Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
Or
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-55983
(Exact name of registrant as specified in its charter)
Pennsylvania
32-0116054
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
9 Old Lincoln Highway, Malvern, Pennsylvania 19355
(Address of principal executive offices) (Zip Code)
(484) 568‑5000
(Registrant’s telephone number, including area code)
Title of class
Trading Symbol
Name of exchange on which registered
Common Stock, $1 par value
MRBK
The NASDAQ Stock Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒Yes ☐No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
☒Yes ☐No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b‑2 of the Exchange Act.
Large accelerated filer ☐
Accelerated filer ☐
Non-accelerated filer ☐
Smaller reporting company ☒
Emerging growth company ☒
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act). ☐ Yes ☒ No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of August 14, 2019 there were 6,406,996 outstanding shares of the issuer’s common stock, par value $1.00 per share.
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1 Financial Statements (Unaudited)
3
Consolidated Balance Sheets – June 30, 2019 and December 31, 2018
Consolidated Statements of Income – Three and Six Months Ended June 30, 2019 and 2018
4
Consolidated Statements of Comprehensive Income – Three and Six Months Ended June 30, 2019 and 2018
5
Consolidated Statements of Stockholders’ Equity – Three and Six Months Ended June 30, 2019 and 2018
6
Consolidated Statements of Cash Flows – Six Months Ended June 30, 2019 and 2018
7
Notes to Consolidated Financial Statements (Unaudited)
8
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations
34
Item 3 Quantitative and Qualitative Disclosures about Market Risk
52
Item 4 Controls and Procedures
53
PART II OTHER INFORMATION
Item 1 Legal Proceedings
55
Item 1A Risk Factors
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 Defaults Upon Senior Securities
Item 4 Mine Safety Disclosures
Item 5 Other Information
Item 6 Exhibits
Signatures
57
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30,
December 31,
(dollars in thousands, except per share data)
2019
2018
Cash and due from banks
$
30,493
23,159
Federal funds sold
137
793
Cash and cash equivalents
30,630
23,952
Securities available-for-sale (amortized cost of $48,276 and $50,942 as of June 30, 2019 and December 31, 2018)
48,529
50,428
Securities held-to-maturity (fair value of $12,480 and $12,655 as of June 30, 2019 and December 31, 2018)
12,287
12,741
Mortgage loans held for sale (amortized cost of $39,066 and $37,337 as of June 30, 2019 and December 31, 2018)
39,288
37,695
Loans, net of fees and costs (includes $12,381 and $11,422 of loans at fair value, amortized cost of $12,012 and $11,466 as of June 30, 2019 and December 31, 2018)
885,172
838,106
Allowance for loan and lease losses
(8,625)
(8,053)
Loans, net of the allowance for loan and lease losses
876,547
830,053
Restricted investment in bank stock
5,872
7,002
Bank premises and equipment, net
9,225
9,638
Bank owned life insurance
11,713
11,569
Accrued interest receivable
3,344
2,889
Other real estate owned
120
—
Deferred income taxes (Footnote 1)
1,644
1,728
Goodwill and intangible assets
4,909
5,046
Other assets
11,798
4,739
Total assets
1,055,906
997,480
Liabilities:
Deposits:
Noninterest bearing
127,158
126,150
Interest-bearing
713,556
625,980
Total deposits
840,714
752,130
Short-term borrowings
74,979
114,300
Long-term debt
8,948
6,238
Subordinated debentures
9,176
9,239
Accrued interest payable
327
305
Other liabilities (Footnote 1)
7,383
5,716
Total liabilities
941,527
887,928
Stockholders’ equity:
Common stock, $1 par value. Authorized 10,000,000 shares; issued and outstanding 6,406,996 and 6,406,795 as of June 30, 2019 and December 31, 2018
6,407
Surplus
80,123
79,919
Retained earnings (Footnote 1)
27,644
23,616
Accumulated other comprehensive loss
205
(390)
Total stockholders’ equity
114,379
109,552
Total liabilities and stockholders’ equity
See accompanying notes to the unaudited consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
Three months ended
Six months ended
Interest income:
Loans, including fees
12,647
10,507
24,534
20,000
Securities:
Taxable
278
168
556
336
Tax-exempt
100
112
209
224
48
22
98
45
Total interest income
13,073
10,809
25,397
20,605
Interest expense:
Deposits
3,715
2,028
6,951
3,687
Borrowings
436
635
1,048
1,080
Total interest expense
4,151
2,663
7,999
4,767
Net interest income
8,922
8,146
17,398
15,838
Provision for loan losses
14
413
233
967
Net interest income after provision for loan losses
8,908
7,733
17,165
14,871
Non-interest income:
Mortgage banking income
6,321
7,312
11,229
12,133
Wealth management income
912
988
1,776
2,066
SBA loan income
515
Earnings on investment in life insurance
72
73
144
151
Net change in the fair value of derivative instruments
(32)
(218)
(16)
(11)
Net change in the fair value of loans held-for-sale
(226)
62
(136)
59
Net change in the fair value of loans held-for-investment
90
(15)
414
(186)
Gain on sale of investment securities available-for-sale
139
Service charges
27
28
54
60
Other
110
438
256
1,452
Total non-interest income
7,928
8,668
14,375
15,724
Non-interest expenses:
Salaries and employee benefits
8,742
9,382
16,469
17,818
Occupancy and equipment
936
990
1,899
1,950
Loan expenses
668
723
1,136
1,193
Professional fees
709
477
1,180
956
Advertising and promotion
730
631
1,196
1,212
Data processing
324
302
648
590
Information technology
319
243
585
568
Communications
162
240
354
486
1,654
1,086
2,893
1,863
Total non-interest expenses
14,244
14,074
26,360
26,636
Income before income taxes
2,592
2,327
5,180
3,959
Income tax expense
570
525
1,152
887
Net income
2,022
1,802
4,028
3,072
Basic earnings per common share
0.28
0.63
0.48
Diluted earnings per common share
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands)
Net income:
Other comprehensive income:
Net change in unrealized gains (losses) on investment securities available for sale:
Net unrealized gains (losses) arising during the period, net of tax (benefit) expense of $95, ($18), $202, and ($101), respectively
330
(63)
703
(339)
Less: reclassification adjustment for net (gains) on sales realized in net income, net of tax (expense) benefit of ($31), $0, ($31), and $0, respectively
(108)
Unrealized investment gains (losses), net of tax expense (benefit) of $64, ($18), $171, and ($101), respectively
222
595
Total other comprehensive income (loss)
Total comprehensive income
2,244
1,739
4,623
2,733
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Accumulated
Common
Retained
Comprehensive
Stock
Earnings
Income (Loss)
Total
Balance, January 1, 2018 (Footnote 1)
6,392
79,501
15,453
(298)
101,048
Comprehensive income:
1,270
Change in unrealized gains on securities available-for-sale, net of tax
(276)
994
Compensation expense related to stock option grants
Balance, March 31, 2018
79,504
16,723
(574)
102,045
Share-based awards and exercises
9
272
Balance, June 30, 2018
6,401
79,776
18,525
(637)
104,065
Balance, January 1, 2019
2,006
373
2,379
61
Balance, March 31, 2019
79,980
25,622
(17)
111,992
143
Balance, June 30, 2019
CONSOLIDATED STATEMENTS OF CASH FLOWS
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on sale of investment securities
(139)
Depreciation and amortization
471
639
Compensation expense for stock options
204
275
Net change in fair value of loans held for sale
136
(59)
Net change in fair value of derivative instruments
16
11
Gain on sale of OREO
(57)
(515)
Proceeds from sale of loans
243,495
317,752
Loans originated for sale
(230,393)
(316,107)
(11,229)
(12,133)
Increase in accrued interest receivable
(455)
(177)
Increase in other assets
(295)
(318)
Earnings from investment in life insurance
(144)
(151)
Deferred income tax expense (benefit) (Footnote 1)
(181)
Increase in accrued interest payable
21
Increase in other liabilities (Footnote 1)
1,394
536
Net cash provided (used) by operating activities
6,874
(5,910)
Cash flows from investing activities:
Activity in available-for-sale securities:
Maturities, repayments and calls
5,231
2,375
Sales
16,665
Purchases
(18,816)
(4,958)
Proceeds from sale of OREO
494
Settlement of forward contracts
(61)
75
Decrease (increase) in restricted stock
1,130
(1,101)
Net increase in loans
(55,768)
(86,642)
Purchases of premises and equipment
(487)
(1,305)
Proceeds from settlement of loans
2,766
Net cash used in investing activities
(52,106)
(88,296)
Cash flows from financing activities:
Net increase in deposits
88,584
56,141
(Decrease) increase in short term borrowings
(39,321)
33,976
Repayment of long term debt (Acquisition note)
(413)
Repayment of long term debt (Subordinated debt)
(4,000)
Proceeds from long term debt (FHLB advances)
3,123
Share based awards and exercises
Net cash provided by financing activities
51,910
85,713
Net change in cash and cash equivalents
6,678
(8,493)
Cash and cash equivalents at beginning of period
35,506
Cash and cash equivalents at end of period
27,013
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest
7,977
4,746
Income taxes
737
390
Transfers from loans and leases to real estate owned
Transfers from loans held for sale to loans held for investment
3,602
Net loans sold, not settled
6,439
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(1) Basis of Presentation
Meridian Corporation (the “Corporation”) was incorporated on June 8, 2009, by and at the direction of the board of directors of Meridian Bank (the “Bank”) for the sole purpose of acquiring the Bank and serving as the Bank’s parent bank holding company. On August 24, 2018, the Corporation acquired the Bank in a merger and reorganization effected under Pennsylvania law and in accordance with the terms of a Plan of Merger and Reorganization dated April 26, 2018 (the “Agreement”). Pursuant to the Agreement, on August 24, 2018 at 5:00 p.m. all of the outstanding shares of the Bank’s $1.00 par value common stock formerly held by its shareholders was converted into and exchanged for one newly issued share of the Corporation’s par value common stock, and the Bank became a subsidiary of the Corporation. Because the Bank and the Corporation were entities under common control, this exchange of shares between entities under common control resulted in the retrospective combination of the Bank and the Corporation for all periods presented as if the combination had been in effect since inception of common control. As the Corporation had no assets, liabilities, revenues, expenses or operations prior to August 24, 2018, the historical financial statements of the Bank are the historical financial statements of the combined entity.
The Corporation’s unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial position and the results of operations for the interim periods presented have been included.
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Amounts subject to significant estimates are items such as the allowance for loan losses and lending related commitments, the fair value of financial instruments, other-than-temporary impairments of investment securities, and the valuations of goodwill and intangible assets.
These unaudited consolidated financial statements should be read in conjunction with the Corporation’s filings with the Securities and Exchange Commission (including our Annual Report on Form 10-K for the year ended December 31, 2018) and, for periods prior to the completion of the holding company reorganization, the Bank’s filings with the FDIC, including the Bank’s annual report on Form 10-K for the year ended December 31, 2017, and subsequently filed quarterly reports on Form 10-Q and current reports on Form 8-K that update or provide information in addition to the information included in Form 10-K and Form 10-Q filings, if any. Certain prior period amounts have been reclassified to conform with current period presentation. Operating results for the three and six months ended June 30, 2019 are not necessarily indicative of the results for the year ended December 31, 2019 or for any other period.
During the prior quarter, the Corporation identified and corrected an immaterial error related to Maryland state licensing requirements for mortgage loan originations by our Mortgage division. As the result of our mortgage operations not being fully compliant with Maryland licensing law, we agreed to reimburse consumers approximately $474 thousand in interest and certain fees on loans originated, in addition to paying a fine of $12 thousand to resolve the matter. The Corporation has revised its comparative consolidated financial statements in the amount of $407 thousand, $315 thousand net of tax, for periods prior to January 1, 2018 related to interest and fees on loans. The error correction impacted beginning retained earnings, deferred tax assets and other liabilities as of January 1, 2018, as shown below.
The following table summarizes the impacts of the correction on the consolidated balance sheet as of January 1, 2018:
Reported
Corrections
Revised
Deferred income taxes
1,312
92
1,404
Other liabilities
5,426
407
5,833
Retained earnings
15,768
(315)
The following table summarizes the impacts of the correction on the consolidated balance sheet as of December 31, 2018:
The following table summarizes the impacts of the corrections to our capital ratios as of December 31, 2018:
December 31, 2018 - as reported
To be well capitalized under
For capital adequacy
prompt corrective action
Actual
purposes *
provisions
(dollars in thousands):
Amount
Ratio
Total capital (to risk-weighted assets)
122,577
71,577
89,472
Common equity tier 1 capital (to risk-weighted assets)
105,196
40,262
58,157
Tier 1 capital (to risk-weighted assets)
53,683
Tier 1 capital (to average assets)
37,578
46,972
December 31, 2018 - as revised
122,262
88,362
89,481
104,881
57,044
58,163
70,466
71,585
37,581
46,977
*Includes capital conservation buffer of 2.50% for 2019 and 1.875% for 2018.
