General
Unless otherwise indicated or unless the context requires otherwise, all
references in this Report to the “Corporation,” “we,” “us,” “our,” or similar
references mean First Business Financial Services, Inc. together with our
subsidiary. “FBB” or the “Bank” refers to our subsidiary, First Business Bank.
Forward-Looking Statements
This report may include forward-looking statements as defined in the Private
Securities Litigation Reform Act of 1995, which reflect our current views with
respect to future events and financial performance. Forward-looking statements
are not based on historical information, but rather are related to future
operations, strategies, financial results, or other developments.
Forward-looking statements are based on management’s expectations as well as
certain assumptions and estimates made by, and information available to,
management at the time the statements are made. Such statements are subject to
risks and uncertainties, including among other things:
•Adverse changes in the economy or business conditions, either nationally or in
our markets, including, without limitation, inflation, supply chain issues,
labor shortages, and the adverse effects of the COVID-19 pandemic on the global,
national, and local economy, which may affect the Corporation’s credit quality,
revenue, and business operations.
•Competitive pressures among depository and other financial institutions
nationally and in our markets.
•Increases in defaults by borrowers and other delinquencies.
•Our ability to manage growth effectively, including the successful expansion of
our client support, administrative infrastructure, and internal management
systems.
•Fluctuations in interest rates and market prices.
•The consequences of continued bank acquisitions and mergers in our markets,
resulting in fewer but much larger and financially stronger competitors.
•Changes in legislative or regulatory requirements applicable to us and our
subsidiaries.
•Changes in tax requirements, including tax rate changes, new tax laws, and
revised tax law interpretations.
•Fraud, including client and system failure or breaches of our network security,
including our internet banking activities.
•Failure to comply with the applicable SBA regulations in order to maintain the
eligibility of the guaranteed portions of SBA loans.
These risks could cause actual results to differ materially from what we have
anticipated or projected. These risk factors and uncertainties should be
carefully considered by our stockholders and potential investors. See Part I,
Item 1A – Risk Factors in our Annual Report on Form 10-K for the year ended
December 31, 2021 for discussion relating to risk factors impacting us.
Investors should not place undue reliance on any such forward-looking
statements, which speak only as of the date made. The factors described within
this Form 10-Q could affect our financial performance and could cause actual
results for future periods to differ materially from any opinions or statements
expressed with respect to future periods.
Where any such forward-looking statement includes a statement of the
assumptions or bases underlying such forward-looking statement, we caution that,
while our management believes such assumptions or bases are reasonable and are
made in good faith, assumed facts or bases can vary from actual results, and the
differences between assumed facts or bases and actual results can be material,
depending on the circumstances. Where, in any forward-looking statement, an
expectation or belief is expressed as to future results, such expectation or
belief is expressed in good faith and believed to have a reasonable basis, but
there can be no assurance that the statement of expectation or belief will be
achieved or accomplished.
We do not intend to, and specifically disclaim any obligation to, update any
forward-looking statements.
The following discussion and analysis is intended as a review of significant
events and factors affecting our financial condition and results of operations
for the periods indicated. The discussion should be read in conjunction with the
unaudited Consolidated Financial Statements and the Notes thereto presented in
this Form 10-Q.
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Overview
We are a registered bank holding company incorporated under the laws of the
State of Wisconsin and are engaged in the commercial banking business through
our wholly-owned banking subsidiary, FBB. All of our operations are conducted
through FBB and First Business Specialty Finance, LLC (“FBSF”), a wholly-owned
subsidiary of FBB. We operate as a business bank focusing on delivering a full
line of commercial banking products and services tailored to meet the specific
needs of small and medium-sized businesses, business owners, executives,
professionals, and high net worth individuals. Our products and services include
those for business banking, private wealth, and bank consulting. Within business
banking, we offer commercial lending, asset-based lending, accounts receivable
financing, equipment financing, floorplan financing, vendor financing, SBA
lending and servicing, treasury management services, and company retirement
plans. Our private wealth services for executives and individuals include trust
and estate administration, financial planning, investment management, consumer
lending, and private banking. For other financial institutions, our bank
consulting experts provide investment portfolio administrative services, asset
liability management services, and asset liability management process
validation. We do not utilize a branch network to attract retail clients. Our
operating philosophy is predicated on deep client relationships within our
commercial bank markets and extensive expertise within our nationwide
specialized lending business lines, combined with the efficiency of centralized
administrative functions, such as information technology, loan and deposit
operations, finance and accounting, credit administration, compliance,
marketing, and human resources. Our focused model allows experienced staff to
provide the level of financial expertise needed to develop and maintain
long-term relationships with our clients.
Financial Performance Summary
Results as of and for the three months ended March 31, 2022 include:
•Net income totaled $8.7 million, or diluted earnings per share of $1.02, for
the three months ended March 31, 2022, compared to $9.7 million, or diluted
earnings per share of $1.12, for the same period in 2021.
•Annualized return on average assets (“ROA”) and annualized return on average
equity (“ROE”) for the three months ended March 31, 2022 measured 1.30% and
14.47%, respectively, compared to 1.51% and 18.48% for the same period in 2021.
•Pre-tax, pre-provision adjusted earnings, which excludes certain one-time and
discrete items, totaled $9.9 million for the three months ended March 31, 2022,
down 6.4% from the same period in 2021. Pre-tax, pre-provision adjusted return
on average assets was 1.49% for the three months ended March 31, 2022, compared
to 1.65% for the same period in 2021. Excluding PPP interest and fee income,
pre-tax, pre-provision adjusted earnings totaled $9.6 million for the three
months ended March 31, 2022, up 23.5% from the same period in 2021. Pre-tax,
pre-provision adjusted return on average assets, excluding the impact of PPP,
was 1.46% for the three months ended March 31, 2022, compared to 1.34% for the
same period in 2021.
•The Corporation completed a private placement to institutional investors of
$32.5 million in new capital consisting of a $20.0 million subordinated note and
$12.5 million of Series A Preferred Stock. A portion of the proceeds were used
to redeem $10.3 million of higher cost trust preferred securities in the first
quarter of 2022. Management plans to redeem an additional $9.1 million of
subordinated notes in the second quarter of 2022. The remainder of the proceeds
will be used for general corporate purposes, including to support the Bank’s
growth strategy, and to fund the Corporation’s previously announced $5 million
share repurchase plan. The redemption of the trust preferred securities included
the accelerated amortization of $236,000 in debt issuance costs.
•Fees in lieu of interest, defined as prepayment fees, asset-based loan fees,
non-accrual interest, and loan fee amortization, totaled $1.3 million for the
three months ended March 31, 2022 compared to $3.1 million for the three months
ended March 31, 2021. PPP fee income, included in loan fee amortization, was
$249,000 for the three months ended March 31, 2022 compared to $2.2 million for
the same period in 2021.
•Net interest margin was 3.39% for the three months ended March 31, 2022
compared to 3.44% for the same period in 2021. Adjusted net interest margin,
which excludes certain one-time and volatile items, was 3.24% for the three
months ended March 31, 2022 up from 3.20% for the same period in 2021. Excluding
the one-time accelerated debt issuance amortization costs, adjusted net interest
margin was 3.28%.
•Top line revenue, defined as net interest income plus non-interest income,
totaled $28.8 million for the three months ended March 31, 2022, up $754,000, or
2.7% from the same period in 2021. Excluding PPP interest income and fees and
the one-time accelerated debt issuance costs, top line revenue increased $3.5
million, up 13.9% from the same period in 2021.
•Provision for loan and lease losses was a benefit of $855,000 for the three
months ended March 31, 2022 compared to a benefit of $2.1 million for the same
period in 2021.
•Total assets at March 31, 2022 increased $71.2 million, or 10.7% annualized, to
$2.724 billion from $2.653 billion at December 31, 2021.
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•Period-end gross loans and leases receivable were $2.253 billion and $2.241
billion as of March 31, 2022 and December 31, 2021, respectively. Average gross
loans and leases of $2.245 billion increased $61.7 million, or 2.8%, for the
three months ended March 31, 2022, compared to $2.183 billion for the same
period in 2021.
•Period-end gross loans and leases receivable, excluding net PPP loans, at
March 31, 2022 increased $20.9 million, or 3.8% annualized, to $2.233 billion
from $2.212 billion as of December 31, 2021. Average gross loans and leases,
excluding net PPP loans, of $2.224 billion increased $283.0 million, or 14.6%,
for the three months ended March 31, 2022, compared to $1.941 billion for the
same period in 2021.
•Period-end gross PPP loans and PPP deferred processing fees were $18.5 million
and $308,000, respectively, at March 31, 2022 compared to $27.9 million and
$557,000 at December 31, 2021. Average PPP loans, net of deferred processing
fees, were $20.9 million for the three months ended March 31, 2022 compared to
$242.2 million for the same period in 2021.
•Non-performing assets were $5.7 million and 0.21% of total assets as of
March 31, 2022, compared to $6.5 million and 0.25% of total assets as of
December 31, 2021.
