UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______to ______
Commission File Number 001-38139
Byline Bancorp, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
36-3012593
(State or Other Jurisdiction of
Incorporation or Organization)
(IRS Employer
Identification Number)
180 North LaSalle Street, Suite 300
Chicago, Illinois 60601
(Address of Principal Executive Offices)
(773) 244-7000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Securities Exchange Act of 1934.
Large accelerated filer
Accelerated filer
Non-accelerated filer
(Do not check if a smaller reporting company)
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐No ☒Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, $0.01 par value, 29,312,600 shares outstanding as of November 14, 2017
BYLINE BANCORP, INC.
September 30, 2017
INDEX
Page
PART I.
FINANCIAL INFORMATION
3
Item 1.
Financial Statements. The Interim Condensed Consolidated Financial Statements of Byline Bancorp, Inc. filed as part of the report are as follows:
Consolidated Statements of Financial Condition at September 30, 2017 (unaudited) and December 31, 2016
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2017 and 2016 (unaudited)
4
Consolidated Statements of Comprehensive Income (Loss) and Accumulated Other Comprehensive Income (Loss) for the Nine Months Ended September 30, 2017 and 2016 (unaudited)
5
Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2017 and 2016 (unaudited)
6
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016 (unaudited)
7
Notes to Unaudited Interim Condensed Consolidated Financial Statements
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
46
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
85
Item 4.
Controls and Procedures
87
PART II.
OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
88
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
2
PART I – FINANCIAL INFORMATION
Financial Statements
BYLINE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)
(dollars in thousands, except share and per share data)
December 31, 2016
ASSETS
Cash and due from banks
$
16,193
17,735
Interest bearing deposits with other banks
46,043
28,798
Cash and cash equivalents
62,236
46,533
Securities available-for-sale, at fair value
584,684
608,560
Securities held-to-maturity, at amortized cost (fair value
September 30, 2017—$122,266, December 31, 2016—$138,082)
121,453
138,846
Restricted stock, at cost
10,628
14,993
Loans held for sale
2,087
23,976
Loans and leases:
Loans and leases
2,216,499
2,148,011
Allowance for loan and lease losses
(15,980
)
(10,923
Net loans and leases
2,200,519
2,137,088
Servicing assets, at fair value
21,669
21,091
Accrued interest receivable
7,183
6,866
Premises and equipment, net
96,334
102,074
Assets held for sale
12,938
14,748
Other real estate owned, net
13,859
16,570
Goodwill
51,975
Other intangible assets, net
17,522
19,826
Bank-owned life insurance
5,680
6,557
Deferred tax assets, net
60,350
67,760
Due from counterparty
21,084
—
Other assets
15,241
18,367
Total assets
3,305,442
3,295,830
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Non-interest bearing demand deposits
753,662
724,457
Interest bearing deposits:
NOW, savings accounts, and money market accounts
1,040,774
989,421
Time deposits
726,493
776,516
Total deposits
2,520,929
2,490,394
Accrued interest payable
1,184
2,427
Line of credit
20,650
Federal Home Loan Bank advances
234,559
313,715
Securities sold under agreements to repurchase
30,807
17,249
Junior subordinated debentures issued to capital trusts, net
27,482
26,926
Accrued expenses and other liabilities
30,948
41,811
Total liabilities
2,845,909
2,913,172
STOCKHOLDERS’ EQUITY
Preferred stock
10,438
25,441
Common stock, voting $0.01 par value at September 30, 2017 and no par value at December 31, 2016; 150,000,000 shares authorized at September 30, 2017 and December 31, 2016; 29,305,400 shares issued and outstanding at September 30, 2017 and 24,616,706 issued and outstanding at December 31, 2016
292
Additional paid-in capital
391,040
313,552
Retained earnings
62,311
50,933
Accumulated other comprehensive loss, net of tax
(4,548
(7,268
Total stockholders’ equity
459,533
382,658
Total liabilities and stockholders’ equity
See accompanying Notes to Unaudited Interim Condensed Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
Nine Months Ended
September 30,
2017
2016
INTEREST AND DIVIDEND INCOME
Interest and fees on loans and leases
30,933
19,081
88,510
56,334
Interest on taxable securities
3,720
3,312
11,213
10,492
Interest on tax-exempt securities
174
152
458
509
Other interest and dividend income
217
112
666
254
Total interest and dividend income
35,044
22,657
100,847
67,589
INTEREST EXPENSE
Deposits
2,112
1,063
5,518
3,281
850
200
2,282
371
Subordinated debentures and other borrowings
670
529
2,286
1,571
Total interest expense
3,632
1,792
10,086
5,223
Net interest income
31,412
20,865
90,761
62,366
PROVISION FOR LOAN AND LEASE LOSSES
3,900
1,683
9,306
5,348
Net interest income after provision for loan and lease losses
27,512
19,182
81,455
57,018
NON-INTEREST INCOME
Fees and service charges on deposits
1,418
1,465
3,985
4,227
Servicing fees
959
2,954
ATM and interchange fees
1,495
1,470
4,342
4,392
Net gains on sales of securities available-for-sale
802
8
3,231
Net gains (losses) on sales of loans
7,499
(60
24,026
(39
Fees on mortgage loan sales, net
101
Other non-interest income
547
1,053
2,102
3,350
Total non-interest income
11,918
4,776
37,419
15,262
NON-INTEREST EXPENSE
Salaries and employee benefits
16,323
11,266
50,151
34,206
Occupancy expense, net
3,301
3,358
10,525
10,511
Equipment expense
630
516
1,809
1,519
Loan and lease related expenses
891
443
2,569
1,090
Legal, audit and other professional fees
1,608
1,065
4,369
3,785
Data processing
2,399
1,990
7,255
5,760
Net loss recognized on other real estate owned and other related expenses
565
136
1,386
Regulatory assessments
326
502
894
1,930
Other intangible assets amortization expense
769
747
2,307
2,242
Advertising and promotions
196
156
803
454
Telecommunications
351
370
1,165
1,284
Other non-interest expense
3,706
1,679
7,182
5,521
Total non-interest expense
31,065
22,384
89,165
69,688
INCOME BEFORE PROVISION FOR INCOME TAXES
8,365
1,574
29,709
2,592
PROVISION (BENEFIT) FOR INCOME TAXES
(1,390
7,248
(222
NET INCOME
9,755
1,565
22,461
2,814
Dividends on preferred shares
195
11,081
INCOME AVAILABLE TO COMMON STOCKHOLDERS
9,560
11,380
EARNINGS PER COMMON SHARE
Basic
0.33
0.08
0.43
0.15
Diluted
0.32
Weighted average common shares outstanding for basic earnings per common share
29,246,900
19,497,811
26,194,025
18,838,354
Diluted weighted average common shares outstanding for diluted earnings per common share
29,752,331
19,763,434
26,697,841
19,103,977
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) AND ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
(dollars in thousands)
Net income
Securities available-for-sale
Unrealized holding gains (losses) arising during the period
1,473
(953
4,920
12,465
Reclassification adjustments for net gains included in net income
(802
(8
(3,231
Tax effect
303
(1,587
Net of tax
1,776
(1,755
3,325
9,234
Cash flow hedges
17
398
(1,408
207
Reclassification adjustments for losses included in net income
159
426
(88
377
402
(605
211
Total other comprehensive income (loss)
1,864
(1,353
2,720
9,445
Comprehensive income
11,619
212
25,181
12,259
Gains (Losses) on Cash Flow
Hedges
Unrealized Gains
(Losses) on
Available-for
-Sale
Securities
Total
Accumulated Other
Comprehensive
Income (Loss)
Balance, January 1, 2016
(5,707
Other comprehensive gain, net of tax
Balance, September 30, 2016
3,527
3,738
Balance, January 1, 2017
2,233
(9,501
Other comprehensive gain (loss), net of tax
Balance, September 30, 2017
1,628
(6,176
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Nine Months Ended September 30, 2017 and 2016
(Dollars in thousands, except share data) (Unaudited)
Additional
Retained Earnings
Preferred Stock
Common Stock
Paid-In
(Accumulated
Stockholders’
Shares
Amount
Capital
Deficit)
Equity
15,003
17,332,775
194,774
(15,796
188,274
Other comprehensive income, net of tax
Issuance of common stock, net of issuance cost
3,078,075
50,018
Share-based compensation expense
553
20,410,850
245,345
(12,982
251,104
24,616,706
Issuance of common stock in connection with merger
246
(246
Repurchase of preferred stock
(15,003
Issuance of common stock,
net of issuance cost
4,630,194
76,783
76,829
Issuance of common stock in connection with restricted stock awards
58,900
Forfeiture of restricted stock awards
(400
Cash dividends declared on preferred stock
(11,081
Cash paid in lieu of fractional shares
(2
951
29,305,400
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan and lease losses
Impairment loss on assets held for sale
408
Depreciation and amortization of premises and equipment
3,919
3,814
Net amortization of securities
3,544
5,673
Net gains on sales of assets held for sale
(167
(967
Net (gains) losses on sales of loans
(24,026
39
Originations of mortgage loans held for sale
(4,045
Proceeds from mortgage loans sold
151
4,512
Originations of government guaranteed loans
(202,176
Proceeds from government guaranteed loans sold
228,852
Accretion of premiums and discounts on acquired loans, net
(24,746
(24,479
Net change in servicing assets
(578
Net valuation adjustments on other real estate owned
367
904
Net gains on sales of other real estate owned
(1,538
(1,134
Amortization of intangible assets
Amortization of time deposit premium
(759
(66
Amortization of Federal Home Loan Bank advances premium
(156
Accretion of junior subordinated debentures discount
556
660
Deferred tax provision
6,196
Increase in cash surrender value of bank owned life insurance
(209
(184
Gain on death benefit of bank owned life insurance
(313
Changes in assets and liabilities:
(345
(659
530
(436
(1,243
(588
(11,382
(3,497
Net cash provided by (used in) operating activities
12,445
(12,319
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available-for-sale
(34,814
(526,084
Proceeds from maturities and calls of securities available-for-sale
7,672
84,272
Proceeds from paydowns of securities available-for-sale
53,171
81,522
Proceeds from sales of securities available-for-sale
507,362
Purchases of securities held-to-maturity
(59,436
Proceeds from maturities and calls of securities held-to-maturity
655
Proceeds from paydowns of securities held-to-maturity
15,597
21,881
Purchases of Federal Home Loan Bank stock
(9,855
(4,642
Federal Home Loan Bank stock repurchases
14,220
1,000
Proceeds from other loans sold
9,984
Net change in loans and leases
(63,502
(357,862
Purchases of premises and equipment
(2,253
(4,515
Proceeds from sales of premises and equipment
Proceeds from sales of assets held for sale
4,398
2,126
Proceeds from sales of other real estate owned
9,583
13,945
Proceeds from bank owned life insurance death benefit
1,399
-
Net cash provided by (used in) investing activities
6,263
(240,343
See accompanying Notes to Unaudited Interim Condensed Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits
31,294
62,285
Proceeds from Federal Home Loan Bank advances
1,993,000
4,967,000
Repayments of Federal Home Loan Bank advances
(2,072,000
(4,822,000
Repayments of line of credit
(20,650
Net increase in securities sold under agreements to repurchase
13,558
1,435
Dividends paid on preferred stock
Proceeds from issuance of common stock
Proceeds from issuance of preferred stock
1,050
Net cash provided by (used in) financing activities
(3,005
258,738
NET INCREASE IN CASH AND CASH EQUIVALENTS
15,703
6,076
CASH AND CASH EQUIVALENTS, beginning of period
44,884
CASH AND CASH EQUIVALENTS, end of period
50,960
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest
11,689
5,217
Cash payments (refunds) during the period for taxes
2,121
(250
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Change in fair value of available-for-sale securities, net of tax
Change in fair value of cash flow hedges, net of tax
Delayed payments of mortgage-backed securities
389
447
Transfers of loans to loans held for sale
10,061
1,477
Transfers of loans to other real estate owned
5,701
3,721
Internally financed sale of other real estate owned
1,447
Transfers of land and premises to assets held for sale
3,372
10,486
Transfers of premises and equipment to other assets
702
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Table dollars in thousands, except share and per share data) (Unaudited)
Note 1—Basis of Presentation
These unaudited interim condensed consolidated financial statements include the accounts of Byline Bancorp, Inc., a Delaware corporation (the “Company,” “we,” “us,” “our”), a bank holding company whose principal activity is the ownership and management of its Illinois state chartered subsidiary bank, Byline Bank (the “Bank”), based in Chicago, Illinois.
These unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”). In preparing these financial statements, the Company has evaluated events and transactions subsequent to September 30, 2017 for potential recognition or disclosure. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Certain information in footnote disclosures normally included in financial statements prepared in accordance with GAAP has been condensed or omitted pursuant to the rules and regulations of the SEC and the accounting standards for interim financial statements. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Consolidated Financial Statements for the years ended December 31, 2016 and 2015.
In accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 855, “Subsequent Events,” the Company’s management has evaluated subsequent events for potential recognition or disclosure through the date of the issuance of these consolidated financial statements. No subsequent events were identified that would have required a change to the consolidated financial statements or disclosure in the notes to the consolidated financial statements.
Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications did not result in any changes to previously reported net income or stockholders’ equity.
Note 2—Recently Issued Accounting Pronouncements
The following reflect recent accounting pronouncements that have been adopted or are pending adoption by the Company. As the Company qualifies as an emerging growth company and has elected the extended transition period for complying with new or revised accounting pronouncements, it is not subject to new or revised accounting standards applicable to public companies during the extended transition period. The accounting pronouncements pending adoption below reflect effective dates for the Company as an emerging growth company with the extended transition period.
Revenue from Contracts with Customers In May 2014, FASB issued Accounting Standards Update (“ASU”) No. 2014-09, deferred by ASU No. 2015-14 and clarifying standards, Revenue from Contracts with Customers, which creates Topic 606 and supersedes Topic 605, Revenue Recognition. The core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, the new guidance requires companies to use more judgment and make more estimates than under current guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. Under the terms of ASU No. 2015-14 the standard is effective for interim and annual periods beginning after December 15, 2017. Early application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. The Company is currently evaluating the provisions of ASU No. 2014-09 to determine the potential impact the standard will have on the Company’s Consolidated Financial Statements. As a financial institution, the Company’s largest component of revenue, interest income, is excluded from the scope of this ASU. The Company is currently evaluating which, if any, of its sources of non-interest income will be impacted by this ASU. Assuming the Company remains an emerging growth company, the Company expects to adopt this new guidance on January 1, 2019, with
a cumulative effect adjustment to opening retained earnings, if such adjustment is deemed to be significant. In April 2016, FASB issued ASU No. 2016-10, Identifying Performance Obligations and Licensing. The amendments in this ASU do not change the core principle of the guidance in Topic 606. Rather, the amendments in this ASU clarify the following two aspects of Topic 606: (1) identifying performance obligations and (2) licensing implementation guidance, while retaining the related principles for those areas. The amendments in this ASU affect the guidance in ASU 2014-09, discussed above, which is not yet effective. The effective date and transition requirements for the amendments in this ASU are the same as the effective date and transition requirements in Topic 606, Revenues from Contracts with Customers. The Company is evaluating the provisions of this ASU in conjunction with ASU No. 2014-09 to determine the potential impact Topic 606 and its amendments will have on the Company’s Consolidated Financial Statements.
In May 2016, FASB issued ASU No. 2016-12, Narrow-Scope Improvements and Practical Expedients, amending ASC Topic 606, Revenue from Contracts with Customers. The amendments in this ASU do not change the core principle of the guidance in Topic 606. Rather, the amendments in this ASU affect only several narrow aspects of Topic 606. The amendments in this ASU affect the guidance in ASU 2014-09, discussed above, which is not yet effective. The effective date and transition requirements for the amendments in this ASU are the same as the effective date and transition requirements in Topic 606. The Company is evaluating the provisions of this ASU in conjunction with ASU No. 2014-09 to determine the potential impact Topic 606 and its amendments will have on the Company’s Consolidated Financial Statements.
Recognition and Measurement of Financial Assets and Financial Liabilities In January 2016, FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this ASU require equity securities to be measured at fair value with changes in the fair value recognized through net income. The amendments allow equity investments that do not have readily determinable fair values to be remeasured at fair value under certain circumstances and require enhanced disclosures about those investments. The amendments simplify the impairment assessment of equity investments without readily determinable fair values. The amendments also eliminate the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The amendments in this ASU require separate presentation in other comprehensive income of the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. This amendment excludes from net income gains or losses that the entity may not realize because those financial liabilities are not usually transferred or settled at their fair values before maturity. The amendments in this ASU require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or in the accompanying notes to the financial statements. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the provisions of ASU No. 2016-01 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements. Assuming the Company remains an emerging growth company, the new authoritative guidance will be effective for reporting periods beginning January 1, 2019 and is not expected to have a significant impact on the Company’s Consolidated Financial Statements.
Leases (Topic 842) In February 2016, FASB issued ASU No. 2016-02, Leases. The amendments in this ASU require lessees to recognize the following for all leases (with the exception of short-term) at the commencement date; a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. The amendments in this ASU leave lessor accounting largely unchanged, although certain targeted improvements were made to align lessor accounting with the lessee accounting model. This ASU simplifies the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is evaluating the new guidance and its impact on the Company’s Consolidated Statements of Operations and Consolidated Statements of Financial Condition. Assuming the Company remains an emerging growth company, the new authoritative guidance will be effective for reporting periods after January 1, 2020.
10
The Company expects an increase in assets and liabilities as a result of recognizing additional lease contracts where the Company is lessee.
Derivatives and Hedging (Topic 815) In March 2016, FASB issued ASU No. 2016-05, Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. The amendments in this ASU clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 (Derivatives and Hedging) does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The amendments in this ASU are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. An entity has an option to apply the amendments in this ASU on either a prospective basis or a modified retrospective basis. Early adoption is permitted, including adoption in an interim period. This ASU became effective for the Company on January 1, 2017 and did not have a material impact on the Company’s Consolidated Financial Statements.
In March 2016, FASB issued ASU No. 2016-06, Contingent Put and Call Options in Debt Instruments. The amendments in this ASU clarify the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. To determine how to account for debt instruments with embedded features, including contingent put and call options, an entity is required to assess whether the embedded derivatives must be bifurcated from the host contract and accounted for separately. Part of this assessment consists of evaluating whether the embedded derivative features are clearly and closely related to the debt host. Under existing guidance, for contingently exercisable options to be considered clearly and closely related to a debt host, they must be indexed only to interest rates or credit risk. ASU 2016-06 addresses inconsistent interpretations of whether an event that triggers an entity’s ability to exercise the embedded contingent option must be indexed to interest rates or credit risk for that option to qualify as clearly and closely related. Diversity in practice has developed because the existing four-step decision sequence in ASC 815 focuses only on whether the payoff was indexed to something other than an interest rate or credit risk. As a result, entities have been uncertain whether they should (1) determine whether the embedded features are clearly and closely related to the debt host solely on the basis of the four-step decision sequence or (2) first apply the four-step decision sequence and then also evaluate whether the event triggering the exercisability of the contingent put or call option is indexed only to an interest rate or credit risk. This ASU clarifies that in assessing whether an embedded contingent put or call option is clearly and closely related to the debt host, an entity is required to perform only the four-step decision sequence in ASC 815 as amended by this ASU. The entity does not have to separately assess whether the event that triggers its ability to exercise the contingent option is itself indexed only to interest rates or credit risk. The amendments in this ASU are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. This ASU became effective for the Company on January 1, 2017 and did not have a material impact on the Company’s Consolidated Financial Statements.
In August 2017, FASB issued ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities. The amendments in this ASU better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The new authoritative guidance will be effective for reporting periods after January 1, 2019 with early adoption permitted. The Company is evaluating the new guidance and its impact on the Company’s Consolidated Statements of Operations and Consolidated Statements of Financial Condition.
Compensation—Stock Compensation (Topic 718) In March 2016, FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. FASB issued this ASU as part of its Simplification Initiative. The areas for simplification in this ASU involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Amendments in this ASU relate to the timing of when excess tax benefits are recognized, minimum statutory withholding requirements, forfeitures, and intrinsic value should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Amendments related to the presentation of employee taxes paid on the statement of cash flows when an employer withholds shares to meet the minimum statutory withholding requirement should be applied retrospectively. Amendments in this ASU require recognition of excess tax benefits and tax deficiencies in the income statement and the practical expedient for estimating expected term should be applied prospectively.
An entity may elect to apply the amendments in this ASU related to the presentation of excess tax benefits on the statement of cash flows using either a prospective transition method or a retrospective transition method. The amendments in
11
this ASU are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. This ASU became effective for the Company on January 1, 2017 and did not have a material impact on the Company’s Consolidated Financial Statements.
In May 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting. The new standard provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. This pronouncement is effective for annual reporting periods beginning after December 15, 2017 but early adoption is permitted. The Company is currently evaluating the impact of adopting this guidance.
Financial Instruments—Credit Losses (Topic 326) In June 2016, FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendments in this ASU replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments in this ASU require a financial asset (or group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses will be based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The amendments in this ASU broaden the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually. The use of forecasted information incorporates more timely information in the estimate of expected credit loss, which will be more decision useful to users of the financial statements. The amendments in this ASU will be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Assuming the Company remains an emerging growth company, the new authoritative guidance will be effective for reporting periods after January 1, 2021. The Company is still evaluating the effects this ASU will have on the Company’s Consolidated Financial Statements. While the Company has not quantified the impact of this ASU, it does expect changing from the current incurred loss model to an expected loss model will result in an earlier recognition of losses.
Statement of Cash Flows (Topic 230) In August 2016, FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. There is diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230 and other Topics. This ASU addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. Those eight issues are (1) debt prepayment or debt extinguishment costs, (2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, (3) contingent consideration payments made after a business combination, (4) proceeds from the settlement of insurance claims, (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, (6) distributions received from equity method investees, (7) beneficial interests in securitization transactions, and (8) separately identifiable cash flows and application of the predominance principle. Current GAAP either is unclear or does not include specific guidance on these eight cash flow classification issues. These amendments provide guidance for each of the eight issues, thereby reducing current and potential future diversity in practice. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. Assuming the Company remains an emerging growth company, the new authoritative guidance will be effective for reporting periods after January 1, 2019. The Company is currently evaluating the provisions of ASU No. 2016-15 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (230), Restricted Cash. The ASU will require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this update apply to all entities that have restricted cash or restricted cash equivalents and are required to present a statement of cash
12
flows under Topic 230. The amendment is effective for annual reporting periods beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption of the update is permitted. Assuming the Company remains an emerging growth company, the new authoritative guidance will be effective for reporting periods after January 1, 2019. The Company does not expect this ASU to have a material impact on the Company’s Consolidated Financial Statements.
Income Taxes (Topic 740) In October 2016, the FASB issued ASU No. 2016-16, Income Taxes, Intra-Entity Transfers of Assets Other Than Inventory. The ASU was issued to improve the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Current GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party; this update clarifies that an entity should recognize the income tax consequences of an intra-entity transfer of assets other than inventory when the transfer occurs. The amendment is effective for annual reporting periods beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption of the update is permitted. Assuming the Company remains an emerging growth company, the new authoritative guidance will be effective for reporting periods after January 1, 2019. The Company does not expect this ASU to have a material impact on the Company’s Consolidated Financial Statements.
Consolidation (Topic 810) In October 2016, the FASB issued ASU No. 2016-17, Consolidation, Interests Held through Related Parties That Are under Common Control. The ASU was issued to amend the consolidation guidance on how a reporting entity that is the single decision maker of a variable interest entity (“VIE”) should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. The primary beneficiary of a VIE is the reporting entity that has a controlling financial interest in a VIE and, therefore, consolidates the VIE. A reporting entity has an indirect interest in a VIE if it has a direct interest in a related party that, in turn, has a direct interest in the VIE. The amendment is effective for annual reporting periods beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption of the update is permitted. The Company adopted this new authoritative guidance on January 1, 2017 and it did not have an impact on the Company’s Consolidated Financial Statements.
Business Combinations (Topic 805) In January 2017, the FASB issued ASU No. 2017-01, Clarifying the Definition of a Business. The guidance clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. This guidance is effective for annual and interim periods beginning after December 15, 2017. Early adoption is permitted. Assuming the Company remains an emerging growth company, the new authoritative guidance will be effective for reporting periods after January 1, 2019. The Company does not expect a material impact of this ASU on the Company’s Consolidated Financial Statements.
Intangibles—Goodwill and Other (Topic 350) In January 2017, FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. The amendments in this ASU are intended to reduce the cost and complexity of the goodwill impairment test by eliminating step two from the impairment test. The amendments modify the concept of impairment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value. Under the amendments in this ASU, an entity will perform its annual, or interim, goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount. An impairment charge should be recognized for the amount which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendments in this ASU are effective for the Company’s annual or any interim goodwill impairment test in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is early adopting these amendments in 2017 and does not expect a material impact on the Company’s Consolidated Financial Statements.
Other Income (Subtopic 610-20) In February 2017, the FASB issued ASU No. 2017-05, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets. This ASU will clarify the scope of Subtopic 610-20 and add guidance for partial sales of nonfinancial assets. The amendments should be applied either on retrospectively to each period presented or with a modified retrospective approach. The amendment is effective for annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019. The Company is currently evaluating the provisions of ASU No. 2017-05 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements.