(2) Earnings per Common Share
Basic earnings per common share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period. Diluted earnings per common share takes into account the potential dilution computed pursuant to the treasury stock method that could occur if stock options were exercised and converted into common stock. The effects of stock options are excluded from the computation of diluted earnings per share in periods in which the effect would be anti-dilutive.
Three Months Ended
Six Months Ended
Numerator:
Net income available to common stockholders
Denominator for basic earnings per share - weighted average shares outstanding
6,395
6,393
Effect of dilutive common shares
29
30
32
Denominator for diluted earnings per share - adjusted weighted average shares outstanding
6,436
6,425
Basic earnings per share
0.32
Diluted earnings per share
0.31
Antidilutive shares excluded from computation of average dilutive earnings per share
197
113
(3) Goodwill and Other Intangibles
The Corporation’s goodwill and intangible assets related to the acquisition of HJ Wealth in April 2017 are detailed below:
Balance
Amortization
Period
Expense
(in years)
Goodwill - Wealth
899
Indefinite
Total Goodwill
Intangible assets - trade name
266
Intangible assets - customer relationships
3,727
(103)
3,624
20
Intangible assets - non competition agreements
154
(34)
Total Intangible Assets
4,147
(137)
4,010
Accumulated amortization on intangible assets was $597 thousand and $290 thousand as of June 30, 2019 and 2018, respectively.
The Corporation performed its annual review of goodwill and identifiable intangible assets in accordance with ASC 350, “Intangibles - Goodwill and Other” as of December 31, 2018. For the period from January 1, 2019 through June 30, 2019, the Corporation determined there were no events that would necessitate impairment testing of goodwill and other intangible assets.
10
(4) Securities
The amortized cost and fair value of securities as of June 30, 2019 and December 31, 2018 are as follows:
June 30, 2019
Gross
Amortized
unrealized
Fair
cost
gains
losses
value
Securities available-for-sale:
U.S. asset backed securities
3,554
U.S. government agency mortgage-backed securities
12,658
(68)
12,682
U.S. government agency collateralized mortgage obligations
27,295
277
(80)
27,492
State and municipal securities
3,769
26
3,795
Investments in mutual funds
1,000
1,006
Total securities available-for-sale
48,276
401
(148)
Securities held to maturity:
U.S. Treasuries
1,997
(2)
1,995
10,290
195
10,485
Total securities held-to-maturity
12,480
December 31, 2018
24,092
(271)
23,866
14,754
(142)
14,664
11,096
(199)
10,919
(21)
979
50,942
119
(633)
1,991
(13)
1,978
10,750
17
(90)
10,677
12,655
At June 30, 2019, the Corporation had nine U.S. government sponsored agency mortgage‑backed securities, eight U.S. government sponsored agency collateralized mortgage obligations, and two U.S. treasuries in unrealized loss positions. At December 31, 2018, the Corporation had twenty-four U.S. government sponsored agency mortgage‑backed securities, twelve U.S. government sponsored agency collateralized mortgage obligations, twenty-six state and municipal securities, one mutual fund, and two U.S. treasuries in unrealized loss positions. Although the Corporation’s investment portfolio overall is in a net unrealized gain position at June 30, 2019, the temporary impairment in the above noted securities is primarily the result of changes in market interest rates subsequent to purchase and the Corporation does not intend to sell these securities prior to recovery and it is more likely than not that the Corporation will not be required to sell these securities prior to recovery to satisfy liquidity needs, and therefore, no securities are deemed to be other‑than‑temporarily impaired.
The following table shows the Corporation’s investment gross unrealized losses and fair value aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position at June 30, 2019 and December 31, 2018:
Less than 12 Months
12 Months or more
Unrealized
5,924
6,360
(37)
2,842
(43)
9,202
8,766
(111)
15,126
Securities held-to-maturity:
2,354
(6)
15,223
(265)
17,577
2,636
(14)
5,620
(128)
8,256
957
8,746
(188)
9,703
980
6,927
(52)
29,589
(581)
36,516
1,545
(5)
4,783
(85)
6,328
6,761
(98)
8,306
The amortized cost and carrying value of securities at June 30, 2019 and December 31, 2018 are shown below by contractual maturities. Actual maturities may differ from contractual maturities as issuers may have the right to call or repay obligations with or without call or prepayment penalties.
Available-for-sale
Held-to-maturity
Investment securities:
Due in one year or less
906
902
Due after one year through five years
1,536
1,542
3,736
3,785
1,236
1,226
3,154
3,148
Due after five years through ten years
1,209
1,218
6,554
6,700
6,411
6,290
7,596
7,529
Due after ten years
4,578
4,589
2,543
2,501
Subtotal
7,323
7,349
Mortgage-related securities
39,953
40,174
38,846
38,530
Mutual funds with no stated maturity
12
(5) Loans Receivable
Loans and leases outstanding at June 30, 2019 and December 31, 2018 are detailed by category as follows:
Mortgage loans held for sale
Real estate loans:
Commercial mortgage
336,566
325,393
Home equity lines and loans
82,381
82,286
Residential mortgage (1)
56,551
53,360
Construction
143,572
116,906
Total real estate loans
619,070
577,945
Commercial and industrial
266,442
259,806
Consumer
650
701
Leases, net
964
1,335
Total portfolio loans and leases
887,126
839,787
Total loans and leases
926,414
877,482
Loans with predetermined rates
295,200
264,376
Loans with adjustable or floating rates
631,214
613,106
Net deferred loan origination (fees) costs
(1,954)
(1,681)
(1)
Includes $12,381 and $11,422 of loans at fair value as of June 30, 2019 and December 31, 2018, respectively.
Components of the net investment in leases at June 30, 2019 and December 31, 2018 are detailed as follows:
Minimum lease payments receivable
1,016
1,420
Unearned lease income
13
Age Analysis of Past Due Loans and Leases
The following tables present an aging of the Corporation’s loan and lease portfolio as of June 30, 2019 and December 31, 2018, respectively:
90+ days
Accruing
Nonaccrual
30-89 days
past due and
Total past
Loans and
loans and
Total loans
Delinquency
past due
still accruing
due
Current
leases
and leases
percentage
335,414
0.34
%
419
81,883
82,302
79
0.60
193
54,337
54,530
2,021
3.92
303
143,242
143,545
0.23
283
398
681
265,296
265,977
465
0.43
Leases
134
830
13.90
1,332
1,730
881,652
883,382
3,744
0.62
(1) Includes $12,381 of loans at fair value as of June 30, 2019 ($11,002 of current, $189 of 30-89 days past due and $1,190 of nonaccrual).
324,169
1,224
0.38
348
81,855
82,203
83
0.52
51,018
51,213
2,147
4.39
217
259,112
259,329
0.27
49
1,286
3.67
809
835,047
835,856
3,931
0.56
(1) Includes $11,422 of loans at fair value as of December 31, 2018 ($10,098 of current, $187 of 30-89 days past due and $1,137 of nonaccrual).
(6) Allowance for Loan Losses (the “Allowance”)
The Allowance is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the Allowance, and subsequent recoveries, if any, are credited to the Allowance.
The Allowance is maintained at a level considered adequate to provide for losses that are probable and estimable. Management’s periodic evaluation of the adequacy of the Allowance is based on known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is subjective as it requires material estimates that may be susceptible to significant revisions as more information becomes available.
Roll-Forward of Allowance for Loan and Lease Losses by Portfolio Segment
The following tables detail the roll‑forward of the Corporation’s Allowance, by portfolio segment, for the three and six month periods ended June 30, 2019 and 2018, respectively:
Balance,
March 31, 2019
Charge-offs
Recoveries
Provision
3,163
2
3,197
Home Equity lines and loans
341
Residential mortgage
212
200
231
2,033
2,846
225
(241)
2,830
1
8,376
235
8,625
3,209
323
23
191
1,627
406
2,690
(183)
(3)
8,053
339
March 31, 2018
June 30, 2018
2,566
443
3,011
262
(71)
76
269
127
(22)
166
1,861
(423)
1,438
2,315
(114)
2,559
7,138
(185)
7,449
December 31, 2017
2,434
573
280
122
82
1,689
(251)
2,214
(194)
33
506
(4)
6,709
(331)
104
15
Allowance for Loan and Lease Losses Allocated by Portfolio Segment
The following tables detail the allocation of the allowance for loan and lease losses and the carrying value for loans and leases by portfolio segment based on the methodology used to evaluate the loans and leases for impairment as of June 30, 2019 and December 31, 2018.
Allowance on loans and leases
Carrying value of loans and leases
Individually
Collectively
evaluated
for impairment
1,842
334,724
857
43,313
44,170
1,278
142,294
172
2,658
265,004
8,453
5,494
869,251
874,745
1,929
323,464
969
40,969
41,938
1,281
115,625
103
2,587
1,537
258,269
7,950
5,799
822,566
828,365
Excludes deferred fees and loans carried at fair value.
Loans and Leases by Credit Ratings
As part of the process of determining the Allowance to the different segments of the loan and lease portfolio, management considers certain credit quality indicators. For the commercial mortgage, construction and commercial and industrial loan segments, periodic reviews of the individual loans are performed by management. The results of these reviews are reflected in the risk grade assigned to each loan. These internally assigned grades are as follows:
·
Pass - Loans considered to be satisfactory with no indications of deterioration.
Special mention – Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard – Loans classified as substandard are inadequately protected by the current net worth and payment capacity of the obligor or of the collateral pledged, if any. Substandard loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of
currently existing factors, conditions, and values, highly questionable and improbable. Loan balances classified as doubtful have been reduced by partial charge-offs and are carried at their net realizable values.
The following tables detail the carrying value of loans and leases by portfolio segment based on the credit quality indicators used to determine the allowance for loan and lease losses as of June 30, 2019 and December 31, 2018:
Special
Pass
mention
Substandard
Doubtful
330,710
2,064
3,792
82,218
163
140,739
2,806
241,906
4,876
19,630
795,573
9,746
23,612
828,961
320,130
3,713
1,550
82,121
165
114,249
2,657
239,181
12,620
7,975
755,681
18,990
9,690
784,391
In addition to credit quality indicators as shown in the above tables, allowance allocations for residential mortgages, consumer loans and leases are also applied based on their performance status as of June 30, 2019 and December 31, 2018. No troubled debt restructurings performing according to modified terms are included in performing residential mortgages below as of June 30, 2019 and December 31, 2018.
Performing
Nonperforming
44,927
45,784
43,005
43,974
There were six nonperforming residential mortgage loans at June 30, 2019 and December 31, 2018 with a combined outstanding principal balance of $1.2 million and $1.9 million, respectively, which were carried at fair value and not included in the table above.
Impaired Loans
The following tables detail the recorded investment and principal balance of impaired loans by portfolio segment, their related allowance for loan and lease losses and interest income recognized for the periods.
At June 30, 2019
At December 31, 2018
Average
Recorded
Principal
Related
recorded
investment
balance
allowance
Impaired loans with related allowance:
666
669
671
676
679
680
Impaired loans without related allowance:
2,335
1,890
1,982
772
859
794
861
945
885
89
81
84
978
1,287
1,293
4,828
5,418
5,123
5,672
5,222
Grand Total
6,087
5,580
6,351
5,902
Interest income recognized on performing impaired loans amounted to $53 thousand and $73 thousand for the three months ended June 30, 2019 and 2018, respectively, and $102 thousand and $125 thousand for the six months ended June 30, 2019 and 2018, respectively.
Troubled Debt Restructuring
The restructuring of a loan is considered a “troubled debt restructuring” (“TDR”) if both of the following conditions are met: (i) the borrower is experiencing financial difficulties, and (ii) the creditor has granted a concession. The most common concessions granted include one or more modifications to the terms of the debt, such as (a) a reduction in the interest rate for the remaining life of the debt, (b) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk, (c) a temporary period of interest-only payments, (d) a reduction in the contractual payment amount for either a short period or remaining term of the loan, and (e) for leases, a reduced lease payment. A less common concession granted is the forgiveness of a portion of the principal.
The determination of whether a borrower is experiencing financial difficulties takes into account not only the current financial condition of the borrower, but also the potential financial condition of the borrower were a concession not granted. The determination of whether a concession has been granted is subjective in nature. For example, simply extending the term of a loan at its original interest rate or even at a higher interest rate could be interpreted as a concession unless the borrower could readily obtain similar credit terms from a different lender.
18
The balance of TDRs at June 30, 2019 and December 31, 2018 are as follows:
TDRs included in nonperforming loans and leases
1,160
1,219
TDRs in compliance with modified terms
2,914
3,047
Total TDRs
4,074
4,266
There were no loan and lease modifications granted during the three and six months ended June 30, 2019 that were categorized as TDRs.
The following table presents information regarding loan and lease modifications granted during the three and six months ended June 30, 2018 that were categorized as TDRs:
For the Three and Six Months Ended June 30, 2018
Pre-Modification
Post-Modification
Outstanding
Number of
(dollar in thousands)
Contracts
Investment
Allowance
Real Estate:
Land and Construction
1,614
1,734
No loan and lease modifications granted during the three and six months ended June 30, 2019 and 2018 subsequently defaulted during the same time period.