•The allowance for loan and lease losses decreased $667,000, or 2.7%, compared
to December 31, 2021. The allowance for loan and lease losses decreased to 1.05%
of total loans, compared to 1.09% at December 31, 2021. Excluding net PPP loans,
the allowance for loan and lease losses decreased to 1.06% of total loans as of
March 31, 2022, compared to 1.10% as of December 31, 2021.
•Period-end in-market deposits at March 31, 2022 increased $83.1 million, or
17.2% annualized, to $2.011 billion from $1.928 billion as of December 31, 2021.
Average in-market deposits of $1.933 billion increased $210.5 million, or 12.2%,
for the three months ended March 31, 2022, compared to $1.722 billion for the
same period in 2021.
•Private wealth and trust assets under management and administration decreased
by $86.7 million, or 3.0%, to $2.834 billion at March 31, 2022, compared to
$2.921 billion at December 31, 2021. Private wealth management service fees
increased $434,000, or 18.0% for the three months ended March 31, 2022, compared
to the three months ended March 31, 2021.
Results of Operations
Top Line Revenue
Top line revenue, comprised of net interest income and non-interest income,
increased $754,000, or 2.7% ,for the three months ended March 31, 2022 compared
to the same period in 2021, due to a 2.7% increase in both net interest income
and non-interest income. The increase in net interest income was muted by a
decrease in PPP interest and fees of $2.5 million and the accelerated
amortization of $236,000 in debt issuance costs. Excluding PPP interest and fees
and the one-time accelerated debt issuance costs, top line revenue grew 13.9%.
The increase in net interest income was driven by an increase in average loans
and leases outstanding, and related interest income, and a decrease in interest
expense, partially offset by the aforementioned reduction in PPP interest and
fees. The increase in non-interest income was primarily due to a $521,000
increase in other fee income, $434,000 increase in private wealth fee income,
and $107,000 increase in loan fee income, partially offset by a reduction in
gains on the sale of SBA loans and commercial loan swap fee income.
The components of top line revenue were as follows:
For the Three Months Ended March 31,
2022 2021 $ Change % Change
(Dollars in Thousands)
Net interest income $ 21,426 $ 20,863 $ 563 2.7 %
Non-interest income 7,386 7,195 191 2.7
Top line revenue $ 28,812 $ 28,058 $ 754 2.7
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Annualized Return on Average Assets and Annualized Return on Average Equity
ROA for the three months ended March 31, 2022 decreased to 1.30% compared
to 1.51% for the three months ended March 31, 2021. The decrease in ROA was due
to a decrease in PPP interest and fee income, decrease in loan loss provision
benefit, and an increase in operating expenses, partially offset by an increase
in top line revenue. Please refer to the Components of the Provision for Loan
and Lease Losses included in the Provision for Loan and Lease Losses section
below for further discussion on the reasons driving the decline in
profitability. We consider ROA a critical metric to measure the profitability of
our organization and how efficiently our assets are deployed. ROA also allows us
to better benchmark our profitability to our peers without the need to consider
different degrees of leverage which can ultimately influence return on equity
measures.
ROE for the three months ended March 31, 2022 was 14.47% compared to 18.48%
for the three months ended March 31, 2021. The primary reason for the decrease
in ROE is consistent with the net income variance explanation as discussed under
Return on Average Assets above. We view ROE as an important measurement for
monitoring profitability and continue to focus on improving our return to our
shareholders by enhancing the overall profitability of our client relationships,
controlling our expenses, and minimizing our costs of credit.
Efficiency Ratio and Pre-Tax, Pre-Provision Adjusted Earnings
Efficiency ratio is a non-GAAP measure representing operating expense, which
is non-interest expense excluding the effects of the SBA recourse benefit or
provision, impairment of tax credit investments, net gains or losses on
foreclosed properties, amortization of other intangible assets, and other
discrete items, if any, divided by operating revenue, which is equal to net
interest income plus non-interest income less realized net gains or losses on
securities, if any. Pre-tax, pre-provision adjusted earnings is defined as
operating revenue less operating expense. In the judgment of the Corporation’s
management, the adjustments made to non-interest expense and non-interest income
allow investors and analysts to better assess the Corporation’s operating
expenses in relation to its core operating revenue by removing the volatility
associated with certain one-time items and other discrete items.
We believe the Corporation will generate positive operating leverage on an
annual basis and progress towards enhancing the long-term efficiency ratio at a
measured pace as we focus on strategic initiatives directed toward revenue
growth, process improvement, and automation. These initiatives include efforts
to grow our existing specialized lending revenues, increase our commercial
banking market share, and scale our private wealth management business in our
less mature commercial banking markets.
We believe the efficiency ratio and pre-tax, pre-provision adjusted earnings
allow investors and analysts to better assess the Corporation’s operating
expenses in relation to its top line revenue by removing the volatility that is
associated with certain non-recurring and other discrete items. The efficiency
ratio and pre-tax, pre-provision adjusted earnings also allow management to
benchmark performance of our model to our peers without the influence of the
loan loss provision and tax considerations, which will ultimately influence
other traditional financial measurements, including ROA and ROE. The information
provided below reconciles the efficiency ratio to its most comparable GAAP
measure.
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Please refer to the Non-Interest Income and Non-Interest Expense sections
below for discussion on additional drivers of the year-over-year change in the
efficiency ratio and pre-tax, pre-provision adjusted earnings.
For the Three Months Ended March 31,
2022 2021 $ Change % Change
(Dollars in Thousands)
Total non-interest expense $ 18,823 $ 17,330 $ 1,493 8.6 %
Less:
Net loss on foreclosed properties 12 3 9 NM
Amortization of other intangible assets – 8 (8) (100.0)
SBA recourse benefit (76) (130) 54 (41.5)
Total operating expense $ 18,887 $ 17,449 $ 1,438 8.2
Net interest income $ 21,426 $ 20,863 $ 563 2.7
Total non-interest income 7,386 7,195 191 2.7
Less:
Net gain (loss) on sale of securities – – – NM
Adjusted non-interest income 7,386 7,195 191 2.7
Total operating revenue $ 28,812 $ 28,058 $ 754 2.7
Efficiency ratio 65.55 % 62.19 %
Pre-tax, pre-provision adjusted earnings $ 9,925 $ 10,609 $ (684) (6.4)
Average total assets $ 2,666,241 $ 2,577,164 $ 89,077 3.5
Pre-tax, pre-provision adjusted return on
average assets 1.49 % 1.65 %
NM = Not Meaningful
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PPP loans, related fees, and interest income had a material impact on the prior
period comparisons in the table above. As this economic stimulus was
non-recurring, we believe these key performance indicators are a better
indicator of current operating performance of the Corporation, excluding PPP
loans and related fee and interest income. The table below includes the
efficiency ratio, and pre-tax, pre-provision adjusted earnings and return on
average assets, excluding average net PPP loans, fee income, and interest
income.
The improvement in efficiency and pre-tax, pre-provision profitability,
excluding the impact of PPP loans, was primarily due to the aforementioned
increase in net interest income driven by an increase in average loans and
leases receivable.
For the Three Months Ended March 31,
2022 2021 $ Change % Change
(Dollars in Thousands)
Total non-interest expense $ 18,823 $ 17,330 $ 1,493 8.6 %
Less:
Net loss on foreclosed properties 12 3 9 NM
Amortization of other intangible assets – 8 (8) (100.0)
SBA recourse benefit (76) (130) 54 (41.5)
Total operating expense $ 18,887 $ 17,449 $ 1,438 8.2
Net interest income $ 21,426 $ 20,863 $ 563 2.7
Less:
PPP interest income 52 603 (551) (91.4)
PPP loan fee amortization 249 2,212 (1,963) (88.7)
Adjusted net interest income 21,125 18,048 3,077 17.0
Total non-interest income 7,386 7,195 191 2.7
Less:
Net gain (loss) on sale of securities – – – NM
Adjusted non-interest income 7,386 7,195 191 2.7
Adjusted operating revenue $ 28,511 $ 25,243 $ 3,268 12.9
Efficiency ratio 66.24 %
69.12 %
Pre-tax, pre-provision adjusted earnings $ 9,624 $ 7,794 $ 1,830 23.5
Average total assets $ 2,666,241 $ 2,577,164 $ 89,077 3.5
Average PPP loans, net 20,935 242,242 (221,307) (91.4)
Adjusted average total assets $ 2,645,306 $ 2,334,922 $ 310,384 13.3
Pre-tax, pre-provision adjusted return on
average assets 1.46 % 1.34 %
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Net Interest Income
Net interest income levels depend on the amount of and yield on
interest-earning assets as compared to the amount of and rate paid on
interest-bearing liabilities. Net interest income is sensitive to changes in
market rates of interest and the asset/liability management processes to prepare
for and respond to such changes.
The following table provides information with respect to (1) the change in net
interest income attributable to changes in rate (changes in rate multiplied by
prior volume) and (2) the change in net interest income attributable to changes
in volume (changes in volume multiplied by prior rate) for the three months
ended March 31, 2022 compared to the same period in 2021. The change in net
interest income attributable to changes in rate and volume (changes in rate
multiplied by changes in volume) has been allocated to the rate and volume
changes in proportion to the relationship of the absolute dollar amounts of the
change in each.
