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 March 31, 2020
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: 001-35654
NATIONAL BANK HOLDINGS CORPORATION
(Exact name of registrant as specified in its charter)
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Delaware |
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27-0563799 |
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(State or other jurisdiction of incorporation or organization) |
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(I.R.S. Employer Identification No.) |
7800 East Orchard, Suite 300, Greenwood Village, Colorado 80111
(Address of principal executive offices) (Zip Code)
Registrant’s telephone, including area code: (303) 892-8715
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class: |
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Trading Symbol |
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Name of each exchange on which registered: |
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Class A Common Stock |
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NBHC |
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NYSE |
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:
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Large accelerated filer |
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☒ |
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Accelerated filer |
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☐ |
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Non-accelerated filer |
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☐ |
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Smaller reporting company |
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☐ |
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Emerging growth company |
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☐ |
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 ☒
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of May 1, 2020, the registrant had outstanding 30,562,457 shares of Class A voting common stock, each with $0.01 par value per share, excluding 164,339 shares of restricted Class A common stock issued but not yet vested.
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6 |
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Consolidated Statements of Financial Condition as of March 31, 2020 and December 31, 2019 |
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6 |
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Consolidated Statements of Operations for the three months ended March 31, 2020 and 2019 |
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7 |
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Consolidated Statements of Comprehensive Income for the three months ended March 31, 2020 and 2019 |
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8 |
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9 |
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Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019 |
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10 |
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11 |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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37 |
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61 |
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2
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, notwithstanding that such statements are not specifically identified. Any statements about our expectations, beliefs, plans, predictions, forecasts, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “believe,” “can,” “would,” “should,” “could,” “may,” “predict,” “seek,” “potential,” “will,” “estimate,” “target,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “intend” and similar words or phrases. These statements are only predictions and involve estimates, known and unknown risks, assumptions and uncertainties. We have based these statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, liquidity, results of operations, business strategy and growth prospects.
Forward-looking statements involve certain important risks, uncertainties and other factors, any of which could cause actual results to differ materially from those in such statements and, therefore, you are cautioned not to place undue reliance on such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:
● our ability to execute our business strategy, as well as changes in our business strategy or development plans;
● business and economic conditions generally and in the financial services industry;
● effects of a government shutdown;
● economic, market, operational, liquidity, credit and interest rate risks associated with our business;
● effects of any changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board;
● changes imposed by regulatory agencies to increase our capital to a level greater than the current level required for well-capitalized financial institutions;
● effects of inflation, as well as, interest rate, securities market and monetary supply fluctuations;
● changes in the economy or supply-demand imbalances affecting local real estate values;
● changes in consumer spending, borrowings and savings habits;
● with respect to our mortgage business, our inability to negotiate our fees with Fannie Mae, Freddie Mac, Ginnie Mae or other investors for the purchase of our loans, our obligation to indemnify purchasers or to repurchase the related loans if the loans fail to meet certain criteria, or higher rate of delinquencies and defaults as a result of the geographic concentration of our servicing portfolio;
● our ability to identify potential candidates for, obtain regulatory approval for, and consummate, acquisitions, consolidations or other expansion opportunities on attractive terms, or at all;
● our ability to integrate acquisitions or consolidations and to achieve synergies, operating efficiencies and/or other expected benefits within expected time-frames, or at all, or within expected cost projections, and to preserve the goodwill of acquired financial institutions;
● our ability to realize the anticipated benefits from enhancements or updates to our core operating systems from time to time without significant change in our client service or risk to our control environment;
● our dependence on information technology and telecommunications systems of third party service providers and the risk of system failures, interruptions or breaches of security, including those that could result in disclosure or misuse of confidential or proprietary client or other information;
3
● our ability to achieve organic loan and deposit growth and the composition of such growth;
● changes in sources and uses of funds, including loans, deposits and borrowings;
● increased competition in the financial services industry, nationally, regionally or locally, resulting in, among other things, lower returns;
● continued consolidation in the financial services industry;
● our ability to maintain or increase market share and control expenses;
● the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;
● the trading price of shares of the Company's stock;
● the effects of tax legislation, including the potential of future increases to prevailing tax rates, or challenges to our tax position;
● our ability to realize deferred tax assets or the need for a valuation allowance, or the effects of changes in tax laws on our deferred tax assets;
● costs and effects of changes in laws and regulations and of other legal and regulatory developments, including, but not limited to, changes in regulation that affect the fees that we charge, the resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations, reviews or other inquiries; and changes in regulations that apply to us as a Colorado state-chartered bank;
● technological changes;
● the timely development and acceptance of new products and services and perceived overall value of these products and services by our clients;
● changes in our management personnel and our continued ability to attract, hire and retain qualified personnel;
● ability to implement and/or improve operational management and other internal risk controls and processes and our reporting system and procedures;
● regulatory limitations on dividends from our bank subsidiary;
● changes in estimates of future loan reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements;
● widespread natural and other disasters, dislocations, political instability, pandemics such as the outbreak of the novel Coronavirus Disease 2019 (“COVID-19”), acts of war or terrorist activities, cyberattacks or international hostilities through impacts on the economy and financial markets generally or on us or our counterparties specifically;
● adverse effects due to COVID-19 on the Company and its clients, counterparties, employees and third-party service providers, and the adverse impacts on our business, financial position, results of operations and prospects;
● a cyber-security incident, data breach or a failure of a key information technology system;
● impact of reputational risk on such matters as business generation and retention;
4
● other risks and uncertainties listed from time to time in the Company’s reports and documents filed with the Securities and Exchange Commission; and
● our success at managing the risks involved in the foregoing items.
Any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events or circumstances, except as required by applicable law.
5
PART I: FINANCIAL INFORMATION
Item 1: FINANCIAL STATEMENTS
NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Financial Condition (Unaudited)
(In thousands, except share and per share data)
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March 31, 2020 |
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December 31, 2019 |
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ASSETS |
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Cash and due from banks |
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$ |
133,426 |
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$ |
109,690 |
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Interest bearing bank deposits |
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500 |
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500 |
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Cash and cash equivalents |
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133,926 |
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110,190 |
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Investment securities available-for-sale (at fair value) |
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629,396 |
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638,249 |
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Investment securities held-to-maturity (fair value of $197,597 and $183,741 at March 31, 2020 and December 31, 2019, respectively) |
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192,902 |
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182,884 |
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Non-marketable securities |
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29,948 |
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29,751 |
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Loans |
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4,505,735 |
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4,415,406 |
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Allowance for credit losses |
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(50,956) |
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(39,064) |
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Loans, net |
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4,454,779 |
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4,376,342 |
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Loans held for sale |
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127,439 |
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117,444 |
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Other real estate owned |
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7,051 |
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7,300 |
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Premises and equipment, net |
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112,393 |
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112,151 |
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Goodwill |
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115,027 |
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115,027 |
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Intangible assets, net |
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10,489 |
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11,361 |
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Other assets |
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214,980 |
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194,813 |
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Total assets |
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$ |
6,028,330 |
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$ |
5,895,512 |
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LIABILITIES AND SHAREHOLDERS’ EQUITY |
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Liabilities: |
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Deposits: |
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Non-interest bearing demand deposits |
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$ |
1,150,437 |
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$ |
1,184,945 |
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Interest bearing demand deposits |
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846,824 |
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738,496 |
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Savings and money market |
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1,693,614 |
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1,755,538 |
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Time deposits |
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1,050,981 |
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1,058,153 |
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Total deposits |
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4,741,856 |
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4,737,132 |
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Securities sold under agreements to repurchase |
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23,703 |
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56,935 |
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Federal Home Loan Bank advances |
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341,506 |
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207,675 |
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Other liabilities |
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157,811 |
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126,850 |
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Total liabilities |
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5,264,876 |
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5,128,592 |
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Shareholders’ equity: |
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Common stock, par value $0.01 per share: 400,000,000 shares authorized; 51,487,907 and 51,487,907 shares issued; 30,483,361 and 31,176,627 shares outstanding at March 31, 2020 and December 31, 2019, respectively |
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|
515 |
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|
515 |
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Additional paid-in capital |
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1,009,478 |
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1,009,223 |
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Retained earnings |
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168,984 |
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164,082 |
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Treasury stock of 20,883,923 and 20,189,082 shares at March 31, 2020 and December 31, 2019, respectively, at cost |
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(427,890) |
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(408,962) |
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Accumulated other comprehensive income, net of tax |
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12,367 |
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2,062 |
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Total shareholders’ equity |
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763,454 |
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766,920 |
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Total liabilities and shareholders’ equity |
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$ |
6,028,330 |
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$ |
5,895,512 |
See accompanying notes to the consolidated interim financial statements.
6
NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)
(In thousands, except share and per share data)
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For the three months ended |
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March 31, |
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2020 |
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2019 |
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Interest and dividend income: |
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Interest and fees on loans |
$ |
53,527 |
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$ |
52,775 |
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Interest and dividends on investment securities |
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4,631 |
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6,012 |
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Dividends on non-marketable securities |
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414 |
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|
423 |
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Interest on interest-bearing bank deposits |
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96 |
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|
210 |
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Total interest and dividend income |
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58,668 |
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|
59,420 |
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Interest expense: |
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Interest on deposits |
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7,326 |
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6,615 |
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Interest on borrowings |
|
995 |
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|
1,639 |
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Total interest expense |
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8,321 |
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|
8,254 |
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Net interest income before provision for loan losses |
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50,347 |
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51,166 |
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Provision for loan losses |
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6,159 |
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1,534 |
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Net interest income after provision for loan losses |
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44,188 |
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|
49,632 |
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Non-interest income: |
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Service charges |
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4,126 |
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|
4,321 |
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Bank card fees |
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3,513 |
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|
3,428 |
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Mortgage banking income |
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13,673 |
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|
6,937 |
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Bank-owned life insurance income |
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590 |
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|
421 |
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Other non-interest income |
|
1,602 |
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|
1,883 |
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OREO-related income |
|
28 |
|
|
61 |
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Total non-interest income |
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23,532 |
|
|
17,051 |
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Non-interest expense: |
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|
|
|
|
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Salaries and benefits |
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33,180 |
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|
27,890 |
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Occupancy and equipment |
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6,898 |
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|
6,882 |
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Telecommunications and data processing |
|
2,265 |
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|
2,290 |
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Marketing and business development |
|
696 |
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|
986 |
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FDIC deposit insurance |
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(76) |
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|
498 |
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Bank card expenses |
|
1,026 |
|
|
810 |
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Professional fees |
|
609 |
|
|
814 |
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Other non-interest expense |
|
3,090 |
|
|
3,173 |
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Problem asset workout |
|
648 |
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|
1,123 |
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Loss (gain) on OREO sales, net |
|
39 |
|
|
(368) |
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Core deposit intangible asset amortization |
|
296 |
|
|
296 |
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Total non-interest expense |
|
48,671 |
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|
44,394 |
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Income before income taxes |
|
19,049 |
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|
22,289 |
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Income tax expense |
|
3,225 |
|
|
3,367 |
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Net income |
$ |
15,824 |
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$ |
18,922 |
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Earnings per share—basic |
$ |
0.51 |
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$ |
0.61 |
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Earnings per share—diluted |
|
0.50 |
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|
0.60 |
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Weighted average number of common shares outstanding: |
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|
|
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|
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Basic |
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31,157,476 |
|
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30,961,187 |
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Diluted |
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31,361,296 |
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|
31,497,538 |
See accompanying notes to the consolidated interim financial statements.
7
NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Unaudited)
(In thousands)
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|
|
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For the three months ended |
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March 31, |
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|
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2020 |
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2019 |
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Net income |
$ |
15,824 |
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$ |
18,922 |
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Other comprehensive income, net of tax: |
|
|
|
|
|
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Securities available-for-sale: |
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|
|
|
|
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Net unrealized gains arising during the period, net of tax expense of $3,301 and $1,706 for the three months ended March 31, 2020 and 2019, respectively. |
|
10,521 |
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5,417 |
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Less: amortization of net unrealized holding gains to income, net of tax benefit of $68 and $90 for the three months ended March 31, 2020 and 2019, respectively. |
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(216) |
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|
(282) |
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Other comprehensive income |
|
10,305 |
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|
5,135 |
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Comprehensive income |
$ |
26,129 |
|
$ |
24,057 |
See accompanying notes to the consolidated interim financial statements.
8
NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
Three months ended March 31, 2020 and 2019
(In thousands, except share and per share data)
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|
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|
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|
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|
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Accumulated |
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Additional |
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other |
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Common |
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paid-in |
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Retained |
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Treasury |
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comprehensive |
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|
|
stock |
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capital |
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earnings |
|
stock |
|
(loss) income, net |
|
Total |
||||||
|
Balance, December 31, 2018 |
|
$ |
515 |
|
$ |
1,014,399 |
|
$ |
106,990 |
|
$ |
(415,623) |
|
$ |
(11,275) |
|
$ |
695,006 |
|
Net income |
|
|
— |
|
|
— |
|
|
18,922 |
|
|
— |
|
|
— |
|
|
18,922 |
|
Stock-based compensation |
|
|
— |
|
|
376 |
|
|
— |
|
|
— |
|
|
— |
|
|
376 |
|
Issuance of stock under purchase and equity compensation plans, including gain on reissuance of treasury stock of $2,291, net |
|
|
— |
|
|
(1,801) |
|
|
— |
|
|
2,397 |
|
|
— |
|
|
596 |
|
Cash dividends declared ($0.17 per share) |
|
|
— |
|
|
— |
|
|
(5,289) |
|
|
— |
|
|
— |
|
|
(5,289) |
|
Cumulative effect adjustment(1) |
|
|
— |
|
|
— |
|
|
256 |
|
|
— |
|
|
— |
|
|
256 |
|
Other comprehensive loss |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
5,135 |
|
|
5,135 |
|
Balance, March 31, 2019 |
|
$ |
515 |
|
$ |
1,012,974 |
|
$ |
120,879 |
|
$ |
(413,226) |
|
$ |
(6,140) |
|
$ |
715,002 |
|
Balance, December 31, 2019 |
|
$ |
515 |
|
$ |
1,009,223 |
|
$ |
164,082 |
|
$ |
(408,962) |
|
$ |
2,062 |
|
$ |
766,920 |
|
Net income |
|
|
— |
|
|
— |
|
|
15,824 |
|
|
— |
|
|
— |
|
|
15,824 |
|
Stock-based compensation |
|
|
— |
|
|
1,222 |
|
|
— |
|
|
— |
|
|
— |
|
|
1,222 |
|
Issuance of stock under purchase and equity compensation plans, including gain on reissuance of treasury stock of $414 net |
|
|
— |
|
|
(967) |
|
|
— |
|
|
548 |
|
|
— |
|
|
(419) |
|
Repurchase of 734,117 shares |
|
|
— |
|
|
— |
|
|
— |
|
|
(19,476) |
|
|
— |
|
|
(19,476) |
|
Cash dividends declared ($0.20 per share) |
|
|
— |
|
|
— |
|
|
(6,299) |
|
|
— |
|
|
— |
|
|
(6,299) |
|
Cumulative effect adjustment(2) |
|
|
— |
|
|
— |
|
|
(4,623) |
|
|
— |
|
|
— |
|
|
(4,623) |
|
Other comprehensive income |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
10,305 |
|
|
10,305 |
|
Balance, March 31, 2020 |
|
$ |
515 |
|
$ |
1,009,478 |
|
$ |
168,984 |
|
$ |
(427,890) |
|
$ |
12,367 |
|
$ |
763,454 |
|
|
|
|
|
(1) |
|
Related to the adoption of Accounting Standards Update No. 2016-02, Leases. |
|
(2) |
|
Related to the adoption of Accounting Standards Update No. 2016-13, Measurement of Credit Losses on Financial Instruments. Refer to note 2 – Recent Accounting Pronouncements of our consolidated financial statements for further details. |
See accompanying notes to the consolidated interim financial statements.
