15,938)
7.9
(9,957)
355,232
25,895
761,093
3,320
876,603
(5,526)
As of September 30, 2021 and December 31, 2020, 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
Carrying Amount
39,200
2,010
40,209
3,019
46
Information about derivative assets and liabilities for the three and nine months ended September 30, 2021 and December 31, 2020, follows:
Amount of
Gain (Loss)
Recognized in
Reclassified
Location of
Location of Gain (Loss)
from Other
Comprehensive
Reclassified from Other
Recognized
Income
Comprehensive Income
in Income
Interest rate swap on wholesale funding
167
(205)
(101)
Interest income
92
(221)
(144)
Forward commitments
(96)
(331)
(589)
(93)
189
1,055
(400)
720
(421)
(45)
1,775
(840)
The Company expects approximately $1.0 million of losses (pre-tax) related to the Company’s cash flow hedges to be reclassified to earnings from AOCI over the next 12 months. This reclassification is due to anticipated payments that will be made and/or received on the swaps based upon the forward curve as of September 30, 2021.
Income(1)
362
(427)
635
(204)
Other Income
(630)
(4,247)
(642)
(1,545)
(145)
(3)
(35)
(825)
49
The effect of cash flow hedging and fair value accounting on the consolidated statements of income for the three months ended September 30, 2021 and 2020:
Interest and Dividend Income
Interest Expense
Non-interest Income
Income and exepense line items presented in the consolidated statements of income
The effects of cash flow and fair value hedging:
Gain (loss) on cash flow hedges:
Gain (loss) on fair value hedges:
(365)
(62)
The effect of cash flow hedging and fair value accounting on the consolidated statements of income for the nine months ended September 30, 2021 and 2020:
(580)
Interest rate swaps on wholesale funding
As of September 30, 2021 the Company has two interest rate swaps on wholesale borrowings (the "SWAPS") to limit its exposure to rising interest rates over a five year term on 3-month FHLB borrowings or brokered certificates, or a combination thereof at each maturity date. The first of the two agreements were entered in November 2019 with a $50.0 million notional amount and pays a fixed interest rate of 1.53%. A second agreement was entered on April 2020 with a $25.0 million notional amount and pays a fixed rate of 0.59%. The financial institution counterparty pays the Company interest on the three-month LIBOR rate. The Company designated the swaps as a cash flow hedge.
In March 2021, the Company entered into a contract with a counterparty to manage interest rate risk associated with its variable rate loans. The instrument is specifically designed to hedge the risk of changes in its cash flows from interest receipts attributable to changes in a contractually specified interest rate, on an amount of the Company’s variable rate loan assets equal to $50 million. The interest rate swap will effectively fix the Company’s interest rate on $50 million of 1 month USD-LIBOR-BBA (or LIBOR less two days) based loan assets at 0.806% plus the credit spread on the loans that reprices on weighted average basis. The Company designated the swap as a cash flow hedge.
51
Fair value hedges
For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged asset or liability attributable to the hedged risk are recognized in current earnings. The Company utilizes interest rate swaps designated as fair value hedges to mitigate the effect of changing interest rates on the fair values of fixed rate callable securities available-for-sale. The hedging strategy on securities converts the fixed interest rates to LIBOR-based variable interest rates. These derivatives are designated as partial term hedges of selected cash flows covering specified periods of time prior to the call dates of the hedged securities. During 2019, the Company entered into eight swap transactions with a notional amount of $37.2 million designated as fair value hedges. These derivatives are intended to protect against the effects of changing interest rates on the fair values of fixed rate securities. The fixed rates on the transactions have a weighted average of 1.696%.
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 $17.0 million with counterparties.
Gross Amounts Offset in the Consolidated Balance Sheet
Derivative
Cash Collateral
Derivative Assets
Pledged
Net Amount
As of September 30, 2021
Customer Loan Derivatives:
MNA counterparty
10,258
17,000
RPA counterparty
5,892
(16,150)
As of December 31, 2020
15,938
23,450
9,957
(25,895)
52
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.
53
NOTE 9. 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 September 30, 2021 and December 31, 2020, 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
16,149
16,196
Derivative liabilities
(18,159)
(18,299)
Derivative assets(1)
28,895
28,917
Derivative liabilities(1)
(31,348)
(31,443)
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 September 30, 2021, 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.
55
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 and nine months ended September 30, 2021:
Assets (Liabilities)
Interest Rate Lock
Forward
Commitments
Realized gain recognized in non-interest income
(126)
(87)
Realized loss recognized in non-interest income
59
(84)
Quantitative information about the significant unobservable inputs within Level 3 recurring assets and liabilities is, as follows:
Significant
Unobservable
(in thousands, except ratios)
Valuation Techniques
Unobservable Inputs
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
(73)
56
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:
Fair Value Measurement Date as of September 30, 2021
Gains (Losses)
Individually evaluated loans
9,247
8,746
(501)
September 2021
Capitalized servicing rights
4,867
3,605
(136)
(1,262)
Premises held for sale
962
December 2020
14,936
13,313
(1,623)
There are no liabilities measured at fair value on a non-recurring basis in 2021 and 2020.