Increase
(Decrease) for the Three Months Ended
March 31,
2022 Compared to 2021
Rate Volume Net
(In Thousands)
Interest-earning assets
Commercial real estate and other mortgage loans(1) $ (122) $ 940 $ 818
Commercial and industrial loans(1) (23) (501) (524)
Direct financing leases(1) 10 (65) (55)
Consumer and other loans(1) 1 37 38
Total loans and leases receivable (134) 411 277
Mortgage-related securities 5 89 94
Other investment securities (8) 36 28
FHLB and FRB Stock 1 19 20
Short-term investments 8 2 10
Total net change in income on interest-earning assets (128) 557 429
Interest-bearing liabilities
Transaction accounts (1) 6 5
Money market accounts 9 55 64
Certificates of deposit (108) (14) (122)
Wholesale deposits 283 (483) (200)
Total deposits 183 (436) (253)
FHLB advances (573) 360 (213)
Other borrowings (67) 169 102
Junior subordinated notes(2) 236 (6) 230
Total net change in expense on interest-bearing liabilities (221) 87 (134)
Net change in net interest income $ 93 $ 470 $ 563
(1)The average balances of loans and leases include non-accrual loans and leases
and loans held for sale.
(2)Rate column includes $236,000 in accelerated amortization of debt issuance
costs.
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The tables below shows our average balances, interest, average yields/rates,
net interest margin, and the spread between the combined average yields earned
on interest-earning assets and average rates on interest-bearing liabilities for
the three months ended March 31, 2022 and 2021. The average balances are derived
from average daily balances.
For the Three Months Ended March 31,
2022 2021
Average Average Average Average
Balance Interest Yield/Rate(4) Balance Interest Yield/Rate(4)
(Dollars in Thousands)
Interest-earning assets
Commercial real estate and other mortgage
loans(1) $ 1,459,891 $ 13,346 3.66 % $ 1,357,141 $ 12,528 3.69 %
Commercial and industrial loans(1) 718,364 9,101 5.07 757,898 9,625 5.08
Direct financing leases(1) 16,540 189 4.57 22,271 244 4.38
Consumer and other loans(1) 49,847 436 3.50 45,648 398 3.49
Total loans and leases receivable(1) 2,244,642 23,072 4.11 2,182,958 22,795 4.18
Mortgage-related securities(2) 184,962 760 1.64 163,324 666 1.63
Other investment securities(3) 50,555 215 1.70 42,177 187 1.77
FHLB and FRB stock 14,002 172 4.91 12,465 152 4.88
Short-term investments 31,111 16 0.21 24,823 6 0.10
Total interest-earning assets 2,525,272 24,235 3.84 2,425,747 23,806 3.93
Non-interest-earning assets 140,969 151,417
Total assets $ 2,666,241 $ 2,577,164
Interest-bearing liabilities
Transaction accounts $ 533,251 255 0.19 $ 521,130 250 0.19
Money market accounts 784,276 338 0.17 657,690 274 0.17
Certificates of deposit 52,519 55 0.42 57,424 177 1.23
Wholesale deposits 16,236 118 2.91 166,752 318 0.76
Total interest-bearing deposits 1,386,282 766 0.22 1,402,996 1,019 0.29
FHLB advances 385,080 1,036 1.08 366,670 1,249 1.36
Other borrowings 40,311 503 4.99 27,296 401 5.88
Junior subordinated notes(5) 9,850 504 20.47 10,063 274 10.89
Total interest-bearing liabilities 1,821,523 2,809 0.62 1,807,025 2,943 0.65
Non-interest-bearing demand deposit accounts 562,530 485,863
Other non-interest-bearing liabilities 42,537 73,695
Total liabilities 2,426,590 2,366,583
Stockholders’ equity 239,651 210,581
Total liabilities and stockholders’ equity $ 2,666,241 $ 2,577,164
Net interest income $ 21,426 $ 20,863
Interest rate spread 3.22 % 3.27 %
Net interest-earning assets $ 703,749 $ 618,722
Net interest margin 3.39 % 3.44 %
Average interest-earning assets to average
interest-bearing liabilities 138.64 % 134.24 %
Return on average assets(4) 1.30 1.51
Return on average equity(4) 14.47 18.48
Average equity to average assets 8.99 8.17
Non-interest expense to average assets(4) 2.82 2.69
(1)The average balances of loans and leases include non-accrual loans and leases
and loans held for sale. Interest income related to non-accrual loans and leases
is recognized when collected. Interest income includes net loan fees in lieu of
interest.
(2)Includes amortized cost basis of assets available-for-sale and
held-to-maturity.
(3)Yields on tax-exempt municipal securities are not presented on a
tax-equivalent basis in this table.
(4)Represents annualized yields/rates.
(5)The calculation for the three months ended March 31, 2022 includes $236,000
in accelerated amortization of debt issuance costs.
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Comparison of Net Interest Income for the Three Months Ended March 31, 2022 and
2021
Net interest income increased $563,000, or 2.7%, during the three months ended
March 31, 2022 compared to the three months ended March 31, 2021. Excluding the
one-time accelerated debt issuance costs, net interest income grew by 3.8%
compared to the prior year period. The increase in net interest income reflected
an increase in average gross loans and leases and a decrease in interest
expense, partially offset by a decrease in the yield on average interest-earning
assets and reduction in fees in lieu of interest. Fees in lieu of interest,
which can vary from quarter to quarter, totaled $1.3 million for the three
months ended March 31, 2022, compared to $3.1 million for the same period in
2021. Excluding fees in lieu of interest and interest income from PPP loans in
both periods of comparison, and the aforementioned accelerated debt issuance
costs, net interest income increased $3.1 million, or 18.3%. Average gross loans
and leases for the three months ended March 31, 2022 increased $61.7 million, or
2.8%, compared to the three months ended March 31, 2021. Excluding net PPP
loans, average gross loans and leases for the three months ended March 31, 2022
increased $283.0 million, or 14.6%, compared to the three months ended March 31,
2021.
The yield on average loans and leases for the three months ended March 31,
2022 was 4.11%, compared to 4.18% for the three months ended March 31, 2021.
Excluding the impact of loan fees in lieu of interest and PPP loan interest
income, the yield on average loans and leases excluding net PPP loans for the
three months ended March 31, 2022 was 3.91%, compared to 3.94% for the three
months ended March 31, 2021. Similarly, the yield on average interest-earning
assets for the three months ended March 31, 2022 measured 3.84%, compared to
3.93% three months ended March 31, 2021. Excluding loan fees in lieu of interest
and PPP loan interest income, the yield on average interest-earning assets
excluding net PPP loans for the three months ended March 31, 2022 was 3.66%,
compared to 3.69% for the three months ended March 31, 2021. The decline in
yields for both periods of comparison was primarily due to the renewal of
fixed-rate loans and reinvestment of cash flows from the securities portfolio at
historically low interest rates.
The average rate paid on total interest-bearing liabilities for the three
months ended March 31, 2022 decreased to 0.62% from 0.65% for the three months
ended March 31, 2021. Total interest-bearing liabilities include
interest-bearing deposits, federal funds purchased, FHLB advances, subordinated
and junior subordinated notes payable, and other borrowings. The average rate
paid declined as the Corporation maintained low deposit rates over the period of
comparison and renewed maturing FHLB advances at historically low fixed rates.
In addition to the reduction in deposit rates and FHLB advance renewals, average
wholesale deposits, which are typically longer duration and therefore a higher
cost funding source than in-market deposits, decreased $150.5 million, or 90.3%.
Net interest margin decreased five basis points to 3.39% for the three
months ended March 31, 2022, compared to 3.44% for the three months ended
March 31, 2021. Adjusted net interest margin measured 3.24% for the three months
ended March 31, 2022, compared to 3.20% for the three months ended March 31,
2021. Adjusted net interest margin is a non-GAAP measure representing net
interest income excluding the fees in lieu of interest and other recurring but
volatile components of net interest margin divided by average interest-earning
assets less average net PPP loans, if any, and other recurring but volatile
components of average interest-earning assets. The increase in adjusted net
interest margin was primarily due to a decrease in the average rate paid on
total bank funding driven by in-market deposit growth, partially offset by a
decrease in the average yield on loans and leases receivable. Excluding the
one-time accelerated debt issuance amortization costs, adjusted net interest
margin was 3.28%.
Management believes its success in growing in-market deposits, disciplined
loan pricing, and increased production in existing higher-yielding specialized
lending lines of business will allow the Corporation to achieve a net interest
margin of at least 3.50%, on average, over the long-term. However, the
collection of loan fees in lieu of interest is an expected source of volatility
to quarterly net interest income and net interest margin. Net interest margin
may also experience volatility due to events such as the collection of interest
on loans previously in non-accrual status or the accumulation of significant
short-term deposit inflows. The Corporation continues to maintain an
asset-sensitive balance sheet and ended the quarter appropriately positioned for
net interest income to benefit from rising short-term interest rates.