The following table presents information regarding the number of contracts by type of loan and lease modifications granted during the three and six months ended June 30, 2018:
Interest Rate
Loan Term
Change and Loan
Extension
Term Extension
(7) Short-Term Borrowings and Long‑Term Debt
The Corporation’s short‑term borrowings generally consist of federal funds purchased and short‑term borrowings extended under agreements with the Federal Home Loan Bank of Pittsburgh (“FHLB”). The Corporation has two unsecured Federal Funds borrowing facilities with correspondent banks: one of $24 million and one of $15 million. Federal funds purchased generally represent one-day borrowings. The Corporation had no Federal funds purchased at June 30, 2019 and December 31, 2018. The Corporation also has a facility with the Federal Reserve discount window of $9.6 million. This facility is fully secured by investment securities and loans. There were no borrowings under this facility at June 30, 2019 or at December 31, 2018.
Short‑term borrowings as of June 30, 2019 consisted of short‑term advances from the FHLB of Pittsburgh in the amount of $71.9 million with interest at 2.46%, and $3.1 million with an original term of 3 years with interest at 2.03%.
19
Short‑term borrowings as of December 31, 2018 consisted of short-term advances from the FHLB of Pittsburgh in the amount of $112.5 million with interest at 2.62%, and $1.8 million with an original term of 4 years and interest at 1.70%.
Long‑term debt at June 30, 2019 and December 31, 2018 consisted of the following fixed rate notes with the FHLB and the acquisition purchase note for the Wealth division:
Balance as of
Maturity
date
rate
Mid-term Repo-fixed
08/10/20
2.76
5,000
06/28/21
1.88
Acquisition Purchase Note
04/01/20
3.00
825
1,238
The FHLB of Pittsburgh has also issued $79.8 million of letters of credit to the Corporation for the benefit of the Corporation’s public deposit funds and loan customers. These letters of credit expire by June 19, 2020. The Corporation has a maximum borrowing capacity with the FHLB of $477.7 million as of June 30, 2019 and $437.2 million as of December 31, 2018. All advances and letters of credit from the FHLB are secured by a blanket lien on non-pledged, mortgage-related loans and securities as part of the Corporation’s borrowing agreement with the FHLB.
(8) Stock-Based Compensation
The Corporation has issued stock options under the Meridian Bank 2004 Stock Option Plan (2004 Plan). The 2004 Plan authorized the Board of Directors to grant options up to an aggregate of 446,091 shares, as adjusted for the 5% stock dividends in 2012, 2014 and 2016 to officers, other employees and directors of the Corporation. No additional shares are available for future grants. The shares granted under the 2004 Plan to directors are nonqualified options. The shares granted under the 2004 Plan to officers and other employees are incentive stock options, and are subject to the limitations under Section 422 of the Internal Revenue Code.
The Corporation has issued stock options under the Meridian Bank 2016 Equity Incentive Plan (2016 Plan), which was amended on May 24, 2018 to authorize the Board of Directors to grant options up to an aggregate of 686,900 shares, adjusted for the 2016 5% stock dividend. A total of 128,450 shares have been granted under the 2016 plan through December 31, 2018. Shares granted under the 2016 Plan to directors are nonqualified options, while shares granted to officers and other employees are incentive stock options, and are subject to the limitations under Section 422 of the Internal Revenue Code.
Stock-based compensation cost is measured at the grant date, based on the fair value of the award and is recognized as an expense over the vesting period. The fair value of stock option grants is determined using the Black-Scholes pricing model. The assumptions necessary for the calculation of the fair value are expected life of options, annual volatility of stock price, risk-free interest rate and annual dividend yield.
All awards granted under the 2004 and 2016 Plan’s have a term that does not exceed ten years and vest 25% upon grant and become fully exercisable after three years of service from the grant date.
The following table provides information about options outstanding for the three months ended June 30, 2019:
Weighted
Exercise
Grant Date
Shares
Price
Fair Value
Outstanding at March 31, 2019
275,070
15.88
4.46
Granted
71,000
17.01
4.89
Outstanding at June 30, 2019
346,070
16.11
4.55
Exercisable at June 30, 2019
233,522
15.43
4.34
Nonvested at June 30, 2019
112,548
17.53
4.99
The following table provides information about options outstanding for the six months ended June 30, 2019:
Outstanding at December 31, 2018
274,070
72,000
4.90
The weighted average remaining contractual life of the outstanding stock options at June 30, 2019 is 7.7 years. The range of exercise prices is $9.88 to $19.00. The aggregate intrinsic value of options outstanding and exercisable was $442 thousand as of June 30, 2019.
The fair value of each option granted in 2019 was estimated on the date of grant using the Black‑Scholes option‑pricing model with the following weighted average assumptions: dividend yield of 0.0%, risk‑free interest rate of between 1.95% and 2.61%, expected life of 5.75 years, and expected volatility of between 22.44% and 22.48% based on an average of the Corporation’s share price since going public and the expected volatility of similar public financial institutions in the Corporation’s market area for the period before the Corporation went public. The weighted average fair value of options granted in 2019 was $4.89 to $5.30 per share.
The fair value of each option granted in 2018 was estimated on the date of grant using the Black‑Scholes option‑pricing model with the following weighted average assumptions: dividend yield of 0.0%, risk‑free interest rate of 2.86%, expected life of 5.75 years, and expected volatility of 26.11% based on an average of the Bank’s share price since going public and the expected volatility of similar public financial institutions in the Bank’s market area for the period before the Bank went public. The weighted average fair value of options granted in 2018 was $5.52 per share.
Total stock compensation cost for the three months ended June 30, 2019 and 2018 was $144 thousand and $272 thousand, respectively, and for the six months ended June 30, 2019 and 2018 was $204 thousand and $275 thousand, respectively. During the three and six months ended June 30, 2019, there were no tax benefits recognized related to stock compensation cost.
In accordance with ASU 2016-09, forfeitures are recognized as they occur instead of applying an estimated forfeiture rate to each grant. For purposes of the determination of stock-based compensation expense for the three and six month periods ended June 30, 2019, there were no forfeitures.
As of June 30, 2019, there was $512 thousand of unrecognized compensation cost related to nonvested stock options. This cost will be recognized over a weighted average period of 1.55 years.
(9) Fair Value Measurements and Disclosures
The Corporation uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation techniques or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
In accordance with this guidance, the Corporation groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 – Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.
For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2019 and December 31, 2018 are as follows:
Level 1
Level 2
Level 3
Securities available for sale:
Investments in mutual funds and other equity securities
4,560
Mortgage loans held-for-sale
Mortgage loans held-for-investment
12,381
Interest rate lock commitments
375
Customer derivatives - Interest rate swaps
365
100,938
100,563
11,422
310
141
99,996
99,686
For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2019 and December 31, 2018 are as follows:
Impaired loans (1)
5,322
Other real estate owned (2)
5,442
Impaired loans are those in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input is significant to the fair value measurements.
Real estate properties acquired through, or in lieu of, foreclosure are to be sold and are carried at fair value less estimated cost to sell. Fair value is based upon independent market prices or appraised value of the property. These assets are included in Level 3 fair value based upon the lowest level of input that is significant to the fair value measurement. Appraised values may be discounted based on management’s expertise, historical knowledge, changes in market conditions from the time of valuation and/or estimated costs to sell.
Below is management’s estimate of the fair value of all financial instruments, whether carried at cost or fair value on the Corporation’s balance sheet. The following information should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair value of the Corporation’s financial instruments:
(a) Cash and Cash Equivalents
The carrying amounts reported in the balance sheet for cash and short‑term instruments approximate those assets’ fair values.
(b) Securities
The fair value of securities available‑for‑sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.
(c) Mortgage Loans Held for Sale
The fair value of mortgage loans held for sale is based on secondary market prices.
(d) Loans Receivable
The fair value of loans receivable is estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate‑risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value below is not reflective of an exit price.
(e) Mortgage Loans Held for Investment
The fair value of mortgage loans held for investment is based on the price secondary markets are currently offering for similar loans using observable market data.
(f) Impaired Loans
Impaired loans are those in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third‑party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.
(g) Restricted Investment in Bank Stock
The carrying amount of restricted investment in bank stock approximates fair value, and considers the limited marketability of such securities.
(h) Accrued Interest Receivable and Payable
The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.
24
(i) Deposit Liabilities
The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed‑rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.
(j) Short‑Term Borrowings
The carrying amounts of short‑term borrowings approximate their fair values.
(k) Long‑Term Debt
Fair values of FHLB advances and the acquisition purchase note payable are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.
(l) Subordinated Debt
Fair values of junior subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity.
(m) Off‑Balance Sheet Financial Instruments
Off-balance sheet instruments are primarily comprised of loan commitments, which are generally priced at market at the time of funding. Fees on commitments to extend credit and stand-by letters of credit are deemed to be immaterial and these instruments are expected to be settled at face value or expire unused. It is impractical to assign any fair value to these instruments and as a result they are not included in the table below. Fair values assigned to the notional value of interest rate lock commitments and forward sale contracts are based on market quotes.
(n) Derivative Financial Instruments
The fair value of forward commitments and interest rate swaps is based on market pricing and therefore are considered Level 2. Derivatives classified as Level 3 consist of interest rate lock commitments related to mortgage loan commitments. The determination of fair value includes assumptions related to the likelihood that a commitment will ultimately result in a closed loan, which is a significant unobservable assumption. A significant increase or decrease in the external market price would result in a significantly higher or lower fair value measurement.
25
The estimated fair values of the Corporation’s financial instruments at June 30, 2019 and December 31, 2018 are as follows:
Carrying
Hierarchy Level
amount
Fair value
Financial assets:
Securities available-for-sale
Securities held-to-maturity
Loans receivable, net
864,166
886,636
818,631
820,512
Forward commitments
Financial liabilities:
857,000
744,300
8,950
6,240
9,687
9,396
71
40
203
176
410
161
Notional
Off-balance sheet financial instruments:
Commitments to extend credit
320,123
290,614
Letters of credit
9,478
5,158
The following table includes a rollforward of interest rate lock commitments for which the Corporation utilized Level 3 inputs to determine fair value on a recurring basis for the three and six month peiods ended June 30, 2019 and 2018.
Three Months Ended June 30,
Six Months Ended June 30,
Balance at beginning of the period
329
586
344
(Decrease) increase in value
46
65
Balance at end of the period
Significant
Valuation Techniques for Level 3 interest rate lock
Unobservable
Range of
commitments as of June 30, 2019
Valuation Technique
Input
Inputs
Market comparable pricing
Pull through
1 - 99
89.54
A realized loss of $16 thousand and a realized gain of $138 thousand due to changes in the fair value of interest rate lock commitments which are classified as Level 3 assets and liabilities for the three months ended June 30, 2019 and 2018, respectively, and realized losses of $34 thousand and $114 thousand for the six months ended June 30, 2019 and 2018, respectively, are recorded in non-interest income as net change in the fair value of derivative instruments in the Corporation’s consolidated statements of income.
(10) Derivative Financial Instruments
Risk Management Objective of Using Derivatives
The Corporation is exposed to certain risk arising from both its business operations and economic conditions. The Corporation principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Corporation manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Corporation enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Corporation’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Corporation’s known or expected cash receipts and its known or expected cash payments principally related to the Corporation’s lending function.
Mortgage Banking Derivatives
In connection with its mortgage banking activities, the Corporation enters into commitments to originate certain fixed rate residential mortgage loans for customers, also referred to as interest rate locks. In addition, the Corporation enters into forward commitments for the future sales or purchases of mortgage-backed securities to or from third-party counterparties to hedge the effect of changes in interest rates on the values of both the interest rate locks and mortgage loans held for sale. Forward sales commitments may also be in the form of commitments to sell individual mortgage loans or interest rate locks at a fixed price at a future date. The amount necessary to settle each interest rate lock is based on the price that secondary market investors would pay for loans with similar characteristics, including interest rate and term, as of the date fair value is measured. Interest rate lock commitments and forward commitments are recorded within other assets/liabilities on the consolidated balance sheets, with changes in fair values during the period recorded within net change in the fair value of derivative instruments on the unaudited consolidated statements of income.
Customer Derivatives – Interest Rate Swaps
Derivatives not designated as hedges are not speculative and result from a service the Corporation provides to certain customers to swap a fixed rate product for a variable rate product, or vice versa. The Corporation executes interest rate derivatives with commercial banking customers to facilitate their respective risk management strategies. Those interest rate derivatives are simultaneously hedged by offsetting derivatives that the Corporation executes with a third party, such that the Corporation minimizes its net interest rate risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings.
The following table presents a summary of the notional amounts and fair values of derivative financial instruments:
Balance Sheet Line Item
NotionalAmount
Asset(Liability)Fair Value
Interest Rate Lock Commitments
Positive fair values
50,137
27,188
Negative fair values
12,076
6,218
(40)
62,213
304
33,406
270
Forward Commitments
4,000
48,000
(203)
26,500
(176)
52,000
Customer Derivatives - Interest Rate Swaps
3,303
3,330
(410)
(161)
6,606
(45)
6,660
(20)
Total derivative financial instruments
120,819
66,566
74
Interest rate lock commitments are considered Level 3 in the fair value hierarchy, while the forward commitments and interest rate swaps are considered Level 2 in the fair value hierarchy.