9
NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
|
|
|
|
|
|
|
|
|
For the three months ended |
||||
|
|
March 31, |
||||
|
|
2020 |
|
2019 |
||
|
Cash flows from operating activities: |
|
|
|
|
|
|
Net income |
$ |
15,824 |
|
$ |
18,922 |
|
Adjustments to reconcile net income to net cash used in operating activities: |
|
|
|
|
|
|
Provision for loan losses |
|
6,159 |
|
|
1,534 |
|
Depreciation and amortization |
|
3,597 |
|
|
2,527 |
|
Current income tax receivable |
|
3,902 |
|
|
2,968 |
|
Deferred income taxes |
|
2,503 |
|
|
1,929 |
|
Net excess tax expense (benefit) on stock-based compensation |
|
28 |
|
|
(753) |
|
Discount accretion, net of premium amortization on securities |
|
501 |
|
|
442 |
|
Loan accretion |
|
(4,142) |
|
|
(4,193) |
|
Gain on sale of mortgages, net |
|
(13,483) |
|
|
(6,276) |
|
Origination of loans held for sale, net of repayments |
|
(337,155) |
|
|
(176,105) |
|
Proceeds from sales of loans held for sale |
|
341,019 |
|
|
171,330 |
|
Bank-owned life insurance income |
|
(590) |
|
|
(421) |
|
Loss (gain) on the sale of other real estate owned, net |
|
39 |
|
|
(368) |
|
Impairment of mortgage servicing rights |
|
509 |
|
|
54 |
|
Impairment on other real estate owned |
|
— |
|
|
596 |
|
Stock-based compensation |
|
1,227 |
|
|
375 |
|
Operating lease payments |
|
(1,396) |
|
|
(1,406) |
|
Change in other assets |
|
(29,095) |
|
|
662 |
|
Change in other liabilities |
|
36,795 |
|
|
(15,437) |
|
Net cash provided by (used in) operating activities |
|
26,242 |
|
|
(3,620) |
|
Cash flows from investing activities: |
|
|
|
|
|
|
Purchase of FHLB stock |
|
(197) |
|
|
(4,248) |
|
Proceeds from redemption of FHLB stock |
|
— |
|
|
7,229 |
|
Proceeds from maturities of investment securities held-to-maturity |
|
15,351 |
|
|
13,217 |
|
Proceeds from maturities of investment securities available-for-sale |
|
48,830 |
|
|
48,328 |
|
Purchase of investment securities held-to-maturity |
|
(25,824) |
|
|
— |
|
Purchase of investment securities available-for-sale |
|
(26,485) |
|
|
— |
|
Net increase in loans |
|
(91,384) |
|
|
(159,027) |
|
Purchases of premises and equipment, net |
|
(2,161) |
|
|
(1,688) |
|
Proceeds from sales of other real estate owned |
|
228 |
|
|
1,262 |
|
Net cash used in investing activities |
|
(81,642) |
|
|
(94,927) |
|
Cash flows from financing activities: |
|
|
|
|
|
|
Net increase in deposits |
|
4,724 |
|
|
178,826 |
|
Net decrease in repurchase agreements and other short-term borrowings |
|
(33,232) |
|
|
(6,504) |
|
Advances from FHLB |
|
607,000 |
|
|
319,041 |
|
FHLB repayments |
|
(473,169) |
|
|
(392,280) |
|
Issuance of stock under purchase and equity compensation plans |
|
(457) |
|
|
(1,646) |
|
Proceeds from exercise of stock options |
|
6 |
|
|
2,221 |
|
Payment of dividends |
|
(6,260) |
|
|
(5,409) |
|
Repurchase of common stock |
|
(19,476) |
|
|
— |
|
Net cash provided by financing activities |
|
79,136 |
|
|
94,249 |
|
Increase (decrease) in cash, cash equivalents and restricted cash(1) |
|
23,736 |
|
|
(4,298) |
|
Cash, cash equivalents and restricted cash at beginning of the year(1) |
|
120,190 |
|
|
119,556 |
|
Cash, cash equivalents and restricted cash at end of period(1) |
$ |
143,926 |
|
$ |
115,258 |
|
Supplemental disclosure of cash flow information during the period: |
|
|
|
|
|
|
Cash paid for interest |
$ |
8,086 |
|
$ |
6,539 |
|
Net tax payment (refund) |
|
54 |
|
|
(86) |
|
Supplemental schedule of non-cash activities: |
|
|
|
|
|
|
Loans transferred to other real estate owned at fair value |
$ |
18 |
|
$ |
288 |
|
Decrease in loans purchased but not settled |
|
(4,450) |
|
|
(7,974) |
|
Loans transferred from loans held for sale to loans |
|
376 |
|
|
198 |
|
Lease right-of-use assets obtained |
|
— |
|
|
30,474 |
|
|
|
|
|
(1) |
|
Included in restricted cash is $10.0 million placed in escrow for certain potential liabilities the Company is indemnified for pursuant to the Peoples merger agreement. The restricted cash is included in other assets in the Company’s consolidated statements of financial condition at March 31, 2020 and 2019. |
See accompanying notes to the consolidated interim financial statements.
10
NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
March 31, 2020
Note 1 Basis of Presentation
National Bank Holdings Corporation ("NBHC" or the "Company") is a bank holding company that was incorporated in the State of Delaware in 2009. The Company is headquartered in Denver, Colorado, and its primary operations are conducted through its wholly owned subsidiary, NBH Bank, (the "Bank"), a Colorado state-chartered bank and a member of the Federal Reserve System. The Company provides a variety of banking products to both commercial and consumer clients through a network of 101 banking centers, as of March 31, 2020, located primarily in Colorado and the greater Kansas City region, and through online and mobile banking products and services.
The accompanying interim unaudited consolidated financial statements serve to update the National Bank Holdings Corporation Annual Report on Form 10-K for the year ended December 31, 2019 and include the accounts of the Company and its wholly owned subsidiary, NBH Bank. The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and where applicable, with general practices in the banking industry or guidelines prescribed by bank regulatory agencies. However, they may not include all information and notes necessary to constitute a complete set of financial statements under GAAP applicable to annual periods and accordingly should be read in conjunction with the financial information contained in the Company's most recent Form 10-K. The unaudited consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results presented. All such adjustments are of a normal recurring nature. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications of prior years' amounts are made whenever necessary to conform to current period presentation. During the first quarter of 2020, the Company updated the loan classifications in its allowance for credit losses model and loans previously referred to as “310-30” were reclassified to “acquired loans”. Certain loan classifications within the consolidated financial disclosures have been updated to reflect this change. The prior period presentations have been reclassified to conform to the current period presentation. Refer to note 4 for further discussion. The results of operations for the interim period is not necessarily indicative of the results that may be expected for the full year or any other interim period. All amounts are in thousands, except share data, or as otherwise noted.
General economic conditions have been declining as a result of the COVID-19 pandemic, which has caused substantial disruption to the communities we serve and has changed the way we live and work. The length of the pandemic and the efficacy of the extraordinary government-mandated measures that have been put into place to address it are unknown, but have already had, and are likely to continue to have, a significant impact to the financial condition and operations of the Company.
GAAP requires management to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosures of contingent assets and liabilities. By their nature, estimates are based on judgment and available information. Management has made significant estimates in certain areas, such as the amount and timing of expected cash flows from assets, the valuation of other real estate owned (“OREO”), the fair value adjustments on assets acquired and liabilities assumed, the valuation of core deposit intangible assets, the valuation of investment securities, the valuation of stock-based compensation, the valuation of mortgage servicing rights (“MSRs”), the fair values of financial instruments, the allowance for credit losses (“ACL”) and contingent liabilities. Because of the inherent uncertainties associated with any estimation process and future changes in market and economic conditions, it is possible that actual results could differ significantly from those estimates.
The Company's significant accounting policies followed in the preparation of the unaudited consolidated financial statements are disclosed in note 2 of the audited financial statements and notes for the year ended December 31, 2019 and are contained in the Company's Annual Report on Form 10-K. There have been no significant changes to the application of significant accounting policies since December 31, 2019, except for the following:
Allowance for credit losses (“ACL”)—The Company adopted ASU 2016-13, Measurement of Credit Losses on Financial Instruments, effective January 1, 2020. This update replaced the current incurred loss methodology for recognizing credit losses with a Current Expected Credit Loss model (“CECL”), which requires a lifetime loss measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts.
11
Loans
The ACL represents management’s estimate of lifetime credit losses inherent in loans as of the balance sheet date. The Company measures expected credit losses for loans on a pooled basis when similar risk characteristics exist. The Company has identified four primary loan segments that are further stratified into 11 loan classes to provide more granularity in analyzing loss history based upon specific loss drivers and risk factors affecting each loan class. Generally, the underlying risk of loss for each of these loan classes will follow certain norms/trends in various economic environments. Loans that do not share risk characteristics are evaluated on an individual basis and are not included in the collective evaluation. Those loans include loans on non-accrual status, loans in bankruptcy, and troubled debt restructurings (“TDRs”) described below. If a specific allowance is warranted based on the borrower’s overall financial condition, the specific allowance is calculated based on discounted expected cash flows using the loan’s initial contractual effective interest rate or the fair value of the collateral less selling costs for collateral-dependent loans.
The Company utilizes a discounted cash flow ("DCF") model developed within a third-party software tool to establish expected lifetime credit losses for the loan portfolio. The ACL is calculated as the difference between the amortized cost basis and the projections from the DCF analysis. The DCF model allows for individual life of loan cash flow modeling, excluding extensions and renewals, using loan specific interest rates and repayment schedules. The model incorporates forecasts of certain national macroeconomic factors which drive correlated Probability of Default (“PD”) and Loss Given Default (“LGD”) rates, which in turn, drive the losses predicted in establishing our ACL. PD and LGD rates along with prepayment rates and loss recovery time delays are determined at a loan class level making use of both internal and peer historical loss rate data. The determination and application of the ACL accounting policy involves judgments, estimates, and uncertainties that are subject to change. For periods beyond the near term, we revert to historical long-term average loss rates on a straight-line basis. The length of the forecast and reversion periods is based on management’s assessment of the length and pattern of the current economic cycle.
Management accounts for the inherent uncertainty of the underlying economic forecast by reviewing and weighting alternate forecast scenarios. Additionally, the ACL calculation includes subjective adjustments for qualitative risk factors that are likely to cause estimated credit losses to differ from historical experience. These qualitative adjustments may increase or reduce reserve levels and include adjustments for lending management experience and risk tolerance, loan review and audit results, asset quality and portfolio trends, loan portfolio growth and industry concentrations. The Company has elected to exclude accrued interest receivable ("AIR") from the allowance for credit losses calculation. When a loan is placed on non-accrual, any recorded AIR is reversed against interest income.
The determination and application of the ACL accounting policy involves judgments, estimates, and uncertainties that are subject to change. Changes in these assumptions, estimates or the conditions surrounding them may have a material impact on our financial condition, liquidity or results of operations. Various regulatory agencies, as an integral part of the examination process, periodically review the ACL. Such agencies may require the Company to recognize additions to the ACL or reserve increases to adversely graded classified loans based on their judgments about information available to them at the time of their examinations.
The ACL is decreased by net charge-offs and is increased by provisions for loan losses that are charged to the statements of operations. Charge-offs, if any, are typically measured for each loan based on a thorough analysis of the most probable source of repayment, such as the present value of the loan’s expected future cash flows, the loan’s estimated fair value, or the estimated fair value of the underlying collateral less costs of disposition for collateral-dependent loans. When it is determined that specific loans, or portions thereof, are uncollectible, these amounts are charged off against the ACL.
The Company uses an internal risk rating system to indicate credit quality in the loan portfolio. The risk rating system is applied to all loans and uses a series of grades, which reflect management’s assessment of the risk attributable to loans based on an analysis of the borrower’s financial condition and ability to meet contractual debt service requirements. Loans that management perceives to have acceptable risk are categorized as “Pass” loans. The “Special Mention” loans represent loans that have potential credit weaknesses that deserve management’s close attention. Special mention loans include borrowers that have potential weaknesses or unwarranted risks that, unless corrected, may threaten the borrower’s ability to meet debt requirements. However, these borrowers are still believed to have the ability to respond to and resolve the financial issues that threaten their financial situation. Loans classified as “Substandard” are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans have a distinct possibility of loss if the deficiencies are not corrected. “Doubtful” loans are loans that management believes the collection of payments in accordance with the terms of the loan agreement is highly questionable and improbable. Credit quality indicators are reviewed and updated in accordance with internal policy based on loan balance and risk rating. Interest accrual is discontinued on doubtful loans and certain substandard loans, as is more fully discussed in note 4.
12
Unfunded loan commitments
In addition to the ACL for funded loans, the Company maintains reserves to cover the risk of loss associated with off-balance sheet unfunded loan commitments. The allowance for off-balance sheet credit losses is maintained within the other liabilities in the statements of financial condition. Under the CECL framework, adjustments to this liability are recorded as provision for credit losses in the statements of operations. Unfunded loan commitment balances are evaluated by loan class and further segregated by revolving and non-revolving commitments. In order to establish the required level of reserve, the Company applies average historical utilization rates and ACL loan model loss rates for each loan class to the outstanding unfunded commitment balances.
Investment securities
Management evaluates all investments in an unrealized loss position on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. If the Company has the intent to sell the security or it is more likely than not that the Company will be required to sell the security, the security is written down to fair value and the entire loss is recorded in earnings. If either of the above criteria is not met, we evaluate whether the decline in fair value is the result of credit losses or other factors. In making the assessment, we may consider various factors including the extent to which fair value is less than amortized cost, performance on any underlying collateral, downgrades in the ratings of the security by a rating agency, the failure of the issuer to make scheduled interest or principal payments and adverse conditions specifically related to the security. If the assessment indicates that a credit loss exists, the present value of cash flows expected to be collected are compared to the amortized cost basis of the security and any excess is recorded as an allowance for credit loss. For U.S. agency-backed securities, since the risk of nonpayment of the amortized cost basis is zero, the Company will not measure expected credit losses on these securities. When the loss is not considered a result of credit loss, the cost basis of the security is written down to fair value, with the loss charge recognized in AOCI. Credit losses are not estimated for AIR from investment securities as interest deemed uncollectible is written off through interest income.
Note 2 Recent Accounting Pronouncements
Financial Instruments - Credit Losses—In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. This update replaces the current incurred loss methodology for recognizing credit losses with a CECL model, which requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This amendment broadens the information that an entity must consider in developing its expected credit loss estimates. Additionally, the update amends the accounting for credit losses for available-for-sale debt securities and purchased financial assets with a more-than-insignificant amount of credit deterioration since origination. This update requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of a company’s loan portfolio. We adopted ASU 2016-13 on January 1, 2020 using a modified retrospective approach. Results for reporting periods beginning after January 1, 2020 are presented under ASU 2016-13 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Company recognized a $5.8 million increase in the allowance for credit losses with a corresponding reduction to retained earnings, net of tax, of $4.6 million. Since the investment securities portfolio is comprised of mortgage-backed securities issued by government sponsored entities, no credit loss allowance was required upon adoption. See CECL loan related financial statement disclosures included within note 1 and note 4 of the consolidated financial statements.
Other Pronouncements— The Company adopted ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement and ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment with no material impact on its financial statements.
Note 3 Investment Securities
The Company’s investment securities portfolio is comprised of available-for-sale and held-to-maturity investment securities. These investment securities totaled $0.8 billion at March 31, 2020 and included $0.6 billion of available-for-sale securities and $0.2 billion of held-to-maturity securities. At December 31, 2019, investment securities totaled $0.8 billion and included $0.6 billion of available-for-sale securities and $0.2 billion of held-to-maturity securities.
13
Available-for-sale
Available-for-sale securities are summarized as follows as of the dates indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2020 |
||||||||||
|
|
|
Amortized |
|
Gross |
|
Gross |
|
|
|
|||
|
|
|
cost |
|
unrealized gains |
|
unrealized losses |
|
Fair value |
||||
|
Mortgage-backed securities (“MBS”): |
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises |
|
$ |
85,972 |
|
$ |
2,577 |
|
$ |
— |
|
$ |
88,549 |
|
Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises |
|
|
528,397 |
|
|
11,588 |
|
|
(110) |
|
|
539,875 |
|
Municipal securities |
|
|
495 |
|
|
8 |
|
|
— |
|
|
503 |
|
Other securities |
|
|
469 |
|
|
— |
|
|
— |
|
|
469 |
|
Total investment securities available-for-sale |
|
$ |
615,333 |
|
$ |
14,173 |
|
$ |
(110) |
|
$ |
629,396 |
At March 31, 2020 and December 31, 2019, mortgage-backed securities represented primarily all of the Company’s available-for-sale investment portfolio and all mortgage-backed securities were backed by government sponsored enterprises (“GSE”) collateral such as Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”), and the government owned agency Government National Mortgage Association (“GNMA”).
The tables below summarize the available-for-sale securities with unrealized losses as of the dates shown, along with the length of the impairment period:
14
Management evaluated all of the available-for-sale securities in an unrealized loss position at March 31, 2020 and December 31, 2019. The portfolio included 10 securities, which were in an unrealized loss position at March 31, 2020, compared to 67 securities at December 31, 2019. The unrealized losses in the Company's investment portfolio at March 31, 2020 were caused by changes in interest rates. The Company has no intention to sell these securities and believes it will not be required to sell the securities before the recovery of their amortized cost. Management believes that default of the available-for-sale securities is highly unlikely. FHLMC, FNMA and GNMA guaranteed mortgage-backed securities have a long history of zero credit losses, an explicit guarantee by the U.S. government (although limited for FNMA and FHLMC securities) and yields that generally trade based on market views of prepayment and liquidity risk rather than credit risk. As such, no allowance for credit loss was recorded as of March 31, 2020.