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Nonrefundable Fees and Other Costs (Subtopic 310-20) In March 2017, FASB issued ASU No. 2017-08, Receivables—Nonrefundable Fees and Other Costs. The amendments in the ASU shorten the amortization period for certain callable debt securities held at a premium at the earliest call date. Under current GAAP, the Company amortizes the premium as an adjustment of yield over the contractual life of the instrument. As a result, upon exercise of a call on a callable debt security held at a premium, the unamortized premium is charged to earnings. The ASU shortens the amortization period for certain callable debt securities held at a premium and requires the premium to be amortized to the earliest call date. However, the amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The amendments are effective for annual periods beginning after December 15, 2019, and interim periods within annual periods beginning after December 15, 2020. Early adoption is permitted. The Company is required to apply the amendments on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Assuming the Company remains an emerging growth company, the new authoritative guidance will be effective for reporting periods after January 1, 2020. The Company is currently evaluating the provisions of ASU No. 2017-08 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements.
Note 3—Acquisition of a Business
On October 14, 2016, the Company acquired stock of Ridgestone Financial Services, Inc. (“Ridgestone”) and its subsidiaries under the terms of a definitive merger agreement (“Agreement”) dated June 9, 2016. Ridgestone operated two wholly-owned subsidiaries, Ridgestone Bank and RidgeStone Capital Trust I, and specialized in government guaranteed lending as a participant in the SBA and USDA lending programs. Ridgestone provided financial services through its two full-service banking offices in Brookfield, Wisconsin and Schaumburg, Illinois. In addition, Ridgestone had loan production offices located in Wisconsin (Green Bay and Wausau), Indiana (Indianapolis) and California (Newport Beach).
Under the terms of the Agreement, each Ridgestone common share was converted into the right to receive, at the election of the stockholder (subject to proration as outlined in the Agreement), either cash or Company common stock, or the combination of both. Total consideration included aggregate cash in the amount of $36.8 million and the issuance of 4,199,791 shares of the Company’s common stock valued at $16.25 per common share. The transaction resulted in goodwill of $26.3 million, which is nondeductible for tax purposes, as this acquisition was a nontaxable transaction. Goodwill represents the premium paid over the fair value of the net tangible and intangible assets acquired and reflects related synergies expected from the combined operations. Acquisition advisory expenses related to the Ridgestone acquisition of $1.1 million are reflected in non-interest expense on the Consolidated Statements of Operations for the nine months ended September 30, 2016. Stock issuance costs were not material. There were no contingent assets or liabilities arising from the acquisition.
The acquisition of Ridgestone was accounted for using the acquisition method of accounting in accordance with ASC Topic 805. Assets acquired, liabilities assumed and consideration exchanged were recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities involves significant judgment regarding methods and assumptions used to calculate estimated fair values. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values become available. Fair values are preliminary estimates due to deferred tax assets and deferred tax liabilities.
14
The following table presents a summary of the estimates of fair values of assets acquired and liabilities assumed as of the acquisition date:
Assets
25,480
27,662
Restricted stock
931
15,363
Loans
351,820
Servicing assets
20,295
Premises and equipment
2,011
Other real estate owned
1,525
Other intangible assets
486
2,352
8,228
Total assets acquired
456,153
Liabilities
361,370
9,773
Junior subordinated debentures
1,339
4,958
Total liabilities assumed
377,440
Net assets acquired
78,713
Consideration paid
Common stock (4,199,791 shares issued at $16.25 per
share)
68,247
Cash paid
36,753
Total consideration paid
105,000
26,287
The following table presents the acquired non-impaired loans as of the acquisition date:
Fair value
312,166
Gross contractual amounts receivable
450,292
Estimate of contractual cash flows not expected to be
collected(1)
19,661
Estimate of contractual cash flows expected to be collected
430,631
(1)
Includes interest payments not expected to be collected due to loan prepayments as well as principal and interest payments not expected to be collected due to customer default.
The discount on the acquired non-impaired loans is being accreted into income over the life of the loans on an effective yield basis.
15
The following table provides the pro forma information for the results of operations for the three and nine months ended September 30, 2016, as if the acquisition had occurred on January 1, 2016. The pro forma results combine the historical results of Ridgestone into the Company’s Consolidated Statements of Operations, including the impact of certain acquisition accounting adjustments, which includes loan discount accretion, intangible assets amortization, deposit premium accretion and borrowing net discount amortization. The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisition actually occurred on January 1, 2016. No assumptions have been applied to the pro forma results of operations regarding possible revenue enhancements, provision for credit losses, expense efficiencies or asset dispositions. The acquisition-related expenses that have been recognized are included in net income in the following table.
September 30, 2016
Total revenues (net interest income and non-interest income)
44,595
130,536
Net income (loss)
6,816
17,603
Earnings per share—basic
0.29
0.76
Earnings per share—diluted
0.28
The operating results of the Company include the operating results produced by the acquired assets and assumed liabilities of Ridgestone for period from January 1, 2017 through September 30, 2017. Revenues and earnings of the acquired company since the acquisition date have not been disclosed as it is not practicable as Ridgestone was merged into the Company and separate financial information is not readily available.
Note 4—Securities
The following tables summarize the amortized cost and fair values of securities available-for-sale and securities held-to-maturity as of the dates shown and the corresponding amounts of gross unrealized gains and losses:
Amortized
Cost
Gross
Unrealized
Gains
Losses
Fair
Value
Available-for-sale
U.S. Treasury Notes
14,998
(73
14,925
U.S. Government agencies
54,231
(1,012
53,219
Obligations of states, municipalities, and political
subdivisions
32,619
129
(213
32,535
Residential mortgage-backed securities
Agency
329,782
(5,749
324,040
Non-agency
25,429
(46
25,470
Commercial mortgage-backed securities
72,190
44
(1,477
70,757
31,838
(581
31,257
Corporate securities
27,093
493
(62
27,524
Other securities
3,626
1,387
(56
4,957
591,806
2,147
(9,269
16
Held-to-maturity
Obligations of states, municipalities, and political subdivisions
24,078
317
(36
24,359
56,453
275
(82
56,646
40,922
364
(25
41,261
956
(143
122,266
14,995
(79
14,920
60,180
(1,323
58,857
16,271
60
(272
16,059
376,800
(8,640
368,160
20,107
(174
19,933
78,954
(1,551
77,403
32,061
(1,009
31,052
17,065
350
(86
17,329
4,161
742
4,847
620,594
1,156
(13,190
24,878
105
(229
24,754
67,692
35
(283
67,444
46,276
50
(442
45,884
190
(954
138,082
The Company did not classify securities as trading during 2016 or during the nine months ended September 30, 2017.
Gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2017 and December 31, 2016 are summarized as follows:
Less than 12 Months
12 Months or Longer
# of
28,418
(438
24,801
(574
Obligations of states, municipalities and
political subdivisions
23
14,431
(122
2,082
(91
16,513
40
222,548
(3,356
93,293
(2,393
315,841
1
4,789
39,378
(1,108
19,740
(369
59,118
4,959
1,938
94
360,705
(5,786
141,854
(3,483
502,559
Obligations of states, municipalities, and
4,855
20,287
4,568
19
29,710
9,918
7,799
(259
115
(13
7,914
41
364,713
(8,483
3,447
(157
70,762
(1,488
6,641
(63
5,097
(78
2,522
7,619
1,994
568,131
(12,893
14,719
(297
582,850
18
22
16,235
52,156
29,245
42
97,636
Certain securities have fair values less than amortized cost and, therefore, contain unrealized losses. At September 30, 2017, the Company evaluated the securities which had an unrealized loss for other than temporary impairment and determined all declines in value to be temporary. There were 113 investment securities with unrealized losses at September 30, 2017, of which only one had a continuous unrealized loss position for 12 consecutive months or longer that is greater than 5% of amortized cost. The Company anticipates full recovery of amortized cost with respect to these securities by maturity, or sooner, in the event of a more favorable market interest rate environment. The Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be at maturity.
The proceeds from all sales of securities were available-for-sale, and the associated gains and losses for the three and nine months ended September 30, 2017 and 2016 are listed below:
For the Three Months Ended
For the Nine Months Ended
Proceeds
107,949
Gross gains
912
3,341
Gross losses
(110
The amount of net gains reclassified from accumulated other comprehensive income (loss) into earnings for the nine months ended September 30, 2017 and 2016 were $8,000 and $3.2 million, respectively. There were no gains or losses reclassified from accumulated other comprehensive income (loss) into earnings for the three months ended September 30, 2017 and $802,000 for the three months ended September 30, 2016.
Securities pledged at September 30, 2017 and December 31, 2016 had carrying amounts of $226.0 million and $178.6 million, respectively. At September 30, 2017 and December 31, 2016, of those pledged, the carrying amounts of securities pledged as collateral for public fund deposits were $189.9 million and $93.2 million, respectively and for customer repurchase agreements of $35.9 million and $19.9 million, respectively. There were no securities pledged for advances from the Federal Home Loan Bank at September 30, 2017. At December 31, 2016 the carrying amount of securities pledged for advances from the Federal Home Loan Bank were $58.7 million. Other securities were pledged for derivative positions, letters of credit and for purposes required or permitted by law. At September 30, 2017 and December 31, 2016, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.
At September 30, 2017, the amortized cost and fair value of debt securities are shown by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.
Due in one year or less
5,289
5,287
Due from one to five years
70,097
69,824
Due from five to ten years
42,448
42,006
Due after ten years
11,807
11,625
Mortgage-backed securities
459,239
451,524
Other securities with no defined maturity
2,926
4,418
524
528
13,735
13,835
9,819
9,996
97,375
97,907
Note 5—Loan and Lease Receivables
Outstanding loan and lease receivables as of the dates shown were categorized as follows:
December 31,
Commercial real estate
862,523
796,950
Residential real estate
582,569
610,699
Construction, land development, and other land
94,639
141,122
Commercial and industrial
503,093
439,476
Installment and other
3,208
2,917
Lease financing receivables
168,924
155,999
Total loans and leases
2,214,956
2,147,163
Net unamortized deferred fees and costs
(1,874
(2,119
Initial direct costs
3,417
2,967
Net minimum lease payments
183,035
168,345
Unguaranteed residual values
1,580
1,787
Unearned income
(15,691
(14,133
Total lease financing receivables
Lease financial receivables before allowance for
lease losses
172,341
158,966
At September 30, 2017 and December 31, 2016, total loans and leases included the guaranteed amount of U.S. Government guaranteed loans of $51.9 million and $34.8 million, respectively. At September 30, 2017 and December 31,
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2016, installment and other loans included overdraft deposits of $483,000 and $1.0 million, respectively, which were reclassified as loans. At September 30, 2017 and December 31, 2016, loans and loans held for sale pledged as security for borrowings were $530.3 million and $507.2 million, respectively. Total loans and leases consist of originated loans and leases, acquired impaired loans and acquired non-impaired loans and leases.
The minimum annual lease payments for lease financing receivables as of September 30, 2017 are summarized as follows:
Minimum Lease
Payments
15,345
2018
62,718
2019
48,463
2020
32,863
2021
17,699
Thereafter
5,947
Originated loans and leases represent originations following a business combination. Acquired impaired loans are loans acquired from a business combination with evidence of credit quality deterioration and are accounted for under ASC Topic 310-30. Acquired non-impaired loans and leases represent loans and leases acquired from a business combination without evidence of credit quality deterioration and are accounted for under ASC Topic 310-20. Leases and revolving loans do not qualify to be accounted for as acquired impaired loans and are accounted for under ASC Topic 310-20. The following tables summarize the balances for each respective loan and lease category as of September 30, 2017 and December 31, 2016:
Originated
Acquired
Impaired
Non-
463,020
173,106
225,759
861,885
398,062
152,149
32,451
582,662
85,666
5,424
3,214
94,304
390,331
11,433
100,291
502,055
2,726
488
38
3,252
134,193
38,148
1,473,998
342,600
399,901
338,752
207,303
250,289
796,344
394,168
175,717
40,853
610,738
119,357
6,979
14,430
140,766
309,097
13,464
115,677
438,238
2,021
574
2,959
118,493
40,473
1,281,888
404,037
462,086
21
The outstanding balance and carrying amount of all acquired impaired loans are summarized below. The balances do not include an allowance for loan and lease losses of $3.8 million and $1.6 million, at September 30, 2017 and December 31, 2016, respectively.
Outstanding
Balance
Carrying
245,182
278,893
215,135
236,384
13,511
15,292
20,255
23,164
1,842
1,976
Total acquired impaired loans
495,925
555,709
The following table summarizes the changes in accretable yield for acquired impaired loans for the three and nine months ended September 30, 2017 and 2016:
Beginning balance
37,619
35,663
36,868
43,915
Accretion to interest income
(8,165
(5,859
(24,768
(20,071
Reclassification from nonaccretable difference
6,901
1,777
24,255
7,737
Ending balance
36,355
31,581
Acquired non-impaired loans and leases—The unpaid principal balance and carrying value for acquired non-impaired loans and leases at September 30, 2017 and December 31, 2016 were as follows:
Unpaid
Principal
232,016
259,055
32,984
41,282
3,277
14,619
111,167
125,806
352
39,053
40,205
Total acquired non-impaired loans and leases
418,849
481,369
Note 6—Allowance for Loan and Lease Losses and Reserve for Unfunded Commitments
Loans and leases considered for inclusion in the allowance for loan and lease losses include acquired non-impaired loans and leases, those acquired impaired loans with credit deterioration after acquisition, and originated loans and leases. Although all acquired loans and leases are included in the following table, only those with credit deterioration subsequent to acquisition date are actually included in the allowance for loan and lease losses.