The following table presents a summary of the fair value gains and losses on derivative financial instruments:
(138)
114
(31)
(23)
(125)
(27)
Net fair value gains (losses) on derivative financial instruments
Realized gains/(losses) on derivatives were ($218) thousand and $4 thousand for the three months ended June 30, 2019 and 2018, respectively, and ($493) and $704 thousand for the six months ended June 30, 2019 and 2018, respectively, and are included in other non-interest income in the unaudited consolidated statements of income.
(11) Segments
ASC Topic 280 – Segment Reporting identifies operating segments as components of an enterprise which are evaluated regularly by the Corporation’s Chief Operating Decision Maker, our Chief Executive Officer, in deciding how to allocate resources and assess performance. The Corporation has applied the aggregation criterion set forth in this codification to the results of its operations.
Our Banking segment consists of commercial and retail banking. The Banking segment generates interest income from its lending (including leasing) and investing activities and is dependent on the gathering of lower cost deposits from its branch network or borrowed funds from other sources for funding its loans, resulting in the generation of net interest income. The Banking segment also derives revenues from other sources including gains on the sale of available for sale investment securities, gains on the sale of loans, service charges on deposit accounts, cash sweep fees, overdraft fees, BOLI income.
Meridian Wealth Partners (“Wealth”), a registered investment advisor and wholly-owned subsidiary of the Bank, provides a comprehensive array of wealth management services and products and the trusted guidance to help its clients and our banking customers prepare for the future. The unit generates non-interest income through advisory fees.
Meridian’s mortgage banking segment (“Mortgage”) consists of one central loan production facility and several loan production offices located throughout the Delaware Valley. The Mortgage segment originates 1 – 4 family residential mortgages and sells all of its production, including servicing to third party investors. The unit generates net interest income on the loans it originates, earns margin income (primarily gain on sales), as well as other fee income.
The table below summarizes income and expenses, directly attributable to each business line, which has been included in the statement of operations.
Three Months Ended June 30, 2019
Three Months Ended June 30, 2018
Bank
Wealth
Mortgage
8,855
41
7,964
Net interest income after provision
8,841
7,551
Non-interest Income
6,259
7,299
879
926
SBA income
Net change in fair values
(152)
(168)
(171)
498
(150)
459
80
539
1,092
5,957
534
7,208
Non-interest Expense
4,066
551
4,125
3,634
439
5,309
372
544
37
409
391
309
170
484
156
361
160
1,757
1,233
3,127
1,345
1,093
2,594
Total non-interest expense
7,232
817
6,195
6,188
745
7,141
Operating Margin
2,701
88
(197)
1,897
187
Six Months Ended June 30, 2019
Six Months Ended June 30, 2018
17,234
64
15,490
146
202
17,001
14,523
101
11,128
43
12,090
78
1,698
1,976
(28)
290
877
(284)
593
773
890
1,663
1,543
11,134
12,842
7,739
1,117
7,613
7,126
928
9,764
1,057
782
1,078
70
802
706
735
210
740
167
289
616
208
388
3,155
285
2,176
5,616
2,568
299
1,833
4,700
13,397
1,638
11,325
12,123
1,516
12,997
5,147
124
(91)
3,306
606
47
(12) Recent Litigation
On November 21, 2017, three former employees of the mortgage-banking division of the Bank filed suit in the United States District Court for the Eastern District of Pennsylvania, Juan Jordan et al. v. Meridian Bank, Thomas Campbell and Christopher Annas, against the Bank purporting to be a class and collective action seeking unpaid and overtime wages under the Fair Labor Standards Act of 1938, the New Jersey Wage and Hour Law, and the Pennsylvania Minimum Wage Act of 1968 on behalf of similarly situated plaintiffs. In June 2019, plaintiffs’ counsel and the Bank agreed to move forward with non-binding mediation. Although the Bank believes it had strong and meritorious defenses, given the expense and inconvenience of litigation, on July 24, 2019 through mediation, the Bank reached an agreement in principle with the plaintiffs to settle this litigation for $990 thousand in total. The Bank had a litigation reserve of $325 thousand at March 31, 2019 and expensed an additional $665 thousand for the three months ended June 30, 2019. The parties are negotiating the definitive settlement agreement that will conclude this matter, which will need to be approved by the Court.
(13) Recent Accounting Pronouncements
As an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”), Meridian Corporation is permitted an extended transition period for complying with new or revised accounting standards affecting public companies. We will remain an emerging growth company until the earliest of (i) the end of the fiscal year during which we have total annual gross revenues of $1,070,000,000 or more, (ii) the end of the fiscal year following the fifth anniversary of the completion of our initial offering, (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt and (iv) the end of the fiscal year in which the market value of our equity securities that are held by non-affiliates exceeds $700 million as of June 30 of that year. We have elected to take advantage of this extended transition period, which means that the financial statements included herein, as well as any financial statements that we file in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as we remain an emerging growth company or until we affirmatively and irrevocably opt out of the extended transition period under the JOBS Act. If we do so, we will prominently disclose this decision in the first periodic report following our decision, and such decision is irrevocable. As a filer under the JOBS Act, we will implement new accounting standards subject to the effective dates required for non-public entities.
FASB ASU 2014‑09 (Topic 606), “Revenue from Contracts with Customers”
Issued in May 2014, ASU 2014‑09 will require an entity to recognize revenue when it transfers promised goods or services to customers using a five-step model that requires entities to exercise judgment when considering the terms of the contracts. In August 2015, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2015‑14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. This amendment defers the effective date of ASU 2014‑09 by one year. In March 2016, the FASB issued ASU 2016‑ 08”, “Principal versus Agent Considerations (Reporting Gross versus Net),” which amends the principal versus agent guidance and clarifies that the analysis must focus on whether the entity has control of the goods or services before they are transferred to the customer. In addition, the FASB issued ASU Nos. 2016‑20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers” and 2016‑12, “Narrow-Scope Improvements and Practical Expedients”, both of which provide additional clarification of certain provisions in Topic 606. These Accounting Standards Codification (“ASC”) updates are effective for public companies for annual reporting periods beginning after December 15, 2017, but early adoption is permitted. Early adoption is permitted only as of annual reporting periods after December 15, 2016. The standard permits the use of either the ‘retrospective’ or ‘retrospectively with the cumulative effect’ transition method. For non-public companies, the ASC updates are effective for annual reporting periods beginning after December 15, 2018, and interim periods beginning after December 15, 2019. The Corporation’s revenue is the sum of net interest income and non-interest income. The scope of the guidance excludes nearly all net interest income as well as many other revenues for financial assets and liabilities including loans, leases, securities, and derivatives. The Corporation performed a review and determined that the majority of non-interest income revenue streams are within the scope of the new standard. Non-interest income streams that are out of scope of the new standard include BOLI, sales of investment securities, mortgage banking activities, and certain items within service charges and other income. Management is finalizing a review of contracts related to service charges on deposits, investment advisory commissions and fee income, and certain items within other service charges and other income. Management is currently assessing the potential impact of ASU. The Corporation will adopt this ASU as of December 31, 2019.
FASB ASU 2017-05 (Topic 610), “Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets”
Issued in February 2017, ASU 2017-05 provides clarification of the scope of ASC 610-20. Specifically, the new guidance clarifies that ASC 610-20 applies to nonfinancial assets which do not meet the definition of a business or not-for-profit activity. Further, the new guidance clarifies that a financial asset is within the scope of ASC 610-20 if it meets the definition of an in-substance nonfinancial asset which is defined as a financial asset promised to a counterparty in a contract where substantially all of the assets promised are nonfinancial. Finally, the new guidance clarifies that each distinct nonfinancial asset and insubstance nonfinancial asset should be derecognized when the
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counterparty obtains control of it. Management is currently assessing the potential impact of ASU. The Corporation will adopt this ASU as of December 31, 2019.
FASB ASU 2017‑01 (Topic 805), “Business Combinations”
Issued in January 2017, ASU 2017‑01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. ASU 2017‑01 is effective for public companies for annual periods beginning after December 15, 2017 including interim periods within those periods, while for non-public companies the ASU is effective for annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019. The Corporation will adopt this ASU as of December 31, 2019 and does not expect the adoption of this ASU to have a material impact on our Consolidated Financial Statements and related disclosures.
FASB ASU 2016‑15 (Topic 320), “Classification of Certain Cash Receipts and Cash Payments”
Issued in August 2016, ASU 2016‑15 provides guidance on eight specific cash flow issues and their disclosure in the consolidated statements of cash flows. The issues addressed include debt prepayment, settlement of zero-coupon debt, contingent consideration in business combinations, proceeds from settlement of insurance claims, proceeds from settlement of BOLI, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the Predominance principle. ASU 2016‑15 is effective for public companies for the annual and interim periods in fiscal years beginning after December 15, 2017, with early adoption permitted. For non-public companies ASU 2016‑15 is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. The Corporation will adopt this ASU as of December 31, 2019 and does not expect the adoption of this ASU to have a material impact on our Consolidated Financial Statements and related disclosures.
FASB ASU 2016‑13 (Topic 326), “Measurement of Credit Losses on Financial Instruments”
Issued in June 2016, ASU 2016‑13 significantly changes how companies measure and recognize credit impairment for many financial assets. This ASU requires businesses and other organizations to measure the current expected credit losses (“CECL”) on financial assets, such as loans, net investments in leases, certain debt securities, bond insurance and other receivables. The amendments affect entities holding financial assets and net investments in leases that are not accounted for at fair value through net income. Current GAAP requires an incurred loss methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. The amendments in this ASU replace the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonableness and supportable information to inform credit loss estimates. An entity should apply the amendments through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (modified retrospective approach). Acquired credit impaired loans for which the guidance in Accounting Standards Codification (ASC) Topic 310-30 has been previously applied should prospectively apply the guidance in this ASU. A prospective transition approach is required for debt securities for which an other-than-temporary impairment has been recognized before the effective date. ASU 2016‑13 is effective for public companies for the annual and interim periods in fiscal years beginning after December 15, 2019, with early adoption permitted. For non-public companies the ASU is effective for fiscal years and interim periods beginning after December 15, 2021, or January 1, 2022 for the Corporation. The Corporation has assembled a cross-functional team from Finance, Credit, and IT that is leading the implementation efforts to evaluate the impact of this guidance on the Corporation's Consolidated Financial Statements and related disclosures, internal systems, accounting policies, processes and related internal controls.
FASB ASU 2016‑02 (Topic 842), “Leases”
Issued in February 2016, ASU 2016‑02 revises the accounting related to lessee accounting. Under the new guidance, lessees will be required to recognize a lease liability and a right-of-use asset for all leases. The new lease guidance also simplifies the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. ASU 2016‑02 is effective for public companies for the first interim period within annual periods beginning after December 15, 2018, with early adoption permitted. For non-public companies the ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within the fiscal years beginning after December 31, 2020. In July 2018 ASU 2018-11 was issued which creates a new, optional transition method for implementing ASU 2016-02 and a lessor practical expedient for separating lease and non-lease components and has the same effective date as ASU 2016-02. Under the optional transition method of ASU 2018-11, the Corporation may initially apply the new lease standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Corporation is evaluating the effects that ASU 2016‑02 and ASU 2018-11 will have on our Consolidated Financial Statements and related disclosures and expects to adopt these ASU’s as of December 31, 2020.
FASB ASU 2016‑01 (Subtopic 825‑10), “Financial Instruments – Overall, Recognition and Measurement of Financial Assets and Financial Liabilities”
Issued in January 2016, ASU 2016‑01 provides that equity investments will be measured at fair value with changes in fair value recognized in net income. When fair value is not readily determinable, an entity may elect to measure the equity investment at cost, minus impairment, plus or minus any change in the investment’s observable price. For financial liabilities that are measured at fair value, the amendment requires an entity to present separately, in other comprehensive income, any change in fair value resulting from a change in instrument-specific credit risk. For public companies, ASU 2016‑01 will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For non-public companies the ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within the fiscal years beginning after December 31, 2019. Early adoption is permitted. Entities may apply this guidance on a prospective or retrospective basis. ASU 2018‑03, Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825‑10) clarifies certain aspects of ASU 2016‑01 and has the same effective dates for non-public companies. The Corporation is evaluating the effects that ASU 2016‑01 and ASU 2018‑03 will have on our Consolidated Financial Statements and related disclosures upon our adoption as of December 31, 2019.
FASB ASU 2017‑08 (Subtopic 310‑20), “Nonrefundable Fees and Other Costs (Subtopic 310‑20): Premium Amortization on Purchased Callable Debt Securities”
Issued in March 2017, ASU 2017‑08 shortens the amortization period for certain callable debt securities held at a premium. Specifically, the amendment requires the premium to be amortized to the earliest call date. The amendment does not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. For public business entities, the amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. For non-public companies the ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within the fiscal years beginning after December 31, 2020. The Corporation is evaluating the effect that ASU 2017‑08 will have on our Consolidated Financial Statements and related disclosures upon our adoption as of December 31, 2019.