Provision for Loan and Lease Losses
We determine our provision for loan and lease losses pursuant to our allowance
for loan and lease loss methodology, which is based on the magnitude of current
and historical net charge-offs recorded throughout the established look-back
period, the evaluation of several qualitative factors for each portfolio
category, and the amount of specific reserves established for impaired loans
that present collateral shortfall positions. Refer to Allowance for Loan and
Lease Losses, below, for further information regarding our allowance for loan
and lease loss methodology.
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The Corporation recognized a $855,000 provision benefit for the three months
ended March 31, 2022, compared to a benefit of $2.1 million for the three months
ended March 31, 2021. The provision benefit for the three months ended March 31,
2022 was primarily due to a $416,000 reduction due to qualitative risk factor
improvements, a net decrease in specific reserves of $280,000, a $206,000
reduction in the general reserve from improving historical loss rates, and net
recoveries of $188,000. These decreases were partially offset by a $235,000
increase in the general reserve due to loan growth.
The following table shows the components of the provision for loan and lease
losses for the three months ended March 31, 2022 compared to the three months
ended March 31, 2021.
For the
Three Months Ended March 31,
2022 2021
(In Thousands)
Change in general reserve due to subjective factor changes $ (416) $ 1,082
Change in general reserve due to historical loss factor
changes (206) (984)
Charge-offs 22 144
Recoveries (210) (2,673)
Change in specific reserves on impaired loans, net (280) (194)
Change due to loan growth, net 235 557
Total provision for loan and lease losses $
(855) $ (2,068)
The addition of specific reserves on impaired loans represents new specific
reserves established when collateral shortfalls or government guaranty
deficiencies are present, while conversely the release of specific reserves
represents the reduction of previously established reserves that are no longer
required. Changes in the allowance for loan and lease losses due to subjective
factor changes reflect management’s evaluation of the level of risk within the
portfolio based upon several factors for each portfolio segment. Charge-offs in
excess of previously established specific reserves require an additional
provision for loan and lease losses to maintain the allowance for loan and lease
losses at a level deemed appropriate by management. This amount is net of the
release of any specific reserve that may have already been provided. Change in
the inherent risk of the portfolio is primarily influenced by the overall growth
in gross loans and leases and an analysis of loans previously charged off, as
well as movement of existing loans and leases in and out of an impaired loan
classification where a specific evaluation of a particular credit may be
required rather than the application of a general reserve loss rate. Refer to
Asset Quality, below, for further information regarding the overall credit
quality of our loan and lease portfolio.
Comparison of Non-Interest Income for the Three Months Ended March 31,
2022 and 2021
Non-Interest Income
Non-interest income increased $191,000, or 2.7%, to $7.4 million for the three
months ended March 31, 2022 compared to $7.2 million for the same period in
2021. Management continues to focus on revenue growth from multiple non-interest
income sources in order to maintain a diversified revenue stream through greater
contributions from fee-based revenues. Total non-interest income accounted for
25.6% of total revenues for the three months ended March 31, 2022 and March 31,
2021. The increase in total non-interest income for the three months ended
March 31, 2022 primarily reflected strong private wealth management services fee
income, an increase in other non-interest income, led by mezzanine fund
investment income, and an increase in loan fees. These favorable variances were
partially offset by a decrease in gains on the sale of SBA loans and a decrease
in commercial loan interest rate swap fee income.
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The components of non-interest income were as follows:
For
the Three Months Ended March 31,
2022 2021 $ Change % Change
(Dollars in Thousands)
Private wealth management services fee
income $ 2,841 $ 2,407 $ 434 18.0 %
Gain on sale of SBA loans 585 1,078 (493) (45.7)
Service charges on deposits 999 917 82 8.9
Loan fees 652 545 107 19.6
Increase in cash surrender value of
bank-owned life insurance 349 350 (1) (0.3)
Swap fees 225 684 (459) (67.1)
Other non-interest income 1,735 1,214 521 42.9
Total non-interest income $ 7,386 $ 7,195 $ 191 2.7
Fee income ratio(1) 25.6 % 25.6 %
(1) Fee income ratio is fee income, per the above table, divided by top line
revenue (defined as net interest income plus non-interest income).
Private wealth management service fees increased $434,000, or 18.0% for the
three months ended March 31, 2022, compared to the three months ended March 31,
2021. Private wealth management fee income is primarily driven by the amount of
assets under management and administration, as well as the mix of business at
different fee structures, and can be positively or negatively influenced by the
timing and magnitude of volatility within the capital markets. This increase was
driven by growth in assets under management and administration attributable to
new client relationships. As of March 31, 2022, private wealth and trust assets
under management and administration totaled $2.834 billion, increasing $447.5
million, or 18.8%, compared to $2.387 billion as of March 31, 2021.
Gain on sale of SBA loans for the three months ended March 31, 2022 decreased
$493,000, or 45.7%, compared to the same period in 2021. Management believes SBA
7a loan production, while variable based on timing of closings, will continue to
increase on an annual basis at a measured pace.
Loan fees increased $107,000, or 19.6%, for the three months ended March 31,
2022, compared to same period in 2021. The increase was principally due to an
increase in conventional, SBA, and floorplan financing activity generating
additional processing and service fee income.
Other non-interest income increased by $521,000 to $1.7 million for the three
months ended March 31, 2022, compared to $1.2 million for the same period in
2021. The increase was as primarily due to an increase in returns from the
Corporation’s investments in mezzanine funds.
Commercial loan interest rate swap fee income was $225,000 for the three months
ended March 31, 2022, compared to $684,000 for the same period in 2021. We
originate commercial real estate loans in which we offer clients a floating rate
and an interest rate swap. The client’s swap is then offset with a counter-party
dealer. The execution of these transactions generates swap fee income. The
aggregate amortizing notional value of interest rate swaps with various
borrowers was $626.8 million as of March 31, 2022, compared to $645.1 million as
of March 31, 2021. Interest rate swaps can be an attractive product for our
commercial borrowers, although associated fee income can be variable from period
to period based on client demand and the interest rate environment in any given
quarter.
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Comparison of Non-Interest Expense for the Three Months Ended March 31,
2022 and 2021
Non-Interest Expense
Non-interest expense for the three months ended March 31, 2022 increased by $1.5
million, or 8.6%, to $18.8 million compared to $17.3 million for the same period
in 2021. Operating expense, which excludes certain one-time and discrete items
as defined in the Efficiency Ratio table above, increased $1.4 million, or 8.2%,
to $18.9 million for the three months ended March 31, 2022 compared to $17.4
million for the same period in 2021. The increase in operating expense was
primarily due to an increase in compensation, professional fees, marketing, and
other non-interest expense.
The components of non-interest expense were as follows:
For
the Three Months Ended March 31,
2022 2021 $ Change % Change
(Dollars in Thousands)
Compensation $ 13,638 $ 12,657 $ 981 7.8 %
Occupancy 555 552 3 0.5
Professional fees 1,170 866 304 35.1
Data processing 780 770 10 1.3
Marketing 500 391 109 27.9
Equipment 244 246 (2) (0.8)
Computer software 1,082 1,115 (33) (3.0)
FDIC insurance 313 362 (49) (13.5)
Collateral liquidation costs 16 94 (78) (83.0)
Net loss on foreclosed properties 12 3 9 NM
Other non-interest expense 513 274 239 87.2
Total non-interest expense $ 18,823 $ 17,330 $ 1,493 8.6
Total operating expense(1) $ 18,887 $ 17,449 $ 1,438 8.2
Full-time equivalent employees 313
306
(1)Total operating expense represents total non-interest expense, adjusted to
exclude the impact of discrete items as previously defined in the non-GAAP
efficiency ratio calculation, above.
Compensation expense for the three months ended March 31, 2022 was $13.6
million, an increase of $981,000, or 7.8%, compared to $12.7 million for the
three months ended March 31, 2021. The increase reflects above average annual
merit increases, reflecting the competitive job market, as well as payroll taxes
paid in the quarter on a record annual cash bonus plan payout, and an expanded
workforce. Average full-time equivalent employees for the three months ended
March 31, 2022 increased to 310, up 1.6%, compared to 305 for the three months
ended March 31, 2021. We expect to continue investing in existing and new talent
to support our long-term strategic plan.
Professional fees increased $304,000, or 35.1%, to $1.2 million for the three
months ended March 31, 2022, compared to $866,000 for the three months ended
March 31, 2021. The increase was principally due to an increase in legal
expenses related to a historic tax credit investment, an increase in audit
expenses, and a general increase in other professional and consulting services
for various projects.
Marketing expense increased $109,000, or 27.9%, for the three months ended
March 31, 2022, compared to the three months ended March 31, 2021 primarily due
to an increase in business development activities as the Corporation continues
to return to pre-pandemic spending levels.