57
Quantitative information about the significant unobservable inputs within Level 3 non-recurring assets is, as follows:
Fair Value September 30, 2021
Range (Weighted Average)(a)
6,226
Fair value of collateral-appraised value
Loss severity
10% to 70%
Appraised value
$71 to $1,792
3,021
Discount cash flow
Discount rate
2.88% to 9.50%
Cash flows
$6 to $939
Discounted cash flow
Constant prepayment rate (CPR)
13.66%
9.53%
Fair value of asset less selling costs
$220 to $386
Selling Costs
6%
Fair Value Dec 31, 2020
6,128
0% to 70%
$0 to $1730
2,618
3.50% to 9.50%
$19 to $953
18.53%
10.05%
There were no Level 1 or Level 2 non-recurring fair value measurements for the periods ended September 30, 2021 and December 31, 2020.
Individually evaluated 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
FHLB stock
2,472,108
Accrued interest receivable
3,272
Cash surrender value of bank-owned life insurance policies
17,019
16,972
Financial Liabilities
Non-maturity deposits
2,538,044
2,452,990
Time deposits
470,000
Securities sold under agreements to repurchase
FHLB advances
169,815
63,660
18,299
18,159
24,163
2,547,970
2,964
25,917
2,207,854
2,122,222
694,700
Short-term other borrowings
248,283
252,698
57,091
31,348
31,443
NOTE 10. 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
3,403
3,256
10,052
9,193
Financial services fees
465
276
1,283
867
Interchange fees
1,882
1,709
5,509
4,910
Customer deposit fees
1,363
937
3,542
2,836
Other customer service fees
270
240
7,383
6,418
21,077
18,497
Timing of Revenue Recognition
Products and services transferred at a point in time
3,737
3,133
10,593
9,026
Products and services transferred over time
3,646
3,285
10,484
9,471
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. These fees are primarily earned over time as the Company charges its customers on a monthly or quarterly basis in accordance with its investment advisory agreements. Fees are generally assessed based on a tiered scale of the market value of assets under management at month end. 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:
Balances from contracts with customers only:
Other Assets
1,277
1,121
Other Liabilities
2,467
2,785
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 11. 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:
Classification
Lease Right-of-Use Assets
Operating lease right-of-use assets
9,488
10,338
Lease Liabilities
Operating lease liabilities
9,841
10,627
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
8.57
9.26
Weighted-average discount rate
3.15
The following table represents lease costs, which includes prepaids and expenses 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.
Lease Costs
Operating lease cost
324
966
988
Variable lease cost
179
177
Total lease cost
1,145
Future minimum payments for operating leases with initial or remaining terms of one year or more as of September 30, 2021 are, as follows:
Payments
Twelve Months Ended:
September 30, 2022
1,314
September 30, 2023
1,318
September 30, 2024
1,319
September 30, 2025
1,125
September 30, 2026
1,032
Thereafter
4,301
Total future minimum lease payments
10,409
Amounts representing interest
(568)
Present value of net future minimum lease payments
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Management’s discussion and analysis 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, 2020.
