FIRT CHOINPV
The purpose of this management's discussion and analysis of financial
condition and results of operations ("MD&A") is to focus on information about
our consolidated financial condition at December 31, 2020 and 2019, and our
consolidated results of operations for the two years ended December 31, 2020 .
Our consolidated financial statements and the supplemental financial data
appearing elsewhere in this Annual Report should be read in conjunction with
this MD&A.
37
--------------------------------------------------------------------------------Overview
First Choice Bancorp , headquartered inCerritos, California , is aCalifornia corporation that was incorporated onSeptember 1, 2017 and is the registered bank holding company forFirst Choice Bank . Incorporated inMarch 2005 and commencing commercial bank operations inAugust 2005 ,First Choice Bank is aCalifornia -chartered member bank.First Choice Bank has a wholly-owned subsidiary,PCB Real Estate Holdings, LLC , which was acquired as part of the acquisition ofPacific Commerce Bank in 2018.PCB Real Estate Holding, LLC is used for holding other real estate owned and other assets acquired by foreclosure. References herein to "First Choice Bancorp ," "Bancorp," or the "holding company," refer toFirst Choice Bancorp on a standalone basis. The words "we," "us," "our," or the "Company" refer toFirst Choice Bancorp ,First Choice Bank andPCB Real Estate Holdings, LLC collectively and on a consolidated basis. References to the "Bank" refer toFirst Choice Bank andPCB Real Estate Holdings, LLC on a consolidated basis. The Bank is a community-based financial institution that serves commercial and consumer clients in diverse communities. The Bank specializes in loans to small- to medium-sized businesses and private banking clients, commercial and industrial loans, and commercial real estate loans with a specialization in providing financial solutions for the hospitality industry. The Bank is aPreferred Small Business Administration ("SBA") Lender. The Bank conducts business through eight full-service branches and two loan production offices located inLos Angeles ,Orange andSan Diego Counties. EffectiveJanuary 29, 2021 , theRowland Heights branch was sold to a third party financial institution who acquired certain branch assets and assumed certain branch liabilities, including deposit liabilities and the Company's obligations under theRowland Heights branch lease. No loans were sold as part of this transaction. As of the date of sale, theRowland Heights branch had total deposits of$22 million . As aCalifornia -chartered member bank, the Bank is primarily regulated by theCalifornia Department of Financial Protection and Innovation (the "DFPI") and theBoard of Governors of theFederal Reserve System (the "Federal Reserve"). The Bank's deposits are insured up to the maximum legal limit by theFederal Deposit Insurance Corporation (the "FDIC").
Recent Developments
The COVID-19 pandemic has resulted in, and is likely to continue to result in, significant economic disruption affecting our business and the businesses of our clients. As of the date of this filing, significant uncertainty continues to exist concerning the magnitude of the impact, the duration of the COVID-19 pandemic and the efficacy of vaccines and other treatment options. For a more detailed discussion of some risks and uncertainties from or relating to the COVID-19 pandemic that could materially and adversely affect our consolidated financial condition and consolidated results of operations, see Part 1, Item 1A - Risk Factors in this Annual Report. See also "CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS," herein. For accounting policies related to COVID-19 loan payment deferrals authorized under the CARES Act, please refer to NOTE 1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Guidance on non-TDR loan modifications due to COVID-19 and NOTE 3. LOANS to the Consolidated Financial Statements included in Item 8 Financial Statements and Supplementary Data, of this Annual Report.
Key Events and Updates Related to COVID-19:
The ongoing COVID-19 pandemic has caused serious disruptions in theU.S. economy and financial markets, and entire industries within our loan portfolio, such as hospitality and restaurants, have been impacted due to quarantines and travel restrictions and other industries we serve are experiencing or likely to experience similar disruptions and economic hardships as the COVID-19 pandemic persists.
Continued Support for Employees, Clients, and Communities.
• AtDecember 31, 2020 , all branches were fully re-opened with appropriate safety precautions in place. Safety and precautionary measures we have implemented include: germ guards, social distancing markers, PPE (masks, gloves and hand sanitizer), daily enhanced cleaning with CDC recommended disinfectants, limited same time client entry and reduced lobby hours • No employee lay-offs, or furloughs •$120,000 in donations to over 50 non-profit organizations within our footprint that serve communities disproportionately impacted by COVID-19 and the economic distress of this pandemic 38 --------------------------------------------------------------------------------
Governmental Credit Assistance Programs
In response to the market volatility and instability resulting from the pandemic, the federal government passed the CARES Act inMarch 2020 which authorized certain government-sponsored credit programs, including the Paycheck Protection Program ("PPP") and theMain Street Lending Program. The loan programs and the Company's participation in these programs are discussed below: Paycheck Protection Program. OnMarch 27, 2020 , the CARES Act was signed into law authorizing the SBA to guarantee an aggregate of up to$349 billion in forgivable PPP loans to assist small businesses nationwide adversely impacted by the COVID-19 pandemic. OnApril 24, 2020 , the PPP and Health Care Enhancement Act was signed into law and provided an additional$310 billion in funding and authority for the PPP. OnJune 5, 2020 , the PPP Flexibility Act of 2020 (the "Flexibility Act") was signed into law which changed key provisions of the PPP, including provisions relating to contractual maturity, the deferral of loan payments, and the forgiveness of such loans. Under the Flexibility Act, the maturity date for PPP loans funded beforeJune 5, 2020 remained at two years from funding while the maturity date for PPP loans funded afterJune 5, 2020 was five years from funding. The Flexibility Act also increased the period during which PPP loan proceeds may be used for purposes that qualify the loan for forgiveness (the "covered period") to 24 weeks. Under the Flexibility Act, borrowers are not required to make any payments of principal or interest before the date on which the SBA remits the loan forgiveness amount to the Bank (or notifies the Bank that no loan forgiveness is allowed). Interest continues to accrue during the PPP payment deferral period. Although PPP borrowers may submit an application for forgiveness at any time prior to the maturity date, if a forgiveness application is not submitted within 10 months after the end of the covered period, such borrowers will be required to begin paying principal and interest after that period. OnDecember 27, 2020 , the President signed into law economic stimulus legislation titled the "Consolidated Appropriations Act" that included the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the "HHSB Act"). Among other things, the HHSB Act renewed the PPP, allocating$284.45 billion for both new first time PPP loans under the existing PPP and the expansion of existing PPP loans for certain qualified, existing PPP borrowers ("PPP Round 3"), and a new simplified forgiveness procedure for PPP loans of$150,000 or less. At origination, we are paid a processing fee by the SBA ranging from 1% to 5% based on the size of the PPP loan. All PPP loans originated in 2020 were funded prior toJune 5, 2020 and, accordingly, have a two-year contractual maturity. Unless these loans are forgiven by the SBA prior toOctober 5, 2021 , it is possible that repayment of principal and interest on these PPP loans will be deferred throughOctober 2021 . AtDecember 31, 2020 , PPP loans, net of deferred fees of$6.6 million , totaled$320.1 million . The deferred fees are accreted to interest income based on the contractual maturity and are accelerated to interest income upon forgiveness or payoff. The SBA began approving forgiveness applications in the fourth quarter of 2020. AtDecember 31, 2020 , approximately$73 million of PPP loans were forgiven by the SBA or repaid by the borrowers, and net deferred fees related to these loans of$1.8 million were accelerated to income as a result of forgiveness or borrower repayments. InJanuary 2021 , we began participating in the new PPP Round 3 and originating both First Draw and Second Draw loans. The maximum loan amount for First Draw borrowers is$10 million and is$2 million for the Second Draw borrowers. Unless extended, PPP Round 3 is scheduled to expire onMarch 31, 2021 . Like the 2020 PPP, loans originated in PPP Round 3 are fully guaranteed by the SBA and are subject to potential forgiveness by the SBA. PPP Liquidity Facility. OnApril 14, 2020 , we were approved by theFederal Reserve to access its SBA Paycheck Protection Program Liquidity Facility ("PPPLF"). The PPPLF enables us to borrow funds through the Federal Reserve Discount Window to fund PPP loans. AtDecember 31, 2020 , we had$204.7 million in borrowings under the PPPLF with a fixed-rate of 0.35% which were collateralized by PPP loans. Main Street Lending Program. OnApril 9, 2020 , theFederal Reserve established the Main Street Lending Program in order to support lending to small and medium-sized for-profit businesses and nonprofit organizations that were in sound financial condition before the onset of the COVID-19 pandemic. Under theMain Street Program, we originated loans to qualifying borrowers and then sold 95% participation interest to the SPV, organized by theFederal Reserve to purchase these interests, while we retained the remaining 5% of the loans as well as servicing rights. Loans originated under the program have a five-year repayment term, an interest rate of 3-month LIBOR plus 3%, interest payments are deferred for one year and principal payments are deferred for the first two years. The borrower must repay 15% of principal in the third and fourth years, and the remaining 70% is due in the final year. Loans originated under theMain Street Lending Program do not have a forgiveness feature. The program expired onJanuary 8, 2021 . 39 -------------------------------------------------------------------------------- During the year endedDecember 31, 2020 , we originated 32 loans under the Main Street Lending Program totaling$172.2 million in principal and sold participation interests totaling$163.6 million to the SPV, resulting in a gain on sale of$1.1 million . The SPV pays us a servicing fee of 0.25% per annum of the total participation interest. We and theFederal Reserve believe that the terms of the Servicing Agreement are commercially reasonable and comparable to terms that unaffiliated third parties would accept to provide enhanced reporting services, under the terms and conditions set out in the Servicing Agreement, with respect to the participation interest. Therefore, no servicing asset or liability was recorded at the time of sale. SBA Debt Relief Program. As a part of the CARES Act, the SBA has agreed to pay up to six months of principal, interest and associated fees for borrowers with current SBA 7(a) loans that were disbursed prior toSeptember 27, 2020 . The program has resumed and the SBA has agreed to pay for an additional three months of principal and interest payments, capped at$9,000 per borrower per month beginningFebruary 2021 . For borrowers considered to be underserved or hard-hit by the pandemic, the SBA has agreed to pay an additional five months of principal and interest payments untilSeptember 2021 .