FASB ASU 2017‑12 (Subtopic 815), “Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities”
Issued in August 2017, ASU 2017‑12 better aligns hedge accounting with an organization’s risk management activities in the financial statements. In addition, the ASU simplifies the application of hedge accounting guidance in areas where practice issues exist. Specifically, the proposed ASU eases the requirements for effectiveness testing,
hedge documentation and application of the shortcut and the critical terms match methods. Entities would be permitted to designate contractually specified components as the hedged risk in a cash flow hedge involving the purchase or sale of nonfinancial assets or variable rate financial instruments. In addition, entities would no longer separately measure and report hedge ineffectiveness. Also, entities, may choose refined measurement techniques to determine the changes in fair value of the hedged item in fair value hedges of benchmark interest rate risk. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020. Early application is permitted in any interim period after issuance of the ASU for existing hedging relationships on the date of adoption and the effect of adoption should be reflected as of the beginning of the fiscal year of adoption (that is, the initial application date). The Corporation has evaluated ASU 2017‑12, and has determined it has no current hedging strategies for which it plans to implement the ASU but we will consider the impact of the ASU on future hedging strategies that may arise.
FASB ASU 2018-16 (Subtopic 815), “Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes”
In October 2018 ASU 2018-16 was issued. The new guidance applies to all entities that elect to apply hedge accounting to benchmark interest rate hedges under Topic 815. It permits the use of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes in addition to the existing applicable rates. The guidance is required to be adopted concurrently with ASU 2017-12, on a prospective basis for qualifying new or redesignated hedging relationships entered into on or after adoption. The Corporation will adopt this ASU as of December 31, 2020 and does not anticipate the adoption of this ASU to have a material impact on our Consolidated Financial Statements and related disclosures.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis in conjunction with the unaudited consolidated interim financial statements contained in Part I, Item 1 of this Quarterly Report on Form 10‑Q and the audited consolidated financial statements and the related notes and the discussion under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the year ended December 31, 2018 (the “2018 10‑K”) included in Meridian Corporation’s Annual Report on Form 10‑K filed with the Securities and Exchange Commission (the “SEC”).
Cautionary Statement Regarding Forward-Looking Statements
Meridian Corporation (the “Corporation”) may from time to time make written or oral “forward-looking statements” within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with respect to Meridian Corporation’s strategies, goals, beliefs, expectations, estimates, intentions, capital raising efforts, financial condition and results of operations, future performance and business. Statements preceded by, followed by, or that include the words “may,” “could,” “should,” “pro forma,” “looking forward,” “would,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” or similar expressions generally indicate a forward-looking statement. These forward-looking statements involve risks and uncertainties that are subject to change based on various important factors (some of which, in whole or in part, are beyond Meridian Corporation’s control). Numerous competitive, economic, regulatory, legal and technological factors, among others, could cause Meridian Corporation’s financial performance to differ materially from the goals, plans, objectives, intentions and expectations expressed in such forward-looking statements. Meridian Corporation cautions that the foregoing factors are not exclusive, and neither such factors nor any such forward-looking statement takes into account the impact of any future events. All forward-looking statements and information set forth herein are based on management’s current beliefs and assumptions as of the date hereof and speak only as of the date they are made. For a more complete discussion of the assumptions, risks and uncertainties related to our business, you are encouraged to review Meridian Corporation’s filings with the Securities and Exchange Commission (including our Annual Report on Form 10-K for the year ended December 31, 2018) and, for periods prior to the completion of the holding company reorganization, Meridian Bank’s filings with the FDIC, including Meridian Bank’s Annual Report on Form 10-K for the year ended December 31, 2017, subsequently filed quarterly reports on Form 10-Q and current reports on Form 8-K that update or provide information in addition to the information included in the Form 10-K and Form 10-Q filings, if any. Meridian Corporation does not undertake to update any forward-looking
statement whether written or oral, that may be made from time to time by Meridian Corporation or by or on behalf of Meridian Bank.
Critical Accounting Policies, Judgments and Estimates
Our accounting and reporting policies conform to GAAP and conform to general practices within the industry in which we operate. To prepare financial statements in conformity with GAAP, management makes estimates, assumptions and judgments based on available information. These estimates, assumptions and judgments affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgements are based on information available as of the date of the financial statements and, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statements. In particular, management has identified the provision and allowance for loan losses as the accounting policy that, due to the estimates, assumptions and judgements inherent in that policy, is critical in understanding our financial statements. Management has presented the application of this policy to the audit committee of our board of directors.
This critical accounting policy, along with other significant accounting policies, are presented in in Footnote 1 of the Corporation’s Consolidated Financial Statements as of and for the years ended December 31, 2018 and 2017 included in the Annual Report on Form 10‑K.
Executive Overview
The following items highlight the Corporation’s results of operations for the three and six months ended June 30, 2019, as compared to the same periods in 2018, and the changes in its financial condition as of June 30, 2019 as compared to December 31, 2018. More detailed information related to these highlights can be found in the sections that follow.
Three Month Results of Operations
Net income for the three months ended June 30, 2019 was $2.0 million, or $0.31 per diluted share, an increase of $220 thousand as compared to net income of $1.8 million, or $0.28 per diluted share, for the same period in 2018.
Return on average equity (“ROE”) and return on average assets (“ROA”) for the three months ended June 30, 2019 were 7.14% and 0.81%, respectively.
Net interest income increased $776 thousand, or 9.5%, to $8.9 million for the three months ended June 30, 2019, as compared to $8.1 million for the same period in 2018.
Provision for loan and lease losses (the “Provision”) of $14 thousand for the three months ended June 30, 2019 was a decrease of $399 thousand from the $413 thousand Provision recorded for the same period in 2018.
Non-interest income of $7.9 million for the three months ended June 30, 2019 was a $740 thousand or 8.5% decrease from the same period in 2018.
Mortgage banking income decreased $991 thousand, or 13.6%, to $6.3 million for the three months ended June 30, 2019, as compared to $7.3 million for the same period in 2018.
Non-interest expense of $14.2 million for the three months ended June 30, 2019 increased $170 thousand, or 1.2%, from $14.1 million for the same period in 2018.
Six Month Results of Operations
Net income for the six months ended June 30, 2019 was $4.0 million, or $0.63 per diluted share, an increase of $956 thousand as compared to net income of $3.1 million, or $0.48 per diluted share, for the same period in 2018.
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ROE and ROA for the six months ended June 30, 2019 were 7.22% and 0.82%, respectively.
Net interest income increased $1.6 million, or 9.9%, to $17.4 million for the six months ended June 30, 2019, as compared to $15.8 million for the same period in 2018.
The Provision of $233 thousand for the six months ended June 30, 2019 was a decrease of $734 thousand from the $967 thousand Provision recorded for the same period in 2018.
Non-interest income of $14.4 million for the six months ended June 30, 2019 was a $1.4 million or 8.6% decrease from the same period in 2018.
Mortgage banking income decreased $904 thousand, or 7.5%, to $11.2 million for the six months ended June 30, 2019, as compared to $12.1 million for the same period in 2018.
Non-interest expense of $26.4 million for the six months ended June 30, 2019 decreased $276 thousand, or 1.0%, from $26.6 million for the same period in 2018.
Changes in Financial Condition
Total assets of $1.1 billion as of June 30, 2019 increased $58.4 million, or 5.9%, from $997.5 million as of December 31, 2018.
Consolidated stockholders’ equity of $114.4 million as of June 30, 2019 increased $4.8 million from $109.6 million as of December 31, 2018.
Total portfolio loans and leases, excluding mortgage loans held for sale, as of June 30, 2019 were $885.2 million, an increase of $47.1 million, or 5.6%, from $838.1 million as of December 31, 2018.
Total non-performing loans and leases of $4.1 million represented 0.45% of portfolio loans and leases as of June 30, 2019 as compared to $3.9 million, or 0.45% of portfolio loans and leases, as of December 31, 2018.
The $8.6 million allowance for loan losses (“Allowance’), as of June 30, 2019, represented 0.99% of portfolio loans and leases, as compared to $8.1 million, or 0.97% of portfolio loans and leases, as of December 31, 2018.
Total deposits of $840.7 million as of June 30, 2019 increased $88.6 million, or 11.8%, from $752.1 million as of December 31, 2018.
Key Performance Ratios
Key financial performance ratios for the three months ended June 30, 2019 and 2018 are shown in the table below:
Annualized return on average equity
7.14
7.02
7.22
6.05
Annualized return on average assets
0.81
0.82
0.72
Net interest margin (tax effected yield)
3.72
3.88
3.69
3.89
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The following table presents certain key period-end balances and ratios as of June 30, 2019 and December 31, 2018:
(dollars in thousands, except per share amounts)
Book value per common share
17.85
17.10
Tangible book value per common share
17.09
16.31
Allowance as a percentage of loans and leases held for investment
0.99
0.97
Tier I capital to risk weighted assets
11.37
11.72
Tangible common equity ratio (1)
10.42
10.53
Loans held for investment
Stockholders' equity
(1) Tangible common equity ratio is a non-GAAP financial measure. See “Non-GAAP Financial Measures” below for a reconciliation of this measure to its most comparable GAAP measure.
Non-GAAP Financial Measures
Meridian believes that non-GAAP measures are meaningful because they reflect adjustments commonly made by management, investors, regulators and analysts to evaluate performance trends and the adequacy of common equity. This non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for performance and financial condition measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of Meridian’s results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.
Meridian believes adjusted net income, adjusted diluted earnings per common share, adjusted ROAA and adjusted ROAE provide a greater understanding of ongoing operations and enhances comparability of results with prior periods. Because management believes that these adjustments are not incurred as a result of ongoing operations, they are not as helpful a measure of the performance of our underlying business, particularly in light of their unpredictable nature and are difficult to forecast. This supplemental presentation should not be construed as an inference that Meridian’s future results will be unaffected by similar adjustments to these measures determined in accordance with GAAP.
(Dollars in thousands, except per share data)
Net income - consolidated
Litigation settlement adjustment, net of tax
Adjusted net income - consolidated(1)
2,539
1,958
4,642
3,228
Net income - excluding Mortgage
2,203
1,701
4,172
3,107
Adjusted net income - excluding Mortgage(1)
2,720
1,857
4,786
3,263
Net income per common share, diluted
0.08
0.02
0.10
Adjusted diluted earnings per share(1)
0.39
0.30
0.73
0.50
Adjusted diluted earnings per share- excluding Mortgage(1)
0.42
0.29
0.74
0.51
Return on average assets - consolidated
Adjusted return on average assets - consolidated(1)
Return on average equity - consolidated
Adjusted return on average equity - consolidated(1)
Return on average assets - excluding Mortgage
Adjusted return on average assets - excluding Mortgage(1)
Return on average equity - excluding Mortgage
Adjusted return on average equity - excluding Mortgage(1)
Adjusted net income, adjusted earnings per common share, adjusted ROAA and adjusted ROAE are non-GAAP measures and remove the tax effect of the charges to earnings for the settlement of outstanding litigation ($148 thousand and $44 thousand for three months ended June 30, 2019 and 2018, respectively, and $176 thousand and $44 thousand for the six months ended June 30, 2019 and 2018, respectively).
Our management used the measure of the tangible common equity ratio to assess our capital strength. We believe that this non-GAAP financial measure is useful to investors because, by removing the impact of our goodwill and other intangible assets, it allows investors to more easily assess our capital adequacy. This non-GAAP financial measure should not be considered a substitute for any regulatory capital ratios and may not be comparable to other similarly titled measures used by other companies. The table below provides the non-GAAP reconciliation for our tangible common equity ratio:
Tangible common equity ratio:
Total stockholders' equity
Less:
Goodwill
Intangible assets
Tangible common equity
109,470
104,506
Tangible assets
1,050,997
992,434
Tangible common equity ratio
The following sections discuss, in detail, the Corporation’s results of operations for the three and six months ended June 30, 2019, as compared to the same periods in 2018, and the changes in its financial condition as of June 30, 2019 as compared to December 31, 2018.
Components of Net Income
Net income is comprised of five major elements:
Net Interest Income, or the difference between the interest income earned on loans, leases and investments and the interest expense paid on deposits and borrowed funds;
Provision For Loan and Lease Losses, or the amount added to the Allowance to provide for estimated inherent losses on portfolio loans and leases;
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Non-interest Income, which is made up primarily of mortgage banking income, wealth management income, gains and losses from the sale of loans, gains and losses from the sale of investment securities available for sale and other fees from loan and deposit services;
Non-interest Expense, which consists primarily of salaries and employee benefits, occupancy, loan expenses, professional fees and other operating expenses; and
Income Taxes, which include state and federal jurisdictions.
NET INTEREST INCOME
Net interest income is an integral source of the Corporation’s revenue. The tables below present a summary, for the three and six months ended June 30, 2019 and 2018, of the Corporation’s average balances and yields earned on its interest-earning assets and the rates paid on its interest-bearing liabilities. The net interest margin is the net interest income as a percentage of average interest-earning assets. The net interest spread is the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. The difference between the net interest margin and the net interest spread is the results of net free funding sources such as noninterest deposits and stockholders’ equity.