Certain securities are pledged as collateral for public deposits, securities sold under agreements to repurchase and to secure borrowing capacity at the Federal Reserve Bank (“FRB”), if needed. The fair value of available-for-sale investment securities pledged as collateral totaled $372.1 million and $352.3 million at March 31, 2020 and December 31, 2019, respectively. The Bank had available-for-sale and held-to-maturity investment securities pledged as collateral for Federal Home Loan Bank (“FHLB”) advances totaling $16.5 million and $17.6 million at March 31, 2020 and December 31, 2019, respectively.
Mortgage-backed securities may have actual maturities that differ from contractual maturities depending on the repayment characteristics and experience of the underlying financial instruments. As of March 31, 2020, the entire municipal securities portfolio with an amortized cost and fair value of $0.5 million was due between one to five years. Other securities of $0.5 million as of March 31, 2020, have no stated contractual maturity date.
As of March 31, 2020 and December 31, 2019, AIR from available-for-sale investment securities totaled $1.7 million and $1.5 million, respectively, and was included with other assets on the statements of financial condition.
Held-to-maturity
Held-to-maturity investment securities are summarized as follows as of the dates indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2020 |
||||||||||
|
|
|
|
|
|
Gross |
|
Gross |
|
|
|
||
|
|
|
Amortized |
|
unrealized |
|
unrealized |
|
|
|
|||
|
|
|
cost |
|
gains |
|
losses |
|
Fair value |
||||
|
Mortgage-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises |
|
$ |
144,218 |
|
$ |
4,065 |
|
$ |
— |
|
$ |
148,283 |
|
Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises |
|
|
48,684 |
|
|
630 |
|
|
— |
|
|
49,314 |
|
Total investment securities held-to-maturity |
|
$ |
192,902 |
|
$ |
4,695 |
|
$ |
— |
|
$ |
197,597 |
15
There were no held-to-maturity securities in an unrealized loss position as of March 31, 2020 compared to 13 securities at December 31, 2019. The table below summarizes the held-to-maturity securities with unrealized losses as of December 31, 2019, along with the length of the impairment period:
The Company does not measure expected credit losses on a financial asset, or group of financial assets, in which historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the amortized cost basis is zero. Management evaluated held-to-maturity securities noting they are backed by loans guaranteed by either U.S. government agencies or U.S. government sponsored entities, and management believes that default is highly unlikely given this governmental backing and long history without credit losses. Additionally, management notes that yields on which the portfolio generally trades are based upon market views of prepayment and liquidity risk and not credit risk. The Company has no intention to sell any held-to-maturity securities and believes it will not be required to sell any held-to-maturity securities before the recovery of their amortized cost.
The carrying value of held-to-maturity investment securities pledged as collateral totaled $168.4 million and $144.2 million at March 31, 2020 and December 31, 2019, respectively.
Actual maturities of mortgage-backed securities may differ from scheduled maturities depending on the repayment characteristics and experience of the underlying financial instruments.
As of March 31, 2020 and December 31, 2019, AIR from held-to-maturity investment securities totaled $0.5 million and $0.5 million, respectively, and was included with other assets on the statements of financial condition.
Note 4 Loans
The loan portfolio is comprised of loans originated by the Company and loans that were acquired in connection with the Company’s acquisitions. During the first quarter of 2020, the Company updated its loan classifications to include energy loans within the commercial and industrial loan class and present municipal and non-profit loans as their own class within the commercial segment. Additionally, loans previously referred to as “310-30 loans” are included in “acquired loans”. The prior year presentation has been reclassified to conform to the current year presentation. In addition, as the concept of impaired loans does not exist under CECL, disclosures that related solely to impaired loans have been removed.
16
The tables below show the loan portfolio composition including carrying value by segment as of the dates shown. The carrying value of loans is net of discounts, fees, cost and fair value marks of $19.0 million and $21.9 million as of March 31, 2020 and December 31, 2019, respectively.
Delinquency for loans is shown in the following tables at March 31, 2020 and December 31, 2019:
17
Loans are considered past due or delinquent when the contractual principal or interest due in accordance with the terms of the loan agreement remains unpaid after the due date of the scheduled payment. Non-accrual loans include non-accrual loans and TDRs on non-accrual status. There was no interest income recognized on non-accrual loans during the three months ended March 31, 2020 or 2019.
The Company’s internal risk rating system uses a series of grades which reflect our assessment of the credit quality of loans based on an analysis of the borrower's financial condition, liquidity and ability to meet contractual debt service requirements and are categorized as “Pass”, “Special mention”, “Substandard” and “Doubtful”. For a description of the general characteristics of the risk grades, refer to note 1 Basis of Presentation.
18
The amortized cost basis for all loans as determined by the Company’s internal risk rating system and year of origination was as follows at March 31, 2020:
19
Loans evaluated individually
We evaluate loans individually when they no longer share risk characteristics with pooled loans. These loans include loans on non-accrual status, loans in bankruptcy, and TDRs described below. If a specific allowance is warranted based on the borrower’s overall financial condition, the specific allowance is calculated based on discounted expected cash flows using the loan’s initial contractual effective interest rate or the fair value of the collateral less selling costs for collateral-dependent loans.
A loan is considered collateral-dependent when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. Management individually evaluates collateral-dependent loans with an amortized cost basis of $250 thousand or more and includes collateral-dependent loans less than $250 thousand within the general allowance population. The amortized cost basis of collateral-dependent loans over $250 thousand was as follows at March 31, 2020:
20
Troubled debt restructurings
The Company’s policy is to review each prospective credit to determine the appropriateness and the adequacy of security or collateral prior to making a loan. In the event of borrower default, the Company seeks recovery in compliance with lending laws, the respective loan agreements, and credit monitoring and remediation procedures that may include restructuring a loan to provide a concession by the Company to the borrower from their original terms due to borrower financial difficulties in order to facilitate repayment. Additionally, if a borrower’s repayment obligation has been discharged by a court, and that debt has not been reaffirmed by the borrower, regardless of past due status, the loan is considered to be a TDR.
During the three months ended March 31, 2020, the Company had four loan modifications totaling $122 thousand due to the effects of the COVID-19 pandemic that were not identified as TDRs, consistent with the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus. The Company anticipates additional loans to be restructured due to the effects of COVID-19 in the coming periods that will not be identified as TDRs.
During the three months ended March 31, 2020, the Company restructured 2 loans with an amortized cost basis of $1.9 million to facilitate repayment. Included in the total TDR balance as of March 31, 2020 were loans totaling $4.2 million previously accounted for under ASC 310-30. Loan modifications were a reduction of the principal payment, a reduction in interest rate, or an extension of term. The tables below provide additional information related to accruing TDRs at March 31, 2020 and December 31, 2019:
The following table summarizes the Company’s carrying value of non-accrual TDRs as of March 31, 2020 and December 31, 2019:
Accrual of interest is resumed on loans that were previously on non-accrual only after the loan has performed sufficiently for a period of time. The Company had five TDRs totaling $0.8 million that were modified within the past twelve months and had defaulted on their restructured terms during the three months ended March 31, 2020. During the three months ended March 31, 2019, the Company had two TDRs totaling $0.2 million that were modified within the past twelve months and had defaulted on their restructured terms. For purposes of this disclosure, the Company considers “default” to mean 90 days or more past due on principal or interest. The allowance for credit losses related to TDRs on non-accrual status is determined by individual evaluation, including collateral adequacy, using the same process as loans on non-accrual status which are not classified as TDRs.
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Note 5 Allowance for Credit Losses
The table below details the Company’s allowance for credit losses as of and for the three months ended March 31, 2020:
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(1) |
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Related to the adoption of Accounting Standards Update No. 2016-13, Measurement of Credit Losses on Financial Instruments. Refer to note 2 – Recent Accounting Pronouncements of our consolidated financial statements for further details. |
The table below details the Company’s allowance for loan losses as of and for the three months ended March 31, 2019:
In evaluating the loan portfolio for an appropriate ACL level, excluding loans evaluated individually, loans were grouped into segments based on broad characteristics such as primary use and underlying collateral. Within the segments, the portfolio was further disaggregated into classes of loans with similar attributes and risk characteristics for purposes of developing the underlying data used within the discounted cash flow model including, but not limited to, prepayment and recovery rates as well as loss rates tied to macro-economic conditions within management’s reasonable and supportable forecast. The ACL also includes subjective adjustments based upon qualitative risk factors including asset quality, loss trends, lending management, portfolio growth and loan review/internal audit results.
Net charge-offs on loans during the three months ended March 31, 2020 and 2019 were $0.4 million and $0.2 million, respectively. Provision for loan losses for funded loans totaled $6.4 million for the three months ended March 31, 2020 to support originated loan growth, net charge-offs and provides coverage for the impact of deterioration in the macro-economic environment as a result of COVID-19. Provision for loan losses totaled $1.5 million for the three months ended March 31, 2019 to support originated loan growth and net charge-offs.
The Company has elected to exclude AIR from the allowance for credit losses calculation. As of March 31, 2020 and December 31, 2019, AIR from loans totaled $19.8 million and $17.2 million, respectively.
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Note 6 Other Real Estate Owned
A summary of the activity in OREO during the three months ended March 31, 2020 and 2019 is as follows:
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For the three months ended March 31, |
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2020 |
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2019 |
||
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Beginning balance |
$ |
7,300 |
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$ |
10,596 |
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Transfers from loan portfolio, at fair value |
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18 |
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|
288 |
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Impairments |
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— |
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(596) |
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Sales |
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(267) |
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(894) |
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Ending balance |
$ |
7,051 |
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$ |
9,394 |
During the three months ended March 31, 2020, the Company sold $0.3 million of OREO. Sales resulted in net OREO losses of $39 thousand and net OREO gains of $0.4 million during the three months ended March 31, 2020 and 2019, respectively, which were included in the consolidated statements of operations.
Note 7 Goodwill and Intangible Assets
Goodwill and core deposit intangible
In connection with our acquisitions, the Company recorded goodwill of $115.0 million. Goodwill is measured as the excess of the fair value of consideration paid over the fair value of net assets acquired. No goodwill impairment was recorded during the three months ended March 31, 2020 or the year ended December 31, 2019.
The gross carrying amount of the core deposit intangibles and the associated accumulated amortization at March 31, 2020 and December 31, 2019, are presented as follows:
The Company is amortizing the core deposit intangibles from acquisitions on a straight line basis over 7-10 years from the date of the respective acquisition, which represents the expected useful life of the assets. The Company recognized core deposit intangible amortization expense of $0.3 million and $0.3 million during the three months ended March 31, 2020 and 2019, respectively.
The following table shows the estimated future amortization expense for the core deposit intangibles as of March 31, 2020:
Mortgage servicing rights
MSRs represent rights to service loans originated by the Company and sold to government sponsored enterprises including FHLMC, FNMA, GNMA and FHLB. Mortgage loans serviced for others were $301.8 million and $376.0 million at March 31, 2020 and 2019, respectively, and are included in other assets in the consolidated statements of financial condition.
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Below are the changes in the MSRs for the periods presented:
The fair value of MSRs was determined based upon a discounted cash flow analysis. The cash flow analysis included assumptions for discount rates and prepayment speeds. Discount rates ranged from 9.5% to 10.5%, and the constant prepayment speed ranged from 16.9% to 21.4% for the March 31, 2020 valuation. Discount rates ranged from 9.5% to 10.5%, and the constant prepayment speed ranged from 13.4% to 19.8% for the March 31, 2019 valuation. Included in mortgage banking income in the consolidated statements of operations were service fees of $0.2 million and $0.3 million for the three months ended March 31, 2020 and 2019, respectively.
MSRs are evaluated, and impairment is recognized to the extent fair value is less than the carrying amount. The Company evaluates impairment by stratifying MSRs based on the predominant risk characteristics of the underlying loans, including loan type and loan term. The Company is amortizing the MSRs in proportion to and over the period of the estimated net servicing income of the underlying loans.
The following table shows the estimated future amortization expense for the MSRs as of March 31, 2020:
Note 8 Borrowings
The Company enters into repurchase agreements to facilitate the needs of its clients. As of March 31, 2020 and December 31, 2019, the Company sold securities under agreements to repurchase totaling $23.7 million and $56.9 million, respectively. The Company pledged mortgage-backed securities with a fair value of approximately $38.2 million and $65.6 million as of March 31, 2020 and December 31, 2019, respectively, for these agreements. The Company monitors collateral levels on a continuous basis and may be required to provide additional collateral based on the fair value of the underlying securities. As of March 31, 2020 and December 31, 2019, the Company had $13.8 million and $7.0 million, respectively, of excess collateral pledged for repurchase agreements.
As a member of the FHLB, the Bank has access to a line of credit and term financing from the FHLB with total available credit of $1.0 billion at March 31, 2020. At March 31, 2020 and December 31, 2019, the Bank had $326.5 million and $192.7 million in line of credit advances from the FHLB, respectively, that mature within a day. At March 31, 2020 and December 31, 2019, the Bank had one term advance from the FHLB totaling $15.0 million with a fixed interest rate of 2.33% and a maturity date in October 2020. The Bank had investment securities and loans pledged as collateral for FHLB advances. Investment securities pledged were $16.5 million and $17.6 million at March 31, 2020 and December 31, 2019, respectively. Loans pledged were $1.5 billion at both March 31, 2020 and December 31, 2019. Interest expense related to FHLB advances and other short-term borrowing totaled $0.9 million and $1.5 million for the three months ended March 31, 2020 and 2019, respectively.
Note 9 Regulatory Capital
As a bank holding company, the Company is subject to regulatory capital adequacy requirements implemented by the Federal Reserve. The federal banking agencies have risk based capital adequacy regulations intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization’s operations. Under these regulations, assets are assigned to one of several risk categories, and nominal dollar amounts of assets and credit equivalent amounts of off-balance-sheet items are multiplied by a risk adjustment percentage for the category.
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Under the Basel III requirements, at March 31, 2020 and December 31, 2019, the Company and the Bank met all capital requirements including the capital conservation buffer of 2.5%, which was fully phased in on January 1, 2019. The Bank had regulatory capital ratios in excess of the levels established for well-capitalized institutions, as detailed in the tables below.
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(1) |
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As of the fully phased-in date of January 1, 2019, including the capital conservation buffer. |
f
Note 10 Revenue from Contracts with Clients
Revenue is recognized when obligations under the terms of a contract with clients are satisfied. Below is the detail of the Company’s revenue from contracts with clients.
Service charges and other fees
Service charge fees are primarily comprised of monthly service fees, check orders, and other deposit account related fees. Other fees include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to clients’ accounts.
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Bank card fees
Bank card fees are primarily comprised of debit card income, ATM fees, merchant services income, and other fees. Debit card income is primarily comprised of interchange fees earned whenever the Company’s debit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Bank cardholder uses a non-Bank ATM or a non-Bank cardholder uses a Bank ATM. Merchant services income mainly represents fees charged to merchants to process their debit card transactions. The Company’s performance obligation for bank card fees are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month.
Gain on OREO sales, net
Gain on OREO sales, net is recognized when the Company meets its performance obligation to transfer title to the buyer. The gain or loss is measured as the excess of the proceeds received compared to the OREO carrying value. Sales proceeds are received in cash at the time of transfer.
The following table presents non-interest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, and non-interest expense in-scope of Topic 606 for the three months ended March 31, 2020 and 2019.
Contract Acquisition Costs
In accordance with Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a client if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a client that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. The Company has not capitalized any contract acquisition costs.
Note 11 Stock-based Compensation and Benefits
The Company provides stock-based compensation in accordance with shareholder-approved plans. In 2014, shareholders approved the 2014 Omnibus Incentive Plan (the "2014 Plan"). The 2014 Plan replaces the NBH Holdings Corp. 2009 Equity Incentive Plan (the "Prior Plan"), pursuant to which the Company granted equity awards prior to the approval of the 2014 Plan. Pursuant to the 2014 Plan, the Compensation Committee of the Board of Directors has the authority to grant, from time to time, awards of stock options, stock appreciation rights, restricted stock, restricted stock units, performance units, other stock-based awards, or any combination thereof to eligible persons.
Stock options
The Company issues stock options which are primarily time-vesting with 1/3 vesting on each of the first, second and third anniversary of the date of grant or date of hire. The expense associated with the awarded stock options was measured at fair value using a Black-Scholes option-pricing model. The outstanding option awards vest or have vested on a graded basis over 1-4 years of continuous service and have 10-year contractual terms.