Payment Deferral Program
Throughout 2020, we granted over 520 loans totaling$629 million a 90-day payment deferral for COVID-19 related reasons. AtDecember 31, 2020 , over 99% of loans that were granted a deferral under this program have resumed making regular, contractually agreed-upon payments or were paid off and three non-PPP loans totaling$3.3 million remained on payment deferral, of which$2.8 million were reported as non-accrual and none are reported as TDRs under Section 4013 of the CARES Act. The table below shows the number and balances of loans on payment deferral at the periods indicated: Loan Balance on Payment # of Loans on Deferral Payment Deferral ($ in millions)
June 30, 2020 520 $ 626 September 30, 2020 12 37 December 31, 2020 3 3 Impacts from COVID-19: The ongoing COVID-19 global pandemic has caused significant disruption in the international andUnited States economies and financial markets and continues to have an adverse effect on our business, consolidated financial condition and consolidated results of operations. In response to the COVID-19 pandemic, the state government ofCalifornia has taken preventative or protective actions which have resulted in significant adverse effects for many different types of businesses, including, among others, those in the travel, hospitality and food and beverage industries, and have resulted in a significant number of layoffs and furloughs of employees nationwide and in the regions in which we operate. Because we have not recently experienced a comparable crisis which resulted in, among other things, the complete cessation of operations for entire industries in our portfolio, our ability to be predictive is uncertain. In addition, the magnitude, duration and speed of the global pandemic is uncertain. As a consequence, we cannot estimate the impact on our business, consolidated financial condition or near- or longer-term financial or consolidated results of operations with reasonable certainty. Net interest income and net interest margin. TheFederal Reserve's 150 basis point reduction in interest rates inMarch 2020 negatively impacted our net interest income and net interest margin for the year endedDecember 31, 2020 , and put further pressure on our net interest margin during 2020. We have proactively worked to lower interest expense by lowering deposit rates, increasing our noninterest-bearing deposits as a percentage of total deposits and taking advantage of lower interest rate borrowing facilities. Participation in the PPP had a significant impact on our asset mix and net interest income for the year endedDecember 31, 2020 and will continue to impact both asset mix and net interest income for the year 2021. These loans contributed$8.7 million of interest income, of which$1.8 million related to accelerated net deferred fee income from loan forgiveness for the year endedDecember 31, 2020 . The weighted average loan yield for PPP loans was 3.34% which lowered the total loan yield by 33 basis points for the year endedDecember 31, 2020 . We anticipate the accelerated deferred fee income as PPP loans payoff or are forgiven will partially offset the decrease in net interest margin from lower PPP interest rates. Provision for loan losses. The provision for loan losses during 2020 was negatively impacted by an increase in qualitative factors related to COVID-19 and macro-economic conditions, in addition to loan growth. With the extension of stay-at-home orders and an increase in reported COVID-19 cases in the fourth quarter of 2020, the timing of an economic recovery 40 -------------------------------------------------------------------------------- continues to remain uncertain. Accordingly, the assumptions underlying the COVID-19 related qualitative factors we analyzed in determining the adequacy of the allowance for loan losses included (a) uncertain and volatile macroeconomic conditions caused by the pandemic; (b) a high unemployment rate; and (c) the additional government stimulus package signed into law in December of 2020. No provision for loan losses on PPP loans was recognized in 2020 as the SBA guarantees 100% of loans funded under the programs. Loans to the hospitality industry. AtDecember 31, 2020 , our total loan commitments to the hospitality industry was$241.2 million , of which$212.3 million was outstanding, representing 11.2% of total loans including loans held for sale, and loans held for investment net of discount and deferred fees. The total outstanding balance consisted of$118.4 million CRE,$10.6 million C&I,$28.5 million construction and land and$54.8 million SBA, of which$25.8 million were SBA PPP loans which are fully guaranteed by the SBA. We originated four hospitality loans under the Main Street Lending Program totaling$14.4 million in principal and sold 95% participation interests totaling$13.7 million to the SPV reducing the Company's net exposure to$700 thousand atDecember 31, 2020 . AtDecember 31, 2020 , non-accrual hospitality loans totaled$82 thousand . AtDecember 31, 2020 , there were no loans on deferment. Loans to the restaurant industry. AtDecember 31, 2020 , our total loan commitments to the restaurant industry was$89.3 million , of which$84.5 million was outstanding, representing 4.5% of total loans including loans held for sale, and loans held for investment net of discounts and deferred fees. The total outstanding balance consisted of$7.1 million CRE,$14.1 million C&I,$63.3 million SBA, of which$45.4 million were SBA PPP loans which are fully guaranteed by the SBA. We originated three restaurant-related loans under the Main Street Lending Program totaling$5.8 million in principal and sold 95% participation interest totaling$5.5 million to the SPV reducing the Company's net exposure to$300 thousand atDecember 31, 2020 . AtDecember 31, 2020 , non-accrual restaurant-related loans totaled$151.0 thousand . AtDecember 31, 2020 , there were no loans on deferment. Capital and liquidity. The Bank opted into the CBLR framework in the first quarter of 2020 and, because the Bank's CBLR was 10.28% as ofDecember 31, 2020 , we exceeded the reduced regulatory minimum requirement of 8%, and were considered "well-capitalized" atDecember 31, 2020 . The Bank's primary and secondary liquidity sources were over$784 million atDecember 31, 2020 . Full Year Highlights • Net income of$29.0 million , up 4.0% over 2019 • Diluted EPS of$2.47 per share, up 4.7% over 2019 • Pre-tax pre-provision income of$46.9 million , up 9.7% from 2019 • Net interest margin of 4.28%, down 96 bps from 2019 • Cost of funds of 0.38%, down 53 bps from 2019 • Return on average assets of 1.38%, compared to 1.74% in 2019 • Return on average equity of 10.70%, compared to 10.93% in 2019 • Efficiency ratio of 49.8%, compared to 50.3% in 2019 •Provision for loan loss expense of$5.9 million , up$3.1 million from 2019 due primarily to COVID-19 and organic loan growth • Total loans held for investment excluding PPP loans increased$186.0 million , an increase of 13.5% over 2019 • Noninterest-bearing demand deposits increased$194.1 million , up 31.0% over 2019 • Cash dividends paid of$1.00 per share
Primary Factors We Use to Evaluate Our Business
As a financial institution, we manage and evaluate various aspects of both our consolidated financial condition and consolidated results of operations. We evaluate the comparative levels and trends of the line items in our consolidated balance sheets and consolidated income statements and various financial ratios that are commonly used in our industry. We analyze these financial trends and ratios against our own historical performance, our budgeted performance and the consolidated financial condition and performance of comparable financial institutions in our region.
Segment Information
We provide a broad range of financial services to individuals and companies
through our branch network. Those services include a wide range of deposit and
lending products for businesses and individuals. While our chief decision makers
monitor
41
--------------------------------------------------------------------------------the revenue streams of our various product and service offerings, we manage our operations and review our financial performance on a company-wide basis. Accordingly, we consider all of our operations to be aggregated into one reportable operating segment.
Results of Operations
In addition to net income, the primary factors we use to evaluate and manage our results of operations include net interest income, noninterest income and noninterest expense. Net Interest Income Net interest income represents interest income less interest expense. We generate interest income from interest and fees (net of costs amortized over the expected life of the loans) plus the accretion of net discounts on interest-earning assets, including loans and investment securities and dividends on restricted stock investments. We incur interest expense from interest paid on interest-bearing liabilities, including interest-bearing deposits and borrowings. Net interest income has been the most significant contributor to our revenues and net income. To evaluate net interest income, we measure and monitor: (a) yields and accretable net discount on our loans and other interest-earning assets; (b) the costs of our deposits and other funding sources; and (c) our net interest margin. Net interest margin is calculated as the annualized net interest income divided by average interest-earning assets. Because noninterest-bearing sources of funds, such as noninterest-bearing deposits and shareholders' equity, also fund interest-earning assets, net interest margin includes the benefit of these noninterest-bearing sources. Changes in market interest rates, the slope of the yield curve, and interest we earn on interest-earning assets or pay on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and noninterest-bearing liabilities, usually have the largest impact on changes in our net interest spread, net interest margin and net interest income during a reporting period. Noninterest Income Noninterest income consists of, among other things: (a) gain on sale of loans; (b) service charges and fees on deposit accounts; (c) net servicing fees; and (d) other noninterest income. Gain on sale of loans includes origination fees, capitalized servicing rights and other related income. Net loan servicing fees are collected as payments are received for loans in the servicing portfolio and offset by the amortization expense of the related servicing asset; this revenue stream is impacted by loan prepayments.
Noninterest Expense
Noninterest expense includes: (a) salaries and employee benefits; (b) occupancy and equipment; (c) data processing; (d) professional fees; (e) office, postage and telecommunication; (f) deposit insurance and regulatory assessments; (g) loan related expenses; (h) customer service related expenses; (i) amortization of core deposit intangible; and (j) other general and administrative expenses.
Financial Condition
The primary factors we use to evaluate and manage our consolidated financial condition are asset levels, liquidity, capital and asset quality.
Asset Levels
We manage our asset levels based upon forecasted loan originations and estimated loan sales to ensure we have both the necessary liquidity and capital to fund asset growth while exceeding the required regulatory capital ratios. We evaluate our funding needs by forecasting loan originations and sales of loans.
Liquidity
We manage our liquidity based upon factors that include the amount of our
custodial and brokered deposits as a percentage of total assets and deposits,
the level of diversification of our funding sources, the allocation and amount
of our deposits among deposit types, the short-term funding sources used to fund
assets, the amount of non-deposit funding used to fund assets, the availability
of unused funding sources, off-balance sheet obligations, the availability of
assets to be readily converted into cash without a material loss on the
investment, the amount of cash and cash equivalent securities we hold, the
42
--------------------------------------------------------------------------------repricing characteristics and maturities of our assets when compared to the repricing characteristics of our liabilities and other factors.
Capital
We manage our regulatory capital based upon factors that include: (a) the level of capital and our overall consolidated financial condition; (b) the trend and volume of problem assets; (c) the level and quality of earnings; (d) the risk exposures and level of reserves in our consolidated balance sheets; and (e) other factors. In addition, our capital has increased as the result of our net income and, when approved by our Board and issued, equity compensation. We also return capital to our shareholders through dividends and share repurchases.
Asset Quality
We manage the diversification and quality of our assets based upon factors that include the level, distribution, severity and trend of problem, classified, delinquent, nonaccrual, nonperforming and restructured assets, the adequacy of our allowance for loan losses, the diversification and quality of loan and investment portfolios, the extent of counterparty risks, credit risk concentrations and other factors.
Non-GAAP Financial Measures
The following tables present a reconciliation of non-GAAP financial measures to
GAAP financial measures for: (1)
efficiency ratio; (2) pre-tax pre-provision income; (3) average tangible common
equity; (4) return on average tangible
common equity; (5) tangible common equity; (6) tangible assets; (7) tangible
common equity to tangible asset ratio; and (8)
tangible book value per share. We believe the presentation of certain non-GAAP
financial measures provides useful
information to assess our consolidated financial condition and consolidated
results of operations and to assist investors in
evaluating our financial results relative to our peers. These non-GAAP financial
measures complement our GAAP reporting
and are presented below to provide investors and others with information that we
use to manage the business each period.
Because not all companies use identical calculations, the presentation of these
non-GAAP financial measures may not be comparable to other similarly titled
measures used by other companies. These non-GAAP measures should be taken
together
with the corresponding GAAP measures and should not be considered a substitute
of the GAAP measures.
Year Ended December 31,
2020 2019
Efficiency Ratio (dollars in thousands)
Noninterest expense (numerator) $ 46,468 $ 43,240
Net interest income (denominator) 84,736 78,262
Plus: Noninterest income 8,607 7,700
Total net interest income and noninterest income (denominator) $ 93,343 $ 85,962
Efficiency ratio (1) 49.8 % 50.3 %
Pre-tax Pre-provision Income
Net interest income $ 84,736 $ 78,262
Noninterest income 8,607 7,700
Total net interest income and noninterest income 93,343 85,962
Less: Noninterest expense 46,468 43,240
Pre-tax pre-provision income (1) $ 46,875 $ 42,722
(1) Non-GAAP measure.
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Year Ended
2020 2019
Return on Average Assets, Equity, Tangible Common Equity (dollars in thousands)
Net income $ 28,951 $ 27,848
Average assets 2,095,784 1,603,600
Average shareholders' equity 270,521 254,770
Less: Average intangible assets 78,790 79,631
Average tangible equity (1) $ 191,731 $ 175,139
Return on average assets 1.38 % 1.74 %
Return on average equity 10.70 % 10.93 %
Return on average tangible common equity (1) 15.10 % 15.90 %
(1) Non-GAAP measure.
December 31,
2020 2019
Tangible Common Equity Ratio/Tangible Book Value Per Share (dollars in thousands)
Shareholders' equity $ 280,741 $ 261,805
Less: Intangible assets 78,381 79,153
Tangible common equity (1) $ 202,360 $ 182,652
Total assets $ 2,283,115 $ 1,690,324
Less: Intangible assets 78,381 79,153
Tangible assets (1) $
2,204,734
Equity to asset ratio 12.30 % 15.49 % Tangible common equity to tangible asset ratio (1) 9.18 % 11.34 % Book value per share$ 23.98 $ 22.50 Tangible book value per share (1)$ 17.29 $ 15.70 Shares outstanding 11,705,684 11,635,531
(1) Non-GAAP measure.