Bar Harbor Bankshares (the "Company") is the parent company 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 regional community bank that thinks differently about banking. The Bank provides the technology offerings and capabilities of larger banks, accompanied by access to local decision makers who are acutely focused on their local markets. As the Company approaches the 135th anniversary of its founding, they have not forgotten that helping customers achieve their goals is the key to the Bank’s success. The Company delivers banking, lending and wealth management services from more than 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 September 30, 2021:
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)
0.61
2.04
1.66
Total book value(5)
27.92
26.74
Tangible book value(1) (5)
19.48
18.21
Market price at period end
28.05
20.55
Dividends
0.24
0.22
0.70
0.66
PERFORMANCE RATIOS(2)
Return on assets
0.88
1.05
0.87
Adjusted return on assets(1)
0.96
1.09
0.91
Pre-tax, pre-provision return on assets
1.43
1.29
1.26
1.24
Adjusted pre-tax, pre-provision return on assets (1) (2)
1.39
1.31
Return on equity(5)
10.38
8.25
9.54
8.10
Adjusted return on equity(1) (5)
10.39
9.98
8.42
Return on tangible equity(5)
15.08
12.32
14.01
12.10
Adjusted return on tangible equity(1) (5)
15.09
13.44
14.50
12.57
Net interest margin, fully taxable equivalent (FTE)(1) (3)
3.02
2.90
2.88
2.95
Adjusted net interest margin(1) (5)
2.75
2.89
2.73
2.94
Efficiency ratio(1)
59.18
59.47
61.48
61.62
FINANCIAL DATA (In millions)
3,738
3,861
Total earning assets(4)
3,394
3,505
Total investments
556
2,534
2,685
Allowance for loan losses
Total goodwill and intangible assets
126
3,007
2,935
Total shareholders' equity(5)
418
399
Adjusted income(1)
ASSET QUALITY AND CONDITION RATIOS
Net charge-offs (annualized)/average loans
0.03
0.06
(0.02)
0.07
Allowance for credit losses/total loans
0.89
0.67
Loans/deposits
Shareholders' equity to total assets(5)
11.19
10.34
Tangible shareholders' equity to tangible assets(1) (5)
8.08
7.27
CONSOLIDATED LOAN AND DEPOSIT ANALYSIS
The following tables present the quarterly trend in loan and deposit data and accompanying quarterly growth rates as of September 30, 2021 on an annualized basis:
LOAN ANALYSIS
Annualized Growth %
Sep 30, 2021
Jun 30, 2021
Mar 31, 2021
Dec 31, 2020
Sep 30, 2020
Quarter To Date
Year To Date
1,170,372
1,135,857
1,118,669
1,045,635
331,091
327,729
317,500
323,864
324,647
Paycheck Protection Program (PPP)
24,227
65,918
77,878
53,774
131,537
*
(74)
Total commercial loans
1,525,690
1,529,504
1,514,047
1,462,019
1,501,819
(1)
Total commercial loans, excluding PPP
1,501,463
1,463,586
1,436,169
1,408,245
1,370,282
849,692
822,774
868,084
997,485
(11)
100,933
103,589
106,835
119,340
(10)
Tax exempt and other
57,839
59,693
62,098
66,326
(12)
2,515,560
2,551,064
2,684,970
DEPOSIT ANALYSIS
599,598
586,487
515,064
802,681
761,817
706,048
578,361
560,095
511,938
371,075
365,507
388,356
(8)
Total non-maturity deposits
2,351,715
2,273,906
2,121,406
Total time deposits
470,758
638,436
813,509
2,822,473
2,912,342
2,934,915
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)
Interest-bearing deposits with other banks(4)
284,429
110
92,066
0.09
Securities available for sale and FHLB stock(2)(3)
610,381
3,986
2.59
627,162
4,787
3.04
1,153,813
10,269
3.53
1,012,194
9,691
3.81
391,191
3,739
3.79
399,734
4,411
4.39
Paycheck protection program
45,835
2,690
23.28
131,605
1,052
3.18
824,686
7,574
3.64
1,060,084
9,886
3.71
101,545
968
3.78
121,248
1,042
3.42
Total loans (1)
2,517,070
25,240
3.98
2,724,865
26,082
Total earning assets
3,411,880
29,336
3.41
3,444,093
30,890
3.57
Other assets(6)
352,208
370,335
Total assets(6)
3,764,088
3,814,428
860,206
272
677,706
243
0.14
591,440
124
0.08
488,508
157
381,755
115
0.12
396,351
163
0.16
471,934
777,424
3,307
1.69
Total interest bearing deposits
2,305,335
0.27
2,339,989
3,870
334,097
2.11
481,687
Total interest bearing liabilities
2,639,432
0.50
2,821,676
0.82
Non-interest bearing demand deposits
641,769
507,844
Other liabilities(6)
61,436
79,848
Total liabilities(6)
3,342,637
3,409,368
Total shareholders' equity(6)
421,451
405,060
Total liabilities and shareholders' equity(6)
Net interest spread
2.91
Net interest margin (1)
Adjusted net interest margin(5)
Yield/
Rate(3)
229,235
52,326
0.21
617,373
12,424
2.69
643,978
15,798
3.28
1,128,134
30,177
3.58
972,330
29,895
4.11
Commercial and industrial(3)
381,753
10,727
3.76
414,532
13,847
4.46
62,562
5,058
10.81
78,782
3.26
861,629
24,145
3.75
1,103,442
31,386
3.80
105,371
2,833
3.59
126,189
3,929
4.16
2,539,449
72,940
3.84
2,695,275
80,978
4.01
3,386,057
85,567
3.38
3,391,579
96,860
357,334
371,792
3,743,391
3,763,371
801,292
760
622,702
1,021
568,726
0.10
451,952
587
0.17
376,775
393,702
0.51
583,529
5,565
1.28
813,442
11,320
1.86
2,330,322
7,110
0.41
2,281,798
14,439