Other non-interest expense increased $239,000, or 87.2% to $513,000 for the
three months ended March 31, 2022, compared to $274,000 for the three months
ended March 31, 2021 partially due to an increase in travel expense. In
addition, the three months ended March 31, 2021 included a reduction in credit
valuation adjustment (“CVA”) related to the commercial loan interest rate swap
program. The CVA can vary from period to period based on the size of the
portfolio, credit metrics, and the interest rate environment in any given
quarter.
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Income Taxes
Income tax expense totaled $2.2 million for the three months ended March 31,
2022 compared to an income tax expense of $3.1 million for the three months
ended March 31, 2021. The effective tax rate, excluding discrete items, for the
three months ended March 31, 2022 was 23.5% compared to 23.4% for the three
months ended March 31, 2021. For 2022, the Corporation expects to report an
effective tax rate of 23%-24%, excluding discrete items, as management intends
to continue actively pursuing tax credit opportunities.
Generally, the provision for income taxes is determined by applying an estimated
annual effective income tax rate to income before taxes and adjusting for
discrete items. The rate is based on the most recent annualized forecast of
pre-tax income, book versus tax differences and tax credits, if any. If we
conclude that a reliable estimated annual effective tax rate cannot be
determined, the actual effective tax rate for the year-to-date period may be
used. We re-evaluate the income tax rates each quarter. Therefore, the current
projected effective tax rate for the entire year may change.
Financial Condition
General
Total assets increased by $71.2 million, or 2.7%, to $2.724 billion as of
March 31, 2022 compared to $2.653 billion at December 31, 2021. The increase in
total assets was primarily driven by short-term investments, securities, and
loans and leases receivable. Total liabilities increased by $58.5 million, or
2.4%, to $2.479 billion at March 31, 2022 compared to $2.420 billion at
December 31, 2021. The increase in total liabilities was principally due to an
increase in deposits and other borrowings, partially offset by a decrease in
junior subordinated debentures. Total stockholders’ equity increased by $12.6
million, or 5.4%, to $245.1 million at March 31, 2022 compared to $232.4 million
at December 31, 2021. The increase in total stockholders’ equity was due to
retention of earnings and issuance of preferred stock, partially offset by
dividends paid to common stockholders.
Cash and Cash Equivalents
Cash and cash equivalents include short-term investments and cash and due from
banks. Short-term investments increased by $28.1 million to $75.5 million at
March 31, 2022 from $47.4 million at December 31, 2021. The increase in
short-term investments was primarily due to solid in-market deposit growth and
elevated loan payoffs. Our short-term investments primarily consist of
interest-bearing deposits held at the FRB. We value the safety and soundness
provided by the FRB, and therefore, we incorporate short-term investments in our
on-balance sheet liquidity program. As of March 31, 2022 and December 31, 2021,
interest-bearing deposits held at the FRB were $74.9 million and $47.0 million,
respectively. In general, the level of our cash and short-term investments will
be influenced by the timing of deposit gathering, scheduled maturities of
wholesale deposits, funding of loan and lease growth, and the level of our
securities portfolio. Please refer to the section entitled Liquidity and Capital
Resources for further discussion.
Securities
Total securities, including available-for-sale and held-to-maturity, increased
by $15.5 million, or 6.9%, to $240.9 million, or 8.8% of total assets at
March 31, 2022 compared to $225.4 million, or 8.5% of total assets at
December 31, 2021. During the three months ended March 31, 2022 we recognized
unrealized losses of $12.5 million before income taxes through other
comprehensive income, compared to unrealized losses of $2.2 million for the same
period in 2021. As of March 31, 2022 and December 31, 2021, our overall
securities portfolio, including available-for-sale securities and
held-to-maturity securities, had an estimated weighted-average expected maturity
of 6.0 years and 5.7 years, respectively. Our investment philosophy remains as
stated in our most recent Annual Report on Form 10-K.
We use a third-party pricing service as our primary source of market prices
for our securities portfolio. On a quarterly basis, we validate the
reasonableness of prices received from this source through independent
verification, data integrity validation primarily through comparison of current
price to an expectation-based analysis of movement in prices based upon the
changes in the related yield curves, and other market factors. No securities
within our portfolio were deemed to be other-than-temporarily impaired as of
March 31, 2022.
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Loans and Leases Receivable
Loans and leases receivable, net of allowance for loan and lease losses,
increased by $12.5 million to $2.228 billion at March 31, 2022 from $2.215
billion at December 31, 2021 which was driven by commercial loan growth,
partially offset by elevated loan payoffs and PPP loan forgiveness. Loans and
leases receivable, net of allowance for loan and lease losses and excluding net
PPP loans, increased by $21.6 million to $2.209 billion at March 31, 2022 from
$2.188 billion at December 31, 2021. The Corporation experienced elevated loan
payoffs of nearly $90 million during the three months ended March 31, 2022,
compared to just over $30 million for the three months ended December 31, 2021.
These elevated levels of payoffs primarily stem from the sales of businesses and
real estate properties, which can be variable depending on market conditions.
Total commercial real estate (“CRE”) loans increased $15.1 million to $1.470
billion, up from $1.455 billion at December 31, 2021. Owner occupied CRE and
construction financing drove CRE loan growth as of March 31, 2022, increasing
$18.6 million, and $20.6 million, respectively, from December 31, 2021,
partially offset by a $17.6 million and $5.2 million decline in multi-family and
non-owner occupied CRE loans, respectively.
There continues to be a concentration in CRE loans which represented 65.8% and
65.8% of our total loans, excluding net PPP loans, as of March 31, 2022 and
December 31, 2021, respectively. As of March 31, 2022, 17.3% of the CRE loans
were owner-occupied CRE, compared to 16.2% as of December 31, 2021. We consider
owner-occupied CRE more characteristic of the Corporation’s C&I portfolio as, in
general, the client’s primary source of repayment is the cash flow from the
operating entity occupying the commercial real estate property.
Excluding net PPP loans, C&I loans decreased $1.0 million, to $702.5 million
from $703.5 million at December 31, 2021. Despite the aforementioned elevated
payoffs, management believes the timely prior-period investments in the
Corporation’s specialized lending business lines, such as dealer floorplan
financing, small-ticket equipment vendor financing, accounts receivable
financing, and asset based lending have positioned C&I lending for strong and
sustainable growth in 2022 and beyond. Including net PPP loans, our C&I
portfolio decreased $10.1 million to $720.7 million from $730.8 million at
December 31, 2021.
We will continue to actively pursue C&I loans across the Corporation as this
segment of our loan and lease portfolio provides an attractive yield
commensurate with an appropriate level of credit risk and creates opportunities
for in-market deposit, treasury management, and private wealth management
relationships which generate additional fee revenue.
Underwriting of new credit is primarily through approval from a serial sign-off
or committee process and is a key component of our operating philosophy.
Business development officers have no individual lending authority limits. In
addition, we make every reasonable effort to ensure that there is appropriate
collateral or a government guarantee at the time of origination to protect our
interest in the related loan or lease. To monitor the ongoing credit quality of
our loans and leases, each credit is evaluated for proper risk rating using a
nine grade risk rating system at the time of origination, subsequent renewal,
evaluation of updated financial information from our borrowers, or as other
circumstances dictate.
While we continue to experience significant competition from banks operating in
our primary geographic areas, we remain committed to our underwriting standards
and will not deviate from those standards for the sole purpose of growing our
loan and lease portfolio. We continue to expect our new loan and lease activity
to be adequate to replace normal amortization, allowing us to continue growing
in future years. The types of loans and leases we originate and the various
risks associated with these originations remain consistent with information
previously outlined in our most recent Annual Report on Form 10-K.
Deposits
As of March 31, 2022, deposits increased by $65.8 million, or 13.4%
annualized, to $2.024 billion from $1.958 billion at December 31, 2021,
primarily due to a $20.7 million and $52.5 million increase in transaction
accounts and money market accounts, respectively, partially offset by a decrease
in wholesale deposits of $17.3 million. The large increase in deposits was
primarily due to successful business development efforts as the Bank’s
deposit-centric sales strategy, led by treasury management sales, contributed to
growth across the majority of in-market deposit categories. Period-end deposit
balances associated with in-market relationships will fluctuate based upon
maturity of time deposits, client demands for the use of their cash, and our
ability to maintain existing and new client relationships.
Our strategic efforts remain focused on adding in-market deposit
relationships. We measure the success of in-market deposit gathering efforts
based on the number and average balances of our deposit accounts as compared to
ending balances due to the volatility of some of our larger relationships. The
Bank’s average in-market deposits, consisting of all transaction accounts, money
market accounts, and certificates of deposit, were approximately $1.933 billion
for the three months ended March 31, 2022, up 14.1% annualized, compared to
$1.867 billion for the three months ended December 31, 2021.
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FHLB Advances and Other Borrowings
As of March 31, 2022, FHLB advances and other borrowings increased by $11.0
million, or 2.7%, to $414.5 million from $403.5 million at December 31, 2021.