Comparison of Operating Results
General
Net income was$29.0 million or$2.47 diluted earnings per share for the year endedDecember 31, 2020 compared to$27.8 million or$2.36 diluted earnings per share for the year endedDecember 31, 2019 . The$1.1 million increase in net income was due to higher net interest income of$6.5 million , noninterest income of$907 thousand and lower income taxes of$50 thousand , partially offset by increases in the provision for loan losses of$3.1 million , and noninterest expense of$3.2 million for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 . The increase in net interest income was a result of higher average loan balances, relating to both PPP loans and organic loan growth, interest income and fees recognized for PPP loan forgiveness and reductions in the costs of interest-bearing deposits and borrowings. Noninterest income increased due to higher gains related to loan sales fromMain Street loans, coupled with higher other income. Noninterest expense increased due primarily to higher salaries and employee benefits, data processing expenses,FDIC assessment fees, and other expenses, partially offset by lower occupancy and equipment expenses and customer service related expenses. 44
--------------------------------------------------------------------------------
Net Interest Income
Net interest income is affected by changes in both interest rates and the
volume of average interest-earning assets and interest-bearing liabilities. The
following table summarizes the distribution of average assets, liabilities and
shareholders' equity, as well as interest income and yields earned on average
interest-earning assets and interest expense and rates paid on average
interest-bearing liabilities for the periods indicated:
Year Ended December 31,
2020 2019 2018
Interest Interest Interest
Average Income / Average Yield Average Income / Average Yield Average Income / Average Yield
Balance Expense / Cost Balance Expense / Cost Balance Expense / Cost
Interest-earning assets: (dollars in thousands)
Loans (1) $ 1,731,049 $ 89,210 5.15 % $ 1,317,345 $ 86,207 6.54 % $ 985,513 $ 61,075 6.20 %
Investment securities 42,064 777 1.85 % 35,883 853 2.38 % 37,642 922 2.45 %
Deposits in other financial
institutions 188,345 825 0.44 % 124,506 2,375 1.91 % 98,353 1,847 1.88 %
Federal funds sold/resale
agreements - - - % 1,243 30 2.41 % 1,258 25 1.99 %
Restricted stock investments and
other bank stocks 14,663 803 5.48 % 13,973 889 6.36 % 7,043 508 7.21 %
Total interest-earning assets 1,976,121 91,615 4.64 % 1,492,950 90,354 6.05 % 1,129,809 64,377 5.70 %
Noninterest-earning assets 119,663 110,650 54,500
Total assets $ 2,095,784 $ 1,603,600 $ 1,184,309
Interest-bearing liabilities:
Interest checking $ 241,275 $ 592 0.25 % $ 120,494 $ 1,268 1.05 % $ 153,403 $ 1,679 1.09 %
Money market accounts 318,216 1,481 0.47 % 278,075 3,498 1.26 % 196,871 2,275 1.16 %
Savings accounts 30,674 80 0.26 % 30,608 232 0.76 % 51,254 410 0.80 %
Time deposits 92,242 1,117 1.21 % 149,921 2,647 1.77 % 176,761 2,912 1.65 %
Brokered time deposits 97,102 1,877 1.93 % 107,958 2,626 2.43 % 52,879 774 1.46 %
Total interest-bearing deposits 779,509 5,147 0.66 % 687,056 10,271 1.49 % 631,168 8,050 1.28 %
Borrowings 134,696 985 0.73 % 49,914 1,143 2.29 % 23,176 412 1.78 %
Paycheck Protection Program
Liquidity Facility 153,679 540 0.35 % - - - % - - - %
Senior secured notes 5,401 207 3.83 % 11,933 678 5.68 % 4,544 248 5.46 %
Total interest-bearing
liabilities 1,073,285 6,879 0.64 % 748,903 12,092 1.61 % 658,888 8,710 1.32 %
Noninterest-bearing liabilities:
Demand deposits 735,129 586,508 353,157
Other liabilities 16,849 13,419 5,790
Shareholders' equity 270,521 254,770 166,474
Total liabilities and
shareholders' equity $ 2,095,784 $ 1,603,600 $ 1,184,309
Net interest spread $ 84,736 4.00 % $ 78,262 4.44 % $ 55,667 4.38 %
Net interest margin 4.28 % 5.24 % 4.93 %
Total deposits $ 1,514,638 $ 5,147 0.34 % $ 1,273,564 $ 10,271 0.81 % $ 984,325 $ 8,050 0.82 %
Total funding sources $ 1,808,414 $ 6,879 0.38 % $ 1,335,411 $ 12,092 0.91 % $ 1,012,045 $ 8,710 0.86 %
(1)Average loans include net discounts and net deferred loan fees and costs.
Interest income on loans includes the accretion of net deferred loan fees of
$6.7 million , of which $1.8 million related to the accelerated accretion of
deferred fee income from PPP loan forgiveness for the year ended December 31,
2020 . For the years ended December 31, 2019 and 2018, the accretion of net
deferred loan fees were $958 thousand and $469 thousand ; there was no
accelerated accretion of deferred fee income from PPP loan forgiveness. In
addition, interest income includes $2.2 million , $4.6 million and $2.2 million
of discount accretion on loans acquired in a business combination, including the
interest recognized on the payoff of PCI loans, for the years ended December 31,
2020 , 2019 and 2018, respectively.
45
--------------------------------------------------------------------------------Rate/Volume Analysis
The volume and interest rate variances table below sets forth the dollar
difference in interest earned and paid for each major category of
interest-earning assets and interest-bearing liabilities for the periods
indicated, and the amount of such change attributable to changes in average
balances (volume) or changes in average interest (rates). Volume variances are
equal to the increase or decrease in the average balance multiplied by the prior
period rate, and rate variances are equal to the increase or decrease in the
average rate multiplied by the prior period average balance. Variances
attributable to both rate and volume changes are allocated proportionately based
on the amounts of the individual rate and volume changes.
Year Ended December 31,
2020 vs. 2019 2019 vs. 2018
Change Attributable to Change Attributable to
Volume Rate Total Change Volume Rate TotalChange Interest and dividend income: (dollars in thousands) Interest and fees on loans$ 23,632 $ (20,629) $ 3,003 $ 21,612 $ 3,520 $ 25,132 Interest on investment securities 68 (144) (76) (40) (29) (69) Interest on deposits in financial institutions 844 (2,394) (1,550) 498 30 528 Federal funds sold/resale agreements (30) - (30) - 5 5 Dividends on restricted stock investments and other bank stocks 42 (128) (86) 448 (67) 381 Change in interest and dividend income 24,556 (23,295) 1,261 22,518 3,459
25,977
Interest expense: Savings, interest checking and money market accounts 986 (3,831) (2,845) 502 132 634 Time deposits (1,085) (1,194) (2,279) 665 922 1,587 Borrowings 986 (1,144) (158) 584 147 731 Paycheck Protection Program Liquidity Facility 540 - 540 - - - Senior secured notes (295) (176) (471) 420 10 430 Change in interest expense 1,132 (6,345) (5,213) 2,171 1,211 3,382 Change in net interest income$ 23,424 $ (16,950) $ 6,474 $ 20,347 $ 2,248 $ 22,595 Net interest income was$84.7 million during 2020, an increase of$6.5 million from$78.3 million during 2019 due to higher interest income of$1.3 million , coupled with lower interest expense of$5.2 million . The increase in net interest income was due primarily to a number of factors as follows: (i) higher average loans and other interest-earning assets offset by lower market interest rates, (ii) higher accelerated accretion of net deferred fee income from PPP loan forgiveness, (iii) higher noninterest-bearing demand deposits in relationship to total deposits, and (iv) lower costs on interest-bearing liabilities. Average loans increased by$413.7 million contributing to an increase in interest income of$23.6 million , partially offset by a decrease in discount accretion on loans acquired in a business combination, and lower market interest rates during 2020, as compared to 2019. Average PPP loans outstanding were$260.5 million and contributed$8.7 million to interest income during 2020. The decrease in interest expense during 2020 was due primarily to lower market interest rates, and lower average time deposits and senior secured notes, partially offset by an increase in average PPPLF. Interest expense on total interest-bearing deposits decreased$5.1 million , coupled with a decrease of$629 thousand on borrowings and senior secured notes, offset by an increase of$540 thousand on PPPLF. Net interest margin decreased 96 basis points to 4.28% for the year endedDecember 31, 2020 compared to 5.24% for the year endedDecember 31, 2019 . The decrease in the net interest margin was due primarily to a 141 basis point decrease in interest-earnings asset yields, of which loan yields (including fees and discounts) decreased 139 basis points, partially offset by a change in the interest-earning asset mix, and a 53 basis points decrease in total funding costs. The net interest margin compression was driven by lower market interest rates resulting from the reduction in the target Federal Funds rate and lower-yielding PPP loans. The average effective federal funds target rate was 0.36% for the year endedDecember 31, 2020 compared to 2.16% for the same 2019 period. The average yield on interest-earning assets decreased to 4.64% for the year endedDecember 31, 2020 compared to 6.05% for the same 2019 period resulting from lower market interest rates and lower yielding PPP loans. Our loan yield decreased to 5.15% for the year endedDecember 31, 2020 46 --------------------------------------------------------------------------------
compared to 6.54% for the same 2019 period, driven by lower market interest rates, lower-yielding PPP loans, and lower discount accretion from loans acquired in a business combination.
The discount accretion related to loans acquired in a business combination, including the interest income recognized on the payoff of PCI loans, of$2.2 million contributed 11 basis points to the net interest margin for the year endedDecember 31, 2020 compared to$4.6 million and 31 basis points for the year endedDecember 31, 2019 . The weighted average loan yield for PPP loans was 3.34% including the$1.8 million accelerated accretion of deferred fee income from PPP loan forgiveness, or 2.66% without such accelerated accretion income. The yield on loans, excluding PPP loans, was 5.48% for the year endedDecember 31, 2020 compared to 6.54% for the same 2019 period. Our average total cost of funds decreased 53 basis points to 0.38% for the year endedDecember 31, 2020 compared to 0.91% for the year endedDecember 31, 2019 due to a lower market interest rates and a change in the funding mix with a higher percentage of average noninterest-bearing demand deposits, and a higher percentage of average total borrowings. Average noninterest-bearing deposits totaled$735.1 million and represented 48.5% of average total deposits for the year endedDecember 31, 2020 compared to$586.5 million and 46.1% of average total deposits for the same 2019 period. Average interest-bearing liabilities were$1.07 billion for the year endedDecember 31, 2020 compared to$748.9 million for the same 2019 period. Our cost of interest-bearing liabilities decreased 97 basis points to 0.64% compared to 1.61% for the same 2019 period. Our average borrowings and senior secured notes increased$78.3 million to$140.1 million , coupled with an increase of$153.7 million from the average PPPLF for the year endedDecember 31, 2020 . The average cost of borrowings and senior secured notes decreased 209 basis points to 0.85%, offset by 35 basis points increase from the PPPLF for the year endedDecember 31, 2020 . Average senior secured notes balance decreased$6.5 million to$5.4 million for the year endedDecember 31, 2020 compared to$11.9 million for the same 2019 period.
Provision for Loan Losses
The provision for loan losses for the year endedDecember 31, 2020 was$5.9 million , an increase of$3.1 million compared to$2.8 million for the year endedDecember 31, 2019 . The increase in the provision for loan losses for the year endedDecember 31, 2020 over the comparable period in 2019 was primarily related to the negative impact of COVID-19 and organic growth in the loan portfolio, partially offset by a decrease in specific reserves. The provision for loan losses for the year endedDecember 31, 2020 was also impacted by an increase in qualitative factors relating to the COVID-19 pandemic and macro-economic conditions. The assumptions underlying the COVID-19 related qualitative factors included (a) uncertain and volatile macroeconomic conditions caused by the pandemic; (b) a high unemployment rate; and (c) the government stimulus packages signed into law in 2020. Loans held for investment, excluding PPP loans, increased to$1.56 billion atDecember 31, 2020 as compared to$1.37 billion atDecember 31, 2019 . No provision for loan losses on PPP loans was recognized during 2020 as the SBA guarantees 100% of loans funded under the program.
Noninterest Income
The following table shows the components of noninterest income between periods:
Year Ended December 31,
2020 2019
(dollars in thousands)Gain on sale of loans$ 4,653 $ 3,674 Service charges and fees on deposit accounts 1,965 1,942 Net servicing fees 644 850 Other income 1,345 1,234 Total noninterest income$ 8,607 $ 7,700 Noninterest income increased$907 thousand to$8.6 million during 2020 compared to$7.7 million during 2019 primarily due to higher gain on the sale of loans of$979 thousand . The 2020 loan sales related to 47 SBA loans with a net carrying value of$46.3 million at an average premium of 7.6%, resulting in a gain of$3.5 million and32 Main Street loans with the net carrying value of$162.0 million , resulting in a gain of$1.1 million during 2020. This compares to 51 SBA loans sold with a net carrying value of$61.6 million at an average premium percentage of 6.0%, resulting in a gain of$3.7 million and 3 commercial and industrial loans with the net carrying value of$2.3 million , resulting in a gain of$1 thousand for the 2019 period. 47 -------------------------------------------------------------------------------- Net servicing fees decreased$206 thousand to$644 thousand during 2020 from$850 thousand for the comparable 2019 period. The decrease was due primarily to higher amortization expense of the related servicing asset during 2020. During 2020 and 2019, contractually-specified servicing fees were$2.0 million for both years. Offsetting these servicing fees was amortization of$1.4 million during 2020 and$1.1 million during 2019. The amortization expense related to early loan pay-offs totaled$527 thousand for the year endedDecember 31, 2020 compared to$438 thousand for the same period of 2019. In addition, our average SBA loan servicing portfolio totaled$204.7 million for the year endedDecember 31, 2020 compared$208.6 million for the same period in 2019. The decrease in our average SBA loan servicing portfolio primarily related to early loan pay-offs during 2020. Other income increased$111 thousand to$1.3 million during 2020 from$1.2 million for the comparable 2019 period. The increase was attributed primarily to gains on transfer of loan collateral to foreclosed assets of$155 thousand for the year endedDecember 31, 2020 . There were no similar gains in 2019.