0.85
336,432
2.15
547,557
1.74
2,666,754
12,525
0.63
2,829,355
21,588
1.02
598,434
464,476
64,360
63,812
3,329,548
3,357,643
413,843
405,728
2.79
Net interest margin
69
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:
Calculations
Non-recurring items:
Gain on sale of securities, net
(1,930)
Loss (gain) on sale of premises and equipment, net
335
Income tax expense (1)
(2)
(245)
(332)
(304)
Total non-recurring items
781
1,067
969
Total adjusted income(2)
(A)
11,036
9,183
30,600
25,573
(B)
Plus: Non-interest income
Total Revenue
36,932
34,767
102,861
102,051
Total adjusted revenue(2)
(C)
35,002
100,881
100,565
Non-recurring expenses:
(Loss) gain on sale of premises and equipment, net
137
(90)
(335)
(366)
(1,768)
(1,351)
(318)
(691)
(1,759)
(952)
Total non-recurring expenses
(1,940)
(1,026)
(3,379)
(2,759)
Adjusted non-interest expense(2)
(D)
21,432
21,393
64,208
64,285
Total revenue
Pre-tax, pre-provision net revenue
13,560
12,348
35,274
35,007
Adjusted revenue(2)
Adjusted pre-tax, pre-provision net revenue(2)
13,570
13,374
36,673
36,280
(in millions)
Average earning assets
(E)
3,412
3,444
3,392
Average paycheck protection program (PPP) loans
(R)
132
Average earning assets, excluding PPP loans
(S)
3,366
3,312
3,323
3,313
Average assets
(F)
3,764
3,814
3,743
3,763
Average shareholders' equity(8)
(G)
421
405
Average tangible shareholders' equity(2)(3)(8)
(H)
295
278
287
Tangible shareholders' equity, period-end(2)(3)(8)
(I)
292
Tangible assets, period-end(2)(3)(8)
(J)
3,612
3,734
Common shares outstanding, period-end
(K)
14,987
14,929
Average diluted shares outstanding
(L)
Adjusted earnings per share, diluted(2)
(A/L)
Tangible book value per share, period-end(2)(8)
(I/K)
Securities adjustment, net of tax(1)(4)
(M)
Tangible book value per share, excluding securities adjustment(2)(4)(8)
(I+M)/K
19.19
17.42
Total tangible shareholders' equity/total tangible assets(2)(8)
(I/J)
7.28
Performance ratios(5)
Adjusted return on assets(2)
(A/F)
Adjusted pre-tax, pre-provision return on assets (2)
(U/F)
Return on equity(8)
Adjusted return on equity(2)(8)
(A/G)
Return on tangible equity(8)
Adjusted return on tangible equity(1)(2)(8)
(A+Q)/H
Efficiency ratio(2)(6)
(D-O-Q)/(C+N)
(B+P)/E
Adjusted net interest margin(2)(7)
(B+P-T)/S
Supplementary data (in thousands)
Taxable equivalent adjustment for efficiency ratio
(N)
570
1,757
1,395
Franchise taxes included in non-interest expense
(O)
143
396
360
Tax equivalent adjustment for net interest margin
(P)
416
1,284
1,041
Intangible amortization
(Q)
Interest and fees on PPP loans
(T)
FINANCIAL SUMMARY
The Company reported third quarter 2021 net income of $11.0 million or $0.73 per diluted share, up from $8.4 million or $0.56 per diluted share in the same quarter of 2020. Adjusted earnings (non-GAAP) were also $11.0 million or $0.73 per diluted share in the third quarter of 2021, compared to $9.2 million, or $0.61 per share for the same period of 2020.
THIRD QUARTER HIGHLIGHTS (ratios compared to the third quarter 2020)
Adjusted earnings per share (non-GAAP) in the third quarter 2021 grew 20% over the same quarter of 2020. The adjusted return on assets in the third quarter was 1.16% compared to 0.96% in the third quarter of 2020, evidencing continued execution of strategies that balance growth with earnings. This is indicative of the strength in the Company’s core businesses and the results of strategic initiatives. The momentum seen in each area affords the Company flexibility with diverse revenue streams to support operations, even in uncertain economic environments.
While fee income and efficiency improvements contributed to increased profitability, the quarterly results also benefited from a 13 basis point expansion in the margin to 2.99% compared with 2.86% in the second quarter 2021 on a normalized basis (excluding PPP and excess cash effects). This improvement is a direct result of increased core deposit funding as the Company gained market share and reduced reliance on wholesale borrowings. As of September 30, 2021, the Company’s wholesale borrowings as a percentage of funding was 9%, down from 23% in the prior year.
The Company’s commercial teams continue to deliver strong loan growth despite the competitive landscape within its footprint. Commercial real estate loan growth this quarter was driven by new multi-family residential and light industrial & manufacturing relationships with proven operators. Risk management remains at the forefront of all that the Company does. The Company saw yields bottoming out on residential loans this quarter and was able to increase contractual rates at times. Given the overall interest rate risk position of the balance sheet and this recent rate increase, the Company strategically directed more residential mortgage production onto the balance sheet rather than sell in the secondary market.”