Total interest income for the three months ending June 30, 2019 was $13.1 million, which represented a $2.3 million, or 21.0%, increase compared with the three months ending June 30, 2018. The increase in income was attributable to a $120.5 million increase in average interest earning assets, year over year, helped by an increase of 32 basis points in yield on earning assets, to 5.44% from 5.12%, for same period in 2018. The commercial real estate loan portfolio yield, in particular, rose 31 basis points over the same period in 2018. Total interest expense rose $1.5 million or 55.9% to $4.2 million for the three months ending June 30, 2019, compared with $2.7 million for the three months ending June 30, 2018. The increase was primarily due to an overall increase of 59 basis points in the cost of interest-bearing funds reflective of the overall increase in market rates.
Net interest income increased $776 thousand, or 9.5%, to $8.9 million for the three months ended June 30, 2019, compared to $8.2 million for the three months ended June 30, 2018. The net-interest margin decreased 16 basis points for the three months ending June 30, 2019 at 3.72%, compared with 3.88% for the three month ending June 30, 2018. The decrease in net interest margin reflects the pressure from the rising cost of funds, which has outpaced the favorable trend in yield on interest earning assets during the quarter. The strength in the Corporation’s net-interest margin in the face of rising cost of funds reflects the size and asset quality of the loan portfolio, as well as the $10.8 million or 10.1% increase in average non-interest bearing deposits period over period.
Total interest income for the six months ending June 30, 2019 was $25.4 million, which represented a $4.8 million, or 23.3%, increase compared with the six months ending June 30, 2018. The increase in income was attributable to a $129.2 million increase in average interest earning assets, year over year, helped by an increase of 36 basis points in yield on earning assets, to 5.39% from 5.03%, for same period in 2018. The commercial real estate loan portfolio yield, in particular, rose 26 basis points over the same period in 2018. Total interest expense rose $3.2 million or 67.8% to $8.0 million for the six months ending June 30, 2019, compared with $4.8 million for the six months ending June 30, 2018. The increase was primarily due to an overall increase of 67 basis points in the cost of interest-bearing funds reflective of the overall increase in market rates as well as an increase in average interest bearing deposits of $124.1 million, year over year.
Net interest income increased $1.6 million, or 9.9%, to $17.4 million for the six months ended June 30, 2019, compared to $15.8 million for the six months ended June 30, 2018. The net-interest margin decreased 20 basis points for the six months ending June 30, 2019 at 3.69%, compared with 3.89% for the six month ending June 30, 2018. The decrease in net interest margin reflects the pressure from the rising cost of funds, which has outpaced the favorable trend in yield on interest earning assets during the six month period. The strength in the Corporation’s net-interest margin in the face of rising cost of funds reflects the size and asset quality of the loan portfolio, as well as the $12.6 million or 11.7% increase in average non-interest bearing deposits period over period.
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Analyses of Interest Rates and Interest Differential
The tables below present the major asset and liability categories on an average daily balance basis for the periods presented, along with interest income, interest expense and key rates and yields on a tax equivalent basis.
For the Three Months Ended June 30,
Income/
Yields/
rates
Assets
Interest-earning assets
Due from banks
7,008
4,471
997
993
Investment securities(1)
62,450
399
52,662
Loans held for sale
20,407
219
28,884
315
Loans held for investment(1)
874,836
12,430
758,141
10,194
895,243
12,649
787,025
10,509
Total interest-earning assets
965,698
13,096
845,151
10,836
Noninterest earning assets
36,210
44,079
1,001,908
889,230
Liabilities and stockholders' equity
Interest-bearing liabilities
Interest-bearing deposits
103,751
112,534
317
Money market and savings deposits
293,727
1,377
224,135
726
Time deposits
320,991
1,925
241,854
985
718,469
578,523
30,113
79,032
Long-term borrowings
5,962
56
6,650
Total Borrowings
36,075
85,682
460
Subordinated Debentures
9,178
9,308
175
Total interest-bearing liabilities
763,722
673,513
Noninterest-bearing deposits
117,664
106,863
Other noninterest-bearing liabilities
6,918
5,630
888,304
786,006
113,605
103,224
Total stockholders' equity and liabilities
8,945
8,173
Net interest spread
Net interest margin
For the Six Months Ended June 30,
7,150
87
4,820
965
940
62,955
812
52,401
609
19,250
432
26,615
555
862,107
24,107
738,452
19,450
881,357
24,539
765,067
20,005
952,427
25,449
823,228
20,659
37,198
40,956
989,625
864,184
108,455
860
102,996
499
279,388
2,512
223,035
304,466
3,579
242,158
1,895
692,309
568,189
43,014
597
63,809
633
5,997
6,756
93
49,011
710
70,565
9,208
338
9,639
750,528
648,393
120,183
107,616
6,507
5,742
877,218
761,751
112,408
102,433
17,450
15,892
Yields and net interest income are reflected on a tax-equivalent basis.
Rate/Volume Analysis (tax-equivalent basis)
The rate/volume analysis table below analyzes dollar changes in the components of interest income and interest expense as they relate to the change in balances (volume) and the change in interest rates (rate) of tax-equivalent net interest income for the three and six months ended June 30, 2019 as compared to the same period in 2018, allocated by rate and volume. Changes in interest income and/or expense attributable to both volume and rate have been allocated proportionately based on the relationship of the absolute dollar amount of the change in each category.
2019 Compared to 2018
Rate
Volume
51
-
94
(536)
739
(96)
106
(229)
(123)
594
1,642
2,236
1,379
3,278
4,657
589
1,551
2,140
1,485
3,049
4,534
636
1,624
2,260
3,811
4,790
Interest checking
248
96
333
384
267
651
835
557
383
1,112
572
1,684
Total interest-bearing deposits
1,189
1,687
2,280
984
3,264
647
(850)
(474)
(36)
Total borrowings
683
(877)
(502)
1,871
(383)
1,488
2,765
467
3,232
Interest differential
(1,234)
(1,786)
1,558
(1)Yields and net interest income are reflected on a tax-equivalent basis.
For the three months ended June 30, 2019 as compared to the same period in 2018, interest income increased $2.3 million as volume changes in average earning assets contributed $1.6 million and favorable rate changes contributed $636 thousand. The favorable change in net interest income due to volume changes was driven largely from growth in the loan portfolio, which increased $108.2 million on average over the three month periods. Total investment securities helped increase interest income $60 thousand, while cash and cash equivalents contributed $13 thousand to interest income, due to volume changes, period over period. In addition to favorable volume changes, favorable loan rate changes of 51 basis points contributed $589 thousand to interest income while investments rate changes of 24 basis points contributed $34 thousand.
On the funding side, interest expense increased $1.5 million due largely to rate changes. Higher rates on cost of funds, particularly from borrowings and time deposits, which rose 80 and 78 basis points, respectively, increased interest expense by $1.2 million. Core deposits, such as interest checking and money market accounts rose 46 and 58 basis points, respectively, increasing interest expense $632 thousand. In addition, interest checking and money market accounts together rose $60.8 million on average, reducing net interest income by $115 thousand. Time deposits increased $79.1 million on average, causing an increase to interest expense of $383 thousand. These unfavorable changes were partially offset by favorable volume changes, particularly in borrowings. Borrowings decreased $49.6 million on average affecting net interest income $877 thousand positively, and lower levels of subordinated debt contributed $3 thousand to the net interest
42
income over the three month periods compared. Overall, the increase in interest income from volume changes contributed $2.0 million and out-paced the unfavorable rate changes to improve net interest income by $772 thousand.
For the six months ended June 30, 2019 as compared to the same period in 2018, interest income increased $4.8 million. The favorable change in net interest income due to volume changes was driven largely from growth in the loan portfolio, which increased $116.3 million on average over the six month periods. This increase contributed $3.0 million to interest income. Total investment securities contributed $739 thousand to interest income due to volume changes, while cash and cash equivalents contributed another $23 thousand, period over period. In addition, interest income increased $1.5 million due to favorable rate changes in interest earning assets as the yield on loans overall increased 37 basis points.
On the funding side, interest expense increased $3.2 million due largely to unfavorable rate changes. Borrowings and time deposits, which rose 84 and 79 basis points, respectively and core deposits, such as interest checking and money market accounts rose 62 and 64 basis points, respectively, contributing to an increase in interest expense of $2.3 million. Also contributing to higher interest expense, were higher levels of deposit balances. Interest checking and money market accounts together rose $61.8 million on average, reducing net interest income by $412 thousand. Time deposits increased $62.3 million on average, causing an increase to interest expense of $572 thousand. Partially offsetting the effect of higher deposit balances, borrowings decreased $21.6 million on average affecting net interest income $502 thousand positively, and lower levels of subordinated debt contributed $15 thousand to the net interest income over the six month periods compared. Overall, the increase in interest income from volume changes contributed $3.3 million and out-paced the unfavorable rate changes to improve net interest income by $1.6 million.
Simulations of net interest income. We use a simulation model on a quarterly basis to measure and evaluate potential changes in our net interest income resulting from various hypothetical interest rate scenarios. Our model incorporates various assumptions that management believes to be reasonable, but which may have a significant impact on results such as:
The timing of changes in interest rates;
Shifts or rotations in the yield curve;
Repricing characteristics for market rate sensitive instruments on the balance sheet;
Differing sensitivities of financial instruments due to differing underlying rate indices;
Varying timing of loan prepayments for different interest rate scenarios;
The effect of interest rate floors, periodic loan caps and lifetime loan caps;
Overall growth rates and product mix of interest-earning assets and interest-bearing liabilities.
Because of the limitations inherent in any approach used to measure interest rate risk, simulated results are not intended to be used as a forecast of the actual effect of a change in market interest rates on our results, but rather as a means to better plan and execute appropriate Asset / Liability Management (“ALM”) strategies.
Potential changes to our net interest income between a flat interest rate scenario and hypothetical rising and declining interest rate scenarios, measured over a one-year period as of June 30, 2019 and 2018 are presented in the following table. The simulation assumes rate shifts occur upward and downward on the yield curve in even increments over the first twelve months (ramp), followed by rates held constant thereafter.
Rate Ramp
Estimated increase
(decrease) in Net Interest
Income
For the year ending
Changes in Market Interest Rates
+300 basis points over next 12 months
1.77
(0.17)
+200 basis points over next 12 months
1.37
(0.15)
+100 basis points over next 12 months
0.84
(0.08)
No Change
-100 basis points over next 12 months
(1.06)
0.07
The above interest rate simulation suggests that the Corporation’s balance sheet is asset sensitive as of June 30, 2019 and was slightly liability sensitive as of June 30, 2018. In its current position, the table indicates that a 100, 200 or 300 basis point increase in interest rates would have a modestly positive impact from rising rates on net interest income over the next 12 months. The simulated exposure to a change in interest rates is contained, manageable and well within policy guidelines. The results continue to drive our funding strategy of increasing relationship-based accounts (core deposits) and utilizing term deposits to fund short to medium duration assets.
Simulation of economic value of equity. To quantify the amount of capital required to absorb potential losses in value of our interest-earning assets and interest-bearing liabilities resulting from adverse market movements, we calculate economic value of equity on a quarterly basis. We define economic value of equity as the net present value of our balance sheet’s cash flow, and we calculate economic value of equity by discounting anticipated principal and interest cash flows under the prevailing and hypothetical interest rate environments. Potential changes to our economic value of equity between a flat rate scenario and hypothetical rising and declining rate scenarios, measured as of June 30, 2019 and 2018, are presented in the following table. The projections assume shifts ramp upward and downward of the yield curve of 100, 200 and 300 basis points occurring immediately. We would note that in a downward parallel shift of the yield curve, interest rates at the short-end of the yield curve are not modeled to decline any further than to 0%.
Estimated increase (decrease) in Net
Economic Value at June 30,
+300 basis points
14.55
5.46
+200 basis points
12.74
4.85
+100 basis points
8.54
3.40
-100 basis points
(14.60)
(6.57)
Gap Analysis
Management measures and evaluates the potential effects of interest rate movements on earnings through an interest rate sensitivity “gap” analysis. Given the size and turnover rate of the originated mortgage loans held for sale, these loans are treated as having a maturity of 12 months or less. Interest rate sensitivity reflects the potential effect on net interest income when there is movement in interest rates. An institution is considered to be asset sensitive, or having a positive gap, when the amount of its interest-earning assets repricing within a given period exceeds the amount of its interest-bearing liabilities also repricing within that time period. Conversely, an institution is considered to be liability sensitive, or having a negative gap, when the amount of its interest-bearing liabilities repricing within a given period exceeds the amount of its interest-earning assets also within that time period. During a period of rising interest rates, a negative gap would tend to decrease net interest income, while a positive gap would tend to increase net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to decrease net interest income.
44
The following tables present the interest rate gap analysis of our assets and liabilities as of June 30, 2019 and December 31, 2018.