Noninterest Expense
The following table shows the components of noninterest expense between periods:
Year Ended December 31,
2020 2019
(dollars in thousands)
Salaries and employee benefits $ 28,626 $ 25,691
Occupancy and equipment 4,476 5,406
Data processing 3,653 2,864
Professional fees 1,875 1,633
Office, postage and telecommunications 1,121 1,032
Deposit insurance and regulatory assessments 963 392 Loan related 644 694 Customer service related 841 1,755 Amortization of core deposit intangible 771
848
Other expenses 3,498
2,925
Total noninterest expense$ 46,468
Noninterest expense increased$3.2 million to$46.5 million during 2020 from$43.2 million for 2019. The increase was due primarily to higher salaries and employee benefits, data processing,FDIC assessment fees and other expenses, partially offset by lower occupancy and equipment expense and customer service related expense. The$2.9 million increase in salaries and employee benefits was due to annual merit increases, higher overtime expense for the roll-out of PPP loans, higher bonus and incentives resulting from an increase in organic production and PPP originations, partially offset by increased deferred loan origination costs during 2020. The$789 thousand increase in data processing expenses was due to increases in transaction volumes from production growth and enhancing automation such as online account opening solutions, coupled with higher software amortization of new and upgraded technology. The$571 thousand increase inFDIC assessment fees was due primarily to the organic growth in the total assets and the Small Bank Assessment Credits received from theFDIC starting in September of 2019 through March of 2020. The$573 thousand increase in other expense related primarily to a$300 thousand increase in the provision for unfunded loan commitments resulting from an increase in unfunded loan commitments and historical loss rates. Occupancy and equipment expense decreased by$930 thousand to$4.5 million due primarily to a$1.2 million impairment charge for the relocation and consolidation of branches in 2019. There was no impairment charge in 2020, partially offset by$168 thousand accrued expenses for asset retirement obligations recognized in 2020. The$914 thousand decrease in customer service related expenses was due primarily to lower earnings credit rates, coupled with a lower average of certain demand deposits accounts during 2020. The efficiency ratio remained strong at 49.8% for the year endedDecember 31, 2020 , compared to 50.3% for the comparable 2019 period. The lower efficiency ratio for the year endedDecember 31, 2020 was driven by higher revenues. 48 --------------------------------------------------------------------------------
Income Taxes
Income tax expense was$12.0 million during 2020, compared to$12.1 million for 2019. The effective tax rate for the year endedDecember 31, 2020 was 29.3% compared to 30.2% for the year endedDecember 31, 2019 . The difference in our effective tax rate compared to the statutory rate of 29.6% for the respective reporting periods was primarily attributable to the impact of the vesting and exercise of equity awards combined with changes in the Company's stock price over time.
Comparison of Financial Condition
General
Total assets atDecember 31, 2020 were$2.28 billion , an increase of$592.8 million , or 35.1% from$1.69 billion atDecember 31, 2019 . The increase is due mostly to a$506.1 million increase in loans held for investment, including PPP loans, net of deferred fees of$320.1 million , to$1.88 billion atDecember 31, 2020 , or an increase of 13.5% excluding PPP loans. In addition, cash and cash equivalents increased$74.6 million , investment securities increased$11.7 million , loans held for sale increased$2.3 million , accrued interest receivable increased$4.1 million primarily related to PPP andMain Street loans, and deferred taxes increased$1.2 million , partially offset by a$5.6 million increase in allowance for loan losses, and a$1.1 million decrease in other assets. Total liabilities atDecember 31, 2020 were$2.00 billion , an increase of$573.9 million , from$1.43 billion atDecember 31, 2019 . Total deposits increased$320.5 million , borrowings increased$55.0 million , PPPLF increased$204.7 million , and other liabilities increased$1.3 million , partially offset by a decrease in senior secured notes of$7.6 million .
Cash and Cash Equivalents
Cash and cash equivalents are comprised of cash and due from banks, interest-bearing deposits at other banks with original maturities of less than 90 days, and federal funds sold. Cash and cash equivalents totaled$236.4 million atDecember 31, 2020 , an increase of$74.6 million fromDecember 31, 2019 . The increase in cash and cash equivalents during 2020 was primarily attributable to increases in deposits to maintain appropriate on balance sheet liquidity given the increase in loans.
The following table presents the carrying values of investment securities available-for-sale and held-to-maturity as of the periods indicated:
December 31, 2020 December 31, 2019
Fair Percentage of Fair Percentage of
Value Total Value Total
Securities available-for-sale: (dollars in thousands)
U.S. Government and agency securities $ 2,705 6.4 % $ - - %
Mortgage-backed securities 5,653 13.5 % 7,431 27.9 %
Collateralized mortgage obligations 25,778 61.3 % 10,598 39.7 %
SBA pools 7,891 18.8 % 8,624 32.4 %
$ 42,027 100.0 % $ 26,653 100.0 %
December 31, 2020 December 31, 2019
Amortized Percentage of Amortized Percentage of
Cost Total Cost Total
Securities held-to-maturity: (dollars in thousands)
U.S. Government and agency securities $ - - % $ 3,342 66.1 %
Mortgage-backed securities 1,358 100.0 % 1,714 33.9 %
$ 1,358 100.0 % $ 5,056 100.0 %
49--------------------------------------------------------------------------------
The following table presents the contractual maturities and the weighted average yield of investment securities available-for-sale and held-to-maturity by investment category at the period indicated::
December 31, 2020
After One After Five
Year Years
One Year Through Through Ten
or Less Five Years Years After Ten Years Total
Securities available-for-sale: (dollars in thousands)
U.S. Government and agency securities $ - $ -
$ -
- - - 5,653 5,653
Collateralized mortgage obligations - - - 25,778 25,778
SBA pools - - - 7,891 7,891
$ - $ -
$ -
- % - % - % 2.13 % 2.13 %
Mortgage-backed securities - % - % - % 1.89 % 1.89 %
Collateralized mortgage obligations - % - % - % 0.90 % 0.90 %
SBA pools - % - % - % 2.43 % 2.43 %
- % - % - % 1.39 % 1.39 %
December 31, 2020
After One After Five
Year Years
One Year Through Through Ten After Ten
or Less Five Years Years Years Total
Securities held-to-maturity: (dollars in thousands)
Mortgage-backed securities $ - $ - $ - $ 1,358 $ 1,358
$ - $ - $ - $ 1,358 $ 1,358
Weighted average yield:
Mortgage-backed securities - % - % - % 2.86 % 2.86 %
- % - % - % 2.86 % 2.86 %
At December 31, 2020 , no issuer represented 10% or more of the Company's
shareholders' equity. There were no sales and maturities of investment
securities available-for-sale and held-to-maturity during the years ended
December 31, 2020 and 2019. There were $295 thousand in calls of investment
securities available-for-sale and $3.4 million in calls of investment securities
held-to-maturity during the year ended December 31, 2020 . There were no calls of
any investment securities available-for-sale or held-to-maturity during the
years ended December 31, 2019 . The Company purchased $26.0 million and $1.0
million of investment securities available-for-sale during the years ended
December 31, 2020 and 2019. At December 31, 2020 , securities held-to-maturity
with a carrying amount of $1.4 million were pledged to the Federal Reserve as
collateral for a secured line of credit. There were no borrowings under this
line of credit for the year ended December 31, 2020 .
Loans
Loans are the single largest contributor to our net income. It is our goal to
continue to grow the consolidated balance sheet through the origination of
loans, and to a lesser extent, through loan purchases. This effort will serve to
maximize our yield on interest-earning assets. We continue to manage our loan
portfolio in accordance with what we believe are conservative and disciplined
loan underwriting policies. Every effort is made to minimize credit risk, while
tailoring loans to meet the needs of our target market including assisting small
and medium sized businesses with new government approved loan programs resulting
from COVID-19. Our lending strategy emphasizes quality loan growth, product
diversification, and competitive and profitable pricing. Continued balanced
growth is anticipated over the coming years.
50
--------------------------------------------------------------------------------The following table shows the composition of our loan portfolio at the periods indicated:
December 31, 2020 December 31, 2019 December 31, 2018 December 31, 2017 December 31, 2016 Percentage Percentage Percentage Percentage Percentage Amount of Amount of Amount of Amount of Amount of Total Total Total Total Total (dollars in thousands) Construction and land development $ 197,634 10.5 % $ 249,504 18.1 % $ 184,177 14.7 %$ 115,427 15.6 %$ 110,696 15.9 % Real estate: Residential 27,683 1.5 % 43,736 3.2 % 57,443 4.6 % 63,415 8.5 % 85,709 12.3 % Commercial real estate - owner occupied 161,823 8.6 % 171,595 12.5 % 179,494 14.3 % 52,753 7.1 % 53,761 7.7 % Commercial real estate - non-owner occupied 550,788 29.1 % 423,823 30.8 % 401,665 32.2 % 251,821 33.9 % 194,720 28.1 % Commercial and industrial 388,814 20.5 % 309,011 22.5 % 281,718 22.5 % 169,183 22.8 % 161,666 23.2 % SBA loans (1) 562,842 29.8 % 177,633 12.9 % 146,462 11.7 % 88,688 12.0 % 81,021 11.6 % Consumer 1 - % 430 - % 159 - % 826 0.1 % 8,325 1.2 % Loans held for investment, net of discounts (2)$ 1,889,585 100.0 %$ 1,375,732 100.0 %$ 1,251,118
100.0 %$ 742,113 100.0 %$ 695,898 100.0 % Net deferred origination (fees) costs (1) (8,808) (1,057) (137) (400) 187 Loans held for investment 1,880,777 1,374,675 1,250,981 741,713 696,085 Allowance for loan losses (19,167) (13,522) (11,056) (10,497) (11,599) Loans held for investment, net$ 1,861,610 $ 1,361,153 $ 1,239,925 $ 731,216 $ 684,486 (1)Includes PPP loans with total outstanding principal of$326.7 million and net deferred fees of$6.6 million as ofDecember 31, 2020 . There were no PPP loans atDecember 31, 2019 , 2018, 2017 and 2016. (2)Includes the net carrying value of PCI loans of$761 thousand ,$1.1 million and$2.6 million andDecember 31, 2020 , 2019 and 2018. There were no PCI loans atDecember 31, 2017 and 2016. AtDecember 31, 2020 , loans held for investment totaled$1.88 billion , an increase of$506.1 million , or 36.8% sinceDecember 31, 2019 ; total loans held for investment excluding PPP loans increased$186.0 million , an increase of 13.5% over 2019. The overall increase in loans held for investment atDecember 31, 2020 as compared toDecember 31, 2019 relates to PPP loans and organic growth in the CRE, C&I and SBA portfolios. During 2020 as compared to 2019, construction and land development loans decreased$51.9 million , commercial real estate loans ("CRE") increased$117.2 million , commercial and industrial loans increased$79.8 million , SBA loans increased$385.2 million , of which$320.1 million related to PPP loans, and residential loans decreased$16.1 million . Excluding the PPP loans totaling$326.7 million atDecember 31, 2020 , the diversification and portfolio composition remained similar atDecember 31, 2020 compared toDecember 31, 2019 . The most significant categories in the loan portfolio are SBA, CRE (non-owner occupied) and commercial and industrial loans which represent 29.8%, 29.1% and 20.5% of total loans held for investments, net of discounts atDecember 31, 2020 . We participated in the Main Street Lending program during the second half of 2020. Under this program, we originated loans to borrowers meeting the terms and requirements of the program, including requirements as to eligibility, use of proceeds and priority, and sold a 95% participation interest in these loans to the SPV formed by theFederal Reserve . During the year endedDecember 31, 2020 , the Company originated 32 loans under the Main Street Lending Program totaling$172.2 million in principal and sold participation interest totaling$163.6 million to the SPV, resulting in a gain on sale of$1.1 million . We retained servicing rights with respect to theMain Street loans participated to the SPV for which we receive a 25-basis point fee annually. The program expired onJanuary 8, 2021 . Per the regulatory definition of commercial real estate, atDecember 31, 2020 and 2019, our concentration of such loans represented 308% and 314% of our total risk-based capital and were below our internal policy limit of 350% of our total risk-based capital. In addition, atDecember 31, 2020 and 2019, total loans secured by commercial real estate under construction and land development represented 94% and 125% of our total risk-based capital and were likewise below our internal policy of 150% of our total risk-based capital. Historically, we have managed loan concentrations by selling participations in, or whole loan sales of, certain loans, primarily commercial real estate and construction and land development loan production. We have total loans held for investment, net of discounts to the hospitality industry (including construction, CRE, C&I and SBA loans) of$213.3 million and$158.9 million atDecember 31, 2020 and 2019. Some of the members of our 51 -------------------------------------------------------------------------------- Board of Directors are active in the hospitality sector, and therefore, are able to provide referrals for financing on hotel properties. There are no loans to any of our board members or to members of their immediate families, but often to other hotel owners referred to us by these directors. We carefully manage our concentration and the levels of hospitality loans are measured against our total risk-based capital and reported to our Board of Directors regularly. Our internal guidance is to limit CRE and construction hospitality industry commitments to 150% and 75% of total risk-based capital, respectively. AtDecember 31, 2020 and 2019, total commitments to fund CRE loans to the hospitality industry represented 71% and 50% of our total risk-based capital. Total commitments to fund construction loans to the hospitality industry were 17% and 36% of our total risk-based capital atDecember 31, 2020 and 2019. AtDecember 31, 2020 , non-accrual hospitality loans totaled$82 thousand . AtDecember 31, 2020 , there were no loans on deferment. We offer small business loans through the SBA 7(a) and 504 loan programs. The SBA 7(a) program provides up to a 75% guaranty for loans greater than$150,000 , an 85% guaranty for loans$150,000 or less, and, in certain circumstances, up to a 90% guaranty. The maximum SBA 7(a) loan amount is$5 million , with the exception of CARES Act SBA PPP loans, which are limited to$10 million , and have a 100% guarantee. The guaranty is conditional and covers a portion of the risk of payment default by the borrower, but not the risk related to improper closing or servicing by the lender. The SBA 504 program consists of real estate backed commercial mortgages where we have the first mortgage and the SBA has the second mortgage on the property. Generally, we have a less than 50% loan-to-value ratio on SBA 504 program loans at origination. As a preferred SBA lender, we participated in the PPP and had gross outstanding balances of$326.7 million , or$320.1 million , net of deferred fees of$6.6 million atDecember 31, 2020 . Borrowers who use the funds from their PPP loans to maintain payroll and pay for certain eligible non-payroll expenses may have up to 100% of their loans forgiven by the SBA. The SBA began approving forgiveness applications and making payments as forgiveness was approved in the fourth quarter of 2020. AtDecember 31, 2020 , approximately$73 million of PPP loans were forgiven by the SBA or repaid by the borrowers. For the year endedDecember 31, 2020 , net deferred fees of$1.8 million was accelerated to income at the time of SBA forgiveness or borrower repayments. For loans originated under the PPP, interest and principal payments were originally deferred for six months following the funding date, during which time interest would continue to accrue. OnOctober 7, 2020 , the Paycheck Protection Program Flexibility Act of 2020 ("Flexibility Act") extended the deferral period for borrower payments of principal, interest and fees on all PPP loans to the date that the SBA remits the borrower's loan forgiveness amount to the lender (or, if the borrower does not apply for loan forgiveness, 10 months after the end of the borrower's loan forgiveness covered period). The extension of the deferral period under the Flexibility Act automatically applied to all PPP loans. AtDecember 31, 2020 and 2019, non-accrual SBA loans totaled$3.3 million and$6.6 million . Excluding PPP loans, our SBA portfolio represents 15.1% of total loans held for investment, net of discounts atDecember 31, 2020 . Please refer to the Recent Developments "Key Events and Updates Related to COVID-19" section for pandemic impact relating to PPP loans. AtDecember 31, 2020 , there was one SBA 7(a) loan with an outstanding balance of$542 thousand on payment deferral.