The Company executed another delever and security remix strategy during the third quarter, prepaying $89 million of FHLB borrowings and selling $44 million of credit sensitive municipal and corporate bonds. The additional purchase of securities was completed subsequent to quarter end. This transaction is expected to expand the NIM by 12 basis points and will be accretive to earnings by $0.02 on a quarterly basis.
The Company continues to build long term shareholder value while providing a favorable dividend rate relative to other community banks. The Company’s return on equity for the third quarter rose to 10.38% from 8.25% in the same quarter of 2020. The Company remains committed to underwriting standards as evidenced by further improvement in past-due accounts, non-accruals and a near zero net-charge-off ratio.
The Company was named by Newsweek Magazine as one of "America's Best Banks." Best Bank winners were selected from over 2,500 financial institutions and assessed on more than 30 separate factors including the overall health of the bank, customer service performance and features, digital and branch presence, account and loan options, interest rate offerings, and fees.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2021 AND DECEMBER 31, 2020
Total assets were $3.7 billion at the end of the third quarter 2021 as well as at year-end 2020. In the third quarter the Company executed a balance sheet delever and security remix strategy, prepaying $89.0 million of Federal Home Loan Bank advances and selling $43.5 million of securities. The replenishment of those securities is expected to be fulfilled in the fourth quarter 2021. Total loans decreased $28.7 million from year-end 2020 primarily due to PPP loan forgiveness outpacing 2021 originations by $29.5 million from year-end 2020. Non-maturity deposits (core deposits) increased $330.2 million from the end of 2020 as over 800 new accounts were opened during the quarter, continuing a trend of almost 1,000 new accounts per quarter. The loan to deposit ratio was 84% at the end of the third quarter compared to 88% at year-end 2020. Asset quality metrics remain strong with an allowance for credit losses to total loans ratio of 0.89% and a coverage ratio to non-accruing loans of 184%, up from 157% as of year-end 2020. Tangible book value per share (non-GAAP) increased to $19.48 from $18.77 at year-end on strong earnings offset by the impact of the CECL adoption in the first quarter 2021.
Cash
Total cash and cash equivalents at September 30, 2021 were $341.2 million, compared to $226.0 million at December 31, 2020. Interest bearing deposits held with other banks totaled $302.1 million at quarter end and $198.4 million at year-end 2020 carrying a yield of 0.15% and 0.11% respectively. The increase in cash balances reflects the growth in core deposits.
Securities totaled $555.5 million in the third quarter 2021 and $599.1 million at year-end 2020 representing 15% and 16% of total assets, respectively. The decrease is primarily due to the security sale of $43.5 million as a part of the balance sheet delever and security remix strategy. In the first nine months of 2021 purchases totaled $123.3 million and were offset by $52.4 million of sales, $103.4 million of maturities, calls and pay-downs of amortizing securities and a $3.8 million reduction in FHLB stock. Fair value adjustments increased the security portfolio by $7.3 million at the end of the third quarter 2021 and $13.1 million at year-end 2020. Unrealized gains decreased for the nine months ended September 30, 2021 due to sales and changes in the long-term treasury yield curve. The weighted average yield of the Company's securities portfolio was 2.82% as of September 30, 2021 compared to 2.96% at year-end 2020. At the end of the third quarter 2021 securities held by the Company had an average life of 5.1 years and an effective duration of 4.4 years compared to 4.8 years and 4.3 years at the end of 2020, respectively.
Loans Held For Sale
Held for sale loans decreased to $7.5 million at September 30, 2021 from $24.0 million at December 31, 2020. The Company sold $28.5 million of residential loan originations in the third quarter 2021 compared with $86.2 million in the same quarter of 2020. Sales in the nine month period of 2021 totaled $153.9 million and $156.0 million in the comparable period of 2020. The decrease in sales reflects the Company strategically directing residential loan production to the balance sheet when rates were higher in the quarter.
Loan balances in the third quarter 2021 were $2.5 billion compared $2.6 billion at year-end 2020. Commercial loans grew 9% on a year-to-date annualized basis, excluding PPP loans and included 2 new relationships totaling $21.2 million during the third quarter. Commercial real estate and commercial and industrial loans, excluding PPP, increased 11% and 3% on a year-to-date annualized basis, respectively. PPP loans totaled $24.2 million at quarter-end, consisting of $24.1 million from 2021 and $145 thousand from 2020, and were $53.8 million at year-end 2020. COVID loan modifications totaled $4.7 million, down from $68.6 million at year-end, as the majority of modified loans have resumed normal payment schedules. Total residential loans decreased $74.2 million from year-end 2020, which includes $156.3 million of originations recorded on the balance sheet and $230.5 million of prepayments/amortization.