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The following table summarizes stock option activity for the three months ended March 31, 2020:
Stock option expense is a component of salaries and benefits in the consolidated statements of operations and totaled $208 thousand and $47 thousand for the three months ended March 31, 2020 and 2019, respectively. At March 31, 2020, there was $0.6 million of total unrecognized compensation cost related to non-vested stock options granted under the plans. The cost is expected to be recognized over a weighted average period of 1.8 years.
Restricted stock awards
The Company issues time-based restricted stock awards that vest over a range of a 1-3 year period. Restricted stock with time-based vesting was valued at the fair value of the shares on the date of grant as they are assumed to be held beyond the vesting period.
Performance stock units
The Company grants performance stock units which represent initial target awards and do not reflect potential increases or decreases resulting from the final performance results, which are to be determined at the end of the three-year performance period (vesting date). The actual number of shares to be awarded at the end of the performance period will range from 0% - 150% of the initial target awards. 60% of the award is based on the Company’s cumulative earnings per share (EPS target) during the performance period, and 40% of the award is based on the Company’s cumulative total shareholder return (TSR target), or TSR, during the performance period. On the vesting date, the Company’s TSR will be compared to the respective TSRs of the companies comprising the KBW Regional Index at the grant date to determine the shares awarded. The fair value of the EPS target portion of the award was determined based on the closing stock price of the Company’s common stock on the grant date. The fair value of the TSR target portion of the award was determined using a Monte Carlo Simulation at the grant date.
The following table summarizes restricted stock and performance stock unit activity during the three months ended March 31, 2020:
As of March 31, 2020, the total unrecognized compensation cost related to the non-vested restricted stock awards and performance stock units totaled $1.4 million and $2.2 million, respectively, and is expected to be recognized over a weighted average period of approximately 1.8 years and 1.5 years, respectively. Expense related to non-vested restricted stock awards totaled $0.5 million and $0.2 million during the three months ended March 31, 2020 and 2019, respectively. Expense related to non-vested performance stock units totaled $0.5 million and $0.2 million during the three months ended March 31, 2020 and 2019, respectively. Expense related to
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non-vested restricted stock awards and units is a component of salaries and benefits in the Company’s consolidated statements of operations.
Employee Stock Purchase Plan
The 2014 Employee Stock Purchase Plan (“ESPP”) is intended to be a qualified plan within the meaning of Section 423 of the Internal Revenue Code of 1986 and allows eligible employees to purchase shares of common stock through payroll deductions up to a limit of $25,000 per calendar year and 2,000 shares per offering period. The price an employee pays for shares is 90.0% of the fair market value of Company common stock on the last day of the offering period. The offering periods are the six-month periods commencing on March 1 and September 1 of each year and ending on August 31 and February 28 (or February 29 in the case of a leap year) of each year. There are no vesting or other restrictions on the stock purchased by employees under the ESPP. Under the ESPP, the total number of shares of common stock reserved for issuance totaled 400,000 shares, of which 317,198 was available for issuance.
Under the ESPP, employees purchased 8,890 shares and 6,201 shares during the three months ended March 31, 2020 and 2019, respectively.
Note 12 Common Stock
The Company had 30,483,361 and 31,176,627 shares of Class A common stock outstanding at March 31, 2020 and December 31, 2019, respectively. Additionally, the Company had 120,623 and 122,198 shares outstanding at March 31, 2020 and December 31, 2019, respectively, of restricted Class A common stock issued but not yet vested under the 2014 Plan that are not included in shares outstanding until such time that they are vested; however, these shares do have voting and certain dividend rights during the vesting period.
On February 26, 2020, the Board of Directors authorized a new share repurchase program for up to $50.0 million from time to time in either the open market or through privately negotiated transactions. During the first quarter of 2020, the Company repurchased 734,117 shares for $19.5 million. Of those repurchases, $12.6 million were part of the previous authorization from August 2016. That authorization has been completed. The remaining authorization under the new program as of March 31, 2020 was $43.1 million.
Note 13 Earnings Per Share
The Company calculates earnings per share under the two-class method, as certain non-vested share awards contain non-forfeitable rights to dividends. As such, these awards are considered securities that participate in the earnings of the Company. Non-vested shares are discussed further in note 12.
The Company had 30,483,361 and 30,958,581 shares of Class A common stock outstanding as of March 31, 2020 and 2019, respectively, exclusive of issued non-vested restricted shares. Certain stock options and non-vested restricted shares are potentially dilutive securities, but are not included in the calculation of diluted earnings per share because to do so would have been anti-dilutive for the three months ended March 31, 2020 and 2019.
The following table illustrates the computation of basic and diluted earnings per share for the three months ended March 31, 2020 and 2019:
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The Company had 652,309 and 1,110,984 outstanding stock options to purchase common stock at weighted average exercise prices of $26.69 and $22.28 per share at March 31, 2020 and 2019, respectively, which have time-vesting criteria, and as such, any dilution is derived only for the time frame in which the vesting criteria had been met and where the inclusion of those stock options is dilutive. The Company had 243,481 and 207,372 unvested restricted shares and units issued as of March 31, 2020 and 2019, respectively, which have performance, market and/or time-vesting criteria, and as such, any dilution is derived only for the time frame in which the vesting criteria had been met and where the inclusion of those restricted shares and units is dilutive.
Note 14 Derivatives
Risk management objective of using derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company has established policies that neither carrying value nor fair value at risk should exceed established guidelines. The Company has designed strategies to confine these risks within the established limits and identify appropriate trade-offs in the financial structure of its balance sheet. These strategies include the use of derivative financial instruments to help achieve the desired balance sheet repricing structure while meeting the desired objectives of its clients. Currently, the Company employs certain interest rate swaps that are designated as fair value hedges as well as economic hedges. The Company manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions.
Fair values of derivative instruments on the balance sheet
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the consolidated statements of financial condition as of March 31, 2020 and December 31, 2019.
Information about the valuation methods used to measure fair value is provided in note 16.
Fair value hedges
Interest rate swaps designated as fair value hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without the exchange of the underlying notional amount. As of March 31, 2020, the Company had interest rate swaps with a notional amount of $410.3 million, which were designated as fair value hedges of interest rate risk. As of December 31, 2019, the Company had interest rate swaps with a notional amount of $403.7 million that were designated as fair value hedges. These interest rate swaps were associated with $413.4 million and $405.9 million of the Company’s fixed-rate loans as of March 31, 2020 and December 31, 2019, respectively, before a gain of $47.6 million and $13.9 million from the fair value hedge adjustment in the carrying amount, included in loans receivable on the statements of financial condition as of March 31, 2020 and December 31, 2019, respectively.
For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in earnings. The Company includes the gain or loss on the hedged items in the same line item as the offsetting loss or gain on the related derivatives.
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Non-designated hedges
Derivatives not designated as hedges are not speculative and consist of interest rate swaps with commercial banking clients that facilitate their respective risk management strategies. Interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the client swaps and the offsetting swaps are recognized directly in earnings. As of March 31, 2020, the Company had matched interest rate swap transactions with an aggregate notional amount of $517.0 million related to this program. As of December 31, 2019, the Company had matched interest rate swap transactions with an aggregate notional amount of $478.9 million related to this program.
As part of its mortgage banking activities, the Company enters into interest rate lock commitments, which are commitments to originate loans where the interest rate on the loan is determined prior to funding and the clients have locked into that interest rate. The Company then locks in the loan and interest rate with an investor and commits to deliver the loan if settlement occurs ("best efforts") or commits to deliver the locked loan in a binding ("mandatory") delivery program with an investor. Fair value changes of certain loans under interest rate lock commitments are hedged with forward sales contracts of MBS. Forward sales contracts of MBS are recorded at fair value with changes in fair value recorded in non-interest income. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Company determines the fair value of interest rate lock commitments and delivery contracts by measuring the fair value of the underlying assets. The fair value of the underlying assets is impacted by current interest rates, remaining origination fees, costs of production to be incurred and the probability that the interest rate lock commitments will close or will be funded.
Certain additional risks arise from these forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. The Company does not expect any counterparty to any MBS contract to fail to meet its obligation. Additional risks inherent in mandatory delivery programs include the risk that, if the Company fails to deliver the loans subject to interest rate risk lock commitments, it will still be obligated to “pair off” MBS to the counterparty. Should this be required, the Company could incur significant costs in acquiring replacement loans and such costs could have an adverse effect on the consolidated financial statements.
The fair value of the mortgage banking derivative is recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change.
The Company had interest rate lock commitments with a notional value of $325.4 million and forward contracts with a notional value of $287.5 million at March 31, 2020. At December 31, 2019, the Company had interest rate lock commitments with a notional value of $99.8 million and forward contracts with a notional value of $181.5 million.
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Effect of derivative instruments on the consolidated statements of operations
The tables below present the effect of the Company’s derivative financial instruments in the consolidated statements of operations for the three months ended March 31, 2020 and 2019:
Credit-risk-related contingent features
The Company has agreements with its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness for reasons other than an error or omission of an administrative or operational nature, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.
The Company also has agreements with certain of its derivative counterparties that contain a provision where if the Company fails to maintain its status as a well/adequately capitalized institution, then the counterparty has the right to terminate the derivative positions and the Company would be required to settle its obligations under the agreements.
As of March 31, 2020, the termination value of derivatives in a net liability position related to these agreements was $70.6 million, which includes accrued interest but excludes any adjustment for nonperformance risk. The Company has minimum collateral posting thresholds with certain of its derivative counterparties, and as of March 31, 2020, the Company had posted $77.4 million in eligible collateral. If the Company had breached any of these provisions at March 31, 2020, it could have been required to settle its obligations under the agreements at the termination value.
Note 15 Commitments and Contingencies
In the normal course of business, the Company enters into various off-balance sheet commitments to help meet the financing needs of clients. These financial instruments include commitments to extend credit, commercial and consumer lines of credit and standby letters of credit. The same credit policies are applied to these commitments as the loans on the consolidated statements of financial condition; however, these commitments involve varying degrees of credit risk in excess of the amount recognized in the consolidated statements of financial condition. The total amounts of unused commitments do not necessarily represent future credit exposure or cash requirements, as commitments often expire without being drawn upon. However, the contractual amount of these commitments, offset by any additional collateral pledged, represents the Company’s potential credit loss exposure.
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Total unfunded commitments at March 31, 2020 and December 31, 2019 were as follows:
Commitments to fund loans—Commitments to fund loans are legally binding agreements to lend to clients in accordance with predetermined contractual provisions providing there have been no violations of any conditions specified in the contract. These commitments are generally at variable interest rates and are for specific periods or contain termination clauses and may require the payment of a fee. The total amounts of unused commitments are not necessarily representative of future credit exposure or cash requirements, as commitments often expire without being drawn upon.
Unfunded commitments under lines of credit—In the ordinary course of business, the Company extends revolving credit to its clients. These arrangements may require the payment of a fee.
Commercial and standby letters of credit—As a provider of financial services, the Company routinely issues commercial and standby letters of credit, which may be financial standby letters of credit or performance standby letters of credit. These are various forms of “back-up” commitments to guarantee the performance of a client to a third party. While these arrangements represent a potential cash outlay for the Company, the majority of these letters of credit will expire without being drawn upon. Letters of credit are subject to the same underwriting and credit approval process as traditional loans, and as such, many of them have various forms of collateral securing the commitment, which may include real estate, personal property, receivables or marketable securities.
Contingencies
Mortgage loans sold to investors may be subject to repurchase or indemnification in the event of specific default by the borrower or subsequent discovery that underwriting standards were not met. The Company established a reserve liability for expected losses related to these representations and warranties based upon management’s evaluation of actual and historic loss history, delinquency trends in the portfolio and economic conditions. The Company recorded a repurchase reserve of $2.8 million and $2.6 million at March 31, 2020 and December 31, 2019, respectively, which is included in other liabilities on the consolidated statements of financial condition.
In the ordinary course of business, the Company and the Bank may be subject to litigation. Based upon the available information and advice from the Company’s legal counsel, management does not believe that any potential, threatened or pending litigation to which it is a party will have a material adverse effect on the Company’s liquidity, financial condition or results of operations.
Note 16 Fair Value Measurements
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to disclose the fair value of its financial instruments. Fair value is defined as 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. For disclosure purposes, the Company groups its financial and non-financial assets and liabilities into three different levels based on the nature of the instrument and the availability and reliability of the information that is used to determine fair value. The three levels are defined as follows:
| ● | Level 1—Includes assets or liabilities in which the valuation methodologies are based on unadjusted quoted prices in active markets for identical assets or liabilities. |
| ● | Level 2—Includes assets or liabilities in which the inputs to the valuation methodologies are based on similar assets or liabilities in inactive markets, quoted prices for identical or similar assets or liabilities in inactive markets, and inputs other than quoted prices that are observable, such as interest rates, yield curves, volatilities, prepayment speeds, and other inputs obtained from observable market input. |
| ● | Level 3—Includes assets or liabilities in which the inputs to the valuation methodology are based on at least one significant assumption that is not observable in the marketplace. These valuations may rely on management’s judgment and may include internally-developed model-based valuation techniques. |
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Level 1 inputs are considered to be the most transparent and reliable and level 3 inputs are considered to be the least transparent and reliable. The Company assumes the use of the principal market to conduct a transaction of each particular asset or liability being measured and then considers the assumptions that market participants would use when pricing the asset or liability. Whenever possible, the Company first looks for quoted prices for identical assets or liabilities in active markets (level 1 inputs) to value each asset or liability. However, when inputs from identical assets or liabilities on active markets are not available, the Company utilizes market observable data for similar assets and liabilities. The Company maximizes the use of observable inputs and limits the use of unobservable inputs to occasions when observable inputs are not available. The need to use unobservable inputs generally results from the lack of market liquidity of the actual financial instrument or of the underlying collateral. While third party price indications may be available in those cases, limited trading activity can challenge the observability of those inputs.
Changes in the valuation inputs used for measuring the fair value of financial instruments may occur due to changes in current market conditions or other factors. Such changes may necessitate a transfer of the financial instruments to another level in the hierarchy based on the new inputs used. The Company recognizes these transfers at the end of the reporting period that the transfer occurs. During the three months ended March 31, 2020 and 2019, there were no transfers of financial instruments between the hierarchy levels.
The following is a description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of each instrument under the valuation hierarchy:
Fair Value of Financial Instruments Measured on a Recurring Basis
Investment securities available-for-sale—Investment securities available-for-sale are carried at fair value on a recurring basis. To the extent possible, observable quoted prices in an active market are used to determine fair value and, as such, these securities are classified as level 1. At March 31, 2020 and December 31, 2019, the Company did not hold any level 1 securities. When quoted market prices in active markets for identical assets or liabilities are not available, quoted prices of securities with similar characteristics, discounted cash flows or other pricing characteristics are used to estimate fair values and the securities are then classified as level 2.
Loans held for sale—The Company has elected to record loans originated and intended for sale in the secondary market at estimated fair value. The portfolio consists primarily of fixed rate residential mortgage loans that are sold within 45 days. The Company estimates fair value based on quoted market prices for similar loans in the secondary market and is classified as level 2.
Interest rate swap derivatives—The Company's derivative instruments are limited to interest rate swaps that may be accounted for as fair value hedges or non-designated hedges. The fair values of the swaps incorporate credit valuation adjustments in order to appropriately reflect nonperformance risk in the fair value measurements. The credit valuation adjustment is the dollar amount of the fair value adjustment related to credit risk and utilizes a probability weighted calculation to quantify the potential loss over the life of the trade. The credit valuation adjustments are calculated by determining the total expected exposure of the derivatives (which incorporates both the current and potential future exposure) and then applying the respective counterparties’ credit spreads to the exposure offset by marketable collateral posted, if any. Certain derivative transactions are executed with counterparties who are large financial institutions ("dealers"). International Swaps and Derivative Association Master Agreements ("ISDA") and Credit Support Annexes ("CSA") are employed for all contracts with dealers. These contracts contain bilateral collateral arrangements. The fair value inputs of these financial instruments are determined using discounted cash flow analysis through the use of third-party models whose significant inputs are readily observable market parameters, primarily yield curves, with appropriate adjustments for liquidity and credit risk, and are classified as level 2.
Mortgage banking derivatives—The Company relies on a third-party pricing service to value its mortgage banking derivative financial assets and liabilities, which the Company classifies as a level 3 valuation. The external valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale includes grouping the interest rate lock commitments by interest rate and terms, applying an average 85.9% estimated pull-through rate based on historical experience, and then multiplying by quoted investor prices determined to be reasonably applicable to the loan commitment groups based on interest rate, terms, and rate lock expiration dates of the loan commitment groups. The Company also relies on an external valuation model to estimate the fair value of its forward commitments to sell residential mortgage loans (i.e., an estimate of what the Company would receive or pay to terminate the forward delivery contract based on market prices for similar financial instruments), which includes matching specific terms and maturities of the forward commitments against applicable investor pricing.