The following table summarizes the SBA loan programs in the portfolio at the periods indicated:
December 31, 2020 December 31, 2019
(dollars in thousands)
SBA 7(a) (1) $ 418,621 $ 100,103
SBA 504 144,221 77,530
Total $ 562,842 $ 177,633
(1) SBA 7(a) includes PPP loans with total gross outstanding principal of
52
--------------------------------------------------------------------------------The following table summarizes the amount of guaranteed and unguaranteed SBA loans in the portfolio, and the collateral categories for the unguaranteed portion of SBA loans at the periods indicated:
December 31, 2020 December 31, 2019
(dollars in thousands)
Secured - industrial warehouse $ 66,969 $ 23,364
Secured - hospitality 25,172 24,858
Secured - retail center/building 24,960 28,182
Secured - other real estate 82,933 58,757
Unsecured or secured by other business assets 11,905 11,921
Total unguaranteed portion 211,939 147,082
Guaranteed portion (1) 350,903 30,551
Total $ 562,842 $ 177,633
(1) Guaranteed portion includes PPP loans with total gross outstanding principal
of $326.7 million as the SBA guarantees 100% of loans funded under the program
at December 31, 2020 .
Loan Maturities. The following table presents the contractual maturities and
the distribution between fixed and adjustable interest rates for loans held for
investment at December 31, 2020 :
December 31, 2020
Within One Year After One Year Through Five Years After Five Years
Adjustable Adjustable Adjustable
Fixed Rate Fixed Rate Fixed Rate Total
(dollars in thousands)
Construction and land
development $ 4,359 $ 118,035 $ 12,044 $ 51,154 $ - $ 12,042 $ 197,634
Real estate:
Residential - - - 934 1,796 24,953 27,683
Commercial real estate -
owner occupied 1,086 1,698 18,019 37,497 22,059 81,464 161,823
Commercial real estate -
non-owner occupied 8,840 8,088 85,943 125,764 69,394 252,759 550,788
Commercial and industrial 932 106,347 42,049 93,442 17,898 128,146 388,814
SBA loans (1) - 24,604 329,432 11,261 9,933 187,612 562,842
Consumer & other 1 - - - - - 1
Total $ 15,218 $ 258,772 $ 487,487 $ 320,052 $ 121,080 $ 686,976 $ 1,889,585 (1) Includes fixed rate PPP loans with total gross outstanding principal of
Potential Problem Loans. Loans are considered delinquent when principal or interest payments are past due 30 days or more; delinquent loans may remain on accrual status between 30 days and 89 days past due. Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Typically, the accrual of interest on loans is discontinued when principal or interest payments are past due 90 days or when, in the opinion of management, there is a reasonable doubt as to collectability in the normal course of business. When loans are placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Loan delinquencies (30-89 days past due) totaled$54 thousand and$1.8 million atDecember 31, 2020 and 2019. Deferred payment loans which met the requirement under Section 4013 of the CARES Act are not considered as TDRs atDecember 31, 2020 . AtDecember 31, 2020 , two deferred payment loans of$2.8 million were reported as non-accrual and none are reported as TDRs under Section 4013 of the CARES Act. We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk. This analysis typically includes larger, non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. We use the following definitions for risk ratings:
Pass - Loans classified as pass represent assets with a level of credit quality which contain no well-defined deficiency or weakness.
53
--------------------------------------------------------------------------------
Special Mention - Loans classified as special mention have a potential weakness
that deserves management's close attention. If left uncorrected, these potential
weaknesses may result in deterioration of the repayment prospects for the loan
or of the institution's credit position at some future date.
Substandard - Loans classified as substandard are inadequately protected by the
current net worth and paying capacity of the obligor or of the collateral
pledged, if any. Loans so classified have a well-defined weakness or weaknesses
that jeopardize the liquidation of the debt. They are characterized by the
distinct possibility that the institution will sustain some loss if the
deficiencies are not corrected.
Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently known facts, conditions and values, highly questionable and improbable.
Loss - Loans classified loss are considered uncollectible and of such little value that their continuance as loans is not warranted.
The following tables present the recorded investment balances of potential
problem loans, excluding PCI loans, classified as substandard, at the periods
indicated:
December 31, 2020
Real Estate
Construction Commercial real Commercial real
and land estate - owner estate - non-owner Commercial and
development Residential occupied occupied industrial SBA loans Consumer Total
(dollars in thousands)
Substandard (1) $ -$ 254 $ 1,417 $ 3,536$ 3,967 $ 9,187 $ -$ 18,361 Total $ -$ 254 $ 1,417 $ 3,536$ 3,967 $ 9,187 $ -$ 18,361
(1)At
December 31, 2019
Real Estate
Construction Commercial real Commercial real
and land estate - owner estate - non-owner Commercial and
development Residential occupied occupied industrial SBA loans Consumer Total
(dollars in thousands)
Substandard (1) $ - $ - $ 9,624 $ 2,092$ 2,630 $ 10,260 $ -$ 24,606 Total $ - $ - $ 9,624 $ 2,092$ 2,630 $ 10,260 $ -$ 24,606 (1)AtDecember 31, 2019 , substandard loans include$11.3 million of impaired loans. The Company had no loans classified as special mention, doubtful or loss atDecember 31, 2019 . SinceDecember 31, 2019 , the decrease in the substandard loans is due to$596 thousand from upgrades, and$756 thousand in charge-offs and$13.1 million in paydowns and payoffs, offset by 13 loans totaling$8.2 million being downgraded to substandard. Nonperforming Assets. Nonperforming assets, excluding PCI loans, are defined as nonperforming loans (defined as accruing loans past due 90 days or more, non-accrual loans and non-accrual troubled-debt restructurings ("TDRs")) plus other real estate owned and other assets acquired through foreclosure ("Foreclosed assets"). 54 -------------------------------------------------------------------------------- The table below reflects the composition of non-performing assets at the periods indicated: December 31, 2020 2019 2018 2017 2016 (dollars in thousands) Accruing loans past due 90 days or more $ - $ - $ - $ - $ - Non-accrual 6,099 11,107 1,128 - 683 Troubled debt restructurings on non-accrual 347 158 594 1,761 2,586 Total nonperforming loans$ 6,446 $ 11,265 $ 1,722 $ 1,761 $ 3,269 Foreclosed assets - - - - - Total nonperforming assets$ 6,446 $ 11,265 $ 1,722 $ 1,761 $ 3,269 Troubled debt restructurings - on accrual$ 319 $ 321
Nonperforming loans as a percentage of gross loans 0.34 % 0.82 % 0.14 % 0.24 % 0.47 % Nonperforming assets as a percentage of total assets 0.28 % 0.67 % 0.11 % 0.19 % 0.38 %
The following table shows our nonperforming loans among our different loan categories as of the dates indicated.