Greater
Than
5 years and
As of June 30, 2019
12 Months
Not Rate
or Less
1-2 Years
2-5 Years
Sensitive
Cash and investments
53,940
5,613
9,618
22,275
91,446
Loans, net (1)
526,956
129,494
233,754
25,631
915,835
Other Assets
48,625
Total Assets
580,896
135,107
243,372
96,531
18,208
8,971
15,725
84,254
372,721
314,155
14,684
11,996
340,835
FHLB advances
74,980
8,122
83,102
Other Liabilities
381
16,505
17,711
Total liabilities and stockholders' equity
780,889
31,777
28,102
215,138
Repricing gap-positive
(Negative) Positive
(199,993)
103,330
215,270
(118,607)
Cumulative repricing gap: Dollar amount
(96,663)
118,607
Percent of total assets
(18.9)%
(9.2)%
Loans include portfolio loans and loans held for sale
As of December 31, 2018
51,092
4,268
12,183
19,578
87,121
476,250
104,422
246,523
48,606
875,801
Other Assets (Footnote 1)
34,558
527,342
108,690
258,706
102,742
17,943
9,013
15,852
83,342
347,264
253,090
13,426
12,200
278,716
119,300
Other Liabilities (Footnote 1)
412
14,917
16,498
Total stockholders' equity (Footnote 1)
733,422
27,851
28,396
207,811
(206,080)
80,839
230,310
(105,069)
(125,241)
105,069
(20.7)
(12.6)
10.5
Under the repricing gap analysis for both periods, we are liability-sensitive in the short-term mainly due to recent loan growth which has out-paced our core deposit growth. In addition, customer preference has been for short-term or liquid deposits. We generally manage our interest rate risk profile close to neutral, using a strategy that is focused on increasing our concentration of relationship-based transaction accounts through efforts of our business developers and new branches. The gap results presented could vary substantially if different assumptions are used or if actual experience differs from the
assumptions used in the preparation of the gap analysis. Furthermore, the gap analysis provides a static view of interest rate risk exposure at a specific point in time and offers only an approximate estimate of the relative sensitivity of our interest-earning assets and interest-bearing liabilities to changes in market interest rates. In addition, the impact of certain optionality is embedded in our balance sheet such as contractual caps and floors, and trends in asset and liability growth. Accordingly, we combine the use of gap analysis with the use of an earnings simulation model that provides a dynamic assessment of interest rate sensitivity.
PROVISION FOR LOAN AND LEASE LOSSES
For the three months ended June 30, 2019, the Corporation recorded a Provision of $14 thousand which was a $399 thousand decrease from the same period in 2018. For the three months ended June 30, 2019 there were recoveries of $235 thousand as compared to net charge-offs of $102 thousand for the same period in 2018.
For the six months ended June 30, 2019, the Corporation recorded a Provision of $233 thousand which was a $734 thousand decrease from the same period in 2018. For the six months ended June 30, 2019 there were recoveries of $339 thousand as compared to net charge-offs of $227 thousand for the same period in 2018.
The decreased provision over the three and six periods was the result of net recoveries and lower levels of loan growth period over period.
Asset Quality and Analysis of Credit Risk
Total nonperforming loans and leases increased $210 thousand from $3.9 million at December 31, 2018 to $4.1 million at June 30, 2019, but dropped to 0.47% of loans and leases held-for-investment, excluding loans at fair value, as of June 30, 2019, compared to 0.48% as of December 31, 2018. Nonaccrual loans at June 30, 2019, included within nonperforming assets, decreased $187 thousand from December 31, 2019. As a result of current asset quality and net recoveries during the three and six month periods ended June 30, 2019, the ratio of the Allowance to total loans held for investment, excluding loans at fair value, improved to 0.99%, from the 0.97% as of December 31, 2018. The Allowance to non-performing loans increased from 204.85% as of December 31, 2018 208.28% as of June 30, 2019.
The Corporation had one property in OREO as of June 30, 2019 in the amount of $120 thousand. There were no properties in OREO as of December 31, 2018.
As of June 30, 2019, the Corporation had $4.1 million of troubled debt restructurings (“TDRs”), of which $2.9 million were in compliance with the modified terms and excluded from non-performing loans and leases. As of December 31, 2018, the Corporation had $4.3 million of TDRs, of which $3.1 million were in compliance with the modified terms, and were excluded from non-performing loans and leases. As of June 30, 2019, the Corporation had a recorded investment of $5.5 million of impaired loans and leases which included $4.1 million of TDRs.
The Corporation continues to be diligent in its credit underwriting process and proactive with its loan review process, including the engagement of the services of an independent outside loan review firm, which helps identify developing credit issues. Proactive steps that are taken include the procurement of additional collateral (preferably outside the current loan structure) whenever possible and frequent contact with the borrower. The Corporation believes that timely identification of credit issues and appropriate actions early in the process serve to mitigate overall risk of loss.
Nonperforming Assets and Related Ratios
As of
Non-performing assets:
Nonaccrual loans:
Commercial construction
3,279
3,454
Total nonaccrual loans
Loans 90 days or more past due and accruing
Total non-performing loans
4,142
Total non-performing assets
4,262
Troubled debt restructurings:
TDRs included in non-performing loans
Asset quality ratios:
Non-performing assets to total assets
Non-performing loans to:
Total loans held-for-investment (excluding loans at fair value)
Allowance for loan losses to:
Non-performing loans
924,460
Total loans and leases held-for-investment
Total loans and leases held-for-investment (excluding loans at fair value)
872,791
826,684
NON-INTEREST INCOME
Three Months Ended June 30, 2019 Compared to the Same Period in 2018
Total non-interest income for the three months ended June 30, 2019 was $7.9 million, down $740 thousand, or 8.5%, from the comparable period in 2018. The overall decrease in non-interest income came primarily from our mortgage division. Also affecting non-interest income, wealth management revenue was down $76 thousand for the three months ended June 30, 2019 compared to the same period in 2018. Fee income reflected market value changes in assets under management, which although up at June 30, 2019 compared to June 30, 2018, were at lower levels in the prior quarter on which fees were based. The decrease in non-interest income was partially offset by $515 thousand in SBA loan income, largely from gains recognized on the sale of SBA loans, as well as $139 thousand in gain on sale of securities, all in the three months ended June 30, 2019. There were no SBA loan sales or sales of securities in the prior year comparable period.
Mortgage banking revenue, for the three months ended June 30, 2019, was $6.3 million, down $991 thousand, or 13.6%, from the comparable period in 2018. This decline in mortgage banking revenue was due primarily to a decline in mortgage originations year over year, despite an increase in the margin on loan sales of 72 basis points for the three months, year over year. Additionally, realized gains on derivatives related to mortgage banking, included in other non-interest income, decreased $222 thousand for the three months ended June 30, 2019 to a loss of $218 thousand, compared to a gain of $4 thousand for the same period in 2018.
Six Months Ended June 30, 2019 Compared to the Same Period in 2018
Total non-interest income for the six months ended June 30, 2019 was $14.4 million, down $1.3 million, or 8.6%, from the comparable period in 2018. The overall decrease in non-interest income came primarily from our mortgage division. Also affecting non-interest income, wealth management revenue was down $290 thousand for the six months ended June 30, 2019 compared to the same period in 2018. Fee income reflected market value changes in assets under management, which although up at June 30, 2019 compared to June 30, 2018, were at lower levels in the prior period on which fees were based. The decrease in non-interest income was partially offset by $515 thousand in SBA loan income, largely from gains recognized on the sale of SBA loans, as well as $139 thousand in gain on sale of securities, all in the three months ended June 30, 2019. There were no SBA loan sales or sales of securities in the prior year comparable period, as noted above. The new SBA lending team, brought on late in 2018, originated $12 million in SBA loans during the first six months of 2019.
Mortgage banking revenue, for the six months ended June 30, 2019, was $11.2 million, down $904 thousand or 7.5%, from the comparable period in 2018. The decline in mortgage banking revenue was due primarily to a decline in mortgage originations year over year, despite an increase in the margin on loan sales of 48 basis points for the six months, due in part to rising interest rates year over year. The net change in fair value of mortgage banking related financial instruments increased $400 thousand for the six months ended June 30, 2019, compared to the same period in 2018. Additionally, realized gains on derivatives related to mortgage banking, included in other non-interest income, decreased $1.2 million for the six months ended June 30, 2019 to a loss of $493 thousand, compared to a gain of $704 thousand for the same period in 2018.
NON-INTEREST EXPENSE
Total non-interest expense was $14.2 million for the three months ended June 30, 2019, up $170 thousand, or 1.2%, from $14.1 million for the three months ended June 30, 2018. There was a reduction in salaries and employee benefits expense of $640 thousand or 6.8% for the three months ended June 30, 2019, compared to prior year, as full-time equivalent employees, particularly in the mortgage division declined. In addition, variable loan expenses decreased by $55 thousand over the three month period ended June 30, 2019, reflecting the lower level of mortgage originations year-over-year. Occupancy and equipment expense was down slightly for the comparable three month period due to a reduction in rent expense resulting from the closure of 2 loan offices, while data processing and information technology expenses were up slightly over these same period due to increased customer transaction volume. Professional fees were up $232 thousand for the three month period ended June 30, 2019 due largely to legal and accounting fees incurred as part of the Maryland mortgage licensing issue announced in the prior quarter, in addition to legal fees incurred related to the litigation matter discussed below.
Other non-interest expenses increased $568 thousand to $1.7 million for the three months ended June 30, 2019, when compared to the prior year comparable period. The settlement of an outstanding litigation matter contributed $665 thousand to other non-interest expense for the three months ended June 30, 2019. On July 24, 2019 the Bank agreed to settle outstanding litigation related to former mortgage division employees for a total cost of $990 thousand.
Total non-interest expense was $26.4 million for six months ended June 30, 2019, down $276 thousand, or 1.0%, from $26.6 million for the same period in the 2018. There was a reduction in salaries and employee benefits expense of $1.4 million or 7.6% for the six months ended June 30, 2019, compared to prior year, as full-time equivalent employees, particularly in the mortgage division declined. In addition, variable loan expenses decreased by $57 thousand over the six month period ended June 30, 2019, reflecting the lower level of mortgage originations year-over-year. Occupancy and equipment expense was down slightly for the comparable six month period due to a reduction in rent expense resulting from the closure of 2 loan offices, while data processing and information technology expenses were up slightly over these same period due to increased customer transaction volume. Professional fees were up $224 thousand for the six month period ended June 30, 2019 due largely to legal and accounting fees incurred as part of the Maryland mortgage licensing issue announced in the prior quarter, in addition to legal fees incurred related to the litigation matter discussed below.
Other non-interest expenses increased $1 million to $2.9 million for the six months ended June 30, 2019, when compared to the prior year comparable period. The settlement of an outstanding litigation matter contributed $790 thousand to other non-interest expense for the six months ended June 30, 2019. On July 24, 2019 the Bank agreed to settle outstanding litigation related to former mortgage division employees for a total cost of $990 thousand. Additionally, for the six months ended June 30, 2019, $79 thousand of other expense was incurred for the current period impact of the Maryland mortgage licensing issue previously disclosed. Other contributors to the increase for the six months ended June 30, 2019 are increases in the FDIC insurance assessment, as well as the PA shares tax assessment due to the growth of the Bank from the prior year.
INCOME TAXES
Income tax expense for the three months ended June 30, 2019 was $570 thousand, as compared to $525 thousand for the same period in 2018. The increase in income tax expense was entirely attributable to the increase in earnings, period over period. Our effective tax rate was 22.0% for the second quarter of 2019 and 22.6% for the second quarter of 2018.
Income tax expense for the six months ended June 30, 2019 was $1.2 million, as compared to $887 thousand for the same period in 2018. The increase in income tax expense was entirely attributable to the increase in earnings, period over period. Our effective tax rate was 22.2% for the first six months of 2019 and 22.4% for the first six months of 2018.
BALANCE SHEET ANALYSIS
As of June 30, 2019, total assets were $1.1 billion compared with $997.5 million as of December 31, 2018. Total assets increased $58.4 million, or 5.9%, on a year-to-date basis primarily due to strong loan growth.
Total loans, excluding mortgage loans held for sale, grew $47.1 million, or 5.6%, to $885.2 million as of June 30, 2019, from $838.1 million as of December 31, 2018. The increase in loans is attributable to several commercial categories as we continue to grow our presence in the Philadelphia market area. Commercial real estate and commercial construction loans combined increased $37.6 million, or 8.5%, during the first six months of the year, while shared national credits and small business loans increased $4.0 million, or 5.6% and $2.7 million, or 46.0%, respectively, during the first six months of the year. Residential loans held in portfolio increased $3.2 million, or 5.9%, during the first six months as certain loan products or terms were targeted to hold in portfolio, prior to origination. Residential mortgage loans held for sale increased $1.6 million, or 4.2%, to $39.3 million as of June 30, 2019 from December 31, 2018.
Deposits were $840.7 million as of June 30, 2019, up $88.6 million, or 11.8%, from December 31, 2018. Non-interest bearing deposits increased $1.0 million, or 0.8%, from December 31, 2018. New business relationships fueled the increases year-over-year. Money market accounts/savings accounts increased $52.0 million, or 22.4%, since December 31, 2018 due to new business relationship money market accounts. Interest-bearing checking accounts decreased $26.6 million or 23.2% from December 31, 2018 due largely to term preference of municipal deposits. Certificates of deposit increased $62.1 million, or 22.3%, since December 31, 2018.