33
The tables below present the financial instruments measured at fair value on a recurring basis as of March 31, 2020 and December 31, 2019 on the consolidated statements of financial condition utilizing the hierarchy structure described above:
The table below details the changes in level 3 financial instruments during the three months ended March 31, 2020:
Fair Value of Financial Instruments Measured on a Non-recurring Basis
Certain assets may be recorded at fair value on a non-recurring basis as conditions warrant. These non-recurring fair value measurements typically result from the application of lower of cost or fair value accounting or a write-down occurring during the period.
34
Individually evaluated loans—The Company records individually evaluated loans based on the fair value of the collateral when it is probable that the Company will be unable to collect all contractual amounts due in accordance with the terms of the loan agreement. The Company relies on third-party appraisals and internal assessments, utilizing a discount rate in the range of 3% - 26% with a weighted average discount rate of 19.1%, in determining the estimated fair values of these loans. The inputs used to determine the fair values of loans are considered level 3 inputs in the fair value hierarchy. At March 31, 2020, the Company recorded a specific reserve of $1.3 million related to seven loans with a carrying balance of $5.2 million. At March 31, 2019, the Company recorded a specific reserve of $1.5 million related to six loans with a carrying balance of $5.6 million.
OREO—OREO is recorded at the fair value of the collateral less estimated selling costs using a range of 6% to 10% with a weighted average discount rate of 10%. The estimated fair values of OREO are updated periodically and further write-downs may be taken to reflect a new basis. The Company recognized $596 thousand of OREO impairments in its consolidated statements of operations during the three months ended March 31, 2019. The fair values of OREO are derived from third party price opinions or appraisals that generally use an income approach or a market value approach. If reasonable comparable appraisals are not available, then the Company may use internally developed models to determine fair values. The inputs used to determine the fair value of OREO properties are considered level 3 inputs in the fair value hierarchy.
Mortgage servicing rights—MSRs represent the value associated with servicing residential real estate loans that have been sold to outside investors with servicing retained. The fair value for servicing assets is determined through discounted cash flow analysis and utilizes discount rates ranging from 9.5% to 10.5% with a weighted average rate of 9.58% at March 31, 2020 and prepayment speed assumption ranges of 16.9% to 21.4% with a weighted average rate of 19.0% at March 31, 2020 as inputs. The weighted average MSRs are subject to impairment testing. The carrying values of these MSRs are reviewed quarterly for impairment based upon the calculation of fair value. For purposes of measuring impairment, the rights are stratified into certain risk characteristics including note type and note term. If the valuation model reflects a value less than the carrying value, MSRs are adjusted to fair value through a valuation allowance included in mortgage banking income on the consolidated statements of operations. The inputs used to determine the fair values of MSRs are considered level 3 inputs in the fair value hierarchy.
The Company may be required to record fair value adjustments on other available-for-sale and municipal securities valued at par on a non-recurring basis.
The tables below provide information regarding the assets recorded at fair value on a non-recurring basis during the three months ended March 31, 2020 and 2019:
|
|
|
|
|
|
|
|
|
|
|
March 31, 2020 |
||||
|
|
|
Total |
|
Losses from fair value changes |
||
|
Individually evaluated loans |
|
$ |
35,935 |
|
$ |
497 |
|
Mortgage servicing rights |
|
|
2,053 |
|
|
509 |
|
Total |
|
$ |
37,988 |
|
$ |
1,006 |
The Company did not record any liabilities measured at fair value on a non-recurring basis during the three months ended March 31, 2020 and 2019.
Note 17 Fair Value of Financial Instruments
The fair value of a financial instrument is the amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is determined based upon quoted market prices to the extent possible; however, in many instances, there are no quoted market prices for the Company’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 that may be significantly impacted by the assumptions used, including the discount rate and estimates of future cash flows. Changes in any of these assumptions could significantly affect the fair value estimates. The fair value of the financial instruments listed below does not reflect a premium or discount that could result
35
from offering all of the Company’s holdings of financial instruments at one time, nor does it reflect the underlying value of the Company, as ASC Topic 825 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies and are based on the exit price concept within ASC Topic 825 and applied to this disclosure on a prospective basis. Considerable judgment is required to interpret market data in order to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange.
The fair value of financial instruments at March 31, 2020 and December 31, 2019, including methods and assumptions utilized for determining fair value of financial instruments, are set forth below:
36
Item 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following management's discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes as of and for the three months ended March 31, 2020, and with our annual report on Form 10-K (file number 001-35654), which includes our audited consolidated financial statements and related notes as of and for the years ended December 31, 2019, 2018 and 2017. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions that may cause actual results to differ materially from management's expectations. Factors that could cause such differences are discussed in the section entitled “Cautionary Note Regarding Forward-Looking Statements” located elsewhere in this quarterly report and in Item 1A “Risk Factors” in the annual report on Form 10-K, referenced above, and should be read herewith.
All amounts are in thousands, except share and per share data, or as otherwise noted.
Overview
Our focus is on building relationships by creating a win-win scenario for our clients and our Company. We believe in providing solutions and services to our clients that are based on fairness and simplicity. We have established a solid financial services franchise with a sizable presence for deposit gathering and building client relationships necessary for growth. We also believe that our established presence in our core markets of Colorado, the greater Kansas City region, New Mexico, Texas and Utah that are outperforming national averages positions us well for growth opportunities. As of March 31, 2020, we had $6.0 billion in assets, $4.5 billion in loans, $4.7 billion in deposits and $0.8 billion in equity.
Recent Events
The COVID-19 pandemic has caused substantial disruption to the communities we serve and has changed the way we live and work. We remain committed to ensuring our associates, clients, and communities are receiving the support they need during these challenging times. All of our banking centers remain operational through our drive-thru services and on an appointment-only basis in the lobbies. We have leveraged our digital banking platform with our clients, and we have implemented company-wide remote working arrangements. Our teams are working diligently to support our clients who are experiencing financial hardship due to COVID-19 through participation in the Small Business Administration’s (“SBA”) Paycheck Protection Program, assistance with expedited deposits of CARES Act stimulus payments, and loan modifications, as needed.
The length of the pandemic and the efficacy of the extraordinary government-mandated measures that have been put into place to address it are unknown, but have already had, and are likely to continue to have, a significantly negative impact to the U.S. labor market, consumer spending and business operations. Several actions have been taken by governmental authorities to address the economic impact of the pandemic, including the Federal Reserve reducing the federal funds rate 1.5 percentage points to 0.00 to 0.25 percent as well as taking additional actions, such as providing up to $2.3 trillion in loans to support the economy, and the passage of the CARES Act by Congress, which provides over $2 trillion in economic assistance for American workers, families and small businesses.
Operating Highlights and Key Challenges
Profitability and returns
|
|
|
|
|
● |
|
Net income was $15.8 million, or $0.50 per diluted share, for the first quarter of 2020 compared to net income of $18.9 million, or $0.60 per diluted share, for the first quarter of 2019. The first quarter of 2020 included a $6.2 million loan loss provision from the CECL model, driven by deteriorating economic conditions caused by the impact of COVID-19, compared to a loan loss provision of $1.5 million for the first quarter of 2019. |
|
● |
|
The return on average tangible assets was 1.12% for the first quarter of 2020, compared to 1.39% for the first quarter of 2019. |
|
● |
|
The return on average tangible common equity was 9.79% for the first quarter of 2020, compared to 13.15% for the first quarter of 2019. |
37
Strategic execution
|
|
|
|
|
● |
|
Moved quickly and pro-actively to address the impacts of the COVID-19 pandemic as detailed in the “Recent Events” section above. |
|
● |
|
As of May 3, 2020, obtained SBA approval for $373.9 million of Paycheck Protection loans for 2,197 clients. |
|
● |
|
Repurchased 734,117 shares, or $19.5 million, of our Company’s stock during the first quarter of 2020. |
|
● |
|
Maintained a conservatively structured loan portfolio represented by diverse industries and concentrations with most industry sector concentrations at 5% or less of total loans, and all concentration levels remain well below our self-imposed limits. |
|
● |
|
We have carefully evaluated our entire loan portfolio and have no industry exposure exceeding 5% of total loans for industries highly impacted by COVID-19, such as restaurants, retailers, hospital/medical, multifamily, oil and gas, hotels and lodging. The Company has no direct exposure to other industries highly impacted, including aviation, cruise lines, energy services, auto manufacturing/dealer floor plans, hedge funds, gaming and casinos, convention centers, malls and taxi/ride share companies. Furthermore, we have no exposure to consumer credit card, indirect auto finance or car leasing. |
|
● |
|
Grew originated loans outstanding to $4.2 billion, an increase of $129.4 million, or 12.8% annualized, since December 31, 2019, led by commercial loan growth of $93.0 million, or 13.0% annualized. |
Loan portfolio
|
|
|
|
|
● |
|
Total loans ended the quarter at $4.5 billion and increased $90.3 million, or 8.2% annualized, since December 31, 2019. |
|
● |
|
Total first quarter loan originations were $292.9 million, led by commercial loan originations of $163.6 million. |
Credit quality
|
|
|
|
|
● |
|
Provision for loan losses totaled $6.2 million, net of a $0.2 million reduction in unfunded loan commitment reserves, during the three months ended March 31, 2020, compared to $1.5 million during the three months ended March 31, 2019. The provision expense increased $4.7 million, compared to the first quarter last year to support originated loan growth, net charge-offs and to provide coverage for the impact of deterioration in the macro-economic environment as a result of COVID-19. |
|
● |
|
Net charge-offs to average total loans for the three months ended March 31, 2020 totaled 0.03%, annualized, compared to 0.19% for the full year ended December 31, 2019. |
|
● |
|
Credit quality remained strong, as non-performing loans (comprised of non-accrual loans and non-accrual TDRs) improved to 0.47% of total loans, compared to 0.49% at December 31, 2019. Non-performing assets to total loans and OREO improved to 0.63% at March 31, 2020, compared to 0.66% at December 31, 2019. |
|
● |
|
Increased the allowance for credit loss balance by 30% from December 31, 2019 to March 31, 2020 due to the adoption of CECL on January 1, 2020 and the impact of deteriorating economic conditions driven by the COVID-19 pandemic. The allowance for credit losses totaled 1.13% of total loans compared to 0.87% at March 31, 2019 and included a CECL adoption day 1 increase of $5.8 million. |
Client deposit funded balance sheet
|
|
|
|
|
● |
|
Average non-interest bearing demand deposits increased $29.1 million, or 2.6%, compared to the first quarter of 2019. |
|
● |
|
Total deposits averaged $4.7 billion during the first quarter of 2020, increasing $94.4 million, compared to the first quarter of 2019. |
|
● |
|
Time deposits averaged $1.1 billion during the first quarter of 2020, decreasing $21.9 million, or 2.0%, from the first quarter of 2019. |
|
● |
|
The mix of transaction deposits to total deposits was 77.8% at March 31, 2020, compared to 77.1% at March 31, 2019. |
|
● |
|
Cost of deposits totaled 0.63%, decreasing one basis point from December 31, 2019, and the cost of funds totaled 0.88%, decreasing seven basis points from December 31, 2019. |
Revenues
|
|
|
|
|
● |
|
Fully taxable equivalent (“FTE”) net interest income totaled $51.6 million and decreased $0.8 million, or 1.5%, compared to the first quarter of 2019. The yield on earning assets decreased 19 basis points, primarily due to five Federal Reserve rate cuts between the periods. The cost of funds remained consistent at 0.88%. |
|
● |
|
The FTE net interest margin narrowed 18 basis points to 3.87% from the first quarter of 2019. The yield on earning assets decreased 19 basis points, led by a 41 basis point decrease in the originated loan portfolio yields due to fed funds rate cuts. |
38
|
● |
|
Non-interest income totaled $23.5 million during the three months ended March 31, 2020, increasing $6.5 million from the three months ended March 31, 2019, primarily driven by an increase of $6.7 million in mortgage banking income. |
Expenses
|
|
|
|
|
● |
|
Non-interest expense totaled $48.7 million during the three months ended March 31, 2020, representing an increase of $4.3 million from the three months ended March 31, 2019. Salaries and benefits increased $5.3 million due to higher mortgage banking commissions. Other non-interest expense decreased $0.8 million largely due to a decrease in FDIC deposit insurance fees as a result of FDIC assessment credits received during the first quarter of 2020. |
|
● |
|
Income tax expense totaled $3.2 million during the three months ended March 31, 2020, compared to $3.4 million during the three months ended March 31, 2019. The effective tax rate for the first quarter was 16.9%, compared to an adjusted rate of 18.7% during the full year 2019. The prior year’s effective tax rate was adjusted for $2.2 million of stock compensation activity. The lower rate compared to the statutory rate reflects the continued success of our tax strategies and tax exempt income. |
Strong capital position
|
|
|
|
|
● |
|
Capital ratios are strong as our capital position remains in excess of federal bank regulatory thresholds. As of March 31, 2020, our consolidated tier 1 leverage ratio was 11.05% and our common equity tier 1 and consolidated tier 1 risk based capital ratios were both 12.87%. |
|
● |
|
The Bank maintains ample liquidity with access to $1 billion in readily available funds. |
|
● |
|
At March 31, 2020, common book value per share was $25.04. The tangible common book value per share increased $0.38 to $21.27 at March 31, 2020 as the quarter’s earnings and positive fair market value adjustments in the available-for-sale securities portfolio outpaced the quarter’s share repurchases, dividend and CECL cumulative effect adjustment. |
Key Challenges
There are a number of significant challenges confronting us and our industry. We face continual challenges implementing our business strategy, including growing the assets, particularly loans, and deposits of our business amidst intense competition, changing interest rates, adhering to changes in the regulatory environment and identifying and consummating disciplined acquisition and other expansionary opportunities in a very competitive environment. Prevailing interest rates began decreasing in mid-2019 and have continued to decrease as a result of five Federal Reserve rate cuts from August 2019 through March 2020.
General economic conditions have been declining as a result of the COVID-19 pandemic. While we are acting quickly and prudently to minimize any disruptions to our business, our clients and communities are facing significant changes and disruption. The markets in which we do business have been subject to shelter-in-place orders, which have forced non-essential business to close temporarily. Our banking centers remain open by appointment-only and through drive-thru services. We have enhanced our digital banking platform and implemented company-wide remote working arrangements. Our teams are working diligently to support our clients experiencing financial hardship due to COVID-19 through participation in the SBA’s Paycheck Participation Program, assistance with expedited deposits of CARES Act stimulus payments and loan modifications as needed. Elevated levels of unemployment and the temporary closure of businesses has affected some of our clients and increases the risk of loss within our loan portfolio.
Our markets have historically outperformed the national averages on many key indicators; however, the economic impact from the COVID-19 pandemic will continue to cause economic strain nationally and across all of our markets. A significant portion of our loan portfolio is secured by real estate and any deterioration in real estate values or credit quality or elevated levels of non-performing assets would ultimately have a negative impact on the quality of our loan portfolio.
As of March 31, 2020, the Company had low exposure to industries highly impacted by the COVID-19 pandemic. Within the commercial loan segment, restaurants were 5.0%, retailers 2.7%, hospital/medical 4.5% and oil and gas 0.7% of total loans. Within the commercial real estate non-owner occupied loan segment, hotel and lodging was 4.0%, multifamily 1.5% and retail 1.2% of total loans. The Company had no direct exposure to other industries and loan types more highly impacted by the pandemic including aviation, cruise lines, energy services, auto manufacturing/dealer floor plans, hedge funds, gaming and casinos, convention centers, credit cards, malls and taxi/ride share businesses. Furthermore, the Company had no consumer credit card, indirect auto or car leasing exposure.
39
The agriculture industry is in the sixth year of depressed commodity prices and is also being impacted by the COVID-19 pandemic. Our food and agribusiness portfolio is only 5.4% of total loans and is well-diversified across food production, crop and livestock types. Crop and livestock loans represent 1.2% of total loans. We have maintained relationships with food and agribusiness clients that generally possess low leverage and, correspondingly, low bank debt to assets, minimizing any potential credit losses in the future.
Our loans outstanding portfolio at March 31, 2020 totaled $4.5 billion, representing an increase of $90.3 million, or 2.0%, compared to December 31, 2019. During the three months ended March 31, 2020, our weighted average rate on new loans funded at the time of origination was 3.78% (FTE), compared to the first quarter 2020 weighted average yield of our originated loan portfolio of 4.47% (FTE). Future growth in our interest income will ultimately be dependent on our ability to continue to generate sufficient volumes of high-quality originated loans as well as Federal Reserve interest rate policy decisions.