The following tables summarize the balance and activity within the allowance for loan and lease losses, the components of the allowance for loan and lease losses in terms of loans and leases individually and collectively evaluated for impairment, and corresponding loan and lease balances by type for the three and nine months ended September 30, 2017 and 2016 are as follows:
Commercial
Real Estate
Residential
Construction,
Land
Development,
and
Other Land
Industrial
Installment
and Other
Lease
Financing
Receivables
Three months ended
3,668
1,835
327
5,689
344
2,106
13,969
Provisions
1,577
52
(111
1,440
929
Charge-offs
(186
(161
(763
(327
(862
(2,299
Recoveries
410
5,059
1,726
216
6,366
30
2,583
15,980
Nine months ended
1,945
2,483
4,196
334
1,223
10,923
3,591
(526
3,932
2,686
(477
(357
(1,762
(2,399
(5,322
1,073
Ending balance:
Individually evaluated for
impairment
1,186
176
1,585
2,949
Collectively evaluated for
1,844
1,237
155
3,389
9,218
Loans acquired with deteriorated
credit quality
2,029
313
61
1,392
3,813
Total allowance for loan and lease
losses
Loans and leases ending balance:
14,928
1,948
6,075
23,518
673,851
428,565
88,315
484,547
2,762
1,850,381
2,119
1,303
489
1,472
740
6,490
27
66
624
(3
928
(1,078
25
(95
(9
(671
(1,830
158
1,068
1,369
460
2,094
355
1,155
6,501
2,280
2,981
232
1,403
357
379
7,632
3,050
(980
323
768
2,179
(4,262
(632
(77
(10
(1,934
(7,010
531
339
192
328
859
669
534
413
1,264
4,036
399
496
47
638
26
1,606
6,374
2,553
9,447
377,090
438,446
104,369
244,566
1,055
154,557
1,320,083
187,359
185,979
7,539
6,512
590
387,979
570,823
626,978
111,908
251,270
1,973
1,717,509
The Company increased the allowance for loan and lease losses by $2.0 million and $5.1 million for the three and nine months ended September 30, 2017, respectively. The Company increased the allowance for loan and lease losses by $11,000 for the three months ended September 30, 2016 and decreased the allowance for loan and lease losses by $1.1 million for the nine months ended September 30, 2016. For acquired impaired loans, the Company increased the allowance for loan and lease losses by $559,000 and $2.2 million for the three and nine months ended September 30, 2017, respectively. The Company increased the allowance for loan and lease losses for acquired impaired loans by $8,000 for the three months ended September 30, 2016 and decreased the allowance for loan and lease losses for acquired impaired loans by $1.7 million for the nine months ended September 30, 2016.
24
The following tables summarize the recorded investment, unpaid principal balance, and related allowance for loans and leases considered impaired as of September 30, 2017 and December 31, 2016, which excludes acquired impaired loans:
Recorded
Investment
Related
Allowance
With no related allowance recorded
9,541
10,149
1,581
2,589
Construction, land development and other land
3,465
3,652
With an allowance recorded
5,387
387
2,610
2,934
310
Total impaired loans
26,107
8,916
9,502
804
1,999
Commercial and Industrial
521
293
861
869
396
361
11,926
13,783
1,017
The following tables summarize the average recorded investment and interest income recognized for loans and leases considered impaired, which excludes acquired impaired loans, for the periods ended as follows:
Average
Interest
Income
Recognized
10,605
419
1,698
33
269
2,391
253
1,043
287
444
1,673
500
213
18,355
1,509
4,129
128
2,479
65
96
2,099
727
171
8,337
For purposes of these tables, the unpaid principal balance represents the outstanding contractual balance. Impaired loans include loans that are individually evaluated for impairment as well as troubled debt restructurings for all loan categories. The sum of non-accrual loans and loans past due 90 days still on accrual will differ from the total impaired loan amount.
The following tables summarize the risk rating categories of the loans and leases considered for inclusion in the allowance for loan and lease losses calculation, excluding acquired impaired loans, as of September 30, 2017 and December 31, 2016:
Pass
617,061
421,109
73,781
400,838
2,761
170,410
1,685,960
Watch
44,273
4,871
11,947
71,752
214
133,060
Special Mention
11,958
2,513
2,587
10,104
28,056
Substandard
15,487
2,020
7,928
639
26,639
Doubtful
184
Loss
688,779
430,513
88,880
490,622
2,764
1,873,899
536,499
419,880
129,732
369,136
2,052
157,296
1,614,595
38,707
10,885
2,897
52,872
324
105,689
5,377
3,116
1,158
1,258
512
11,422
8,458
1,140
1,508
739
12,173
95
589,041
435,021
133,787
424,774
2,385
1,743,974
The following tables summarize contractual delinquency information for acquired non-impaired and originated loans and leases by category at September 30, 2017 and December 31, 2016:
30-59
Days
Past Due
60-89
Greater than
90 Days and
Accruing
accrual
Current
596
8,672
9,618
679,161
220
1,852
2,072
428,441
Construction, land development, and
other land
2,245
416
3,537
6,198
484,424
995
495
1,818
170,523
3,592
1,560
15,121
20,273
1,853,626
2,944
648
3,935
7,527
581,514
243
1,118
1,361
433,660
1,363
132,424
6,066
374
958
7,398
417,376
2,057
2,070
390
445
2,905
156,061
12,686
1,412
6,784
20,882
1,723,092
At September 30, 2017 and December 31, 2016, the Company had a recorded investment in troubled debt restructurings of $2.3 million and $1.2 million, respectively. The restructurings were granted due to borrower financial difficulty and provide for a modification of loan repayment terms. The Company has not allocated any specific allowance for these loans at September 30, 2017 and December 31, 2016. In addition, there were no commitments outstanding on troubled debt restructurings.
Loans modified as troubled debt restructurings that occurred during the three and nine months ended September 30, 2017 and year ended December 31, 2016 did not result in any charge-offs or permanent reductions of the recorded investments in the loans. There were $867,000 and $2.1 million of loans modified as troubled debt restructurings during the three and nine months ended September 30, 2017. Troubled debt restructurings that subsequently defaulted within twelve months of the restructure date during the year ended December 31, 2016 had a recorded investment of $477,000. No troubled debt restructurings subsequently defaulted within twelve months of the restructure date during the three and nine months ended September 30, 2017.
At September 30, 2017 and December 31, 2016, the reserve for unfunded commitments was $1.0 million and $760,000, respectively. During the nine months ended September 30, 2017 and 2016, the provisions for unfunded commitments were $272,000 and $56,000, respectively. There were no charge-offs or recoveries related to the reserve for unfunded commitments during the periods.
Note 7—Servicing Assets
As part of the Ridgestone acquisition, the Company acquired loan servicing assets. The Company did not hold any servicing assets until the acquisition on October 14, 2016.
Loans serviced for others are not included in the Consolidated Statements of Financial Condition. The unpaid principal balances of these loans serviced for others were as follows as of September 30, 2017 and December 31, 2016:
Loan portfolios serviced for:
SBA guaranteed loans
1,001,845
911,803
USDA guaranteed loans
87,589
106,125
1,089,434
1,017,928
Activity for servicing assets and the related changes in fair value for the nine months ended September 30, 2017 is as follows:
Additions, net
4,675
Changes in fair value
(4,097
Loan servicing income totaled $1.0 million and $3.0 million for the three and nine months ended September 30, 2017, respectively.
The fair value of servicing rights is highly sensitive to changes in underlying assumptions. Changes in prepayment speed assumptions have the most significant impact on the fair value of servicing rights.
Generally, as interest rates rise on variable rate loans, loan prepayments increase due to an increase in refinance activity, which may result in a decrease in the fair value of servicing assets. Measurement of fair value is limited to the condition existing and the assumptions used as of a particular point in time, and those assumptions may change over time. Refer to Note 16—Fair Value Measurement for further details.
Note 8—Other Real Estate Owned
The following table presents the change in other real estate owned (“OREO”) for the nine months ended September 30, 2017 and 2016.
Nine Months Ended September 30,
26,715
Net additions to OREO
Proceeds from the sales of OREO
(9,583
(15,392
Net gains on sales of OREO
1,538
1,134
Valuation adjustments
(367
(904
15,274
The recorded investment in residential mortgage loans secured by residential real estate properties (including purchased credit-impaired loans) for which foreclosure proceedings are in process totaled $2.0 million and $2.7 million at September 30, 2017 and December 31, 2016, respectively.
28
Note 9—Goodwill, Core Deposit Intangible and Other Intangible Assets
The following table summarizes the changes in the Company’s goodwill and core deposit intangible assets for the nine months ended September 30, 2017 and 2016:
Core Deposit
Intangible
19,776
25,688
22,275
Amortization or accretion
(2,293
(2,228
17,483
20,047
Accumulated amortization or accretion
N/A
12,703
9,653
Weighted average remaining amortization or accretion
period
5.8 Years
6.8 Years
The Company had other intangible assets of $39,000 and $50,000 as of September 30, 2017 and December 31, 2016, respectively, related to trademark-related transactions.
The following table presents the estimated amortization expense for core deposit intangible and other intangible assets recognized at September 30, 2017:
Estimated
Amortization
767
3,060
3,027
3,017
4,601
Note 10—Income Taxes
The Company uses an estimated annual effective tax rate method in computing its interim tax provision. This effective tax rate is based on forecasted annual pre-tax income, permanent tax differences and statutory tax rates.
The effective tax rates for the nine months ended September 30, 2017 and 2016 were 24.4% and (8.6)%, respectively. The Company began to recognize income tax expense in the quarter ended December 31, 2016 after the reversal of $61.9 million of the Company’s previously established valuation allowance on its net deferred tax assets.
Deferred tax assets decreased $7.4 million from $67.8 million at December 31, 2016 to $60.4 million at September 30, 2017. This decrease was primarily due to a reduction in the Company’s net operation loss carryforwards being applied to the current year tax liability.
As part of a budget package passed by the Legislature of the State of Illinois, the corporate income tax rate increased from 5.25% to 7.00% effective July 1, 2017. As a result of the increase in the corporate income tax rate, we recorded a state income tax benefit of $4.6 million due to increased value of our deferred tax asset related to our Illinois net loss deduction.
29
Note 11—Deposits
The composition of deposits was as follows as of September 30, 2017 and December 31, 2016:
Interest bearing checking accounts
187,232
173,929
Money market demand accounts
418,006
369,074
Other savings
435,536
446,418
Time deposits (below $100,000)
377,929
392,854
Time deposits ($100,000 and above)
348,564
383,662
Time deposits of $100,000 or more included $30.8 million of brokered deposits at December 31, 2016 and none at September 30, 2017. Time deposits in denominations of $250,000 or more at September 30, 2017 and December 31, 2016 were $83.4 million and $117.4 million, respectively.
Note 12—Federal Home Loan Bank Advances
The following table summarizes the FHLB advances as of September 30, 2017 and December 31, 2016, which include acquisition accounting adjustments of $72,000 and $228,000, respectively, along with weighted average costs and scheduled maturities:
Weighted average cost
1.32
%
0.73
Scheduled
Maturities
225,000
9,559
At September 30, 2017, advances had fixed terms with interest rates ranging from 1.24% to 3.22% and maturities ranging from December 2017 to February 2018. The Bank’s advances from the FHLB are collateralized by residential real estate loans and securities. At September 30, 2017 and December 31, 2016, the Bank had additional borrowing capacity from the FHLB of $913.0 million and $647.9 million, respectively, subject to the availability of proper collateral. The Bank’s maximum borrowing capacity is limited to 35% of total assets.
FHLB advances assumed from the Ridgestone acquisition of $1.5 million are putable quarterly and are required to be repaid upon the request of the FHLB.
The Company hedges interest rates on borrowed funds using interest rate swaps through which the Company receives variable amounts and pays fixed amounts. Refer to Note 17—Derivative Instruments and Hedge Activities for additional information.
Note 13—Other Borrowings
The following is a summary of the Company’s other borrowings as of September 30, 2017 and December 31, 2016:
37,899
Securities sold under agreements to repurchase represent a demand deposit product offered to customers that sweep balances in excess of the FDIC insurance limit into overnight repurchase agreements. The Company pledges securities as collateral for the repurchase agreements. Refer to Note 4—Securities for additional discussion.