Capital
Consolidated stockholders’ equity of the Corporation was $114.4 million, or 10.83% of total assets as of June 30, 2019, as compared to $109.6 million, or 10.98% of total assets as of December 31, 2018. At June 30, 2019, the Tier 1 leverage ratio was 10.96%, the Tier 1 risk-based capital and common equity ratios were 11.37%, and total risk-based capital was 13.23%. At December 31, 2018, the Tier 1 leverage ratio was 11.16%, the Tier 1 risk-based capital and common equity ratios were 11.72%, and total risk-based capital was 13.66%. Tangible book value per share was $17.09 as of June 30, 2019, compared with $16.31 as of December 31, 2018. Refer to Footnote 1 for discussion of an immaterial error correction that impacted beginning retained earnings as of January 1, 2018.
The following table presents the Corporation’s capital ratios and the minimum capital requirements to be considered “well capitalized” by regulators as of June 30, 2019 and December 31, 2018:
127,156
100,886
96,082
109,271
67,257
62,453
81,669
76,865
39,880
49,850
The capital ratios for the Corporation, as of June 30, 2019, as shown in the above tables, indicate levels above the regulatory minimum to be considered “well capitalized.” The capital ratios to risk-weighted assets have all decreased from their December 31, 2018 levels largely as a result of the increase in risk-weighted assets, much of which was in the commercial mortgage, construction, and commercial and industrial segments of the loan portfolio, which are typically risk-weighted at 100%.
Liquidity
Management maintains liquidity to meet depositors’ needs for funds, to satisfy or fund loan commitments, and for other operating purposes. Meridian’s foundation for liquidity is a stable and loyal customer deposit base, cash and cash
50
equivalents, and a marketable investment portfolio that provides periodic cash flow through regular maturities and amortization or that can be used as collateral to secure funding. In addition, as part of its liquidity management, Meridian maintains a segment of commercial loan assets that are comprised of shared national credits (“SNCs”), which have a national market and can be sold in a timely manner. Meridian’s primary liquidity, which totaled $148.5 million at June 30, 2019, compared to $128 million at June 30, 2018, includes investments, SNCs, Federal funds sold, mortgages held-for-sale and cash and cash equivalents, less the amount of securities required to be pledged for certain liabilities. Meridian also anticipates scheduled payments and prepayments on its loan and mortgage-backed securities portfolios. In addition, Meridian maintains borrowing arrangements with various correspondent banks, the FHLB and the Federal Reserve Bank of Philadelphia to meet short-term liquidity needs. Through its relationship at the Federal Reserve, Meridian had available credit of approximately $9.6 million at June 30, 2019. As a member of the FHLB, we are eligible to borrow up to a specific credit limit, which is determined by the amount of our residential mortgages, commercial mortgages and other loans that have been pledged as collateral. As of June 30, 2019, Meridian’s maximum borrowing capacity with the FHLB was $477.6 million. At June 30, 2019, Meridian had borrowed $83.1 million and the FHLB had issued letters of credit, on Meridian’s behalf, totaling $79.8 million against its available credit lines. At June 30, 2019, Meridian also had available $39 million of unsecured federal funds lines of credit with other financial institutions as well as $105.6 million of available short or long term funding through the Certificate of Deposit Account Registry Service (“CDARS”) program and $53.9 million of available short or long term funding through brokered CD arrangements. Management believes that Meridian has adequate resources to meet its short-term and long-term funding requirements.
Discussion of Segments
As of June 30, 2019, the Corporation has three principal segments as defined by FASB ASC 280, “Segment Reporting.” The segments are Banking, Mortgage Banking and Wealth Management (see Note 11 in the accompanying Notes to Unaudited Consolidated Financial Statements).
The Banking Segment recorded net income before tax (“operating margin”) of $2.7 million and $5.2 million for the three and six months ended June 30, 2019, respectively, as compared to operating margin of $1.9 million and $3.3 million for the same respective periods in 2018. The Banking Segment provided 104.2% and 99.4% of the Corporation’s pre-tax profit for the three and six month periods ended June 30, 2019, respectively, as compared to 81.5% and 83.5% for the same respective periods in 2018.
The Wealth Management Segment recorded operating margin of $88 thousand and $124 thousand for the three and six months ended June 30, 2019, respectively, as compared to operating margin of $243 thousand and $606 thousand for the same respective periods in 2018.
The Mortgage Banking Segment recorded operating losses of $197 thousand and $91 thousand for the three and six months ended June 30, 2019, respectively, as compared to operating margins of $187 thousand and $47 thousand for the same respective periods in 2018. Mortgage Banking income and expenses related to loan originations and sales decreased due to lower origination volume, but certain non-interest expenses increased from the prior year due to Maryland mortgage licensing issue previously disclosed and the settlement of outstanding litigation discussed above.
Off Balance Sheet Risk
The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the loan agreement. Total commitments to extend credit at June 30, 2019 were $320.1 million, as compared to $290.6 million at December 31, 2018.
Standby letters of credit are conditional commitments issued by the Corporation to a customer for a third party. Such standby letters of credit are issued to support private borrowing arrangements. The credit risk involved in issuing standby
letters of credit is similar to that involved in granting loan facilities to customers. The Corporation’s obligation under standby letters of credit at June 30, 2019 amounted to $9.5 million, as compared to $5.2 million at December 31, 2018.
Estimated fair values of the Corporation’s off-balance sheet instruments are based on fees and rates currently charged to enter into similar loan agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. Since fees and rates charged for off-balance sheet items are at market levels when set, there is no material difference between the stated amount and the estimated fair value of off-balance sheet instruments.
In certain circumstances the Corporation may be required to repurchase loans from investors under the terms of loan sale agreements. Generally, these circumstances include the breach of representations and warranties made to investors regarding borrower default or early payment, as well as a violation of the applicable federal, state, or local lending laws. The Corporation agrees to repurchase loans if the representations and warranties made with respect to such loans are breached, and such breach has a material adverse effect on the loans. The Corporation did not repurchase any loans sold, based on the obligations described above, for the three and six months ended June 30, 2019, and did repurchase 1 loan in the amount of $94 thousand for the three and six months ended June 30, 2018.
Recent Litigation
See “Part II, Item 1. Legal Proceedings” below for information regarding a lawsuit filed in November 2017 against the Corporation.
Regulatory Update
The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Act”), which was designed to ease certain restrictions imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, was enacted into law on May 24, 2018. Most of the changes made by the Act can be grouped into five general areas: mortgage lending; certain regulatory relief for “community” banks; enhanced consumer protections in specific areas, including subjecting credit reporting agencies to additional requirements; certain regulatory relief for large financial institutions, including increasing the threshold at which institutions are classified a systemically important financial institutions (from $50 billion to $250 billion) and therefore subject to stricter oversight, and revising the rules for larger institution stress testing; and certain changes to federal securities regulations designed to promote capital formation. Some of the key provisions of the Act as it relates to community banks and bank holding companies include, but are not limited to: (i) designating mortgages held in portfolio as “qualified mortgages” for banks with less than $10 billion in assets, subject to certain documentation and product limitations; (ii) exempting banks with less than $10 billion in assets from Volcker Rule requirements relating to proprietary trading; (iii) simplifying capital calculations for banks with less than $10 billion in assets by requiring federal banking agencies to establish a community bank leverage ratio of tangible equity to average consolidate assets not less than 8% or more than 10% and provide that banks that maintain tangible equity in excess of such ratio will be deemed to be in compliance with risk-based capital and leverage requirements; (iv) assisting smaller banks with obtaining stable funding by providing an exception for reciprocal deposits from FDIC restrictions on acceptance of brokered deposits; (v) raising the eligibility for use of short-form Call Reports from $1 billion to $5 billion in assets; and (vi) clarifying definitions pertaining to high volatility commercial real estate loans (HVCRE), which require higher capital allocations, so that only loans with increased risk are subject to higher risk weightings. The Corporation continues to analyze the changes implemented by the Act and further rulemaking from federal banking regulators, but, at this time, does not believe that such changes will materially impact the Corporation’s business, operations, or financial results.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
See the discussion of quantitative and qualitative disclosures about market risks in “Management’s Discussion and Analysis of Results of Operations – Interest Rate Summary,” “– Interest Rate Sensitivity,” and “Gap Analysis” in this Quarterly Report on Form 10‑Q.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our CEO and CFO, has evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a- 15(e) and 15d- 15(e) under the Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, the Corporation’s CEO and CFO have concluded that the Corporation’s disclosure controls and procedures were not effective as of June 30, 2019 to ensure that the information required to be disclosed by the Corporation in the reports that the Corporation files or submits under the Exchange Act is recorded, processed, summarized, and reported completely and accurately within the time periods specified in SEC rules and forms.
As disclosed in Part I, Item 4 of our Quarterly Report on Form 10-Q as of March 31, 2019, in the first quarter of 2019, the Corporation identified that residential mortgage loans have been originated without a required license in a neighboring state since 2012. We concluded that our risk assessment process was not sufficient, and therefore ineffective, to ensure controls were designed and implemented to respond to the risks related to periodically reviewing our compliance with state licensing laws and reflecting that compliance within our mortgage origination system. As a result, we noted there was insufficient monitoring of the Corporation’s compliance with mortgage licensing laws. This led to the identification of control deficiencies over the Corporation’s recognition of interest and fee income, the analysis of the accounting for loan transfers, specifically the impact of the recourse obligation resulting from a breach in representations and warranties, as well as the controls over the Corporation’s determination of the mortgage repurchase reserve. The aggregation of these control deficiencies created a reasonable possibility that a material misstatement to our consolidated financial statements would not be prevented or detected on a timely basis and therefore we concluded that, the aggregation of these deficiencies represents a material weakness in our internal control over financial reporting as of June 30, 2019. This material weakness also existed at March 31, 2019 and December 31, 2018.
This material weakness resulted in an immaterial error correction that impacted beginning retained earnings, deferred tax assets and other liabilities as of January 1, 2018, relating to interest and fee income on mortgage loan originations made before January 1, 2018 to which we were not entitled due to the violation of state licensing law. The total pre-tax impact of this issue was $486 thousand, with $407 thousand of this relating to prior periods. These amounts include a penalty and amounts to be paid to certain mortgage loan customers.
Notwithstanding this material weakness, based on additional analyses and other procedures performed, management concluded that the financial statements included in the Quarterly Report on Form 10-Q as of June 30, 2019 and March 31, 2019, fairly presented in all material respects our financial position, results of operations, capital position, and cash flows for the periods presented, in conformity with GAAP.
Remediation Status of Previously Reported Material Weakness
We continue to implement our remediation plan for the previously reported material weakness in internal control over financial reporting, described in Part I, Item 4 of our Quarterly Report on Form 10-Q as of March 31, 2019, which includes the following measures: management discontinued the origination of mortgage loan originations into this state until the matter is satisfactorily resolved with the licensing authority, and restricted access within the mortgage loan origination system to prevent further origination activity in that state.
We are also in the process of implementing a control to help ensure the Corporation maintains ongoing compliance with state licensing requirements. Going forward the Corporation is considering whether to outsource this licensing compliance control to a third-party that will notify us real-time of licensing change requirements. Also in the second quarter we commenced an internal audit program to review compliance with licensing laws and to help develop a monitoring program to further ensure compliance with licensing laws. Lastly the Corporation will not originate loans in this particular state until it is compliant with licensing laws.
We are committed to maintaining a strong internal control environment and implementing measures designed to help ensure that control deficiencies contributing to the material weakness are remediated through implementation of processes
and controls to ensure strict compliance with GAAP. We will consider the material weakness remediated after the applicable controls operate for a sufficient period of time, and management has concluded, through testing, that the controls are operating effectively.
Changes in Internal Control Over Financial Reporting
Other than the changes related to our remediation efforts described above, we made no changes in internal control over financial reporting during the second quarter of 2019 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II–OTHER INFORMATION
Item 1. Legal Proceedings.
Item 1A. Risk Factors.
Not applicable.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults upon Senior Securities.
Item 4. Mine Safety Disclosures.
Item 5. Other Information.
Item 6. Exhibits.
The exhibits filed or incorporated by reference as part of this report are listed in the Exhibit Index, which appears at page 56.
EXHIBIT INDEX
ExhibitNumber
Description
2.1
Plan of Merger and Reorganization dated April 26, 2018 by and between Registrant, Bank and Meridian Interim Bank, filed as Exhibit 2.1 to Form 8-K on August 24, 2018 and incorporated herein by reference.
3.1
Articles of Incorporation of Registrant, filed as Exhibit 3.1 to Form 8-K on August 24, 2018 and incorporated herein by reference.
3.2
Bylaws of Registrant, filed as Exhibit 3.2 to Form 8-K on August 24, 2018 and incorporated herein by reference.
31.1
Rule 13a‑14(a)/ 15d‑14(a) Certification of the Principal Executive Officer, filed herewith.
31.2
Rule 13a‑14(a)/ 15d‑14(a) Certification of the Principal Financial Officer, filed herewith.
Section 1350 Certifications, filed herewith.
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase 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.
Date:
August 14, 2019
Meridian Corporation
By:
/s/ Christopher J. Annas
Christopher J. Annas
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Denise Lindsay
Denise Lindsay
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)