Continued regulation, impending new liquidity and capital constraints, and a continual need to bolster cybersecurity are adding costs and uncertainty to all U.S. banks and could affect profitability. Also, nontraditional participants in the market may offer increased competition as non-bank payment businesses, including fintechs, are expanding into traditional banking products. While certain external factors are out of our control and may provide obstacles to our business strategy, we are prepared to deal with these challenges. We seek to remain flexible, yet methodical and proactive, in our strategic decision making so that we can quickly respond to market changes and the inherent challenges and opportunities that accompany such changes.
40
Performance Overview
In evaluating our consolidated statements of financial condition and results of operations financial statement line items, we evaluate and manage our performance based on key earnings indicators, balance sheet ratios, asset quality metrics and regulatory capital ratios, among others. The table below presents some of the primary performance indicators that we use to analyze our business on a regular basis for the periods indicated:
|
|
|
|
|
(1) |
|
Ratios are annualized. |
|
(2) |
|
Ratio represents non-GAAP financial measure. See non-GAAP reconciliations below. |
|
(3) |
|
Interest earning assets include assets that earn interest/accretion or dividends. Any market value adjustments on investment securities are excluded from interest-earning assets. |
|
(4) |
|
Net interest margin represents net interest income, including accretion income on interest earning assets, as a percentage of average interest earning assets. |
|
(5) |
|
Interest rate spread represents the difference between the weighted average yield on interest earning assets and the weighted average cost of interest bearing liabilities. |
|
(6) |
|
Non-performing loans consist of non-accruing loans and restructured loans on non-accrual. |
|
(7) |
|
Non-performing assets include non-performing loans and OREO. |
|
(8) |
|
Total loans are net of unearned discounts and fees. |
|
(9) |
|
Presented on an FTE basis using the statutory rate of 21% for all periods presented. The taxable equivalent adjustments included above are $1,268, $1,290 and $1,227 the three months ended March 31, 2020, December 31, 2019 and March 31, 2019, respectively. |
41
About Non-GAAP Financial Measures
Certain of the financial measures and ratios we present, including “tangible assets,” “return on average tangible assets,” “return on average tangible common equity,” “tangible common book value,” “tangible common book value per share,” “tangible common equity,” “tangible common equity to tangible assets,” and “fully taxable equivalent” metrics, are supplemental measures that are not required by, or are not presented in accordance with, U.S. generally accepted accounting principles (GAAP). We refer to these financial measures and ratios as “non-GAAP financial measures.” We consider the use of select non-GAAP financial measures and ratios to be useful for financial and operational decision making and useful in evaluating period-to-period comparisons. We believe that these non-GAAP financial measures provide meaningful supplemental information regarding our performance by excluding certain expenses or assets that we believe are not indicative of our primary business operating results or by presenting certain metrics on an FTE basis. We believe that management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting, analyzing and comparing past, present and future periods.
These non-GAAP financial measures should not be considered a substitute for financial information presented in accordance with GAAP and you should not rely on non-GAAP financial measures alone as measures of our performance. The non-GAAP financial measures we present may differ from non-GAAP financial measures used by our peers or other companies. We compensate for these limitations by providing the equivalent GAAP measures whenever we present the non-GAAP financial measures and by including a reconciliation of the impact of the components adjusted for in the non-GAAP financial measure so that both measures and the individual components may be considered when analyzing our performance.
A reconciliation of our GAAP financial measures to the comparable non-GAAP financial measures is as follows:
Tangible Common Book Value Ratios
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
December 31, |
|
March 31, |
|||
|
|
|
2020 |
|
2019 |
|
2019 |
|||
|
Total shareholders’ equity |
|
$ |
763,454 |
|
$ |
766,920 |
|
$ |
715,002 |
|
Less: goodwill and core deposit intangible assets, net |
|
|
(123,462) |
|
|
(123,758) |
|
|
(124,645) |
|
Add: deferred tax liability related to goodwill |
|
|
8,469 |
|
|
8,241 |
|
|
7,555 |
|
Tangible common equity (non-GAAP) |
|
$ |
648,461 |
|
$ |
651,403 |
|
$ |
597,912 |
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
6,028,330 |
|
$ |
5,895,512 |
|
$ |
5,802,666 |
|
Less: goodwill and core deposit intangible assets, net |
|
|
(123,462) |
|
|
(123,758) |
|
|
(124,645) |
|
Add: deferred tax liability related to goodwill |
|
|
8,469 |
|
|
8,241 |
|
|
7,555 |
|
Tangible assets (non-GAAP) |
|
$ |
5,913,337 |
|
$ |
5,779,995 |
|
$ |
5,685,576 |
|
|
|
|
|
|
|
|
|
|
|
|
Tangible common equity to tangible assets calculations: |
|
|
|
|
|
|
|
|
|
|
Total shareholders' equity to total assets |
|
|
12.66% |
|
|
13.01% |
|
|
12.32% |
|
Less: impact of goodwill and core deposit intangible assets, net |
|
|
(1.69)% |
|
|
(1.74)% |
|
|
(1.80)% |
|
Tangible common equity to tangible assets (non-GAAP) |
|
|
10.97% |
|
|
11.27% |
|
|
10.52% |
|
|
|
|
|
|
|
|
|
|
|
|
Tangible common book value per share calculations: |
|
|
|
|
|
|
|
|
|
|
Tangible common equity (non-GAAP) |
|
$ |
648,461 |
|
$ |
651,403 |
|
$ |
597,912 |
|
Divided by: ending shares outstanding |
|
|
30,483,361 |
|
|
31,176,627 |
|
|
30,958,581 |
|
Tangible common book value per share (non-GAAP) |
|
$ |
21.27 |
|
$ |
20.89 |
|
$ |
19.31 |
|
|
|
|
|
|
|
|
|
|
|
|
Tangible common book value per share, excluding accumulated other comprehensive (income) loss calculations: |
|
|
|
|
|
|
|
|
|
|
Tangible common equity (non-GAAP) |
|
$ |
648,461 |
|
$ |
651,403 |
|
$ |
597,912 |
|
Accumulated other comprehensive (income) loss, net of tax |
|
|
(12,367) |
|
|
(2,062) |
|
|
6,140 |
|
Tangible common book value, excluding accumulated other comprehensive (income) loss, net of tax (non-GAAP) |
|
|
636,094 |
|
|
649,341 |
|
|
604,052 |
|
Divided by: ending shares outstanding |
|
|
30,483,361 |
|
|
31,176,627 |
|
|
30,958,581 |
|
Tangible common book value per share, excluding accumulated other comprehensive (income) loss, net of tax (non-GAAP) |
|
$ |
20.87 |
|
$ |
20.83 |
|
$ |
19.51 |
42
Return on Average Tangible Assets and Return on Average Tangible Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of and for the three months ended |
|||||||
|
|
|
March 31, |
|
December 31, |
|
March 31, |
|||
|
|
|
2020 |
|
2019 |
|
2019 |
|||
|
Net income |
|
$ |
15,824 |
|
$ |
19,519 |
|
$ |
18,922 |
|
Add: impact of core deposit intangible amortization expense, after tax |
|
|
225 |
|
|
225 |
|
|
225 |
|
Net income adjusted for impact of core deposit intangible amortization expense, after tax |
|
$ |
16,049 |
|
$ |
19,744 |
|
$ |
19,147 |
|
|
|
|
|
|
|
|
|
|
|
|
Average assets |
|
$ |
5,862,851 |
|
$ |
5,924,459 |
|
$ |
5,711,020 |
|
Less: average goodwill and core deposit intangible asset, net of deferred tax liability related to goodwill |
|
|
(115,156) |
|
|
(115,665) |
|
|
(117,235) |
|
Average tangible assets (non-GAAP) |
|
$ |
5,747,695 |
|
$ |
5,808,794 |
|
$ |
5,593,785 |
|
|
|
|
|
|
|
|
|
|
|
|
Average shareholders' equity |
|
$ |
774,380 |
|
$ |
764,694 |
|
$ |
707,832 |
|
Less: average goodwill and core deposit intangible asset, net of deferred tax liability related to goodwill |
|
|
(115,156) |
|
|
(115,665) |
|
|
(117,235) |
|
Average tangible common equity (non-GAAP) |
|
$ |
659,224 |
|
$ |
649,029 |
|
$ |
590,597 |
|
|
|
|
|
|
|
|
|
|
|
|
Return on average assets |
|
|
1.09% |
|
|
1.31% |
|
|
1.34% |
|
Return on average tangible assets (non-GAAP) |
|
|
1.12% |
|
|
1.35% |
|
|
1.39% |
|
Return on average equity |
|
|
8.22% |
|
|
10.13% |
|
|
10.84% |
|
Return on average tangible common equity (non-GAAP) |
|
|
9.79% |
|
|
12.07% |
|
|
13.15% |
Fully Taxable Equivalent Yield on Earning Assets and Net Interest Margin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of and for the three months ended |
|||||||
|
|
|
March 31, |
|
December 31, |
|
March 31, |
|||
|
|
|
2020 |
|
2019 |
|
2019 |
|||
|
Interest income |
|
$ |
58,668 |
|
$ |
59,616 |
|
$ |
59,420 |
|
Add: impact of taxable equivalent adjustment |
|
|
1,268 |
|
|
1,290 |
|
|
1,227 |
|
Interest income FTE (non-GAAP) |
|
$ |
59,936 |
|
$ |
60,906 |
|
$ |
60,647 |
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income |
|
$ |
50,347 |
|
$ |
50,388 |
|
$ |
51,166 |
|
Add: impact of taxable equivalent adjustment |
|
|
1,268 |
|
|
1,290 |
|
|
1,227 |
|
Net interest income FTE (non-GAAP) |
|
$ |
51,615 |
|
$ |
51,678 |
|
$ |
52,393 |
|
|
|
|
|
|
|
|
|
|
|
|
Average earning assets |
|
$ |
5,358,404 |
|
$ |
5,438,041 |
|
$ |
5,247,265 |
|
Yield on earning assets |
|
|
4.40% |
|
|
4.35% |
|
|
4.59% |
|
Yield on earning assets FTE (non-GAAP) |
|
|
4.50% |
|
|
4.44% |
|
|
4.69% |
|
Net interest margin |
|
|
3.78% |
|
|
3.68% |
|
|
3.95% |
|
Net interest margin FTE (non-GAAP) |
|
|
3.87% |
|
|
3.77% |
|
|
4.05% |
43
Efficiency Ratio
|
|
|
|
|
|
|
|
|
|
|
|
As of and for the three months ended |
|||||||
|
|
March 31, |
|
December 31, |
|
March 31, |
|||
|
|
2020 |
|
2019 |
|
2019 |
|||
|
Net interest income |
$ |
50,347 |
|
$ |
50,388 |
|
$ |
51,166 |
|
Add: impact of taxable equivalent adjustment |
|
1,268 |
|
|
1,290 |
|
|
1,227 |
|
Net interest income, FTE (non-GAAP) |
$ |
51,615 |
|
$ |
51,678 |
|
$ |
52,393 |
|
|
|
|
|
|
|
|
|
|
|
Non-interest income |
$ |
23,532 |
|
$ |
20,282 |
|
$ |
17,051 |
|
|
|
|
|
|
|
|
|
|
|
Non-interest expense |
$ |
48,671 |
|
$ |
46,107 |
|
$ |
44,394 |
|
Less: core deposit intangible asset amortization |
|
(296) |
|
|
(296) |
|
|
(296) |
|
Non-interest expense, adjusted for core deposit intangible asset amortization |
$ |
48,375 |
|
$ |
45,811 |
|
$ |
44,098 |
|
|
|
|
|
|
|
|
|
|
|
Efficiency ratio |
|
65.48% |
|
|
64.82% |
|
|
64.64% |
|
Efficiency ratio FTE (non-GAAP) |
|
64.37% |
|
|
63.66% |
|
|
63.50% |
Application of Critical Accounting Policies
We use accounting principles and methods that conform to GAAP and general banking practices. We are required to apply significant judgment and make material estimates in the preparation of our financial statements and with regard to various accounting, reporting and disclosure matters. Assumptions and estimates are required to apply these principles where actual measurement is not possible or practical. The most significant of these estimates relate to the determination of the ACL. See additional discussion of our ACL policy in note 1 – Basis of Presentation.
Future Accounting Pronouncements
The Company is still evaluating the impact from ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The Company has reviewed ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes and does not expect the adoption of that pronouncement to have a material impact on its financial statements.
Financial Condition
Total assets increased to $6.0 billion at March 31, 2020 from $5.9 billion at December 31, 2019, primarily driven by increases in total loans of $90.3 million, or 2.0%, cash and cash equivalents of $23.7 million, or 21.5%, and other assets of $20.2 million, or 10.4%. The allowance for credit losses increased 30.4% to $51.0 million at March 31, 2020 from $39.1 million at December 31, 2019, and included a CECL adoption day 1 increase of $5.8 million, partially offsetting the increase in total assets.
During the first quarter of 2020, lower cost demand, savings, and money market deposits ("transaction deposits") increased $11.9 million, or 1.3% annualized, compared to December 31, 2019, as we continued to develop full banking relationships with our clients. The increase in transaction deposits provided low-cost funding utilized to fund loan growth.
Investment securities
Available-for-sale
Total investment securities available-for-sale decreased 1.4% due to paydowns and maturities totaling $48.8 million and $48.3 million during the three months ended March 31, 2020 and 2019, respectively. Purchases of available-for-sale securities during the three months ended March 31, 2020 and 2019 totaled $26.5 million and $0.0 million, respectively.
44
Our available-for-sale investment securities portfolio is summarized as follows as of the dates indicated:
As of March 31, 2020 and December 31, 2019, nearly all the available-for-sale investment portfolio was backed by mortgages. The residential mortgage pass-through securities portfolio is comprised of both fixed rate and adjustable rate FHLMC, FNMA and GNMA securities. The other mortgage-backed securities are comprised of securities backed by FHLMC, FNMA and GNMA securities.
Mortgage-backed securities may have actual maturities that differ from contractual maturities depending on the repayment characteristics and experience of the underlying financial instruments. The estimated weighted average life of the available-for-sale mortgage-backed securities portfolio was 2.2 years and 2.9 years at March 31, 2020 and December 31, 2019, respectively. This estimate is based on assumptions and actual results may differ. At March 31, 2020 and December 31, 2019, the duration of the total available-for-sale investment portfolio was 2.1 years and 2.7 years, respectively.
At March 31, 2020 and December 31, 2019, adjustable rate securities comprised 2.7% and 2.8%, respectively, of the available-for-sale MBS portfolio. The remainder of the portfolio was comprised of fixed rate amortizing securities with 10 to 30 year contractual maturities, with a weighted average coupon of 2.42% per annum and 2.40% per annum at March 31, 2020 and December 31, 2019, respectively.
The available-for-sale investment portfolio included $14.2 million and $5.3 million of unrealized gains and $0.1 million and $5.1 million of unrealized losses at March 31, 2020 and December 31, 2019, respectively. We believe any unrealized losses are a result of prevailing interest rates, and as such, we do not believe that any of the securities with unrealized losses were impaired. Management believes that default of the available-for-sale securities is highly unlikely. FHLMC, FNMA and GNMA guaranteed mortgage-backed securities have a long history of zero credit losses, an explicit guarantee by the U.S. government (although limited for FNMA and FHLMC securities) and yields that generally trade based on market views of prepayment and liquidity risk rather than credit risk. No allowance for credit loss was recorded as of March 31, 2020. The Company has no intention to sell these securities and believes it will not be required to sell the securities before the recovery of their amortized cost.
Held-to-maturity
At March 31, 2020, held-to-maturity investment securities increased 5.5% due to purchases totaling $25.8 million, partially offset by paydowns and maturities totaling $15.4 million during the three months ended March 31, 2020. Paydowns and maturities totaled $13.2 million during the three months ended March 31, 2019.
Held-to-maturity investment securities are summarized as follows as of the dates indicated:
45
The residential mortgage pass-through and other residential MBS held-to-maturity investment portfolios are comprised of fixed rate FHLMC, FNMA and GNMA securities.
The fair value of the held-to-maturity investment portfolio included $4.7 million and $1.3 million of unrealized gains and $0.0 million and $0.5 million of unrealized losses at March 31, 2020 and December 31, 2019, respectively.
The Company does not measure expected credit losses on a financial asset, or group of financial assets, in which historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the amortized cost basis is zero. Management evaluated held-to-maturity securities noting they are backed by loans guaranteed by either U.S. government agencies or U.S. government sponsored entities, and management believes that default is highly unlikely given this governmental backing and long history without credit losses. Additionally, management notes that yields on which the portfolio generally trades are based upon market views of prepayment and liquidity risk and not credit risk. The Company has no intention to sell securities and believes it will not be required to sell the securities before the recovery of their amortized cost.