While total wholesale funding as a percentage of total bank funding has
decreased meaningfully overall due to significant in-market deposit growth, we
continue to replace our maturing brokered certificates of deposit with FHLB
advances at lower rates, as needed, to match-fund fixed rate loans and mitigate
interest rate risk. Total bank funding is defined as total deposits plus FHLB
advances.
As of March 31, 2022 and December 31, 2021, the Corporation had other borrowings
of $9.8 million and $10.4 million respectively, which consisted of sold loans
which were accounted for as a secured borrowing, because they did not qualify
for true sale accounting, in addition to borrowings associated with our
investment in a community development entity.
The Corporation completed a private placement of $20.0 million in new
subordinated debt to one institutional investor. Management plans to use a
portion of the proceeds during the second quarter of 2022 to redeem $9.1 million
of subordinated notes bearing a fixed interest rate of 6.00%. The remainder of
the proceeds will be used for general corporate purposes, including to support
the Bank’s growth strategy, and to fund the Corporation’s previously announced
$5 million share repurchase plan. The subordinated note bears a fixed interest
rate of 3.50% with a maturity date of March 15, 2032 and has certain performance
debt covenants of which the Corporation was in compliance as of March 31, 2022.
The Corporation may, at its option, redeem the note, in whole or part, at any
time after the fifth anniversary of issuance. As of March 31, 2022, $771,000 of
debt issuance cost remain in the subordinated note payable balance, and $480,000
is related to the recently issued subordinated note. When and if the $9.1
million subordinated debt is redeemed during the second quarter of 2022, the
Corporation will accelerate the amortization of approximately $12,000 in prior
debt issuance costs.
Consistent with our funding philosophy to manage interest rate risk, we will
use the most efficient and cost effective source of wholesale funds. We will
utilize FHLB advances to the extent we maintain an adequate level of excess
borrowing capacity for liquidity and contingency funding purposes and pricing
remains favorable in comparison to the wholesale deposit alternative. We will
use FHLB advances and/or brokered certificates of deposit in specific maturity
periods needed, typically three to five years, to match-fund fixed rate loans
and effectively mitigate the interest rate risk measured through our
asset/liability management process and to support asset growth initiatives while
taking into consideration our operating goals and desired level of usage of
wholesale funds. Please refer to the section entitled Liquidity and Capital
Resources, below, for further information regarding our use and monitoring of
wholesale funds.
Preferred Stock
On March 4, 2022, the Corporation issued 12,500 shares, or $12.5 million in
aggregate liquidation preference, of its 7.0% Fixed-to-Floating Rate
Non-Cumulative Perpetual Preferred Stock, Series A, par value $0.01 per share,
with a liquidation preference of $1,000 per share (the “Series A Preferred
Stock”) in a private placement to institutional investors. The net proceeds
received from the issuance of the Series A Preferred Stock were $12.0 million.
The proceeds were used to redeem $10.1 million of junior subordinated notes in
the first quarter of 2022.
The Corporation expects to pay dividends on the Series A Preferred Stock when
and if declared by its Board, at a fixed rate of 7.0% per annum, payable
quarterly, in arrears, on March 15, June 15, September 15 and December 15 of
each year up to, but excluding, March 15, 2027. For each dividend period from
and including March 15, 2027, dividends will be paid at a floating rate of
Three-Month Term SOFR plus a spread of 539 basis points per annum. The Series A
Preferred Stock is perpetual and has no stated maturity. The Corporation may
redeem the Series A Preferred Stock at its option at a redemption price equal to
$1,000 per share, plus any declared and unpaid dividends (without regard to any
undeclared dividends), subject to regulatory approval, on or after March 15,
2027 or within 90 days following a regulatory capital treatment event, in
accordance with the terms of the Series A Preferred Stock.
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Derivatives
The Board approved Bank policies allow the Bank to participate in hedging
strategies or to use financial futures, options, forward commitments, or
interest rate swaps. The Bank utilizes, from time to time, derivative
instruments in the course of its asset/liability management. The Corporation’s
derivative financial instruments, under which the Corporation is required to
either receive cash from or pay cash to counterparties depending on changes in
interest rates applied to notional amounts, are carried at fair value on the
consolidated balance sheets.
As of March 31, 2022, the aggregate amortizing notional value of interest rate
swaps with various commercial borrowers was approximately $626.8 million,
compared to $640.6 million as of December 31, 2021. We receive fixed rates and
pay floating rates based upon designated benchmark interest rates on the swaps
with commercial borrowers. These swaps mature between May 2024 and March 2038.
Commercial borrower swaps are completed independently with each borrower and are
not subject to master netting arrangements. As of March 31, 2022, the commercial
borrower swaps were reported on the Consolidated Balance Sheet as a derivative
asset of $7.7 million and as a derivative liability of $24.9 million compared to
a derivative asset and liability of $26.3 million and $6.6 million,
respectively, as of December 31, 2021. On the offsetting swap contracts with
dealer counterparties, we pay fixed rates and receive floating rates based upon
designated benchmark interest rates. These interest rate swaps also have
maturity dates between May 2024 and March 2038. Dealer counterparty swaps are
subject to master netting agreements among the contracts within our Bank and
were reported on the Consolidated Balance Sheet as a net derivative asset of
$17.2 million as of March 31, 2022, compared to a net derivative liability of
$19.7 million as of December 31, 2021. The gross amount of dealer counterparty
swaps as of March 31, 2022, without regard to the enforceable master netting
agreement, was a gross derivative liability of $7.7 million and a gross
derivative asset of $24.9 million, compared to a gross derivative liability of
$26.3 million and gross derivative asset of $6.6 million as of December 31,
2021.
The Corporation also enters into interest rate swaps to manage interest rate
risk and reduce the cost of match-funding certain long-term fixed rate loans.
These derivative contracts involve the receipt of floating rate interest from a
counterparty in exchange for the Corporation making fixed-rate payments over the
life of the agreement, without the exchange of the underlying notional value.
The instruments are designated as cash flow hedges as the receipt of floating
rate interest from the counterparty is used to manage interest rate risk
associated with forecasted issuances of short-term FHLB advances. The change in
the fair value of these hedging instruments is recorded in accumulated other
comprehensive income and is subsequently reclassified into earnings in the
period that the hedged transactions affects earnings. As of March 31, 2022, the
aggregate notional value of interest rate swaps designated as cash flow hedges
was $109.4 million. These interest rate swaps mature between December 2022 and
March 2034. A pre-tax unrealized gain of $3.9 million was recognized in other
comprehensive income for the three months ended March 31, 2022 and there was no
ineffective portion of these hedges.
The Corporation also enters into interest rate swaps to mitigate market value
volatility on certain long-term fixed securities. The objective of the hedge is
to protect the Corporation against changes in fair value due to changes in
benchmark interest rates. The instruments are designated as fair value hedges as
the changes in the fair value of the interest rate swap are expected to offset
changes in the fair value of the hedged item attributable to changes in the SOFR
swap rate, the designated benchmark interest rate. These derivative contracts
involve the receipt of floating rate interest from a counterparty in exchange
for the Corporation making fixed-rate payments over the life of the agreement,
without the exchange of the underlying notional value. The change in the fair
value of these hedging instruments is recorded in accumulated other
comprehensive income and is subsequently reclassified into earnings in the
period that the hedged transactions affects earnings. As of March 31, 2022, the
aggregate notional value of interest rate swaps designated as fair value hedges
was $12.5 million. These interest rate swaps mature between February 2031 and
October 2034. A pre-tax unrealized loss of $50,000 was recognized in other
comprehensive income for the three months ended March 31, 2022 and there was no
ineffective portion of these hedges.
For further information and discussion of our derivatives, see Note 13 –
Derivative Financial Instruments of the Consolidated Financial Statements.
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Asset Quality
Impaired Assets
Total impaired assets consisted of the following at March 31, 2022 and
December 31, 2021, respectively:
March 31, December 31,
2022 2021
(Dollars in Thousands)
Non-accrual loans and leases
Commercial real estate:
Commercial real estate – owner occupied $ 344 $ 348
Commercial real estate – non-owner occupied – –
Land development – –
Construction – –
Multi-family – –
1-4 family 331 339
Total non-accrual commercial real estate 675 687
Commercial and industrial 4,858 5,572
Direct financing leases, net 84 99
Consumer and other:
Home equity and second mortgages – –
Other – –
Total non-accrual consumer and other loans – –
Total non-accrual loans and leases 5,617 6,358
Foreclosed properties, net 117 164
Total non-performing assets 5,734 6,522
Performing troubled debt restructurings 203 217
Total impaired assets
$ 5,937 $ 6,739
Total non-accrual loans and leases to gross loans and leases 0.25 % 0.28 %
Total non-performing assets to gross loans and leases plus foreclosed
properties, net
0.25 0.29
Total non-performing assets to total assets 0.21 0.25
Allowance for loan and lease losses to gross loans and leases 1.05 1.09
Allowance for loan and lease losses to non-accrual loans and leases
421.38 382.76
Net PPP loans outstanding as of March 31, 2022 and December 31, 2021, were
$18.2 million and $27.3 million, respectively. The following asset quality
ratios exclude net PPP loans as they are fully guaranteed by the SBA:
March 31, December 31,
2022 2021
Total non-accrual loans and leases to gross loans and leases 0.25 % 0.29 %
Total non-performing assets to gross loans and leases plus
foreclosed properties, net
0.26 0.29
Total non-performing assets to total assets 0.21 0.25
Allowance for loan and lease losses to gross loans and leases 1.06 1.10
Non-accrual loans decreased $741,000, or 11.7%, to $5.6 million at March 31,
2022, compared to $6.4 million at December 31, 2021. The decrease in non-accrual
loans was principally due to loan payoffs, loans returning to accrual status,
and $22,000 of charge-offs. The Corporation’s non-accrual loans as a percentage
of total gross loans and leases measured 0.25% and 0.28% at March 31, 2022 and
December 31, 2021, respectively. Non-accrual loans as a percentage of total
gross loans and leases, excluding net PPP loans, was 0.25% and 0.29% at
March 31, 2022 and December 31, 2021, respectively. As
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of March 31, 2022 and December 31, 2021, $621,000 and $627,000 of non-accrual
loans and leases were considered TDRs, respectively.