On October 13, 2016, in connection with the Ridgestone acquisition, the Company entered into a $30.0 million credit agreement with The PrivateBank and Trust and Company, now known as CIBC Bank USA (“CIBC”), with a $300,000 commitment fee payable at such time. The line of credit matured on October 12, 2017 and carried an interest rate equal to the Prime Rate. At September 30, 2017 and December 31, 2016, the interest rate was 4.25% and 3.75%, respectively. As of September 30, 2017 and December 31, 2016, the Company was in compliance with all financial covenants set forth in the line of credit agreement. In April 2017, the revolving line of credit was amended to a non-revolving line of credit as long as the outstanding balance exceeds $5.0 million. When the outstanding balance reaches $5.0 million, the line of credit will be converted to a revolving line of credit with credit availability up to $5.0 million until maturity. In July 2017, the Company repaid the outstanding balance, in full, under this line of credit of $16.2 million with proceeds from its initial public offering. On October 12, 2017, the Company amended the credit agreement, which extended the maturity date to October 11, 2018. The amended revolving line of credit bears interest at either the LIBOR Rate plus 250 basis points or the Prime Rate minus 25 basis points, based on the Company’s election, which is required to be communicated to CIBC at least three business days prior to the commencement of an interest period. If the Company fails to provide timely notification, the interest rate will be Prime Rate minus 25 basis points.
The following table presents short-term credit lines available for use, for which the Company did not have an outstanding balance as of September 30, 2017 and December 31, 2016:
Federal Reserve Bank of Chicago discount window line
135,278
110,600
Available federal funds lines
40,000
20,000
Note 14—Junior Subordinated Debentures
At September 30, 2017 and December 31, 2016, the Company’s junior subordinated debentures by issuance were as follows:
Name of Trust
Aggregate
Stated
Maturity
Contractual Rate at September 30, 2017
Interest Rate Spread
Metropolitan Statutory Trust 1
35,000
March 17, 2034
4.11
Three-month LIBOR + 2.79%
RidgeStone Capital Trust I
1,500
June 30, 2033
5.09
Five-year LIBOR + 3.50%
Total liability, at par
36,500
Discount
(9,018
(9,574
Total liability, at carrying value
In 2004, the Company’s predecessor, Metropolitan Bank Group, Inc., issued $35.0 million floating rate junior subordinated debentures to Metropolitan Statutory Trust 1, which was formed for the issuance of trust preferred securities.
31
The debentures bear interest at three-month London Interbank Offered Rate (“LIBOR”) plus 2.79% (4.11% and 3.78% at September 30, 2017 and December 31, 2016, respectively). Interest is payable quarterly. The Company has the right to redeem the debentures, in whole or in part, on any interest payment date on or after March 2009. Accrued interest payable was $54,000 and $50,000 as of September 30, 2017 and December 31, 2016, respectively.
As part of the Ridgestone acquisition, the Company assumed the obligations to RidgeStone Capital Trust I of $1.5 million in principal amount, which was formed for the issuance of trust preferred securities. Refer to Note 3—Acquisition of a Business for additional information. Beginning on June 30, 2008, the interest rate reset to the five-year LIBOR plus 3.50% (5.09% at September 30, 2017 and December 31, 2016), which is in effect until September 30, 2018 and updated every five years. Interest is paid on a quarterly basis. The Company has the right to redeem the debentures, in whole or in part, on any interest payment date on or after June 30, 2008. There was no accrued interest payable as of September 30, 2017 or December 31, 2016.
The Trusts are not consolidated with the Company. Accordingly, the Company reports the subordinated debentures held by the Trusts as liabilities. The Company owns all of the common securities of each trust. The junior subordinated debentures qualify, and are treated as, Tier 1 regulatory capital of the Company subject to regulatory limitations. The trust preferred securities issued by each trust rank equally with the common securities in right of payment, except that if an event of default under the indenture governing the notes has occurred and is continuing, the preferred securities will rank senior to the common securities in right of payment.
Note 15—Commitments and Contingent Liabilities
Legal contingencies—In the ordinary course of business, the Company and Bank have various outstanding commitments and contingent liabilities that are not recognized in the accompanying consolidated financial statements. In addition, the Company may be a defendant in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is currently not expected to have a material adverse effect on the Company’s Consolidated Statements of Financial Condition.
Operating lease commitments—The Company has entered into various operating lease agreements primarily for facilities and land on which banking facilities are located. Certain lease agreements have renewal options at the end of the original lease term and certain lease agreements have escalation clauses in the rent payments.
The minimum annual rental commitments for operating leases subsequent to September 30, 2017, exclusive of taxes and other charges, are summarized as follows:
Minimum Rental
Commitments
754
2,849
2,506
2,006
1,759
3,025
12,899
The Company’s rental expenses for the nine months ended September 30, 2017 and 2016 were $3.4 million and $2.7 million, respectively. Rental expenses for the three months ended September 30, 2017 and 2016 were $1.1 million and $950,000, respectively. For the nine months ended September 30, 2017 and 2016, the Company received $526,000 and $551,000, respectively, in sublease income which is included in the Consolidated Statements of Operations as a reduction of occupancy expense. Sublease income for the three months ended September 30, 2017 and 2016 was $166,000 and $187,000, respectively. In addition to the above required lease payments, the Company has contractual obligations related primarily to information technology contracts and other maintenance contracts. The amounts are not material.
Commitments to extend credit—The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate
32
risk in excess of the amount recognized in the Consolidated Statements of Financial Condition. The contractual or notional amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.
The Bank’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for funded instruments. The Bank does not anticipate any material losses as a result of the commitments and standby letters of credit.
The following table summarizes the contract or notional amount of outstanding loan and lease commitments at September 30, 2017 and December 31, 2016:
Fixed Rate
Variable Rate
Commitments to extend credit
46,427
425,115
37,731
332,928
Standby letters of credit
3,655
1,060
4,135
47,477
428,770
38,791
337,063
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral is primarily obtained in the form of commercial and residential real estate (including income producing commercial properties).
Standby letters of credit are conditional commitments issued by the Bank to guarantee to a third-party the performance of a customer. Those guarantees are primarily issued to support public and private borrowing arrangements, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Commitments to make loans are generally made for periods of 90 days or less. The fixed rate loan commitments have interest rates ranging from 3.23% to 19.50% and maturities up to 2020. Variable rate loan commitments have interest rates ranging from 2.45% to 8.25% and maturities up to 2040.
Note 16—Fair Value Measurement
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In addition, the Company has the ability to obtain fair values for markets that are not accessible.
These types of inputs create the following fair value hierarchy:
Level 1—Quoted prices in active markets for identical assets or liabilities.
Level 2—Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available. The Company’s own data used to develop unobservable inputs may be adjusted for market considerations when reasonably available.
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to assets and liabilities.
The Company used the following methods and significant assumptions to estimate fair value for certain assets measured and carried at fair value on a recurring basis:
Securities available-for-sale—The Company obtains fair value measurements from an independent pricing service. Management reviews the procedures used by the third party, including significant inputs used in the fair value calculations. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. When market quotes are not readily accessible or available, alternative approaches are utilized, such as matrix or model pricing.
The Company’s methodology for pricing non-rated bonds focuses on three distinct inputs: equivalent rating, yield and other pricing terms. To determine the rating for a given non-rated municipal bond, the Company references a publicly issued bond by the same issuer if available as well as other additional key metrics to support the credit worthiness. Typically, pricing for these types of bonds would require a higher yield than a similar rated bond from the same issuer. A reduction in price is applied to the rating obtained from the comparable bond, as the Company believes if liquidated, a non-rated bond would be valued less than a similar bond with a verifiable rating. The reduction applied by the Company is one notch lower (i.e. a “AA” rating for a comparable bond would be reduced to “AA-” for the Company’s valuation). In 2017 and 2016, all of the ratings derived by the Company were “BBB” or better with and without comparable bond proxies. The fair value measurement of municipal bonds is sensitive to the rating input, as a higher rating typically results in an increased valuation. The remaining pricing inputs used in the bond valuation are observable. Based on the rating determined, the Company obtains a corresponding current market yield curve available to market participants. Other terms including coupon, maturity date, redemption price, number of coupon payments per year, and accrual method are obtained from the individual bond term sheets.
Servicing assets—Fair value is based on a loan-by-loan basis taking into consideration the original term to maturity, the current age of the loan and the remaining term to maturity. The valuation methodology utilized for the servicing assets begins with generating future cash flows for each servicing asset, based on their unique characteristics and market-based assumptions for prepayment speeds. The present value of the future cash flows are then calculated utilizing market-based discount rate assumptions.
Derivative instruments—Interest rate swaps are valued by a third party, using models that primarily use market observable inputs, such as yield curves, and are validated by comparison with valuations provided by the respective counterparties. Derivative financial instruments are included in other assets and other liabilities in the Consolidated Statements of Financial Condition.
34
The following tables summarize the Company’s financial assets and liabilities that were measured at fair value on a recurring basis at September 30, 2017 and December 31, 2016:
Fair Value Measurements Using
Fair Value
Level 1
Level 2
Level 3
Financial assets
31,985
550
Mortgage-backed securities; residential
Non-Agency
Mortgage-backed securities; commercial
2,480
539
Derivative assets
3,913
Financial liabilities
Derivative liabilities
1,190
15,509
2,379
4,317
559
During 2016, the Company acquired the servicing assets and single-issuer trust preferred securities included in other securities categorized as Level 3 of the fair value hierarchy through a business combination.
In addition, during 2016, the Company purchased privately-issued municipal securities that are categorized as Level 3. These municipal securities are bonds issued for one municipal government entity located in the Chicago metropolitan area and are privately placed, non-rated bonds without Committee on Uniform Security Identification Procedures numbers.
The Company did not have any transfers between Level 1 and Level 2 of the fair value hierarchy during the nine months ended September 30, 2017 and 2016. The Company’s policy for determining transfers between levels occurs at the end of the reporting period when circumstances in the underlying valuation criteria change and result in transfer between levels.
The following table presents additional information about financial assets measured at fair value on recurring basis for which the Company used significant unobservable inputs (Level 3):
Investment Securities
Servicing Assets
Balance, beginning of period
1,080
Change in unrealized loss
Change in fair value
Balance, end of period
1,089
The following table presents additional information about the unobservable inputs used in the fair value measurements on recurring basis that were categorized within Level 3 of the fair value hierarchy as of September 30, 2017:
Financial Instruments
Valuation Technique
Unobservable Inputs
Range of
Inputs
Weighted
Range
Impact to
Valuation from an
Increased or
Higher Input Value
Obligations of states, municipalities,
and political obligations
Discounted cash flow
Probability of default
2.0%—2.4%
2.2
Decrease
Single issuer trust preferred
7.5%—9.9%
8.9
Prepayment speeds
1.7%—9.0%
7.6
Discount rate
9.1%—16.2%
12.8
Expected weighted
average loan life
0.4—11.5 years
6.1 years
Increase
The Company used the following methods and significant assumptions to estimate fair value for certain assets measured and carried at fair value on a non-recurring basis:
Impaired loans (excluding acquired impaired loans)—Impaired loans, other than those existing on the date of a business acquisition, are primarily carried at the fair value of the underlying collateral, less estimated costs to sell, if the loan is collateral dependent. Valuations of impaired loans that are collateral dependent are supported by third party appraisals in accordance with the Bank’s credit policy. Impaired loans that are not collateral dependent are not material.
Assets held for sale—Assets held for sale consist of former branch locations, vacant land, and a house previously purchased for expansion. Assets are considered held for sale when management has approved to sell the assets following a branch closure or other events. The properties are being actively marketed and transferred to assets held for sale based on the lower of carrying value or its fair value, less estimated costs to sell.
Other real estate owned—Certain assets held within other real estate owned represent real estate or other collateral that has been adjusted to its estimated fair value, less cost to sell, as a result of transferring from the loan portfolio at the time of foreclosure or repossession and based on management’s periodic impairment evaluation. From time to time, non-recurring
36
fair value adjustments to other real estate owned are recorded to reflect partial write-downs based on an observable market price or current appraised value of property.
Adjustments to fair value based on such non-recurring transactions generally result from the application of lower-of-cost-or-market accounting or write-downs of individual assets due to impairment. The following tables summarize the Company’s assets that were measured at fair value on a non-recurring basis, excluding acquired impaired loans, as of September 30, 2017 and December 31, 2016:
Non-recurring
Impaired loans
(excluding acquired impaired loans)
13,742
1,772
4,490
1,007
986
The following table provides a description of the valuation technique, unobservable inputs and qualitative information about the Company’s assets and liabilities classified as Level 3 and measured at fair value on a non-recurring basis as of September 30, 2017:
Range of Inputs
Impaired loans (excluding
acquired impaired loans)
Appraisals
Appraisal adjustments,
sales costs and other
discount adjustments for
market conditions
6% - 10%
List price, contract price
Sales costs and other
7%
7% - 20%
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The following methods and assumptions were used by the Company in estimating fair values of other assets and liabilities for disclosure purposes:
Cash and cash equivalents—For these short-term instruments, the carrying amount is a reasonable estimate of fair value. The fair value for time certificates with other banks is based on the market values for comparable investments.