Mortgage-backed securities may have actual maturities that differ from contractual maturities depending on the repayment characteristics and experience of the underlying financial instruments. The estimated weighted average expected life of the held-to-maturity mortgage-backed securities portfolio as of March 31, 2020 and December 31, 2019 was 2.0 years and 2.4 years, respectively. This estimate is based on assumptions and actual results may differ. The duration of the total held-to-maturity investment portfolio was 1.9 years and 2.3 years as of March 31, 2020 and December 31, 2019, respectively.
Loans overview
At March 31, 2020, our loan portfolio was comprised of new loans that we have originated and loans that were acquired in connection with our six acquisitions to date.
The table below shows the loan portfolio composition at the respective dates:
Our loan portfolio increased 2.0%, or 8.2% annualized, since December 31, 2019, driven by new loan originations. Originated commercial loans grew $93.0 million, or 13.0% annualized, from December 31, 2019. The strong originations were the result of continued market penetration benefiting from our focus on building client relationships.
46
Our commercial and industrial loan portfolio is comprised of diverse industry segments, and our ability to generate new relationships with small- to medium-sized businesses has driven strong loan growth within these segments. At March 31, 2020, these segments included finance and financial services, primarily lender finance loans, of $385.2 million, hospital/medical loans of $202.3 million, manufacturing-related loans of $143.1 million, and a variety of smaller subcategories of commercial and industrial loans. Food and agribusiness loans, which are well-diversified across food production, crop and livestock types, totaled $242.5 million and were 35.7% of the Company’s risk based capital. Crop and livestock loans represent 1.2% of total loans.
Non-owner occupied CRE loans were 94.7% of the Company’s risk based capital, or 14.3% of total loans, and no specific property type comprised more than 4.0% of total loans. The Company maintains very little exposure to retail properties, comprising 3.9% of total loans. Multi-family loans totaled $77.3 million, or 1.5% of total loans as of March 31, 2020.
The Company maintains a granular and well-diversified loan portfolio with self-imposed concentration limits. In light of the strain placed on certain industries by the COVID-19 pandemic, the Company has carefully evaluated our entire loan portfolio. Within the commercial loan segment, certain higher impacted industries are noted as follows: restaurants comprised 5.0%, retailers 2.7%, hospital/medical 4.5% and oil and gas 0.7% of total loans. Within the commercial real estate non-owner occupied loan segment, hotel and lodging comprised 4.0%, multifamily 1.5% and retail 1.2% of total loans. The Company had no direct exposure to other industries more highly impacted by the pandemic including aviation, cruise lines, energy services, auto manufacturing/dealer floor plans, hedge funds, gaming and casinos, convention centers, credit cards, malls and taxi/ride share businesses. Furthermore, the Company had no consumer credit card, indirect auto or car leasing exposure.
New loan origination is a direct result of our ability to recruit and retain top banking talent, connect with clients in our markets and provide needed services at competitive rates. Loan originations totaled $1.2 billion over the past twelve months, led by commercial and industrial loan originations of $458.1 million. Originations are defined as closed end funded loans and revolving lines of credit advances, net of any current period paydowns. Management utilizes this more conservative definition of originations to better approximate the impact of originations on loans outstanding and ultimately net interest income.
The following tables represent new loan originations during 2020 and 2019:
Included in originations are net fundings under revolving lines of credit of $48,789, $1,756, $37,062, $48,955 and $105,235 as of the first quarter 2020, fourth quarter 2019, third quarter 2019, second quarter 2019 and first quarter 2019, respectively.
47
The tables below show the contractual maturities of our total loans for the dates indicated:
The stated interest rate (which excludes the effects of non-refundable loan origination and commitment fees, net of costs and the accretion of fair value marks) of total loans with maturities over one year is as follows at the dates indicated:
48
|
|
|
|
|
(1) |
|
Included in municipal and non-profit fixed rate loans are loans totaling $410,294 and $403,700 that have been swapped to variables rates at current market pricing at March 31, 2020 and December 31, 2019, respectively. Included in the municipal and non-profit segment are tax exempt loans totaling $708,401 and $701,825 with a weighted average rate of 3.38% and 3.41% at March 31, 2020 and December 31, 2019, respectively. |
Asset quality
Asset quality is fundamental to our success and remains a strong point, driven by our disciplined adherence to our self-imposed concentration limits across industry sector and real estate property type. Accordingly, for the origination of loans, we have established a credit policy that allows for responsive, yet controlled lending with credit approval requirements that are scaled to loan size. Within the scope of the credit policy, each prospective loan is reviewed in order to determine the appropriateness and the adequacy of the loan characteristics and the security or collateral prior to making a loan. We have established underwriting standards and loan origination procedures that require appropriate documentation, including financial data and credit reports. For loans secured by real property, we require property appraisals, title insurance or a title opinion, hazard insurance and flood insurance, in each case where appropriate.
Additionally, we have implemented procedures to timely identify loans that may become problematic in order to ensure the most beneficial resolution to the Company. Asset quality is monitored by our credit risk management department and evaluated based on quantitative and subjective factors such as the timeliness of contractual payments received. Additional factors that are considered, particularly with commercial loans over $500,000, include the financial condition and liquidity of individual borrowers and guarantors, if any, and the value of our collateral. To facilitate the oversight of asset quality, loans are categorized based on the number of days past due and on an internal risk rating system, and both are discussed in more detail below.
In the event of borrower default, we may seek recovery in compliance with state lending laws, the respective loan agreements, and credit monitoring and remediation procedures that may include modifying or restructuring a loan from its original terms, for economic or legal reasons, to provide a concession to the borrower from their original terms due to borrower financial difficulties in order to facilitate repayment. Such restructured loans are considered TDRs in accordance with ASC 310-40. Assets that have been foreclosed on or acquired through deed-in-lieu of foreclosure are classified as OREO until sold, and are carried at the fair value of the collateral less estimated costs to sell, with any initial valuation adjustments charged to the ALL and any subsequent declines in carrying value charged to impairments on OREO.
Non-performing assets and past due loans
Non-performing assets consist of non-accrual loans, TDRs on non-accrual and OREO. Interest income that would have been recorded had non-accrual loans performed in accordance with their original contract terms during the three months ended March 31, 2020 and 2019 was $0.3 million and $0.3 million, respectively.
Past due status is monitored as an indicator of credit deterioration. Loans are considered past due or delinquent when the contractual principal or interest due in accordance with the terms of the loan agreement remains unpaid after the due date of the scheduled payment. Loans that are 90 days or more past due are put on non-accrual status unless the loan is well secured and in the process of collection.
49
The following table sets forth the non-performing assets and past due loans as of the dates presented:
During the first quarter of 2020, total non-performing loans decreased $0.4 million, or 1.9%, from December 31, 2019. During the first quarter of 2020, accruing TDRs decreased $1.1 million due to paydowns.
Loans 30-89 days past due and still accruing interest increased $4.3 million from December 31, 2019 to March 31, 2020, and loans 90 days or more past due and still accruing interest decreased $0.3 million from December 31, 2019 to March 31, 2020, for a collective increase in total past due loans of $4.0 million.
Allowance for credit losses
The ACL represents the amount that we believe is necessary to absorb probable losses inherent in the loan portfolio at the balance sheet date and involves a high degree of judgment and complexity. On January 1, 2020, the Company adopted ASU 2016-13, Measurement of Credit Losses on Financial Instruments which replaced the incurred loss methodology for recognizing credit losses with a CECL model. The Company utilizes a DCF model developed within a third-party software tool to establish expected lifetime credit losses for the loan portfolio. The DCF model allows for individual, life of loan, cash flow modeling using loan specific interest rates and scheduled repayment rates. The model incorporates national economic forecasts of certain macroeconomic factors which drive correlated PD and LGD rates. PD and LGD rates, along with prepayment rates and loss recovery time delays, are determined at a loan class level making use of both peer loss rate data and internal historical data. The ACL is calculated as the difference between the amortized cost basis and the projections from the DCF analysis and includes qualitative adjustments and reserves for individually evaluated loans. The DCF model allows for individual life of loan cash flow modeling using loan specific interest rates and scheduled repayment rates. The model incorporates forecasted national macro-economic data for unemployment, GDP, retail sales, and home price index, which drive correlated PD and LGD rates. PD and LGD rates along with prepayment rates and loss recovery time delays are determined at a loan class level making use of both peer loss rate data and internal historical data.
As mentioned above, we utilize national forecast projections to predict near-term national economic conditions, which in turn, drive the losses predicted in establishing our ACL. For periods beyond the near term, we revert to historical long-term average losses on a straight-line basis. The length of the forecast and reversion periods is based on management’s assessment of the length and pattern of the current economic cycle. Management accounts for the inherent uncertainty of the underlying economic forecast by reviewing and weighting alternate forecast scenarios. We continually monitor economic trends within relevant markets as a means to capture leading and lagging indicators, including national unemployment, national GDP, national retail sales and national home price index, that could be indicative of probable losses.
We measure expected credit losses for loans on a pooled basis when similar risk characteristics exist. We have identified four primary loan segments that are further stratified into 11 loan classes to provide more granularity in analyzing loss history and to allow for more definitive qualitative adjustments based upon specific risk factors affecting each loan class. Generally, the underlying risk of loss for
50
each of these loan segments will follow certain norms/trends in various economic environments. Loans that do not share risk characteristics are evaluated on an individual basis and are not included in the collective evaluation. Following are the loan classes within each of the four primary loan segments:
Loans on non-accrual, in bankruptcy and TDRs with a balance greater than $250,000 are excluded from the pooled analysis and are evaluated individually. If management determines that foreclosure is probable, expected credit losses are evaluated based on the criteria listed below, adjusted for selling costs as appropriate. Typically, these loans consist of commercial, commercial real estate and agriculture loans and exclude homogeneous loans such as residential real estate and consumer loans. Specific allowances are determined by collectively analyzing:
|
|
|
|
|
● |
|
the borrower's resources, ability, and willingness to repay in accordance with the terms of the loan agreement; |
|
● |
|
the likelihood of receiving financial support from any guarantors; |
|
● |
|
the adequacy and present value of future cash flows, less disposal costs, of any collateral; and |
|
● |
|
the impact current economic conditions may have on the borrower's financial condition and liquidity or the value of the collateral. |
The collective resulting ACL for loans is calculated as the sum of the general reserves, specific reserves on individually evaluated loans, and qualitative factor adjustments. While these amounts are calculated by individual loan or on a pool basis by segment and class, the entire ACL is available for any loan that, in our judgment, should be charged-off. The determination and application of the ACL accounting policy involves judgments, estimates, and uncertainties that are subject to change. Changes in these assumptions, estimates or the conditions surrounding them may have a material impact on our financial condition, liquidity or results of operations.
During the three months ended March 31, 2020, the Company recorded provision for loan losses of $6.2 million, net of a $0.2 million reduction in unfunded loan commitment reserves. The provision was recorded to support originated loan growth, net charge-offs and to provide coverage for the impact of deterioration in the macro-economic environment as a result of COVID-19. Net charge-offs were $0.4 million, or 0.03%, annualized, and specific reserves on loans totaled $1.3 million at March 31, 2020. The increase of $11.9 million in the allowance for credit losses from December 31, 2019 includes a CECL Day 1 increase of $5.8 million and increased provision expense recorded during the first quarter due to declining economic conditions as a result of COVID-19.
During the three months ended March 31, 2019, provision for loan losses of $1.6 million was recorded to support originated loan growth. Net charge-offs were $0.2 million, or 0.02%, annualized, and specific reserves on individually evaluated loans totaled $1.5 million at March 31, 2019.
The Company has elected to exclude AIR from the allowance for credit losses calculation. As of March 31, 2020 and December 31, 2019, AIR from investment securities totaled $2.2 million and $2.0 million, respectively, and was included with other assets on the statements of financial condition. As of March 31, 2020 and December 31, 2019, AIR from loans totaled $19.8 million and $17.2 million, respectively. When a loan is placed on non-accrual, any recorded AIR is reversed against interest income.
Total ACL
After considering the above mentioned factors, we believe that the ACL of $51.0 million is adequate to cover estimated lifetime losses inherent in the loan portfolio at March 31, 2020. However, it is likely that future adjustments to the ACL will be necessary. Any changes to the underlying assumptions, circumstances or estimates, including but not limited to impacts of COVID-19 on the macro-economic forecast, used in determining the ACL could adversely affect the Company's results of operations, liquidity or financial condition.
51
The following schedules present, by class stratification, the changes in the ACL during the periods listed:
|
|
|
|
|
(1) |
|
Related to the adoption of Accounting Standards Update No. 2016-13, Measurement of Credit Losses on Financial Instruments. Refer to note 1 – Basis of Presentation and note 5 – Allowance for Credit Losses of our consolidated financial statements for further details. |
The following tables present the allocation of the ACL and the percentage of the total amount of loans in each loan category listed as of the dates presented:
52
Deposits
Deposits from banking clients serve as a primary funding source for our banking operations, and our ability to gather and manage deposit levels is critical to our success. Deposits not only provide a low-cost funding source for our loans, but also provide a foundation for the client relationships that are critical to future loan growth. The following table presents information regarding our deposit composition at March 31, 2020 and December 31, 2019:
The following table shows scheduled maturities of certificates of deposit with denominations greater than or equal to $250,000 as of March 31, 2020:
At March 31, 2020 and December 31 2019, time deposits that were scheduled to mature within 12 months totaled $716.2 million and $726.9 million, respectively. Of the time deposits scheduled to mature within 12 months at March 31, 2020, $103.2 million were in denominations of $250,000 or more, and $613.0 million were in denominations less than $250,000.
Other borrowings
As of March 31, 2020 and December 31, 2019, the Bank sold securities under agreements to repurchase totaling $23.7 million and $56.9 million, respectively. In addition, as a member of the FHLB, the Bank has access to a line of credit and term financing from the FHLB with total available credit of $1.0 billion at March 31, 2020. The bank utilizes its FHLB line of credit as a funding mechanism for originated loans and loans held for sale. At March 31, 2020 and December 31, 2019, the Bank had $326.5 million and $192.7 million in line of credit advances from the FHLB, respectively, that mature within a day. At March 31, 2020 and December 31, 2019, the Bank had one term advance totaling $15.0 million with a fixed interest rate of 2.33% and a maturity date in October 2020. The Bank pledged investment securities and loans as collateral for FHLB advances. Investment securities pledged were $16.5 million at March 31, 2020 and $17.6 million at December 31, 2019. Loans pledged were $1.5 billion at March 31, 2020 and $1.5 billion at December 31, 2019. Interest expense related to FHLB advances totaled $0.9 million and $1.5 million for the three months ended March 31, 2020 and 2019, respectively.
Results of Operations
Our net income depends largely on net interest income, which is the difference between interest income from interest earning assets and interest expense on interest bearing liabilities. Our results of operations are also affected by provisions for loan losses and non-interest income, such as service charges, bank card income, swap fee income, and gain on sale of mortgages, net. Our primary operating expenses, aside from interest expense, consist of salaries and benefits, occupancy costs, telecommunications data processing expense and intangible asset amortization. Any expenses related to the resolution of problem assets are also included in non-interest expense.
53
Overview of results of operations
We recorded net income of $15.8 million, or $0.50 per diluted share, during the three months ended March 31, 2020, compared to net income of $18.9 million, or $0.60 per diluted share, during the three months ended March 31, 2019.
Net interest income
We regularly review net interest income metrics to provide us with indicators of how the various components of net interest income are performing. We regularly review: (i) our loan mix and the yield on loans; (ii) the investment portfolio and the related yields; (iii) our deposit mix and the cost of deposits; and (iv) net interest income simulations for various forecast periods.
54
The table below presents the components of net interest income on a FTE basis for the three months ended March 31, 2020 and 2019. The effects of trade-date accounting of investment securities for which the cash had not settled are not considered interest earning assets and are excluded from this presentation for time frames prior to their cash settlement, as are the market value adjustments on the investment securities available-for-sale and loans.
|
|
|
|
|
(1) |
|
Originated loans are net of deferred loan fees, less costs, which are included in interest income over the life of the loan. |
|
(2) |
|
Presented on an FTE basis using the statutory tax rate of 21% for the three months ended March 31, 2020 and 2019. The taxable equivalent adjustments included above are $1,268 and $1,227 for the three months ended March 31, 2020 and 2019, respectively. |
|
(3) |
|
Loan fees included in interest income totaled $1,823 and $1,325 for the three months ended March 31, 2020 and 2019, respectively. |
Net interest income totaled $50.3 million and $51.2 million during the three months ended March 31, 2020 and 2019, respectively, and benefited from $1.2 million of accelerated accretion on acquired loans. The yield on earning assets decreased 19 basis points, led by a 41 basis point decrease in the originated portfolio yields due to fed funds rate cuts. The cost of funds of 0.88% remained consistent from the three months ended March 31, 2019.