December 31, 2020
2019
Nonperforming loans: (dollars in thousands)
Real estate:
Residential $ 254 $ -
Commercial real estate - owner occupied 1,293 3,049
Commercial real estate - non-owner occupied 1,465 1,368
Commercial and industrial 183 229
SBA loans 3,251 6,619
Total nonperforming loans (1) $ 6,446
(1) There were no PCI loans on nonaccrual at
SinceDecember 31, 2019 , the decrease in nonperforming loans was due mostly to$756 thousand in charge-offs,$5.0 million in payoffs and paydowns, offset by seven loans totaling$894 thousand being downgraded to nonaccrual. There were no loans over 90 days past due that were still accruing interest atDecember 31, 2020 and 2019. Troubled Debt Restructurings. AtDecember 31, 2020 and 2019, the total recorded investment for loans identified as a TDR was approximately$666 thousand and$479 thousand . There were no specific reserves allocated for these loans and the Company has not committed to lend any additional amounts to customers with outstanding loans that are classified as TDR's as ofDecember 31, 2020 and 2019. Loan modifications resulting in TDR status generally included one or a combination of the following concessions: extensions of the maturity date, principal payment deferrals or signed forbearance agreements with a payment plan. During the year endedDecember 31, 2020 , a single non-accrual loan with a recorded investment of$202 thousand was classified as a new TDR. During the year endedDecember 31, 2019 , there were no new loan modifications resulting in TDRs. A loan is considered to be in payment default once it is 90 days contractually past due under the modification. During the years endedDecember 31, 2020 and 2019, there was one SBA loan totaling$82 thousand and$88 thousand classified as a TDR for which there was a payment default within twelve months following the modification. COVID Related Payment Deferrals. During 2020, we granted payment deferrals on over 520 loans totaling$629 million for COVID-19 related reasons. AtDecember 31, 2020 , over 99% of loans that were granted a deferral have resumed making regular, contractually agreed-upon payments or were paid off. AtDecember 31, 2020 , three non-PPP loans totaling$3.3 million remained on payment deferral, of which two loans totaling$2.8 million were reported as non-accrual and none are reported as TDRs under Section 4013 of the CARES Act. 55 -------------------------------------------------------------------------------- SBA Debt Relief Program. As a part of the CARES Act, the SBA has agreed to pay for up to six months of principal, interest and associated fees for borrowers with current SBA 7(a) loans that were disbursed prior toSeptember 27, 2020 . The program has resumed and the SBA has agreed to pay for an additional three months of principal and interest payments, capped at$9,000 per borrower per month beginningFebruary 2021 . For borrowers considered to be underserved or hard-hit by the pandemic, the SBA has agreed to pay for an additional five months of principal and interest payments untilSeptember 2021 . Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the un-collectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off. Amounts are charged-off when available information confirms that specific loans or portions thereof, are uncollectible. This methodology for determining charge-offs is consistently applied to each loan portfolio segment. The Company determines a separate allowance for each loan portfolio segment. The allowance consists of specific and general reserves. Specific reserves relate to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status, collateral value and the probability of collecting all amounts when due. Measurement of impairment is based on the expected future cash flows of an impaired loan, which are to be discounted at the loan's effective interest rate, or measured by reference to an observable market value, if one exists, or the fair value of the collateral for a collateral-dependent loan. We select the measurement method on a loan-by-loan basis except that collateral-dependent loans for which foreclosure is probable are measured at the fair value of the collateral, less estimated selling costs. General reserves cover non-impaired loans and are based on historical loss rates for each portfolio segment adjusted for the effects of qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the portfolio segment's historical loss experience. Qualitative factors include consideration of the following: changes in lending policies and procedures; changes in economic conditions; changes in the nature and volume of the portfolio; changes in the experience, ability and depth of lending management and other relevant staff; changes in the volume and severity of past due, nonaccrual and other adversely graded loans; changes in the loan review system; changes in the value of the underlying collateral for collateral-dependent loans; concentrations of credit; and the effect of other external factors such as competition, COVID-19 pandemic and legal and regulatory requirements. Portfolio segments identified by the Company include construction and land development, residential and commercial real estate, commercial and industrial, SBA loans, and consumer loans. Relevant risk characteristics for these portfolio segments generally include debt service coverage, loan-to-value ratios, collateral type, borrower financial performance, credit scores, and debt-to-income ratios for consumer loans. In addition, the evaluation of the appropriate allowance for loan losses on non-PCI loans in the various loan segments considers discounts recorded as a part of the initial determination of the fair value of the loans. For these loans, no allowance for loan losses is recorded at the acquisition date. Interest and credit discounts are components of the initial fair value. Additional credit deterioration on acquired non-PCI loans, in excess of the remaining discounts are being recognized in the allowance through the provision for loan losses. The evaluation of the appropriate allowance for loan losses for purchased credit-impaired loans in the various loan segments considers the expected cash flows to be collected from the borrower. These loans are initially recorded at fair value and, therefore, no allowance for loan losses is recorded at the acquisition date. Subsequent to the acquisition date, the expected cash flows of purchased loans are subject to evaluation. Decreases in expected cash flows are recognized by recording an allowance for loan losses with the related provision for loan losses. If the expected cash flows on the purchased loans increase, a previously recorded impairment allowance can be reversed. Increases in expected cash flows of purchased loans, when there are no reversals of previous impairment allowances, are recognized over the remaining life of the loans. AtDecember 31, 2020 , we evaluated and considered the impacts relating to COVID-19 and macro-economic conditions on our qualitative factors. The assumptions underlying the COVID-19 related qualitative factors we analyzed in determining the adequacy of the provision for loan losses included (a) uncertain and volatile macroeconomic conditions caused by the pandemic; (b) a high unemployment rate; and (c) the government stimulus package signed into law in 2020. No provision for loan losses on PPP loans was recognized in 2020 as the SBA guarantees 100% of loans funded under the program. 56 -------------------------------------------------------------------------------- AtDecember 31, 2020 , the allowance for loan losses was$19.2 million , or 1.02% of loans held for investment, compared to$13.5 million , or 0.98% of loans held for investment atDecember 31, 2019 . The allowance for loan losses as a percentage of total loans held for investment without PPP loans was 1.23% atDecember 31, 2020 . AtDecember 31, 2020 , the net carrying value of acquired loans totaled$164.5 million and included a remaining net discount of$3.9 million . The discount is available to absorb losses on the acquired loans and represented 2.4% of the net carrying value of acquired loans and 0.21% of total gross loans held for investment. Given the growth and the composition of our loan portfolio, as well as the unamortized discount on loans acquired, the ALLL was considered adequate to cover probable incurred losses inherent in the loan portfolio. We will continue to assess the adequacy of the allowance for loan losses for specific loans and the loan portfolio as a whole during the pandemic. Should any of the factors considered by management in evaluating the appropriate level of the ALLL change, our estimate of probable incurred loan losses could also change, which could affect the level of future provisions for loan losses. The table below presents a summary of activity in our allowance for loan losses for the periods indicated: Year Ended December 31, 2020 2019 2018 2017 2016 (dollars in thousands) Balance, beginning of period$ 13,522 $ 11,056
Commercial and industrial (330) (567) (539) (1,386) (1,556)
SBA loans (447) (12) (610) (459) -
(777) (579) (1,149) (1,845) (1,556)
Recoveries:
Commercial and industrial 488 57 188 56 -
SBA loans 34 188 - 45 -
522 245 188 101 -
Net charge-offs (255) (334) (961) (1,744) (1,556)
Provision for loan losses 5,900 2,800 1,520 642 1,740
Balance, end of period $ 19,167 $ 13,522 Loans held for investment$ 1,880,777 $ 1,374,675
$ 1,731,049 $ 1,317,345 $ 985,513 $ 739,935 $ 673,635 Allowance for loan losses as a percentage of loans held for investment 1.02 % 0.98 % 0.88 % 1.42 % 1.67 % Allowance for loan losses to nonperforming loans 297.35 % 120.04 % 642.04 % 596.08 % 354.82 % Ratio of net charge-offs to average loans held for investment 0.01 % 0.03 % 0.10 % 0.24 % 0.23 % 57
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The following table shows the allocation of the allowance for loan losses by loan type at the periods indicated:
December 31, 2020 December 31, 2019 December 31, 2018 December 31, 2017 December 31, 2016 % of Loans in % of Loans in % of Loans in % of Loans in % of Loans in Allowance for Each Category
Allowance for Each Category Allowance for Each Category Allowance for Each Category Allowance for
Each Category
Loan Losses to Total Loans Loan Losses to Total Loans Loan Losses to Total Loans
Loan Losses to Total Loans Loan Losses to Total Loans
(dollars in thousands)
Construction and land
development $ 2,129 10.5 % $ 2,350 18.1 % $ 1,721 14.7 % $ 1,597 15.6 % $ 1,827 15.9 %
Real estate:
Residential 233 1.5 % 292 3.2 % 422 4.6 % 375 8.5 % 924 12.3 %
Commercial real estate -
owner occupied 1,290 8.6 % 918 12.5 % 734 14.3 % 655 7.1 % 618 7.7 %
Commercial real estate -
non-owner occupied 5,545 29.1 % 3,074 30.8 % 2,686 32.2 % 3,136 33.9 % 2,501 28.1 %
Commercial and industrial 6,714 20.5 % 4,145 22.5 % 3,686 22.5 % 3,232 22.8 % 3,541 23.2 %
SBA loans 3,256 29.8 % 2,741 12.9 % 1,807 11.7 % 1,494 12.0 % 2,086 11.6 %
Consumer - - % 2 - % - - % 8 0.1 % 102 1.2 %
$ 19,167 100.0 % $ 13,522 100.0 % $ 11,056 100.0 % $ 10,497 100.0 % $ 11,599 100.0 %
Loans Held for Sale. Loans held for sale typically consist of the guaranteed
portion of SBA 7(a) loans and Main Street loans that are originated and intended
for sale in the secondary market and to the SPV and may also include commercial
real estate loans and SBA 504 loans. Loans held for sale are carried at the
lower of carrying value or estimated market value. At December 31, 2020 , loans
held for sale were $9.9 million an increase of $2.3 million from $7.7 million at
December 31, 2019 . The increase in loans held for sale during 2020 was primarily
attributable to the origination of $209.6 million in loans, offset by SBA and
Main Street loan sales with an aggregate carrying value of $208.2 million . In
addition, $933 thousand of loans held for investment were transferred to loans
held for sale during the year ended December 31, 2020 . At December 31, 2020 and
2019, loans held for sale consisted entirely of SBA 7(a) loans and the fair
value of these loans totaled $10.6 million and $8.4 million .
Servicing Asset and Loan Servicing Portfolio. We sell loans in the secondary
market and, for certain loans retain the servicing responsibility. The loans
serviced for others are accounted for as sales and are therefore not included in
the accompanying consolidated balance sheets. We receive servicing fees ranging
from 0.25% to 1.00% for the services provided over the life of the loan; the
servicing asset is initially recognized at fair value based on the present value
of the estimated future net servicing income, incorporating assumptions that
market participants would use in their estimates of fair value. The risks
inherent in the SBA servicing asset relates primarily to changes in prepayments
that result from shifts in interest rates and a reduction in the estimated
future cash flows. The servicing asset activity includes additions from loan
sales with servicing retained and acquired servicing rights and reductions from
amortization as the serviced loans are repaid and servicing fees are earned.
Loans serviced for others totaled $454.3 million and $278.6 million at December
31, 2020 and 2019. The loan servicing portfolio includes SBA loans serviced for
others of $222.5 million and $214.8 million for which there is a related
servicing asset of $2.9 million and $3.2 million at December 31, 2020 and 2019.
Consideration for each SBA loan sale includes the cash received and the fair
value of the related servicing asset. The significant assumptions used in the
valuation of the SBA servicing asset at December 31, 2020 included a weighted
average discount rate of 11.0% and a weighted average prepayment speed
assumption of 20.3%.
In addition, the loan servicing portfolio includes construction and land
development loans, commercial real estate loans and commercial & industrial
loans participated out to various other institutions and the SPV of
Under the Main Street Lending Program, the SPV will pay the Company a servicing fee of 0.25% per annum of the total principal amount of the participation interest. The Company and theFederal Reserve believe that the terms of the Servicing Agreement are commercially reasonable and comparable to terms that unaffiliated third parties would accept to provide Enhanced Reporting Services, under the terms and conditions set out in the Servicing Agreement, with respect to the participation interest. Therefore no servicing asset or liability was recorded at the time of sale.
As a result of the PCB acquisition in 2018, we recorded goodwill and a core deposit intangible ("CDI") with
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balances of $73.4 million and $5.0 million at December 31, 2020 . Goodwill is
tested for impairment no less than annually or more frequently when
circumstances arise indicating impairment may have occurred. Due to the COVID-19
pandemic and the resulting volatility in our stock price during the year of
2020, we evaluated goodwill for impairment quarterly. At
December 31, 2020 , we tested goodwill for impairment by comparing an estimated
fair value to our book value. The fair value was estimated using the following
three tests: (i) recent acquisition price-to-tangible book multiples were
applied to our tangible book value to compute the estimated fair value; (ii) an
"average price to last twelve month earnings" market multiple was applied to:
(a) actual earnings and (b) forecasted fiscal year 2021 earnings; (iii) implied
fair value calculated by the discounted dividend analysis was compared to the
book value. These tests resulted in the estimated fair value exceeding book
value, and therefore, we did not recognize any impairment of goodwill for the
year ended December 31, 2020 . There were no changes in the carrying amount of
goodwill during 2020 and 2019. For the years ended December 31, 2020 and 2019,
the Company did not recognize any impairment of CDI.
Deposits
The following table presents the ending balance and percentage of deposits at
the periods indicated:
December 31, 2020 December 31, 2019 December 31, 2018
Amount Percentage of Total Amount Percentage of Total Amount Percentage of Total
(dollars in thousands)
Noninterest-bearing demand $ 820,711 50.2 % $ 626,569 47.7 % $ 546,713 43.7 %
Interest-bearing deposits:
Interest checking (1) 297,337 18.2 % 167,581 12.8 % 129,884 10.4 %
Money market (2) 309,488 19.0 % 319,694 24.2 % 296,085 23.6 %
Savings 32,805 2.0 % 27,091 2.1 % 39,154 3.1 %
Retail time deposits 62,742 3.8 % 97,220 7.4 % 151,995 12.1 %
Wholesale time deposits 111,075 6.8 % 75,538 5.8 % 88,508 7.1 %
$ 1,634,158 100.0 % $ 1,313,693 100.0 % $ 1,252,339 100.0 %
(1) Included brokered deposits of $33.7 million and $33.0 million at December
31, 2020 and 2019. There were no brokered deposits at December 31, 2018 .
(2) Included brokered money market deposits of $45.0 million , $15.1 million and
$21.6 million at December 31, 2020 , 2019 and 2018.
Total deposits increased $320.5 million to $1.63 billion at December 31, 2020
from $1.31 billion at December 31, 2019 . The increase in deposits was primarily
a result of higher noninterest-bearing demand deposits of $194.1 million and
interest-bearing non-maturity deposits of $125.3 million , offset by reductions
in time deposits of $1.1 million . The increase in noninterest-bearing demand
deposits and interest-bearing non-maturity deposits is attributed to continued
growth of our core deposit relationships, deposits from PPP and Main Street
borrowers, depositors participating in the FDIC Insurance Program through DDM,
deposits from other financial institutions and brokered money market deposits.
The decrease in time deposits includes a $34.5 million decrease in retail time
deposits due to maturities that were not renewed at our current offer rates and
a $35.5 million increase in wholesale time deposits due to our strategy of
lowering our cost of funds. At December 31, 2020 , noninterest-bearing deposits
represented 50.2% of total deposits compared to 47.7% at December 31, 2019 .