Securities held-to-maturity—The Company obtains fair value measurements from an independent pricing service. Management reviews the procedures used by the third party, including significant inputs used in the fair value calculations. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. When market quotes are not readily accessible or available, alternative approaches are utilized, such as matrix or model pricing.
Restricted stock—The fair value has been determined to approximate cost.
Loans held for sale—The fair value of loans held for sale are based on quoted market prices, where available, and determined by discounted estimated cash flows using interest rates approximating the Company’s current origination rates for similar loans adjusted to reflect the inherent credit risk.
Loan and lease receivables, net—For certain variable rate loans that reprice frequently and with no significant changes in credit risk, fair value is estimated at carrying value. The fair value of other types of loans is estimated by discounting future cash flows, using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Deposit liabilities—The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting future cash flows, using rates currently offered for deposits of similar remaining maturities.
Federal Home Loan Bank advances—The fair value of FHLB advances is estimated by discounting the agreements based on maturities using rates currently offered for FHLB advances of similar remaining maturities adjusted for prepayment penalties that would be incurred if the borrowings were paid off on the measurement date.
Securities sold under agreements to repurchase—The carrying amount approximates fair value due to maturities of less than ninety days.
Junior subordinated debentures—The fair value of junior subordinated debentures, in the form of trust preferred securities, is determined using rates currently available to the Company for debt with similar terms and remaining maturities.
Accrued interest receivable and payable—The carrying amount approximates fair value.
Commitments to extend credit and commercial and standby letters of credit—The fair values of these off-balance sheet commitments to extend credit and commercial and standby letters of credit are not considered practicable to estimate because of the lack of quoted market prices and the inability to estimate fair value without incurring excessive costs.
The estimated fair values of financial instruments and levels within the fair value hierarchy are as follows:
Hierarchy
Level
Securities held-to-maturity
Other restricted stock
2,335
26,487
Loans and lease receivables, net
2,118,769
2,068,157
Non-interest bearing deposits
Interest bearing deposits
1,767,267
1,721,537
1,765,937
1,723,941
234,543
313,646
Securities sold under repurchase agreement
26,779
26,943
Note 17—Derivative Instruments and Hedge Activities
The Company recognizes derivative financial instruments at fair value regardless of the purpose or intent for holding the instrument. The Company records derivative assets and derivative liabilities on the Consolidated Statements of Financial Condition within accrued interest receivable and other assets and accrued interest payable and other liabilities, respectively. The following tables present the fair value of the Company’s derivative financial instruments and classification on the Consolidated Statements of Financial Condition as of September 30, 2017 and December 31, 2016:
Notional
Other
Derivatives designated as hedging instruments
Interest rate swaps designated as cash
flow hedges
250,000
3,265
545
100,000
3,719
Derivatives not designated as hedging instruments
Other interest rate swaps
81,712
645
51,213
598
Total derivatives
331,712
151,213
Interest rate swaps designated as cash flow hedges—Cash flow hedges of interest payments associated with certain FHLB advances had notional amounts totaling $250.0 million as of September 30, 2017. The aggregate fair value of the swaps is recorded in other assets or other liabilities with changes in fair value recorded in other comprehensive income (loss), net of taxes, to the extent effective. The amount included in accumulated other comprehensive income (loss) would be reclassified to current earnings when the hedged FHLB advances affect earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in fair value of the derivative hedging instrument with the changes in fair value of the designated hedged transactions. The Company expects the hedges to remain highly effective during the remaining terms of the swaps and did not recognize any hedge ineffectiveness in current earnings during the three or nine months ended September 30, 2017 and 2016.
Interest expense recorded on these swap transactions totaled $159,000 and $426,000 during the three and nine months ended September 30, 2017, respectively, and is reported as a component of interest expense on FHLB advances.
Interest expense recorded on swap transactions totaled $4,000 during the three and nine months ended September 30, 2016. At September 30, 2017, the Company estimates $249,000 of the unrealized gain to be reclassified as an increase to interest expense during the next twelve months.
The following table reflects the net gains (losses) recorded in accumulated other comprehensive income (loss) and the Consolidated Statements of Operations relating to the cash flow derivative instruments for the nine months ended September 30, 2017.
Amount of
Gain
Recognized in
OCI
(Effective
Portion)
Reclassified
from OCI to
Income as an
Increase to
Expense
Gain (Loss)
Non-Interest
(Ineffective
Interest rate swaps
(426
Other interest rate swaps—The total combined notional amount was $81.7 million with maturities ranged from January 2020 to August 2027. The fair values of the interest rate swap agreements are reflected in other assets and other liabilities with corresponding gains or losses reflected in non-interest income. During the three and nine months ended September 30, 2017, transaction fees related to these derivative instruments were $40,000 and $219,000, respectively. During the three and nine months ended September 30, 2016, transaction fees were $191,000 and $580,000, respectively.
The following table reflects other interest rate swaps as of September 30, 2017:
Notional amounts
Derivative assets fair value
Derivative liabilities fair value
Weighted average pay rates
4.26
Weighted average receive rates
3.68
Weighted average maturity
Credit risk—Derivative instruments are inherently subject to market risk and credit risk. Market risk is associated with changes in interest rates and credit risk relates to the Company’s risk of loss when the counterparty to a derivative contract fails to perform according to the terms of the agreement. Market and credit risks are managed and monitored as part of the Company’s overall asset-liability management process. The credit risk related to derivatives entered into with certain qualified borrowers is managed through the Company’s loan underwriting process. The Company’s loan underwriting process also approves the Bank’s swap counterparty used to mirror the borrowers’ swap. The Company has a bilateral agreement with each swap counterparty that provides that fluctuations in derivative values are to be fully collateralized with either cash or securities. The credit valuation adjustment (“CVA”) is a fair value adjustment to the derivative to account for this risk. During the three and nine months ended September 30, 2017, the CVA resulted in a decrease to non-interest income of $6,000 and $36,000, respectively. During the three and nine months ended September 30, 2016, the CVA resulted in a decrease to non-interest income of $14,000 and $51,000, respectively.
The Company has agreements with its derivative counterparties that contain a cross-default provision under which if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations. The Company also has agreements with certain derivative counterparties that contain a provision where if the Company fails to maintain its status as a well or adequately capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations resulted in a net asset position.
The Company records interest rate derivatives subject to master netting agreements at their gross value and does not offset derivative asset and liabilities on the Consolidated Statements of Financial Condition. The table below summarizes the Company’s interest rate derivatives and offsetting positions as of September 30, 2017:
Derivative
Gross amounts recognized
Less: Amounts offset in the Consolidated Statements of Financial Condition
Net amount presented in the Consolidated Statements of Financial Condition
Gross amounts not offset in the Consolidated Statements of Financial Condition
Offsetting derivative positions
(677
Collateral posted
(2,949
(502
Net credit exposure
Note 18 – Share-Based Compensation
In June 2017, the Company adopted the 2017 Omnibus Incentive Compensation Plan (the “Omnibus Plan”) in connection with our initial public offering (“IPO”). The Omnibus Plan provides for the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, dividend equivalent rights and other equity-based, equity-related or cash-based awards. A total of 1,550,000 shares of our common stock have been reserved and are available for issuance under the Omnibus Plan.
On July 6, 2017, in conjunction with the completion of the IPO, the Company granted 58,900 restricted shares of the Company’s voting common stock, par value of $0.01 per share, to certain key employees, pursuant to the Omnibus Plan. The restricted shares will cliff vest on the third anniversary of the grant date, subject to continued employment. Subsequent to the grant date, 400 restricted shares were forfeited. As of September 30, 2017, there were 1,491,500 shares available for future grants under the Omnibus Plan.
The following table discloses the changes in restricted shares for the nine months ended September 30, 2017:
Omnibus Plan
Number of Shares
Weighted Average Grant Date Fair Value
Granted
20.18
Vested
Forfeited
Ending balance outstanding at September 30, 2017
58,500
No restricted shares vested during the nine months ended September 30, 2017.
The Company recognizes share-based compensation based on the estimated fair value of the restricted stock at the grant date. Share-based compensation expense is included in non-interest expense in the Consolidated Statements of Operations. No restricted shares were outstanding in 2016.
The following table summarizes restricted stock compensation expense for the nine months ended September 30, 2017:
Total share-based compensation - restricted stock
Income tax benefit
Unrecognized compensation expense
1,087
Weighted-average amortization period remaining
2.8 years
In October 2017, the Company granted 7,500 restricted shares of the Company’s voting common stock, par value $0.01 per share, under the Omnibus Plan. These restricted shares will vest ratably over four years on each anniversary of the grant date, subject to continued employment.
The Company maintained a nonqualified, share-based, stock option plan adopted prior to recapitalization (“MBG Plan”). There were no options granted or exercised under this plan during the year ended December 31, 2016 or for the nine months ended September 30, 2017. At the time of the Company’s reincorporation in Delaware, in June 2017, the Board of Directors cancelled the MBG Plan and all outstanding options were cancelled.
In October 2014, the Company adopted the Byline Bancorp, Inc. Equity Incentive Plan (“BYB Plan”). The maximum number of shares available for grants under this Plan was 2,476,122 shares. During 2016 and 2015, the Company granted options to purchase 212,400 and 1,634,568 shares, respectively, under this plan. The Company did not grant any stock options during the nine months ended September 30, 2017. In June 2017, the Board of Directors terminated the BYB Plan and no future grants can be made under this plan. Options to purchase a total of 1,798,220 shares remain outstanding under the BYB Plan.
The types of stock options granted under the BYB Plan were Time Options and Performance Options. The exercise price of each option is equal to the fair value of the stock as of the date of grant. These option awards have vesting periods ranging from 1 to 5 years and have 10-year contractual terms. Stock volatility was computed as the average of the volatilities of peer group companies.
The vesting of Time Options is conditional based on completion of service. Performance Options have conditional vesting based on either performance targets or market performance. Certain Performance Options’ performance goals will be satisfied (in whole or in part) if the Bank achieves various performance targets such as profitability, asset quality, and conditional based on market performance, as outlined in the BYB Plan. Each of the performance goals identified are measured for achievement (or failure to achieve) independent of each other. In October 2017, the Board of Directors determined that the Performance Option goals were satisfied, in whole, and these Performance Options converted to Time Options. As a result of the previous completion of service, 414,894 performance options vested on October 3, 2017.
The fair values of the stock options were determined using the Black-Scholes-Merton model for Time Options and a Monte Carlo simulation model for Performance Options. The fair values of options under the BYB Plan were determined using the following assumptions as of the grant dates:
Time Options Grants
2015
Risk-free interest rate
1.34% - 1.40%
1.68% - 1.85%
Expected term (years)
5.2 - 5.6
5.7 - 6.3
Expected stock price volatility
20.39
16.18%-16.55%
Expected dividend yield
0.00
Weighted average grant date fair value
3.55
2.25
Performance Options Grants
Implied forward rates
Variable
20.34% - 20.39%
3.75
1.65
The following table discloses the activity in shares subject to options and the weighted average exercise prices, in actual dollars, for the nine months ended September 30, 2017:
BYB Plan
Weighted Average Exercise Price
Intrinsic Value
Weighted Average Remaining Contractual Term (in Years)
1,798,220
11.95
15,788
9.8
Expired
Exercised
16,545
7.9
Exercisable at September 30, 2017
835,263
11.31
8,310
7.7
There were no stock options exercised during the nine months ended September 30, 2017. The total fair value of stock options vested during the nine months ended September 30, 2017 was $477,000.
The Company recognizes share-based compensation based on the estimated fair value of the option at the grant date. Forfeitures are estimated based upon industry standards. Share-based compensation expense is included in non-interest expense in the Consolidated Statements of Operations. The following table summarizes stock option compensation expense for the nine months ended September 30, 2017 and 2016:
Total share-based compensation – stock options
857
348
1,074
1,431
1.2 years
2.0 years
Note 19—Earnings per Share
A reconciliation of the numerators and denominators for earnings per common share computations is presented below. Incremental shares represent outstanding stock options for which the exercise price is less than the average market price of the Company’s common stock during the periods presented. Options to purchase 1,798,223 shares of common stock were outstanding as of September 30, 2017 and 2016. There were 58,500 restricted stock awards outstanding at September 30, 2017. There were no restricted stock awards outstanding at September 30, 2016.
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The following represent the calculation of basic and diluted earnings per share:
Three Months Ended September 30,
Less: Dividends on preferred shares
Net income available to common stockholders
Weighted-average common stock outstanding:
Weighted-average common stock outstanding (basic)
Incremental shares
505,431
265,623
503,816
Weighted-average common stock outstanding (dilutive)
Basic earnings per common share
Diluted earnings per common share
Note 20—Stockholders’ Equity
A summary of the Company’s preferred and common stock at September 30, 2017 and December 31, 2016 is as follows:
Series A non-cumulative perpetual preferred stock
Par value
0.01
Shares authorized
Shares issued
Shares outstanding
Series B 7.5% fixed non-cumulative perpetual
preferred stock
50,000
9,388
Subscription receivable
Common stock, voting
150,000,000
During 2016, the Company authorized and issued Series B 7.50% fixed-to-floating non-voting, noncumulative perpetual preferred stock with a liquidation preference of $1,000 per share, plus the amount of unpaid dividends, if any, which is redeemable at the Company’s option on or after March 31, 2022. Holders of either Series A or Series B preferred stock do not have any rights to convert such stock into shares of any other class of capital stock of the Company.