55
Average loans comprised $4.4 billion, or 81.9%, of total average interest earning assets during the three months ended March 31, 2020, compared to $4.1 billion, or 78.7%, during the three months ended March 31, 2019. The increase in average loan balances was driven by a $418.4 million increase in originated loans.
Average investment securities comprised 15.2% and 19.4% of total interest earning assets during the three months ended March 31, 2020 and 2019, respectively. The decrease in the investment portfolio was a result of scheduled paydowns and reflects the re-mixing of the interest-earning assets as we have utilized the paydowns of the investment portfolio to fund loan originations.
Average balances of interest bearing liabilities increased $20.1 million during the three months ended March 31, 2020, compared to the three months ended March 31, 2019. The increase was driven by interest bearing demand, savings and money market deposits of $87.1 million, partially offset by decreases in FHLB advances of $29.4 million, time deposits of $21.9 million and securities sold under agreement to repurchase of $15.7 million. Additionally, the cost of deposits increased five basis points to 0.63% during the three months ended March 31, 2020, compared to 0.58% during the three months ended March 31, 2019, due to higher cost of time deposits.
The following table summarizes the changes in net interest income on an FTE basis by major category of interest earning assets and interest bearing liabilities, identifying changes related to volume and changes related to rates for the three months ended March 31, 2020 compared to the three months ended March 31, 2019:
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Originated loans are net of deferred loan fees, less costs, which are included in interest income over the life of the loan. |
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Presented on an FTE basis using the statutory tax rate of 21% for the three months ended March 31, 2020 and 2019. The taxable equivalent adjustments included above are $1,268 and $1,227 for three months ended March 31, 2020 and 2019, respectively. |
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Loan fees included in interest income totaled $1,823 and $1,325 for the three months ended March 31, 2020 and 2019, respectively. |
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Below is a breakdown of average deposits and the average rates paid during the periods indicated:
Provision for loan losses
The provision for loan losses represents the amount of expense that is necessary to bring the ACL to a level that we deem appropriate to absorb estimated lifetime losses inherent in the loan portfolio as of the balance sheet date. The determination of the ACL, and the resultant provision for loan losses, is subjective and involves significant estimates and assumptions.
Provision for loan loss expense of $6.2 million, net of a $0.2 million reduction in unfunded loan commitment reserves, was recorded under the CECL model to support originated loan growth, net charge-offs and to provide coverage for the impact of deterioration in the macro-economic environment as a result of COVID-19. Provision of $1.6 million was recorded under the prior incurred loss model during the first quarter of 2019 to support originated loan growth. The allowance for credit losses totaled 1.13% of total loans at March 31, 2020, compared to the allowance for originated acquired loan losses of 0.88% at March 31, 2019, and included a CECL adoption day 1 increase of $5.8 million.
Non-interest income
The table below details the components of non-interest income for the periods presented:
During the first quarter of 2020, non-interest income increased $6.5 million, or 38.0%, compared to the first quarter of last year primarily due to higher mortgage banking income driven by higher loan production due to lower prevailing interest rates during the first quarter of 2020.
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Non-interest expense
The table below details the components of non-interest expense for the periods presented:
During the first quarter of 2020, non-interest expense increased $4.3 million, or 9.6%, compared to the first quarter of last year primarily driven by higher salaries and benefits due to higher mortgage banking commissions, partially offset by decreases in FDIC deposit insurance and problem asset workout expenses. The Company recognized $0.5 million of FDIC assessment credits during the first quarter of 2020, which fully offset the FDIC deposit insurance expense for the first quarter of 2020.
Income taxes
Income tax expense attributable to income before income taxes was $3.2 million for the three months ended March 31, 2020, compared to an income tax expense of $3.4 million for the three months ended March 31, 2019. The effective tax rate for the three months ended March 31, 2020 was 16.9%, compared to an adjusted rate of 18.7% during the full year 2019. The prior year’s effective tax rate was adjusted for $2.2 million of stock compensation activity. The effective tax rate is lower than the federal statutory rate primarily due to interest income from tax-exempt lending, bank-owned life insurance income, and the relationship of these items to pre-tax income. The Company forecasts the full year estimated effective tax rate in accordance with ASC Topic 740; as a result, the relationship between pre-tax income and tax-exempt income within each reporting period can create fluctuations in the effective tax rate from period-to-period.
Additional information regarding income taxes can be found in note 19 of our audited consolidated financial statements in our 2019 Annual Report on Form 10-K.
Liquidity and Capital Resources
Liquidity is monitored and managed to ensure that sufficient funds are available to operate our business and pay our obligations to depositors and other creditors, while providing ample available funds for opportunistic and strategic investments. On-balance sheet liquidity is represented by our cash and cash equivalents, and unencumbered investment securities, and is detailed in the table below as of March 31, 2020 and December 31, 2019:
Total on-balance sheet liquidity decreased $18.7 million at March 31, 2020 compared to December 31, 2019. The decrease was due to a reduction of $42.4 million in unencumbered available-for-sale and held-to-maturity securities balances partially offset by higher cash and due from banks of $23.7 million.
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Through our relationship with the FHLB, we have pledged qualifying loans and investment securities allowing us to obtain additional liquidity through FHLB advances and lines of credit. The Bank pledged investment securities and loans as collateral for FHLB advances. Investment securities pledged were $16.5 million at March 31, 2020 and $17.6 million at December 31, 2019. The Bank also had loans pledged as collateral for FHLB advances of $1.5 billion at March 31, 2020 and $1.5 billion at December 31, 2019. FHLB advances, lines of credit and other short-term borrowing availability totaled $1.0 billion, of which $341.5 million was used at March 31, 2020. The Bank can obtain additional liquidity through FHLB advances if required, and also has access to federal funds lines of credit with correspondent banks.
Our primary sources of funds are deposits, securities sold under agreements to repurchase, prepayments and maturities of loans and investment securities, the sale of investment securities, and funds provided from operations. We anticipate having access to other third party funding sources, including the ability to raise funds through the issuance of shares of our common stock or other equity or equity-related securities, incurrence of debt, and federal funds purchased, that may also be a source of liquidity. We anticipate that these sources of liquidity will provide adequate funding and liquidity for at least a 12-month period.
Our primary uses of funds are loan originations, investment security purchases, withdrawals of deposits, settlement of repurchase agreements, capital expenditures, operating expenses, and share repurchases. For additional information regarding our operating, investing, and financing cash flows, see our consolidated statements of cash flows in the accompanying unaudited consolidated financial statements.
Exclusive from the investing activities related to acquisitions, our primary investing activities are originations and pay-offs and pay downs of loans and purchases and sales of investment securities. At March 31, 2020, pledgeable investment securities represented a significant source of liquidity. Our available-for-sale investment securities are carried at fair value and our held-to-maturity securities are carried at amortized cost. Our collective investment securities portfolio totaled $0.8 billion at March 31, 2020, inclusive of pre-tax net unrealized gains of $14.1 million on the available-for-sale securities portfolio. Additionally, our held-to-maturity securities portfolio had $4.7 million of pre-tax net unrealized gains at March 31, 2020. The gross unrealized gains and losses are detailed in note 3 of our consolidated financial statements. As of March 31, 2020, our investment securities portfolio consisted primarily of mortgage-backed securities, all of which were issued or guaranteed by U.S. Government agencies or sponsored enterprises. The anticipated repayments and marketability of these securities offer substantial resources and flexibility to meet new loan demand, reinvest in the investment securities portfolio, or provide optionality for reductions in our deposit funding base.
At present, financing activities primarily consist of changes in deposits and repurchase agreements, and advances from the FHLB, in addition to the payment of dividends and the repurchase of our common stock. Maturing time deposits represent a potential use of funds. As of March 31, 2020, $716.2 million of time deposits were scheduled to mature within 12 months. Based on the current interest rate environment, market conditions, and our consumer banking strategy focusing on both lower cost transaction accounts and term deposits, our strategy is to replace a portion of those maturing time deposits with transaction deposits and market-rate time deposits.
Under the Basel III requirements, at March 31, 2020, the Company and the Bank met all capital adequacy requirements, and the Bank had regulatory capital ratios in excess of the levels established for well-capitalized institutions. For more information on regulatory capital, see note 9 in our consolidated financial statements.
Our shareholders' equity is impacted by earnings, changes in unrealized gains and losses on securities, net of tax, stock-based compensation activity, share repurchases and the payment of dividends.
The Board of Directors has authorized multiple programs to repurchase shares of the Company’s common stock from time to time either in open market or in privately negotiated transactions in accordance with applicable regulations of the SEC.
On February 26, 2020, the Board of Directors authorized a new share repurchase program for up to $50.0 million from time to time in either the open market or through privately negotiated transactions. This authorization was in addition to the $12.6 million remaining for share repurchase that was previously approved by the Board on August 5, 2016. During the first quarter of 2020, the Company repurchased 734,117 shares for $19.5 million. This completed the previous authorization approved in August 2016. The remaining authorization under the program approved in February 2020 was $43.1 million as of March 31, 2020.
On May 5, 2020, our Board of Directors declared a quarterly dividend of $0.20 per common share, payable on June 15, 2020 to shareholders of record at the close of business on May 29, 2020.
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Asset/Liability Management and Interest Rate Risk
Management and the Board of Directors are responsible for managing interest rate risk and employing risk management policies that monitor and limit this exposure. Interest rate risk is measured using net interest income simulations and market value of portfolio equity analyses. These analyses use various assumptions, including the nature and timing of interest rate changes, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment/replacement of asset and liability cash flows.
The principal objective of the Company's asset and liability management function is to evaluate the interest rate risk within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing earnings and preserving adequate levels of liquidity and capital. The asset and liability management function is under the guidance of the Asset Liability Committee from direction of the Board of Directors. The Asset Liability Committee meets monthly to review, among other things, the sensitivity of the Company's assets and liabilities to interest rate changes, local and national market conditions and rates. The Asset Liability Committee also reviews the liquidity, capital, deposit mix, loan mix and investment positions of the Company.
Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest margin. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates and utilize various assumptions, including, but not limited to, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows.
We also analyze the economic value of equity as a secondary measure of interest rate risk. This is a complementary measure to net interest income where the calculated value is the result of the market value of assets less the market value of liabilities. The economic value of equity is a longer term view of interest rate risk because it measures the present value of the future cash flows. The impact of changes in interest rates on this calculation is analyzed for the risk to our future earnings and is used in conjunction with the analyses on net interest income.
Our interest rate risk model indicated that the Company was asset sensitive in terms of interest rate sensitivity at March 31, 2020. During the three months ended March 31, 2020, our asset sensitivity increased slightly for a declining rate environment as a result of the balance sheet mix. The table below illustrates the impact of an immediate and sustained 200 and 100 basis point increase at March 31, 2020 and December 31, 2019 and a 25 basis point decrease in interest rates on net interest income based on the interest rate risk model at March 31, 2020:
Many assumptions are used to calculate the impact of interest rate fluctuations. Actual results may be significantly different than our projections due to several factors, including the timing and frequency of rate changes, market conditions and the shape of the yield curve. The computations of interest rate risk shown above do not include actions that management may undertake to manage the risks in response to anticipated changes in interest rates and actual results may also differ due to any actions taken in response to the changing rates.
As part of the asset/liability management strategy to manage primary market risk exposures expected to be in effect in future reporting periods, management has emphasized the origination of longer duration loans. The strategy with respect to liabilities has been to continue to emphasize transaction account growth, particularly non-interest or low interest bearing non-maturing deposit accounts while building long-term client relationships. Non-maturing deposit accounts totaled 77.8% of total deposits at March 31, 2020, compared to 77.7% at December 31, 2019. We currently have no brokered time deposits.
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Off-Balance Sheet Activities
In the normal course of business, we are a party to various contractual obligations, commitments and other off-balance sheet activities that contain credit, market, and operational risk that are not required to be reflected in our consolidated financial statements. The most significant of these are the loan commitments that we enter into to meet the financing needs of clients, including commitments to extend credit, commercial and consumer lines of credit and standby letters of credit. As of March 31, 2020 and December 31, 2019, we had loan commitments totaling $816.5 million and $850.3 million, respectively, and standby letters of credit that totaled $10.5 million and $11.9 million, respectively. Unused commitments do not necessarily represent future credit exposure or cash requirements, as commitments often expire without being drawn upon.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by this item is provided under the caption Asset/Liability Management and Interest Rate Risk in Part I, Item 2-Management's Discussion and Analysis of Financial Condition and Results of Operations and is incorporated herein by reference.
Item 4. CONTROLS AND PROCEDURES
Our management, with the participation of our principal executive officer and principal financial officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as of March 31, 2020. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of March 31, 2020.
During the most recently completed fiscal quarter, there were no changes made in the Company's internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
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PART II: OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
From time to time, we are a party to various litigation matters incidental to the conduct of our business. We are not presently party to any legal proceedings the resolution of which we believe would have a material adverse effect on our business, prospects, financial condition, liquidity, results of operation, cash flows or capital levels.
Item 1A. RISK FACTORS
There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2019 with the exception of the following:
The COVID-19 pandemic is adversely affecting us, our clients and third-party service providers, and the adverse impacts on our business, financial position, operations and prospects could be significant.
The COVID-19 pandemic has adversely impacted our business and financial results, and its ultimate impact on our business will depend on highly uncertain and unpredictable future developments, including the magnitude and duration of the pandemic and actions taken by governmental authorities in response to the pandemic, particularly within our geographic footprint. The pandemic has resulted in temporary closures of many businesses, some of which include our borrowers, and the institution of social distancing and sheltering in place requirements in many states and communities. As a result, the demand for our products and services may be significantly impacted, which could adversely affect our revenue. Furthermore, the pandemic could continue to result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses remain closed, the impact on the national economy worsens, or more clients draw on their lines of credit or seek additional loans to help finance their businesses. Small and mid-sized businesses make up a large portion of our commercial loan portfolio, and are particularly vulnerable to the financial effects of the COVID-19 pandemic due to their increased reliance on continuing cash flow to fund day-to-day operations. Although government programs have sought, and may further seek, to provide relief to these types of businesses, there can be no assurance that these programs will succeed. Our business operations may also be disrupted if significant portions of our workforce, key personnel or third-party service providers are unable to work effectively, including because of illness, quarantines, government actions, or other restrictions in connection with the pandemic. Until the COVID-19 pandemic subsides, it will continue to impact our business, results of operations, and financial condition, as well as our regulatory capital and liquidity ratios.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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These shares represent shares purchased other than through publicly announced plans and were purchased pursuant to the Company’s stock incentive plans. Pursuant to the plans, shares were purchased from plan participants at the then current market value in satisfaction of stock option exercise prices, settlements of restricted stock and tax withholdings. |
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On August 5, 2016, the Company’s Board of Directors authorized the repurchase of $50.0 million of common stock. This program has been completed. |
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On February 26, 2020, the Company’s Board of Directors authorized the repurchase of up to an additional $50.0 million of common stock. Under this authorization, $43,101,943 remained available at March 31, 2020. |
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Item 5. OTHER INFORMATION
None.
Item 6. EXHIBITS
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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.
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National Bank Holdings Corporation |
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/s/ Aldis Birkans |
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Aldis Birkans |
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Chief Financial Officer |
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(principal financial officer) |
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Date: May 5, 2020
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Certifications of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, G. Timothy Laney, Chief Executive Officer, certify that:
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I have reviewed this quarterly report on Form 10-Q of National Bank Holdings Corporation; |
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Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
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Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
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Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
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Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
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Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
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Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
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All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
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Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
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Date: |
May 5, 2020 |
/s/ G. Timothy Laney |
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G. Timothy Laney |
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Chairman, President and Chief Executive Officer |
Certifications of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Aldis Birkans, Chief Financial Officer, certify that:
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I have reviewed this quarterly report on Form 10-Q of National Bank Holdings Corporation; |
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Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
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Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
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The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
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Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
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Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
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Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
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Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
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All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
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Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
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Date: |
May 5, 2020 |
/s/ Aldis Birkans |
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Aldis Birkans |
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Chief Financial Officer |
Certifications of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the quarterly report of National Bank Holdings Corporation (the “Company”) on Form 10-Q for the period ended March 31, 2020, as filed with the Securities and Exchange Commission (the “Report”), each of the undersigned officers certifies pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge: (1) this Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Company.
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Date: |
May 5, 2020 |
/s/ G. Timothy Laney |
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G. Timothy Laney |
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Chairman, President and Chief Executive Officer |
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Date: |
May 5, 2020 |
/s/ Aldis Birkans |
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Aldis Birkans |
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Chief Financial Officer |