Wholesale time deposits includes brokered time deposits and collateralized
time deposits from the State of California . Collateralized time deposits from
the State of California totaled $10.0 million and $25.1 million at December 31,
2020 and 2019. These deposits are collateralized by letters of credit issued by
the FHLB under our secured line of credit with the FHLB. Refer to Note 9 -
Deposits and Note 10 - Borrowing Arrangements to the Consolidated Financial
Statements in Item 8 Financial Statements and Supplementary Data, of this Annual
Report. Our ten largest depositor relationships accounted for approximately 28%
of total deposits at December 31, 2020 and 2019. The following table shows the
maturities of time deposits greater than $250,000 at the period indicated:
December 31, 2020
(dollars in thousands)
Three months or less $ 17,690
Over three months through six months 2,784
Over six months through twelve months 2,658
Over twelve months 7,608
$ 30,740
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Borrowings
In addition to deposits, we use borrowings, including short-term and
long-term FHLB advances,
The following table presents the ending balance of borrowings, PPPLF and senior secured notes at the periods indicated:
December 31,
2020 2019
(dollars in thousands)
FHLB advances $ 145,000 $ 90,000
Paycheck Protection Program Liquidity Facility $ 204,719 $ -
Senior secured notes $ 2,000 $ 9,600
Federal Home Loan Bank Secured Line of Credit. At December 31, 2020 , we had a
secured line of credit of $436.3 million from the FHLB, of which $220.3 million
was available. This secured borrowing arrangement is collateralized under the
blanket lien and is subject to us providing adequate collateral and continued
compliance with the Advances and Security Agreement and other eligibility
requirements established by the FHLB. At December 31, 2020 , we had pledged $1.7
billion of loans under the blanket lien, including PPP loans, of which $896.1
million was considered as eligible collateral. PPP loans are not considered
eligible collateral under this borrowing agreement. In addition, at December 31,
2020 , we used $71.0 million of our secured FHLB borrowing capacity by having the
FHLB issue letters of credit to meet collateral requirements for deposits from
the State of California and other public agencies. At December 31, 2020 , we
participated in the FHLB San Francisco's new Recovery Advance loan program for
$5.0 million at zero percent interest with a maturity date in May 2021 . The
following table reflects the balances, interest rates and maturity dates of FHLB
advances at the periods indicated:
December 31, 2020 December 31, 2019
Balance Rate Maturity Date Balance Rate Maturity Date
Advances: (dollars in thousands)
Recovery advance $ 5,000 - % 5/19/2021 $ - - % -
Term and fixed-rate advance 50,000 0.19 % 2/26/2021 60,000 1.72 %
Term and fixed-rate advance 30,000 0.25 % 5/26/2021 - - %
-
Term and fixed-rate advance 30,000 0.21 % 5/27/2021 - - %
-
Term and fixed-rate advance 30,000 1.93 % 6/11/2021 30,000 1.93 % 6/11/2021
$ 145,000 0.56 % $ 90,000 1.79 %
The following table presents certain information with respect to only our FHLB borrowings at the periods indicated:
December 31,
2020 2019 2018
(dollars in thousands)
FHLB Advances:
Average amount outstanding during the period $ 133,986 $ 49,277 $ 22,707
Maximum month-ending amount outstanding during the
period $ 150,000 $ 210,000 $ 90,000
Balance, end of period $ 145,000 $ 90,000 $ 90,000
Weighted average interest rate, end of period 0.56 % 1.79 % 2.56 %
Weighted average interest rate during the period 0.73 % 2.29 % 1.76 %
Federal Reserve Bank Secured Line of Credit. At December 31, 2020 , we had a
secured line of credit of $130.6 million from the Federal Reserve Bank ,
including secured borrowing capacity through the Borrower-in-Custody ("BIC")
program. At December 31, 2020 , we had pledged qualifying loans with an unpaid
principal balance of $193.9 million and securities held-to-maturity with a
carrying value of $1.4 million as collateral for this line of credit. Borrowings
under the BIC
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program are overnight advances with interest chargeable at the
Paycheck Protection Program Liquidity Facility. OnApril 14, 2020 , we were approved by theFederal Reserve to access the SBA PPPLF through the discount window. The PPPLF enables us to fund PPP loans without taking on additional liquidity or funding risks by providing non-recourse loans collateralized by the PPP loans. Borrowings under the PPPLF have a term that matches the underlying loans pledged of two years. The following table presents certain information with respect to our PPPLF at the periods indicated: December 31, 2020 2019 2018 (dollars in thousands) Paycheck Protection Program Liquidity Facility: Average amount outstanding during the period$ 153,679 $ - $ - Maximum month-ending amount outstanding during the period$ 259,184 $ - $ - Balance, end of period$ 204,719 $ - $ - Weighted average interest rate, end of period 0.35 % - % - % Weighted average interest rate during the period 0.35
% - % - %
Federal Funds Unsecured Lines of Credit. We have established unsecured overnight borrowing arrangements for an aggregate amount of$125.0 million , subject to availability, with five of its correspondent banks. In general, interest rates on these lines approximate the federal funds target rate. There were no overnight borrowings under these credit facilities atDecember 31, 2020 and 2019. The following table presents certain information with respect to our federal funds unsecured lines of credit at the periods indicated: December 31, 2020 2019 2018 (dollars in thousands) Federal Funds Unsecured Lines of Credit: Average amount outstanding during the period $ - $
631
$ - $ 30,000 $ 18,000
Balance, end of period $ - $ - $ 14,998
Weighted average interest rate, end of period - % - % 2.64 %
Weighted average interest rate during the period - % 2.69 % 2.43 %
Senior Secured Notes. The holding company has a senior secured revolving line
of credit for $25 million , which matures on March 22, 2022 . At December 31,
2020 , the outstanding balance under this secured line of credit totaled $2.0
million with a floating interest rate equal to Wall Street Journal Prime, or
3.25%. At December 31, 2019 , the outstanding balance totaled $9.6 million with
an interest rate of 5.00%. The average outstanding borrowings under this
facility totaled $5.4 million and $11.9 million with an average interest rate of
3.83% and 5.68% for the years ended December 31, 2020 and 2019. At December 31,
2020 , we were in compliance with all loan covenants on the facility and the
remaining available credit was $23.0 million . One of our executives is also a
member of the lending bank's Board of Directors.
Shareholders' Equity
Total shareholders' equity increased$18.9 million , or 7.2%, to$280.7 million atDecember 31, 2020 from$261.8 million atDecember 31, 2019 . The increase in shareholders' equity is primarily due to$29.0 million in net earnings,$2.0 million of stock-based compensation,$127 thousand of stock options exercised and$545 thousand related to changes in the fair value of investment securities available-for-sale and the resulting impact on accumulated other comprehensive income, partially offset by$11.7 million in cash dividends, and$1.0 million in stock repurchases during the year endedDecember 31, 2020 .
Liquidity and Capital Resources
Liquidity is the ability to raise funds on a timely basis at an acceptable cost
in order to meet cash needs. Adequate liquidity is necessary to handle
fluctuations in deposit levels, to provide for client credit needs, and to take
advantage of
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investment opportunities as they are presented in the market place. We believe
we currently have the ability to generate sufficient liquidity from our
operating activities to meet our funding requirements. As a result of our
growth, we may need to acquire additional liquidity to fund our activities in
the future.
Holding Company Liquidity
As a bank holding company, we currently have no significant assets other than
our equity interest in First Choice Bank . Our primary sources of liquidity at
the holding company include dividends from the Bank, cash on hand, which was
approximately $399 thousand at December 31, 2020 , a $25.0 million secured
revolving line of credit of which $23.0 million was available at December 31,
2020 , and our ability to raise capital, issue subordinated debt, and secure
other outside borrowings. The holding company's ability to declare and pay cash
dividends to shareholders and repurchase our common
stock depends upon cash on hand, availability on our senior secured revolving
line of credit and dividends from the Bank.
Dividends from the Bank to the holding company depend upon the Bank's earnings,
financial position, regulatory standing,
ability to meet current and anticipated regulatory capital requirements, and
other factors deemed relevant by our Board of
Directors. The Bank paid $20.0 million in dividends to the holding company
during the year ended December 31, 2020 . Please refer to the section "-
Regulatory Capital and Dividends" in this MD&A for a discussion of dividend
limitations at both the holding company and the Bank.
Consolidated Company Liquidity
Our liquidity ratio is defined as the liquid assets (cash and due from banks, fed funds sold and repos, interest-bearing deposits at other banks, other investments with a remaining maturity of one year or less, available-for-sale and equity securities, unpledged held-to-maturity securities and fully funded loans held for sale) divided by total assets. AtDecember 31, 2020 , our liquidity ratio was 13%. Our objective is to ensure adequate liquidity at all times by maintaining liquid assets, gathering deposits and arranging for secondary sources of funding. Having too little liquidity can present difficulties in meeting commitments to fund loans or honor deposit withdrawals. Having too much liquidity can result in lower income because highly liquid assets are short-term in nature and generally yield less than long-term assets. A proper balance is the goal of management and the Board of Directors, as administered by various policies and guidelines. Our policy targets a minimum daily liquidity ratio of 11.0%.
Net cash provided by operating activities for the years ended
Net cash used in investment activities for the years endedDecember 31, 2020 and 2019 was$513.3 million and$126.7 million . For the year endedDecember 31, 2020 and 2019, the primary components of cash flows used in investing activities were the net increase in loans, which totaled$498.6 million and$128.7 million , and the purchases of available for sale securities totaling$26.0 million and$1.0 million . Net cash provided by financing activities for the years endedDecember 31, 2020 and 2019 was$560.0 million and$30.8 million . For the year endedDecember 31, 2020 , cash provided by financing activities primarily results from a$320.5 million increase in deposits, a$55.0 million net increase in borrowings and a$204.7 million net increase in PPPLF, partially offset by$7.6 million net repayments of senior secured notes,$11.7 million in cash dividends paid and$1.0 million in stock repurchases. For the year endedDecember 31, 2019 , cash provided by financing activities primarily results from a$61.4 million increase in deposits, a$1.2 million net increase in senior secured notes, and$2.6 million in proceeds from stock option exercises, partially offset by$15.0 million net decrease in borrowing,$9.9 million in cash dividends paid and$9.4 million in stock repurchases. Additional sources of liquidity available to us atDecember 31, 2020 included$220.3 million in remaining secured borrowing capacity with the FHLB,$130.6 million in secured borrowing capacity with theFederal Reserve Bank through the Borrower-in-Custody Program ("BIC") and discount window, and unsecured lines of credit with correspondent banks with a remaining borrowing capacity of$125.0 million , and$122.0 million in PPPLF borrowing capacity with theFederal Reserve Bank through the Discount Window.
We believe that we will be able to meet our contractual obligations as they come due through the maintenance of adequate liquidity levels. We expect to maintain adequate liquidity levels through profitability, loan payoffs, securities repayments and maturities, and continued deposit gathering activities. We also have in place various borrowing mechanisms for both short-term and long-term liquidity needs.
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OnDecember 3, 2018 , the Company announced a stock repurchase plan, providing for the repurchase of up to 1.2 million shares, or approximately 10%, of our then outstanding shares (the "repurchase plan"). The repurchase plan permits shares to be repurchased in open market or private transactions, through block trades, and pursuant to any trading plan that may be adopted in accordance with Rules 10b5-1 and 10b-18. The repurchase plan may be suspended, terminated or modified at any time for any reason, including market conditions, the cost of repurchasing shares, the availability of tentative investment opportunities, liquidity, and other factors management deems appropriate. These factors may also affect the timing and amount of share repurchases. The repurchase plan does not obligate us to purchase any particular number of shares. OnMarch 17, 2020 , the Company suspended the stock repurchase plan. For the year endedDecember 31, 2020 , the Company repurchased 38,411 shares at an average price of$22.34 and a total cost of$858 thousand . The remaining number of shares authorized to be repurchased under this program was 695,489 shares atDecember 31, 2020 . Contractual Obligations
The following table summarizes aggregated information about our outstanding
contractual obligations and other long-term liabilities at
Payments Due by Period
After One But After Three But
Within Three Within Five After
Total Within One Year Years Years Five Years
(dollars in thousands)
Deposits without a stated maturity $ 1,460,341 $ 1,460,341 $ - $ - $ -
Time deposits (1) 173,817 82,093 62,950 28,774 -
Borrowings 145,000 145,000 - - -
Paycheck Protection Program
Liquidity Facility 204,719 - 204,719 - -
Senior secured notes 2,000 - 2,000 - -
Operating lease obligations 5,629 2,470 2,974 185 -
$ 1,991,506 $ 1,689,904 $ 272,643 $ 28,959 $ -
(1) Includes
Off-Balance-Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our consolidated financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. These transactions generally take the form of loan commitments, unused lines of credit and standby letters of credit. AtDecember 31, 2020 , we had unused credit commitments of$429.5 million , standby letters of credit of$3.8 million and commitments to contribute capital to a low income housing tax credit project partnerships and other CRA investments of$2.1 million and$61 thousand . AtDecember 31, 2019 , we had unused loan commitments of$376.9 million , standby letters of credit of$7.6 million and commitments to contribute capital to a low income housing tax credit project partnership and other CRA investments of$1.7 million and$236 thousand .