We use a wide variety of available metrics to assess the overall asset quality
of the portfolio and no one metric is used independently to make a final
conclusion as to the asset quality of the portfolio. Non-performing assets as a
percentage of total assets decreased to 0.21% at March 31, 2022 from 0.25% at
December 31, 2021. As of March 31, 2022, the payment performance of our loans
and leases did not point to any new areas of concern, as approximately 99.9% of
the total portfolio was in a current payment status, compared to 99.8% as of
December 31, 2021. We also monitor asset quality through our established
categories as defined in Note 5 – Loan and Lease Receivables, Impaired Loans and
Leases and Allowance for Loan and Lease Losses of the Consolidated Financial
Statements. As we continue to actively monitor the credit quality of our loan
and lease portfolios, we may identify additional loans and leases for which the
borrowers or lessees are having difficulties making the required principal and
interest payments based upon factors including, but not limited to, the
inability to sell the underlying collateral, inadequate cash flow from the
operations of the underlying businesses, liquidation events, or bankruptcy
filings. We are proactively working with our impaired loan borrowers to find
meaningful solutions to difficult situations that are in the best interests of
the Bank.
As of March 31, 2022, as well as in all previous reporting periods, there were
no loans over 90 days past due and still accruing interest. Loans and leases
greater than 90 days past due are considered impaired and are placed on
non-accrual status. Cash received while a loan or a lease is on non-accrual
status is generally applied solely against the outstanding principal. If
collectability of the contractual principal and interest is not in doubt,
payments received may be applied to both interest due on a cash basis and
principal.
The following represents additional information regarding our impaired loans
and leases:
As of and for
the
As of and for the Three Months Ended Year Ended
March 31, December 31,
2022 2021 2021
(In Thousands)
Impaired loans and leases with no impairment
reserves required $ 4,284
$ 10,391 $ 4,419
Impaired loans and leases with impairment reserves
required
1,536 8,660 2,156
Total impaired loans and leases 5,820 19,051 6,575
Less: Impairment reserve (included in allowance
for loan and lease losses) 1,225 3,487 1,505
Net impaired loans and leases $ 4,595 $ 15,564 $ 5,070
Average impaired loans and leases $ 6,400 $ 22,091 $ 14,260
Foregone interest income attributable to impaired
loans and leases $ 105
$ 603 $ 1,104
Less: Interest income recognized on impaired loans
and leases
28 68 454
Net foregone interest income on impaired loans and
leases
$ 77
$ 535 $ 650
Allowance for Loan and Lease Losses
The allowance for loan and lease losses decreased $667,000, or 2.7%, to $23.7
million as of March 31, 2022 from $24.3 million as of December 31, 2021. The
allowance for loan and lease losses as a percentage of gross loans and leases
decreased to 1.05% as of March 31, 2022 from 1.09% as of December 31, 2021. The
allowance for loan and lease losses as a percentage of gross loans and leases,
excluding net PPP loans, was 1.06% as of March 31, 2022 compared to 1.10% as of
December 31, 2021. The decrease in allowance for loan and lease losses as a
percent of gross loans and leases was principally due to the net decrease in
specific reserves and qualitative risk factor improvements. These general and
specific reserve releases were partially offset primarily by an increase in
general reserve commensurate with loan growth. All loan segments experienced a
reduction in historical loss factors as the look-back period continued to roll
off the Corporation’s higher loss rates from the Great Recession. Absent any
significant charge-offs, management believes this will continue in 2022.
There have been no substantive changes to our methodology for estimating the
appropriate level of allowance for loan and lease loss reserves from what was
previously outlined in our most recent Annual Report on Form 10-K.
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During the three months ended March 31, 2022, we recorded net recoveries on
impaired loans and leases of $188,000, comprised of $22,000 of charge-offs and
$210,000 of recoveries. While we likely will continue to experience some level
of periodic charge-offs in the future, as exit strategies are considered and
executed, management believes charge-offs in the foreseeable future will remain
at low levels based on total non-accrual loans and leases as a percentage of
gross loans and leases of 0.25% at March 31, 2022; which is the Corporation’s
lowest level of non-accrual loans since the fourth quarter of 2006. Loans and
leases with previously established specific reserves, however, may ultimately
result in a charge-off under a variety of scenarios.
As of March 31, 2022 and December 31, 2021, our ratio of allowance for loan
and lease losses to total non-accrual loans and leases was 421.38% and 382.76%,
respectively. This ratio increased primarily due to the substantial decrease in
non-accrual loans and leases discussed above, in comparison to the decrease in
the allowance for loan and leases losses. Impaired loans and leases exhibit
weaknesses that inhibit repayment in compliance with the original terms of the
note or lease. However, the measurement of impairment on loans and leases may
not always result in a specific reserve included in the allowance for loan and
lease losses. As part of the underwriting process, as well as our ongoing
monitoring efforts, we try to ensure that we have sufficient collateral to
protect our interest in the related loan or lease. As a result of this practice,
a significant portion of our outstanding balance of non-performing loans or
leases may not require additional specific reserves or require only a minimal
amount of required specific reserve. Management is proactive in recording
charge-offs to bring loans to their net realizable value in situations where it
is determined with certainty that we will not recover the entire amount of our
principal. This practice may lead to a lower allowance for loan and lease loss
to non-accrual loans and leases ratio as compared to our peers or industry
expectations. As asset quality strengthens, our allowance for loan and lease
losses is measured more through general characteristics, including historical
loss experience, of our portfolio rather than through specific identification
and we would therefore expect this ratio to rise. Conversely, if we identify
further impaired loans, this ratio could fall if the impaired loans are
adequately collateralized and therefore require no specific or general reserve.
Given our business practices and evaluation of our existing loan and lease
portfolio, we believe this coverage ratio is appropriate for the probable losses
inherent in our loan and lease portfolio as of March 31, 2022.
To determine the level and composition of the allowance for loan and lease
losses, we break out the portfolio by segments with similar risk
characteristics. First, we evaluate loans and leases for potential impairment
classification. We analyze each loan and lease identified as impaired on an
individual basis to determine a specific reserve based upon the estimated value
of the underlying collateral for collateral-dependent loans, or alternatively,
the present value of expected cash flows. For each segment of loans and leases
that has not been individually evaluated, management segregates the Bank’s loss
factors into a quantitative general reserve component based on historical loss
rates throughout the defined look back period. The quantitative general reserve
component also considers an estimate of the historical loss emergence period,
which is the period of time between the event that triggers the loss to the
charge-off of that loss. The methodology also focuses on evaluation of several
qualitative factors for each portfolio category, including but not limited to:
management’s ongoing review and grading of the loan and lease portfolios,
consideration of delinquency experience, changes in the size of the loan and
lease portfolios, existing economic conditions, level of loans and leases
subject to more frequent review by management, changes in underlying collateral,
concentrations of loans to specific industries, and other qualitative factors
that could affect credit losses.
When it is determined that we will not receive our entire contractual
principal or the loss is confirmed, we record a charge against the allowance for
loan and lease loss reserve to bring the loan or lease to its net realizable
value. Many of the impaired loans as of March 31, 2022 are collateral dependent.
It is typically part of our process to obtain appraisals on impaired loans and
leases that are primarily secured by real estate or equipment at least annually,
or more frequently as circumstances warrant. As we have completed new appraisals
and/or market evaluations, in specific situations current fair values
collateralizing certain impaired loans were inadequate to support the entire
amount of the outstanding debt. Foreclosure actions may have been initiated on
certain of these commercial real estate and other mortgage loans.
As a result of our review process, we have concluded an appropriate allowance
for loan and lease losses for the existing loan and lease portfolio was $23.7
million, or 1.05% of gross loans and leases, at March 31, 2022. However, given
ongoing complexities with current workout situations and the uncertainty
surrounding future economic conditions, further charge-offs, and increased
provisions for loan and lease losses may be recorded if additional facts and
circumstances lead us to a different conclusion. In addition, various federal
and state regulatory agencies review the allowance for loan and lease losses.