On January 30, 2017, the Company issued an additional 1,050 shares of Series B preferred stock, which is reflected as a subscription receivable as of December 31, 2016. For the nine months ended September 30, 2017, the Company declared and paid dividends on the Series B preferred stock of $580,000.
On May 31, 2017, the Company filed a registration statement on Form S-1with the SEC in connection with its initial public offering (the ”Registration Statement”), which was subsequently amended on June 19, 2017. The Registration Statement was declared effective by the SEC on June 29, 2017. In connection with the IPO, the Company issued 4,630,194 shares of common stock, par value $0.01 per share, which included 855,000 shares sold pursuant to the underwriters’ exercise of their option to purchase additional shares. The securities were sold at a price to the public of $19.00 per share and
began trading on the New York Stock Exchange on June 30, 2017. On July 6, 2017, the closing date of the IPO, the Company received net proceeds of $82.7 million.
On June 14, 2017, the Company’s stockholders approved the reincorporation of the Company to a Delaware corporation. Under the terms of the merger agreement, the Company reincorporated from Illinois to Delaware by merging with and into Byline Bancorp, Inc. Delaware (“Byline Delaware”), with Byline Delaware surviving (such transaction, the “Merger”). Each share of Company common stock issued and outstanding immediately prior to the effective time of the Merger, was converted automatically into the right to receive one fifth (0.20) of a share of common stock of Byline Delaware. There were no fractional shares issued in connection with the Merger. The reincorporation and share conversion are retrospectively reflected in the consolidated financial statements.
On June 16, 2017, after obtaining the necessary approval from the Federal Reserve, the Board of Directors of Byline Delaware unanimously approved the repurchase of all of the Company’s outstanding Series A preferred stock at a purchase price per share representing a liquidation value of $1,000 per share, equal to the cash value of (i) 89.469 shares of the Company’s common stock, multiplied by (ii) the initial public offering price of the common stock of $19.00 per share. On July 14, 2017, the Company completed the repurchase of all of the Series A Preferred Stock for $25.5 million. The $10.5 million excess of the purchase price over the carrying value of the Series A was recorded as a dividend.
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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is a discussion and analysis of Byline Bancorp, Inc.’s financial condition and results of operations and should be read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this report. The words “the Company,” “we,” “our” and “us” refer to Byline Bancorp, Inc. and its consolidated subsidiaries, unless we indicate otherwise.
Overview
Our business
We are a bank holding company headquartered in Chicago, Illinois and conduct all our business activities through our subsidiary, Byline Bank, a full service commercial bank, and Byline Bank’s subsidiaries. Through Byline Bank, we offer a broad range of banking products and services to small and medium sized businesses, commercial real estate and financial sponsors and to consumers who generally live or work near our branches. In addition to our core commercial banking products, we provide small ticket equipment leasing solutions through Byline Financial Group, a wholly-owned subsidiary of Byline Bank, headquartered in Bannockburn, Illinois with sales offices in Texas, North Carolina, Florida, New York, Michigan and Arizona. Following our acquisition of Ridgestone Financial Services, Inc. (“Ridgestone”) in October 2016, we also participate in U.S. government guaranteed lending programs and originate U.S. government guaranteed loans. Byline Bank was the eighth most active originator of Small Business Administration (“SBA”) loans in the country and the most active SBA lender in Illinois and Wisconsin, as reported by the SBA for the year ended September 30, 2017.
We offer traditional retail deposit products through our branch network, along with online, mobile and direct banking channels. The wide variety of deposit products we offer include non-interest bearing accounts, interest-bearing demand products, savings accounts, money market accounts and certificates of deposit with original maturities ranging from seven days to five years. We also offer consumer lending products, including mortgage loans, home equity loans and other consumer loans to individuals through our branch network.
Recapitalization
In 2013, our predecessor, Metropolitan Bank Group (“Metropolitan”), experienced significant credit and financial losses resulting primarily from the collapse of real estate prices during the severe economic recession occurring during 2007 through 2009, in addition to a number of regulatory and other operational challenges. Despite deterioration in asset quality and financial performance, Metropolitan maintained a high quality deposit base, an attractive branch network and strong customer loyalty, which made it an ideal candidate for a turnaround.
An investment group raised $206.7 million in equity capital to recapitalize and gain control of Metropolitan through a series of transactions by which Metropolitan merged its multiple subsidiary banks into one and an investor group acquired voting common stock and Series A Preferred Stock of Metropolitan.
We accounted for the Recapitalization as a business combination in accordance with Accounting Standards Codification Topic 805, Business Combinations (“Topic 805”). The transaction qualified as a recapitalization under Section 368(a)(1)(E) of the Internal Revenue Code (the “Code”) and resulted in carryover treatment of the existing tax bases and tax loss carryforwards treatment of the existing tax bases and tax loss carryforwards, although the utilization of tax attributes (including net operating loss carryforwards and tax credits) became subject to limitations under Sections 382 and 383 of the Code. Accordingly, the assets acquired and liabilities assumed were recorded at their fair value on the date of acquisition. Fair value amounts were determined in accordance with the guidance provided in ASC Topic 820, Fair Value Measurements (“Topic 820”). In many cases, the determination of the fair value required management to make estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature.
As of the Recapitalization, which occurred on June 28, 2013, we had $2.5 billion in assets that were measured at fair value, including $1.3 billion in loans, $212.2 million in investment securities, $84.0 million of OREO and $29.7 million of core deposit intangible assets. We also acquired $2.3 billion of liabilities at fair value, including $2.2 billion of deposits and $36.9 million of borrowings. The Recapitalization resulted in goodwill of $21.2 million as the estimated fair value of liabilities assumed and consideration paid exceeded the estimated fair value of assets acquired. The goodwill is included within “Goodwill” in our consolidated statement of condition.
As of the Recapitalization, approximately 76.5%, or $1.0 billion, of the loans acquired in the Recapitalization were accounted for under ASC Topic 310-30, Accounting for Purchased Loans with Deteriorated Credit Quality. We also acquired loans with a fair value of $310.3 million that are accounted for under ASC Topic 310-20, Receivables—Nonrefundable Fees and Other Costs, as these specific loans did not exhibit deteriorated credit quality since origination or were loans to borrowers that had revolving privileges at the acquisition date.
Since the Recapitalization, we have added $1.5 billion in net originated loans and leases while significantly improving our asset quality to create a more diversified and balanced loan and lease portfolio. We aggressively reduced the level of non-performing loans and leases and other real estate owned in our portfolio as a percentage of loans and leases and real estate owned, declining to 1.4% as of September 30, 2017 and 1.1% as of December 31, 2016 from 28.2% as of March 31, 2013. In addition, we sought to optimize our deposit base by expanding the percentage of non-interest bearing deposits to total deposits, enhance online and mobile capabilities and broaden our cash management products to better meet our customers’ needs. Since the Recapitalization, we consolidated from 88 to 57 branches, reducing our costs with minimal deposit attrition, and improving our efficiency, including through the consolidation of multiple banking platforms into one. In addition to improving efficiency, consolidating our banking platforms allowed us to better manage our customer relationships and their banking activities while strengthening our governance and controls for compliance, legal and operational risk.
Small Ticket Leasing Acquisition
On October 10, 2014, Byline Bank acquired certain assets and liabilities related to the small ticket leasing operation of Baytree National Bank and Trust Company and Baytree Leasing Company LLC (collectively, “Baytree”). The purchase was accounted for under the acquisition method of accounting in accordance with ASC Topic 805 and resulted in lease financing receivables of $42.0 million and goodwill of $4.5 million. There are no contingent assets or liabilities remaining from the acquisition.
In a separate but related transaction, on September 3, 2014, Byline Bank purchased approximately $55.7 million of direct finance leases that Baytree had sold to a third party. We have grown our leasing portfolio to $172.3 million as of September 30, 2017.
Ridgestone Acquisition
On October 14, 2016, we completed the Ridgestone acquisition under the terms of a definitive merger agreement (the “Ridgestone Agreement”). As of the acquisition date, Ridgestone had $447.4 million in assets, including $347.3 million of loans, $14.7 million of loans held for sale, $27.2 million of securities, $21.5 million of servicing assets and total deposits of $358.7 million. Ridgestone’s loan portfolio was primarily comprised of the retained unguaranteed portion of U.S. government guaranteed loans as a participant in the SBA and USDA lending programs.
As a result of the acquisition, each share of Ridgestone common stock was converted into the right to receive, at the election of the shareholder and subject to proration under the terms of the Ridgestone Agreement, either cash or shares of our common stock, or a combination of both. Total consideration included aggregate cash consideration in the amount of $36.8 million and the issuance of 4,199,791 shares of our common stock valued at $16.25 per common share. There were no contingent assets or liabilities arising from the acquisition.
As a result of the Ridgestone acquisition, we:
•
Grew consolidated total assets from $2.8 billion to $3.3 billion as of October 14, 2016, after giving effect to acquisition accounting adjustments;
Increased total loans from $1.7 billion to $2.1 billion as of October 14, 2016;
Increased total deposits from $2.2 billion to $2.6 billion as of October 14, 2016;
Expanded our employee base from 684 full time equivalent employees to 834 full time equivalent employees as of October 14, 2016; and
Expanded our footprint through the addition of two full-service banking offices in Brookfield, Wisconsin, and Schaumburg, Illinois. In addition, Ridgestone had loan production offices located in Wisconsin (Green Bay and Wausau), Indiana (Indianapolis) and California (Newport Beach) where we continue to operate.
We determined that the Ridgestone acquisition constituted a business combination as defined by ASC Topic 805. Accordingly, the assets acquired and liabilities assumed were recorded at their fair value amount on the date of acquisition. Fair values were determined in accordance with the guidance provided in ASC Topic 820. The fair values may be adjusted through the end of the measurement period, which closes at the earlier of the Company receiving all necessary information to complete the acquisition or one year from the date of acquisition.
Strategic Branch Consolidation
During 2015 and 2016, we performed a strategic review of our existing core banking footprint. With technology improvements and changes to customers’ banking preferences, we examined branch growth potential, customer usage, branch profitability, services provided, markets served and proximity to other locations with a goal of minimizing customer impact and deposit runoff. Since the Recapitalization, our branch network has been reduced from 88 to 57. We will continue to strategically evaluate our locations based on our growth and profitability standards.
Our Initial Public Offering
On June 29, 2017, we commenced our initial public offering (the “IPO”) whereby we sold 4,630,194 shares of our common stock at a price to the public of $19.00 per share, resulting in net proceeds to us of $76.8 million after deducting offering related commissions and expenses. In addition, certain selling stockholders participated in the offering and sold an aggregate of 1,924,806 shares of our common stock at the same price per share. Our common stock is currently traded on the New York Stock Exchange under the symbol “BY”. We believe that the capital raised through our IPO will allow us to continue to grow our franchise and increase our market share among small businesses and middle-market companies in the markets we serve.
Critical Accounting Policies and Significant Estimates
Our accounting and reporting policies conform to GAAP and conform to general practices within the industry in which we operate. To prepare financial statements in conformity with GAAP, management makes estimates, assumptions and judgments based on available information. These estimates, assumptions and judgments affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgements are based on information available as of the date of the financial statements and, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statements. In particular, management has identified several accounting policies that, due to the estimates, assumptions and judgements inherent in those policies, are critical in understanding our financial statements.
These policies include (i) acquisition-related fair value computations, (ii) the carrying value of loans and leases, (iii) determining the provision and allowance for loan and lease losses, (iv) the valuation of intangible assets such as goodwill, servicing assets and core deposit intangibles, (v) the determination of fair value for financial instruments, including Other Than Temporary Impairment (“OTTI”) losses, (vi) the valuation of real estate held for sale and (vii) the valuation of or recognition of deferred tax assets and liabilities.
The Jumpstart Our Business Startups Act of 2012, or the JOBS Act, permits us an extended transition period for complying with new or revised accounting standards affecting public companies. We have elected to take advantage of this extended transition period, which means that the financial statements included in this report, as well as any financial statements that we file in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as we remain an emerging growth company or until we affirmatively and irrevocably opt out of the extended transition period under the JOBS Act.
The following is a discussion of the critical accounting policies and significant estimates that require us to make complex and subjective judgments. Additional information about these policies can be found in Note 1 of Byline’s Consolidated Financial Statements as of December 31, 2016 and 2015, included in our prospectus in connection with our initial public offering that we filed with the SEC on July 3, 2017.