The allowance for credit losses (ACL) totaled $22.4 million at the end of the third quarter 2021 and $19.0 million at year-end 2020. The increase is primarily due to the Company’s adoption of CECL as of January 1, 2021, which increased the ACL by $5.2 million and unfunded commitment reserves by $1.6 million. Since adoption the ACL has decreased due to improved economic forecasts and lower reserves on specific loans offset by changes in loan mix.
Net charge offs totaled $434 thousand in the first nine months of 2021, or 0.02% of total average loans, compared to $1.9 million, or 0.07% of total average loans, for the same period of 2020. Non-accruing loans were $12.2 million, or 0.48% of total loans, at the end of the third quarter 2021 and were $12.2 million or 0.48% of total loans at year-end 2020. The ratio of accruing past due loans to total loans improved to 0.12% of total loans, decreasing from 0.58% as of December 31, 2020.
Total other assets were $322.4 million at the end of the third quarter 2021 compared to $331.4 million as of December 31, 2020. The decrease is primarily from a $9.7 million decrease in the fair value in customer loan derivatives offset by $2.9 million increase in community limited partnership investments. Additionally, derivative balances and deferred taxes have been restated for prior periods as described in Note 1 Revision of Previously Issued Financial Statements.
Deposits and Borrowings
Total deposits were $3.0 billion at the end of the third quarter 2021 compared to $2.9 billion at year-end 2020. Non-maturity deposits increased $330.2 million over the first nine months of 2021, or 20% on an annualized basis due to growth in new accounts with over 2,900 new customer relationships added. Growth in core deposits during 2021 and the prepayment of $89.0 million in FHLB borrowings resulted in a reduction of wholesale funding as a percentage of total funding to 9% from 18% at year-end 2020. Time deposits decreased $229.1 million to $469.2 million at quarter-end as $162.3 million of brokered deposits matured in the first nine months of 2021 and were not replaced due to excess liquidity. Retail time deposits decreased $66.9 million as customers moved funds to transactional accounts upon contractual maturity. Total borrowings decreased by $85.7 million primarily from the aforementioned delever strategy. The average cost of deposits was 0.27% in the third quarter of 2021 compared to 0.61% in the fourth quarter 2020 and borrowing costs were 2.11% compared to 1.83% for the same periods. The change in cost of funds reflects the attrition of balances on prepaid or matured borrowings and time deposits.
Derivative Financial Instruments and Other Liabilities
The notional balance of derivative financial instruments increased to $929.9 million at the end of the third quarter 2021 from $876.6 million at year-end 2020. The increase is principally due to a $50.0 million new hedge on variable rate loans tied to one-month LIBOR. The net fair value of all derivatives was a liability of $2.2 million at the end of the third quarter 2021 compared to liability of $5.5 million at year-end 2020. The reduction in net derivative fair values reflects the rise in long-term interest rates. Additionally, derivative balances have been restated for prior periods as described in Note 1 Revision of Previously Issued Financial Statements.
Other liabilities totaled $62.3 million at the end of the third quarter 2021 compared to $75.0 million as of December 31, 2020. The decrease primarily reflects the $9.7 million reduction in the fair value of customer loan derivatives and a $3.3 million decrease in cash flow and fair value hedges.
Equity
Total equity was $418.4 million, compared with $407.1 million at year-end 2020. The Company’s book value per share was $27.92 as of September 30, 2021 compared with $27.29 at December 31, 2020. Equity included net unrealized securities totaling $4.4 million at the end of the third quarter 2021 and $10.0 million at year-end 2020. Equity was reduced by $5.2 million due to the Company’s CECL adoption in the first quarter 2021. Additionally, accumulated other comprehensive income has been restated for prior periods as described in Note 1 Revision of Previously Issued Financial Statements.
COMPARISON OF OPERATING RESULTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2021 AND 2020
Summary
Net income in the third quarter 2021 was $11.0 million, or $0.73 per diluted share, compared to $8.4 million, or $0.56 per share, in the same quarter of 2020. Net income improved on higher fee income and fees from PPP loans in the quarter. PPP loan fees contributed $0.13 to earnings per share in the third quarter of 2021 and $0.06 in the same period of 2020. Adjusted earnings totaled $11.0 million or $0.73 per share, compared to $9.1 million, or $0.61 per share, in the same
quarter of 2020. Non-recurring items (non-GAAP) reduced net income by $8 thousand and $781 thousand in third quarters of 2021 and 2020, respectively. The Company's return on assets ratio was 1.16% in the third quarter of 2021 and 0.88% in the same quarter of 2020. Adjusted return on assets (non-GAAP) was 1.16% and 0.96% for the third quarters of 2021 and 2020, respectively evidencing continued execution of strategic initiatives that balance growth and earnings
The Company reported year-to-date 2021 net income of $29.5 million or $1.96 per diluted share, compared with $24.6 million or $1.60 per diluted share in the same period of 2020. Adjusted earnings increased to $30.6 million, or $2.04 per diluted share compared with $25.6 million, or $1.66 per diluted share, for the respective periods. Non-recurring items (non-GAAP) in the first nine months reduced net income by $1.1 million and $969 thousand in 2021 and 2020, respectively. The return on assets ratio year-to-date 2021 was 1.05% compared to 0.87% in the prior year and adjusted return on assets was 1.09% during the first nine months of 2021 and 0.91% in the same period of 2020. These changes largely reflect the same factors and trends discussed above that drove third quarter net income and average assets.