These agencies could require certain loan and lease balances to be classified
differently or charged off when their credit evaluations differ from those of
management, based on their judgments about information available to them at the
time of their examination.
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A summary of the activity in the allowance for loan and lease losses follows:
As
of and for the Three Months Ended
March 31,
2022 2021
(Dollars in Thousands)
Allowance at beginning of period $ 24,336 $ 28,521
Charge-offs:
Commercial real estate:
Commercial real estate – owner occupied – –
Commercial real estate – non-owner occupied – –
Construction and land development – –
Multi-family – –
1-4 family – –
Commercial and industrial (22) (144)
Direct financing leases – –
Consumer and other:
Home equity and second mortgages – –
Other – –
Total charge-offs (22) (144)
Recoveries:
Commercial real estate:
Commercial real estate – owner occupied 115 140
Commercial real estate – non-owner occupied 1 –
Construction and land development – 2,078
Multi-family – –
1-4 family – 1
Commercial and industrial 84 453
Direct financing leases – –
Consumer and other:
Home equity and second mortgages – 1
Other 10 –
Total recoveries 210 2,673
Net recoveries 188 2,529
Provision for loan and lease losses (855) (2,068)
Allowance at end of period $ 23,669 $ 28,982
Annualized net (recoveries) charge-offs as a percent of average
gross loans and leases
(0.03) % (0.46) %
Annualized net (recoveries) charge-offs as a percent of average
gross loans and leases, excluding average net PPP loans
(0.03) % (0.52) %
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Liquidity and Capital Resources
The Corporation expects to meet its liquidity needs through existing cash on
hand, established cash flow sources, its third party senior line of credit, and
dividends received from the Bank. While the Bank is subject to certain generally
applicable regulatory limitations regarding its ability to pay dividends to the
Corporation, we do not believe that the Corporation will be adversely affected
by these dividend limitations. The Corporation’s principal liquidity
requirements at March 31, 2022 were the interest payments due on subordinated
notes and cash dividends payable to both common and preferred stockholders. The
capital ratios of the Bank met all applicable regulatory capital adequacy
requirements in effect on March 31, 2022, and continue to meet the heightened
requirements imposed by Basel III, including the capital conservation buffer.
The Corporation’s Board and management teams adhere to the appropriate
regulatory guidelines on decisions which affect their capital positions,
including but not limited to, decisions relating to the payment of dividends and
increasing indebtedness.
The Bank maintains liquidity by obtaining funds from several sources. The
Bank’s primary source of funds are principal and interest payments on loans
receivable and mortgage-related securities, deposits, and other borrowings, such
as federal funds, and FHLB advances. The scheduled payments of loans and
mortgage-related securities are generally a predictable source of funds. Deposit
flows and loan prepayments, however, are greatly influenced by general interest
rates, economic conditions, and competition.
We view on-balance sheet liquidity as a critical element to maintaining adequate
liquidity to meet our cash and collateral obligations. We define our on-balance
sheet liquidity as the total of our short-term investments, our unencumbered
securities available-for-sale, and our unencumbered pledged loans. As of
March 31, 2022 and December 31, 2021, our immediate on-balance sheet liquidity
was $638.9 million and $529.5 million, respectively. At March 31, 2022 and
December 31, 2021, the Bank had $74.9 million and $47.0 million on deposit with
the FRB recorded in short-term investments, respectively. Any excess funds not
used for loan funding or satisfying other cash obligations were maintained as
part of our on-balance sheet liquidity in our interest-bearing accounts with the
FRB, as we value the safety and soundness provided by the FRB. We plan to
utilize excess liquidity to fund loan and lease portfolio growth, pay down
maturing debt, allow run off of maturing wholesale certificates of deposit or
invest in securities to maintain adequate liquidity at an improved margin.
We had $373.7 million of outstanding wholesale funds at March 31, 2022,
compared to $398.4 million of wholesale funds as of December 31, 2021, which
represented 15.7% and 17.1%, respectively, of ending balance total bank funding.
Wholesale funds include FHLB advances, brokered certificates of deposit, and
deposits gathered from internet listing services. Total bank funding is defined
as total deposits plus FHLB advances. We are committed to raising in-market
deposits while utilizing wholesale funds to mitigate interest rate risk.
Wholesale funds continue to be an efficient and cost effective source of funding
for the Bank and allows it to gather funds across a larger geographic base at
price levels and maturities that are more attractive than local time deposits
when required to raise a similar level of in-market deposits within a short time
period. Access to such deposits and borrowings allows us the flexibility to
refrain from pursuing single service deposit relationships in markets that have
experienced unfavorable pricing levels. In addition, the administrative costs
associated with wholesale funds are considerably lower than those that would be
incurred to administer a similar level of local deposits with a similar maturity
structure. During the time frames necessary to accumulate wholesale funds in an
orderly manner, we will use short-term FHLB advances to meet our temporary
funding needs. The short-term FHLB advances will typically have terms of one
week to one month to cover the overall expected funding demands.
Period-end in-market deposits increased $83.1 million, or 17.2% annualized,
to $2.011 billion at March 31, 2022 from $1.928 billion at December 31, 2021 as
in-market deposit balances increased due to successful business development
efforts. Our in-market relationships continue to grow; however, deposit balances
associated with those relationships will fluctuate. We expect to establish new
client relationships and continue marketing efforts aimed at increasing the
balances in existing clients’ deposit accounts. Nonetheless, we will continue to
use wholesale funds in specific maturity periods, typically three to five years,
needed to effectively mitigate the interest rate risk measured through our
asset/liability management process or in shorter time periods if in-market
deposit balances decline. In order to provide for ongoing liquidity and funding,
all of our wholesale certificates of deposit do not allow for withdrawal at the
option of the depositor before the stated maturity (with the exception of
deposits accumulated through the internet listing service which have the same
early withdrawal privileges and fees as do our other in-market deposits) and
FHLB advances with contractual maturity terms. The Bank limits the percentage of
wholesale funds to total bank funds in accordance with liquidity policies
approved by its Board. The Bank was in compliance with its policy limits as of
March 31, 2022.
The Bank was able to access the wholesale funding market as needed at rates
and terms comparable to market standards during the year ended March 31, 2022.
In the event that there is a disruption in the availability of wholesale funds
at maturity, the Bank has managed the maturity structure, in compliance with our
approved liquidity policy, so at least one year of maturities could be funded
through on-balance sheet liquidity. These potential funding sources include
deposits maintained at the FRB or Federal Reserve Discount Window utilizing
currently unencumbered securities and acceptable loans as collateral.
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As of March 31, 2022, the available liquidity was in excess of the stated policy
minimum. We believe the Bank will also have access to the unused federal funds
lines, cash flows from borrower repayments, and cash flows from security
maturities. The Bank also has the ability to raise local market deposits by
offering attractive rates to generate the level required to fulfill its
liquidity needs.
The Corporation has filed a shelf registration with the Securities and Exchange
Commission that would allow the Corporation to offer and sell, from time to time
and in one or more offerings, up to $75.0 million in aggregate initial offering
price of common and preferred stock, debt securities, warrants, subscription
rights, units, or depository shares, or any combination thereof.
The Bank is required by federal regulation to maintain sufficient liquidity to
ensure safe and sound operations. We believe that the Bank has sufficient
liquidity to match the balance of net withdrawable deposits and short-term
borrowings in light of present economic conditions and deposit flows.
As previously announced, effective March 4, 2022, the Corporation’s Board
authorized the repurchase by the Corporation of shares of its common stock with
a maximum aggregate purchase price of $5.0 million, effective March 4, 2022
through March 4, 2023. During March, the Corporation repurchased a total of
4,502 shares for approximately $148,000 at an average cost of $32.87 per share.
During the three months ended March 31, 2022, operating activities resulted in
a net cash inflow of $2.1 million, which included net income of $8.7 million,
partially offset by a $7.0 million net decrease in other liabilities primarily
due to a reduction in annual cash bonus and profit sharing accruals. Net cash
used by investing activities for the three months ended March 31, 2022 was $40.1
million primarily due to investments made in securities available for sale and
net loan disbursements. Net cash provided by financing activities was $76.5
million for the three months ended March 31, 2022 primarily due to a net
increase in deposits and private placement to institutional investors of $32.5
million in new capital consisting of $20.0 million of subordinated note and
$12.5 million of preferred stock, partially offset by the redemption of trust
preferred securities and related payoff of junior subordinated debentures, and a
net reduction in FHLB advances. Please refer to the Consolidated Statements of
Cash Flows included in PART I., Item 1 for further details regarding significant
sources of cash flow for the Corporation.
Contractual Obligations and Off-Balance Sheet Arrangements
As of March 31, 2022, there were no material changes to our contractual
obligations and off-balance sheet arrangements disclosed in our Annual Report on
Form 10-K for the year ended December 31, 2021. We continue to believe that we
have adequate capital and liquidity available from various sources to fund
projected contractual obligations and commitments.
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