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's and the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
At
63
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Statement (Regulation Y, Appendix C) and, therefore, is not subject to
consolidated capital rules at the bank holding
company level. The Bank has also opted into the CBLR framework, beginning with
the Call Report filed for the first quarter of 2020. At December 31, 2020 , the
Bank's CBLR ratio was 10.28% which exceeded the regulatory capital requirements
under the CBLR framework and the Bank was considered to be ''well-capitalized.''
Banks and their bank holding companies that have less than $10 billion in total
consolidated assets and meet other
qualifying criteria, including a leverage ratio (equal to tier 1 capital divided
by average total consolidated assets) of greater
than 9%, are eligible to opt into the CBLR framework. Qualifying community
banking organizations that elect to use the
CBLR framework and that maintain a leverage ratio of greater than 9% will be
considered to have satisfied the generally
applicable risk-based and leverage capital requirements in the agencies' capital
rules (generally applicable rule) and, if applicable, will be considered to have
met the well-capitalized ratio requirements for purposes of section 38 of the
Federal
Deposit Insurance Act. Accordingly, a qualifying community banking organization
that exceeds the 9% CBLR will be
considered to have met: (i) the generally applicable risk-based and leverage
capital requirements of the generally applicable
capital rules; (ii) the capital ratio requirements in order to be considered
well-capitalized under the prompt corrective action
framework; and (iii) any other applicable capital or leverage requirements. A
qualifying community banking organization
that elects to be under the CBLR framework generally would be exempt from the
current capital framework, including risk-based capital requirements and capital
conservation buffer requirements. A banking organization meets the definition of
a
"qualifying community banking organization" if the organization has:
• A leverage ratio of greater than 9%;
• Total consolidated assets of less than $10 billion ;
• Total off-balance sheet exposures (excluding derivatives other than sold
credit derivatives and unconditionally
cancellable commitments) of 25% or less of total consolidated assets; and
• Total trading assets plus trading liabilities of 5% or less of total
consolidated assets.
Even though a banking organization meets the above-stated criteria, federal
banking regulators have reserved the
authority to disallow the use of the CBLR framework by a depository institution
or depository institution holding company,
based on the risk profile of the banking organization.
On April 6, 2020 , the federal banking regulators, implementing the applicable
provisions of the CARES Act, issued
interim rules which modified the CBLR framework so that: (i) beginning in the
second quarter 2020 through the end of 2020, a banking organization that has a
leverage ratio of 8% or greater and meets certain other criteria may elect to
use the
CBLR framework; and (ii) community banking organizations will have until January
1, 2022 , before the CBLR requirement
is reestablished at greater than 9%. Under the interim rules, the minimum CBLR
is 8% beginning in the second quarter and
for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9%
thereafter. The interim rules also maintain a
two-quarter grace period for a qualifying community banking organization whose
leverage ratio falls no more than 1% below
the applicable community bank leverage ratio. Assets originated under the PPP
which are also pledged under the PPPLF are
deducted from average total consolidated assets for purposes of the CBLR.
However, such assets are included in total
consolidated assets for purposes of determining the eligibility to elect the
CBLR framework.
The following table sets forth the actual capital amounts and ratios for the
Bank and the minimum ratio and amount
of capital required to be categorized as well-capitalized and adequately
capitalized at December 31, 2019 :
Minimum Capital Required
For Capital
Adequacy Capital Conservation For Well Capitalized
First Choice Bank Actual Purposes Buffer Phase-In Requirement
December 31, 2019:
Total Capital (to risk-weighted assets) 14.03 % 8.00 % 10.50 % 10.00 %
Tier 1 Capital (to risk-weighted assets) 13.04 % 6.00 % 8.50 % 8.00 %
CET1 Capital (to risk-weighted assets) 13.04 % 4.50 % 7.00 % 6.50 %
Tier 1 Capital (to average assets) 12.01 % 4.00 % 4.00 % 5.00 %
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Dividends
Our general dividend policy is to pay cash dividends within the range of typical peer payout ratios, provided that such payments do not adversely affect our consolidated financial condition and are not overly restrictive to our growth capacity. While we have paid an increasing level of quarterly cash dividends since the first quarter of 2017, no assurance can be given that our financial performance in any given year will justify the continued payment of a certain level of cash dividend, or any cash dividend at all.
The following table sets forth per share dividend amounts declared for the periods indicated:
Year Ended December 31,
Dividends declared: 2020 2019
Fourth quarter $ 0.25 $ 0.25
Third quarter $ 0.25 $ 0.20
Second quarter $ 0.25 $ 0.20
First quarter $ 0.25 $ 0.20
The ability of the holding company and the Bank to pay dividends is limited by
federal and state laws, regulations
and policies of their respective banking regulators. California law allows a
California corporation, such as the holding
company, to pay dividends if retained earnings equal at least the amount of the
proposed dividend. If a California corporation
does not have sufficient retained earnings available for the proposed dividend,
it may still pay a dividend to its shareholders
if, immediately after the dividend, the value of its assets would equal or
exceed the sum of its total liabilities. Policies of the
Federal Reserve , our primary federal regulator, also limit the amount of
dividends that bank holding companies may pay to
income available over the past year, and only if prospective earnings retention
is consistent with the institution's expected
future needs and financial condition and consistent with the Federal Reserve's
principle that bank holding companies should
serve as a source of strength to their banking subsidiaries.
The holding company's primary source of funds is dividends from the Bank, as
well as availability under our $25
million secured line of credit. Under the California Financial Code, the Bank is
permitted to pay a dividend in the following
circumstances: (i) without the consent of either the California Department of
Financial Protection and Innovation ("DFPI") or
the Bank's shareholders, in an amount not exceeding the lesser of (a) the
retained earnings of the Bank; or (b) the net income
of the Bank for its last three fiscal years, less the amount of any
distributions made during the prior period; (ii) with the prior
approval of the DFPI, in an amount not exceeding the greatest of: (x) the
retained earnings of the Bank; (y) the net income of
the Bank for its last fiscal year; or (z) the net income for the Bank for its
current fiscal year; and (iii) with the prior approval
of the DFPI and the Bank's shareholders in connection with a reduction of its
contributed capital. Further, as a Federal
Reserve member bank, the Bank is prohibited from declaring or paying a dividend
if the dividend would exceed the Bank's
undivided profits as reportable on its Reports of Condition and Income in the
absence of prior regulatory and shareholder
approvals.
The Federal Reserve limits the amount of dividends that bank holding companies
may pay on common stock to
income available over the past year, and only if prospective earnings retention
is consistent with the organization's expected future needs and financial
condition. It is also the Federal Reserve's policy that bank holding companies
should not maintain
dividend levels that undermine their ability to be a source of strength to its
banking subsidiaries. Additionally, in
consideration of the current financial and economic environment, the Federal
Reserve has indicated that bank holding
companies should carefully review their dividend policies.
On May 24, 2018 , the Economic Growth, Regulatory Relief and Consumer Protection
Act (the "Relief Act") was
signed into law. Among the Relief Act's key provisions are targeted tailoring
measures to reduce the regulatory burden on
community banks, including increasing the threshold for institutions qualifying
for relief under the Policy Statement from $1
billion to $3 billion .
Summary of Critical Accounting Policies
We follow financial accounting and reporting policies that are in accordance with accounting principles generally accepted inthe United States ("GAAP"). The more significant of these policies are summarized in Note 1 - Operations and Summary of Significant Accounting Policies to the Consolidated Financial Statements included in Item 8 Financial Statements and Supplementary Data, of this Annual Report. 65 -------------------------------------------------------------------------------- The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates. Accounting estimates are necessary in the application of certain accounting policies and procedures that are particularly susceptible to significant change. Critical accounting policies are defined as those that require the most complex or subjective judgment and are reflective of significant uncertainties, and could potentially result in materially different results under different assumptions and conditions. Management has identified our most critical accounting policies and accounting estimates as: allowance for loan losses (ALLL), the valuation of acquired loans, goodwill and separately identifiable intangible assets associated with mergers and acquisitions, loan sales and servicing of financial assets and deferred tax assets and liabilities. Please refer to Note 1 - Operations and Summary of Significant Accounting Policies to the Consolidated Financial Statements included in Item 8 Financial Statements and Supplementary Data, of this Annual Report for a description of these policies.
Recent Accounting Guidance Not Yet Effective
The impact that recently issued accounting standards will have on our consolidated financial statements is contained in Note 1 - Basis of Presentation and Summary of Significant Accounting Policies to the Consolidated Financial Statements included in Item 8 Financial Statements and Supplementary Data, of this Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in the normal course of business through exposures to market interest rates, equity prices, and credit spreads. Our primary market risk is interest rate risk, which is the risk of loss of net interest income or net interest margin resulting from changes in market interest rates.
Interest Rate Risk
Interest rate risk results from the following risks:
•Repricing risk - timing differences in the repricing and maturity of interest-earning assets and interest-bearing liabilities; •Option risk - changes in the expected maturities of assets and liabilities, such as borrowers' ability to prepay loans at any time and depositors' ability to redeem certificates of deposit before maturity; •Yield curve risk - changes in the yield curve where interest rates increase or decrease in a nonparallel fashion; and •Basis risk - changes in spread relationships between different yield curves, such asU.S. Treasuries,U.S. Prime Rate and LIBOR. OnJuly 27, 2017 , theUnited Kingdom's Financial Conduct Authority , which regulates LIBOR, publicly announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot be guaranteed after 2021. The market transition away from LIBOR to an alternative reference rates is complex and could have a range of adverse effects on our business, consolidated financial condition, and consolidated results of operations. For more information, refer to Part I, Item 1A - "Risk Factors." Although the manner and impact of the transition from LIBOR to an alternative reference rate, as well as the effect of these developments on our funding costs, loan and investment and trading securities portfolios, asset-liability management, and business, is uncertain, we are currently evaluating the amount, reviewing the contracts of our LIBOR-based products to ensure that our credit documentation provides for the flexibility to move to alternative reference rates, and choosing the substitute index. Management does not believe that the discontinuation of LIBOR will have any material adverse impact on the Company. Since our earnings are primarily dependent on our ability to generate net interest income, we focus on actively monitoring and managing the effects of adverse changes in interest rates on our net interest income. Management of our interest rate risk is overseen by our Asset Liability Committee ("ALCO"). ALCO ensures that we are following the appropriate and current regulatory guidance in the formulation and implementation of our interest rate risk program. ALCO reviews the results of our interest rate risk modeling quarterly to ensure that we have appropriately measured our interest rate risk, mitigated our exposures appropriately and any residual risk is acceptable. In addition to our annual review of this policy, our Board of Directors explicitly reviews the interest rate risk policy limits at least annually. 66 -------------------------------------------------------------------------------- Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk posture given business forecasts, management objectives, market expectations, and policy constraints. Our consolidated balance sheet is considered "asset sensitive" when an increase in short-term interest rates is expected to expand our net interest margin, as rates earned on our interest-earning assets reprice higher at a pace faster than rates paid on our interest-bearing liabilities. Conversely, our consolidated balance sheet is considered "liability sensitive" when an increase in short-term interest rates is expected to compress our net interest margin, as rates paid on our interest-bearing liabilities reprice higher at a pace faster than rates earned on our interest-earning assets. AtDecember 31, 2020 , we were "asset sensitive." In order to model and evaluate interest rate risk, we use two approaches: Net Interest Income at Risk ("NII at Risk"), and Economic Value of Equity ("EVE"). Under NII at Risk, the impact on net interest income from changes in interest rates on interest-earning assets and interest-bearing liabilities is modeled utilizing various assumptions for assets, liabilities, and derivatives. EVE measures the period end market value of assets minus the market value of liabilities and the change in this value as rates change. EVE is a period end measurement. The following table presents the projected changes in NII at Risk and EVE that would occur upon an immediate change in interest rates based on independent analysis, but without giving effect to any steps that management might take to counteract that change atDecember 31, 2020 : NII at Risk EVE Adjusted Net Percentage Change from Percentage of Change Interest Income Base Case Market Value from Base Case Interest rate scenario (dollars in thousands) Up 300 basis points$ 103,186 19.1 %$ 381,345 9.6 % Up 200 basis points $ 96,300 11.2 %$ 367,508 5.6 % Up 100 basis points $ 90,087 4.0 %$ 355,169 2.1 % Base $ 86,622 -$ 347,909 - Down 100 basis points $ 86,481 (0.2) %$ 342,669 (1.5) % Down 200 basis points $ 86,439 (0.2) %$ 345,226 (0.8) % 67
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