Net Interest Income
Net interest income was $25.6 million in the third quarter 2021 compared with $24.7 million in the same quarter of 2020. Net interest margin was 3.02% compared to 2.90% in third quarter of 2020. Acceleration of PPP loan fee amortization due to forgiveness contributed 28 basis points to NIM in the third quarter 2021 and 1 basis point in the same period of 2020. Interest-bearing cash balances, held mostly at the Federal Reserve Bank, reduced NIM by 26 basis points in the quarter and 8 basis points in the third quarter 2020. The yield on earning assets totaled 3.41% compared to 3.57% in the third quarter 2020. Excluding the impact of PPP and excess cash, the yield on earning assets totaled 3.42% and 3.67% for the same periods. The yield on loans was 3.98% in the third quarter 2021and 3.81% in the third quarter of 2020. Excluding PPP loans the yield on loans was 3.62% in the third quarter of 2021, and 3.83% in the third quarter of 2020. Costs of funds decreased to 0.50% from 0.82% in the third quarter 2020 due to increased core deposit levels, lower deposit rates and reduced wholesale borrowings.
For the first nine months of 2021, net interest income was $71.8 million compared with $73.9 million in the same period of 2020. Net interest margin for the nine months ended was 2.88% in the third quarter 2021 compared to 2.95% in the third quarter of 2020. The decrease in net interest income and NIM was driven by rate compression triggered by the pandemic, combined with growth in the Company’s interest-bearing cash balances. PPP loan accretion in 2021 helped to offset interest rate compression on yields. Costs of funds for the nine months ended September 30, 2021 decreased to 0.63% from 1.02% due to increased core deposit levels, lower deposit rates and reduced wholesale borrowings.
Provision for Credit Losses
The provision for credit losses (the “provision”) for the quarter was a benefit of $174 thousand, compared to an expense of $1.8 million in the third quarter of 2020. For the first nine months of 2021, the provision was a benefit of $1.4 million compared to an expense of $4.3 million in the same period of 2020. The benefits experienced in the periods of 2021 are attributable to continued strong credit quality and improving economic forecasts.
Non-Interest Income
Non-interest income in the third quarter 2021 was $11.4 million, compared to $10.1 million in the same quarter of 2020. The increase was due to higher customer service fees, wealth management income, and a gain on securities sales. Customer service fees were $3.5 million in the third quarter compared to $2.9 million in the same period of 2020. The increase is due to over 800 new accounts that were opened during the quarter and a higher volume of customer activity and transactions. Wealth management income increased 10% over the same quarter of 2020 to $3.9 million with assets under management of $2.4 billion compared to $2.1 billion in the same period of 2020. The Company sold securities resulting in a $1.9 million gain as part of its delever and security remix strategy. Mortgage banking activities contributed $850 thousand, compared to $2.6 million in the same period of 2020. The Company took advantage of volatility in the yield curve in the third quarter and put residential mortgages on the balance sheet when rates were higher and sold loans in the secondary market when rates were low.
Non-interest income for the first nine months of 2021 was $31.1 million compared to $28.2 million in the same period in 2020. The increase reflects a 13% increase in wealth management income, 15% increase in customer service fees, 18% increase in mortgage banking income and gains on securities; all of which were driven by the same reasons as the quarterly period.
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Non-Interest Expense
Non-interest expense was $23.4 million in the third quarter 2021 from $22.4 million in the same quarter of 2020. Salaries and benefits expense decreased to $11.7 million compared to $11.8 million in the same quarter of 2020, reflecting full-time equivalents of 428 compared to 457 in the third quarter of 2020. Non-core expenses (non-GAAP) in the third quarter 2021 totaled $1.9 million and were mostly made up of the $1.8 million prepayment penalty on debt extinguishment. In the same quarter of 2020 non-core expenses (non-GAAP) totaled $1.0 million and included costs to consolidate the Company’s wealth management systems. The efficiency ratio for the third quarter was 59.18% compared to 59.47% in the same period of 2020. Excluding the effects of PPP the efficiency ratio was 63.35% and 61.30% for the same respective periods.
For the first nine months of 2021, non-interest expense was $67.6 million and $67.0 million in the same period of 2020. The Company’s year-to-date efficiency ratio was 61.48% in 2021 compared to 61.62% in 2020 which reflects managements disciplined approach to expense management as revenue grows and the above noted expense initiatives. Non-recurring expenses (non-GAAP) in the first nine months of 2021 totaled $3.3 million and $2.8 million in the same period of 2020. In the first nine months of 2021 these expenses mostly consisted of workforce reduction charges and loss on debt extinguishment and in 2020 primarily consisted of a loss on debt extinguishment and costs to consolidate wealth management systems.
Income Tax Expense
The third quarter effective tax rate decreased to 19.7% in 2021 compared with 20.3% in the same quarter of 2020, reflecting higher pre-tax income being offset by the proportional amounts of tax-advantaged revenue.
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.
The Company’s liquidity position remains strong. During the quarter we initiated pandemic-specific liquidity stress tests to analyze potential impacts from payment deferrals, unanticipated use of committed lines of credit, as well as the possibility of required servicer advances on sold loans. At September 30, 2021, available same-day liquidity totaled approximately $1.3 billion, including cash, borrowing capacity at 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 Company's amortizing securities and loan portfolios. The Company had unused borrowing capacity at the FHLB of $467.2 million, unused borrowing capacity at the Federal Reserve of $72.0 million and unused lines of credit totaling $51.0 million, in addition to over $200.0 million in unencumbered, liquid investment portfolio assets.
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.
77
Capital Resources
Please see the “Equity” section of the Comparison of Financial Condition for a discussion of shareholders’ equity together with the Note 6 Capital Ratios and Shareholders’ Equity in the consolidated financial statements. Additional information about regulatory capital is contained in the notes to the consolidated financial statements and in the Company's most recent Form 10-K.
The Company’s principal cash requirement is the payment of dividends on our common stock, as and when declared by the Company's Board of Directors. Dividends to shareholders in the aggregate amount of $10.5 million and $10.1 million for the nine months ended September 30, 2021 and 2020, respectively. All dividends declared and distributed by the Company will be in compliance with applicable state corporate law and regulatory requirements.
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, 2020.
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 exercise. 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:
•
A flat interest rate scenario in which current prevailing rates are locked in and the only balance sheet fluctuations that occur are due to cash flows, maturities, new volumes, and re-pricing volumes consistent with this flat rate assumption;
A 200 basis point rise or decline in interest rates (or as appropriate given the absolute level of market rates) applied against a parallel shift in the yield curve over a twelve-month horizon together with a dynamic balance sheet anticipated to be consistent with such interest rate changes;
Various non-parallel shifts in the yield curve, including changes in either short-term or long-term rates over a twelve-month horizon, together with a dynamic balance sheet anticipated to be consistent with such interest rate changes; and
An extension of the foregoing simulations to each of two, three, four and five year horizons to determine the interest rate risk with the level of interest rates stabilizing in years two through five. Even though rates remain stable during this two to five year time period, re-pricing opportunities driven by maturities, cash flow, and adjustable rate products will continue to change the balance sheet profile for each of the interest rate conditions.
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 September 30, 2021 interest rate sensitivity modeling results indicate that the Bank’s balance sheet in years 1 and 2 was 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 (-2.4% versus the base case) while deteriorating further from that level over the two-year horizon (-9.8% 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 over the one and two-year horizons (10.6% and 21.8%, respectively).
As compared to December 31, 2020, the year-one sensitivity in the down 100 basis points scenario was up slightly for the nine months ended September 30, 2021 (-2.6% prior, versus -2.4% current). The year-two sensitivities in the down 100 basis points scenario were mostly unchanged going from -9.5% to -9.8%. In the year-one up 200 basis points scenario, results were up slightly going from 7.7% to 10.6%. Year-two, up 200 basis points was up (18.4% prior, versus 21.8% 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.
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 September 30, 2021 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
There were no material changes to the risk factors discussed in Part I, Item 1A. of the Company’s Annual Report on Form 10-K for the year ended December 31, 2020. In addition to the other information set forth in this report, you should carefully consider those risk factors, which could materially affect our business, financial condition and future operating results. Those risk factors are not the only risks facing our company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may have a material adverse effect on our business, financial condition and operating results.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c)On April 20, 2021, Company's Board of Directors approved a twelve-month plan to repurchase up to 5% of its outstanding common stock, representing 747,000 shares.
The following table indicates that no shares were repurchased by the Company in the third quarter of 2021:
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
shares purchased
paid per share
plans or programs
the plans or programs
July 1-31, 2021
747,000
August 1-31, 2021
September 1-30, 2021
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
The following financial information from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2021 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: November 8, 2021
By:
/s/ Curtis C. Simard
Curtis C. Simard
President & Chief Executive Officer
/s/ Josephine Iannelli
Josephine Iannelli
Executive Vice President & Chief Financial Officer