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Business Combinations
We account for business combinations under the acquisition method of accounting in accordance with ASC Topic 805. We recognize the fair value of the assets acquired and liabilities assumed as of the date of acquisition, with any excess of the fair value of consideration provided over the fair value of the identifiable net tangible and intangible assets acquired recorded as goodwill. Transaction costs are expensed as incurred. Application of the acquisition method requires extensive use of accounting estimates and judgements to determine the fair values of the identifiable assets acquired and liabilities assumed at the acquisition date.
In accordance with ASC Topic 805, the acquiring company retains the right to make appropriate adjustments to the assets and liabilities of the acquired entity for information obtained during the measurement period about facts and circumstances that existed as of the acquisition date. The measurement period ends as of the earlier of (i) one year from the acquisition date or (ii) the date when the acquirer receives the information necessary to complete the business combination accounting.
Carrying Value of Loans and Leases
Our accounting methods for loans and leases differ depending on whether the loans and leases are new loans and leases, or acquired loans and leases; and for acquired loans, whether the loans were acquired at a discount as a result of credit deterioration since the date of origination.
Originated Loans and Leases
We account for originated loans and leases and purchased loans and leases not acquired through business combinations as originated loans. The new loans that management has the intent and ability to hold for the foreseeable future are reported at their outstanding principal balances net of any allowance for loan and lease losses, unamortized deferred fees and costs and unamortized premiums or discounts. The net amount of nonrefundable loan origination fees and certain direct costs associated with the lending process are deferred and amortized to interest income over the contractual lives of the new loans using methods which approximate the level yield method. Discounts and premiums are amortized or accreted to interest income over the estimated term of the new loans using methods that approximate the effective yield method. Interest income on new loans is accrued based on the unpaid principal balance outstanding.
Acquired Loans and Leases
Acquired loans and leases are recorded at fair value as of the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan and lease losses is not recorded at the acquisition date. Acquired loans are evaluated upon acquisition and classified as either acquired impaired or acquired non-impaired. Acquired impaired loans reflect evidence of credit deterioration since origination for which it is probable that all contractually required principal and interest will not be collected by us. Subsequent to acquisition, we periodically update for changes in cash flow expectations, and is reflected in interest income over the life of the loan as accretable yield. Any subsequent decreases in expected cash flow attributable to credit deterioration are recognized by recording a provision for loan and lease losses.
For acquired non-impaired loans and leases, the excess or deficit of the loan or lease principal balance over the fair value is recorded as a discount or premium at acquisition and is accreted through interest income over the life of the loan or lease. Subsequent to acquisition, these loans and leases are evaluated for credit deterioration and a provision for loan and lease losses would be recorded when probable loss is incurred. These loans and leases are evaluated for impairment consistent with originated loans and leases.
Provision and Allowance for Loan and Lease Losses
The provision for loan and lease losses reflects the amount required to maintain the allowance for loan and lease losses (“ALLL”) at an appropriate level based upon management’s evaluation of the adequacy of general and specific loss reserves.
The ALLL is maintained at a level that management believes is appropriate to provide for known and inherent incurred loan and lease losses as of the date of the Consolidated Statements of Financial Condition and we have established methodologies for the determination of its adequacy. The methodologies are set forth in a formal policy and take into consideration the need for an overall general valuation allowance as well as specific allowances that are determined on an
49
individual loan basis. We increase our ALLL by charging provisions for probable losses against our income and it is decreased by charge-offs, net of recoveries.
The evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. While management uses available information to recognize losses on loans and leases, changes in economic or other conditions may necessitate revision of the estimate in future periods.
The ALLL is maintained at a level management believes is sufficient to provide for probable losses based upon an ongoing review of the originated and acquired non-impaired loan and lease portfolios by portfolio category, which include consideration of actual loss experience, peer loss experience, changes in the size and risk profile of the portfolio, identification of individual problem loan and lease situations which may affect a borrower’s ability to repay, and evaluation of prevailing economic conditions.
For acquired impaired loans, a specific valuation allowance is established when it is probable that we will be unable to collect all of the cash flows expected at acquisition, plus the additional cash flows expected to be collected arising from changes in estimates after acquisition.
The originated and acquired non-impaired loans have limited delinquency and credit loss history and have not yet exhibited an observable loss trend. The credit quality of loans in these loan portfolios are impacted by delinquency status and debt service coverage generated by the borrowers’ businesses and fluctuations in the value of real estate collateral.
Acquired non-impaired loans and originated loans are considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreements. All acquired non-impaired loans and originated loans of $250,000 or greater with an internal risk rating of substandard or below and on non-accrual, as well as loans classified as TDR, are reviewed individually for impairment on a quarterly basis.
Goodwill and Intangible Assets
Goodwill represents the excess of the purchase consideration over the fair value of net assets acquired in connection with the Recapitalization and acquisitions using the acquisition method of accounting. Goodwill is not amortized but is periodically evaluated for impairment under the provisions of ASC Topic 350, Intangibles—Goodwill and Other (“ASC Topic 350”).
Impairment testing is performed by comparing the carrying value of the reporting unit with the fair value of the reporting unit. Our goodwill is allocated to Byline Bank, which is our only applicable reporting unit for the purposes of testing goodwill for impairment. We have selected November 30 as the date to perform the annual goodwill impairment test. Additionally, we perform a goodwill impairment evaluation on an interim basis when events or circumstances indicate impairment potentially exists.
Servicing assets are recognized separately when they are acquired through sales of loans or when the rights to service loans are purchased. When loans are sold, servicing assets are recorded at fair value in accordance with ASC Topic 860, Transfers and Servicing (“ASC Topic 860”). Fair value is based on market prices for comparable servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The fair value of servicing rights is highly sensitive to changes in underlying assumptions. Changes in the prepayment speed and discount rate assumptions have the most significant impact on the fair value of servicing rights. See Note 7 and Note 16 of our Unaudited Interim Condensed Consolidated Financial Statements as of September 30, 2017, included in this report, for additional information.
Core Deposit Intangible
Other intangible assets primarily consist of core deposit intangible assets. In valuing core deposit intangibles, we consider variables such as deposit servicing costs, attrition rates and market discount rates. Core deposit intangibles are reviewed annually or more frequently, when events or changes in circumstances occur that indicate that their carrying values
may not be recoverable. If the recoverable amount of the core deposit intangibles is determined to be less than its carrying value, we then measure the amount of impairment based on an estimate of the fair value at that time. We also evaluate whether the events or circumstances have occurred that warrant a revision to the remaining useful lives of intangible assets. In cases where a revision is deemed appropriate, the remaining carrying amounts of the intangible assets are amortized over the revised remaining useful life. Core deposit intangibles are currently amortized over a ten year period.
Fair value of Financial Instruments
ASC Topic 820, Fair Value Measurement defines fair value as the price that would be received to sell a financial asset or paid to transfer a financial liability in an orderly transaction between market participants at the measurement date.
The degree of management judgment involved in determining the fair value of assets and liabilities is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not available, management judgment is necessary to estimate fair value. In addition, changes in market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, we would use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement.
See Note 18 of Byline’s Consolidated Financial Statements as of December 31, 2016 and 2015, included in our prospectus in connection with our initial public offering that we filed with the SEC on July 3, 2017, for a complete discussion of our use of fair value of financial assets and liabilities and their related measurement practices.
Valuation of Real Estate Held for Sale
Other Real Estate Owned (OREO)
OREO includes real estate assets that have been acquired through, or in lieu of, loan foreclosure or repossession and are to be sold. OREO assets are initially recorded at fair value, less estimated costs to sell, of the collateral of the loan, on the date of foreclosure or repossession, establishing a new cost basis. Adjustments that reduce loan balances to fair value at the time of foreclosure or repossession are recognized as charge-offs in the allowance for loan and lease losses. Positive adjustments, if any, at the time of foreclosure or repossession are recognized, as a reduction, in non-interest expense. After foreclosure or repossession, management periodically obtains new valuations and real estate or other assets may be adjusted to a lower carrying amount, determined by the fair value of the asset, less estimated costs to sell. Any subsequent write-downs are recorded as a decrease in the asset and charged against other real estate owned valuation adjustments. Operating expenses of such properties, net of related income, are included in non-interest expense, and gains and losses on their disposition are included in non-interest expense. Gains on internally financed other real estate owned sales are accounted for in accordance with the methods stated in ASC Topic 360-20, Real Estate Sales (“ASC Topic 360-20”). Any losses on the sales of other real estate owned properties are recognized immediately.
Assets Held for Sale
Assets held for sale consist of former branch locations and real estate purchased for expansion. Assets are considered held for sale when management has approved a plan to sell the assets following a branch closure or other events. The properties are being actively marketed and transferred to assets held for sale based at the lower of its carrying value or its fair value, less estimated costs to sell. Adjustments to reduce the asset balances to fair value are recorded at the time of transfer and are recognized through a charge to non-interest expense.
Income Taxes
We use the asset and liability method to account for income taxes. The objective of the asset and liability method is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the income tax basis of our assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. Our annual tax rate is based on its income, statutory tax rates and available tax planning opportunities. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining tax expense and in evaluating tax positions, including evaluating uncertainties.
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Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss carryforwards. We review our deferred tax positions quarterly for changes which may impact realizability. We evaluate the recoverability of these future tax deductions by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. We use short and long-range business forecasts to provide additional information for our evaluation of the recoverability of deferred tax assets. It is our policy to recognize interest and penalties associated with uncertain tax positions, if applicable, as components of non-interest expense.
A deferred tax valuation allowance is established to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not that all or some of the deferred tax asset will not be realized. See Note 11 of Byline’s Consolidated Financial Statements as of December 31, 2016 and 2015, included in our prospectus in connection with our initial public offering that we filed with the SEC on July 3, 2017, for further information on income taxes.
Recently Issued Accounting Pronouncements
Refer to Note 2 of our Interim Unaudited Condensed Consolidated Financial Statements as of September 30, 2017, included in this report, for a description of recent accounting pronouncements, including the effective dates of adoption and anticipated effects on our results of operations and financial condition.
Primary Factors Used to Evaluate Our Business
As a financial institution, we manage and evaluate various aspects of both our results of operations and our financial condition. We evaluate the levels and trends of the line items included in our consolidated balance sheet and income statement as well as various financial ratios that are commonly used in our industry. We analyze these ratios and financial trends against our own historical performance, our budgeted performance and the final condition and performance of comparable financial institutions in our region. Comparison of our financial performance against other financial institutions is impacted by the accounting for acquired non-impaired and acquired impaired loans.
These factors and metrics described in this report may not provide an appropriate basis to compare our results or financial condition to the results or financial condition of other financial services companies, given our limited operating history and strategic acquisitions since the Recapitalization.
Results of Operations
Our results of operations depend substantially on net interest income, which is the difference between interest income on interest-earning assets, consisting primarily of interest income on loans and lease receivables, including accretion income on loans and leases, investment securities and other short-term investments, and interest expense on interest-bearing liabilities, consisting primarily of deposits and borrowings. Our results of operations are also dependent upon our generation of non-interest income, consisting primarily of income from fees and service charges on deposits, servicing fees, ATM and interchange fees, and net gains on sales of investment securities and loans. Other factors contributing to our results of operations include our provisions for loan and lease losses, income taxes, and non-interest expenses, such as salaries and employee benefits, occupancy and equipment expenses and other miscellaneous operating costs.
Our third quarter 2017 results reflect the positive impact of our efforts over the past year to continue to drive revenue growth and improve efficiencies. Compared to the third quarter of 2016, our total revenues increased by more than 65% while our efficiency ratio improved to 69.92% from 84.38%. As a result, we were able to deliver a 523.4% year-over-year increase in net income.
Selected Financial Data
As of or For the Three Months Ended September 30,
As of or For the Nine Months Ended September 30,
Summary of Operations
Non-interest income
Non-interest expense
Income before provision for income taxes
Provision (benefit) for income taxes
Earnings per Common Share
Weighted average common shares outstanding (basic)
Weighted average common shares outstanding (diluted)
Common shares outstanding
Key Ratios (annualized where applicable)
Net interest margin
4.18
3.37
4.07
3.46
Cost of deposits
0.19
0.20
Efficiency ratio(1)
69.92
84.38
67.76
86.88
Non-interest income to total revenues(2)
27.51
18.62
29.19
19.66
Non-interest expense to average assets
3.73
3.33
3.61
Return on average stockholders' equity
8.44
2.63
7.23
1.70
Return on average assets
1.17
0.23
0.91
0.14
Pre-tax pre-provision return on average assets(2)
1.47
0.48
1.58
0.40
Non-interest bearing deposits to total deposits
29.90
30.04
Deposits per branch
44,227
33,475
Loans and leases held for sale and loans and lease held for investment to total deposits
88.01
76.63
Deposits to total liabilities
88.58
89.83
Tangible book value per common share(2)
12.95
9.32
Asset Quality Ratios
Non-performing loans and leases to total loan and leases held for investment, net before ALLL
0.46
ALLL to total loans and leases held for investment, net before ALLL
0.72
0.38
0.65
Net charge-offs to average total loans and leases held for investment, net before ALLL
0.34
0.26
0.56
Acquisition accounting adjustments(3)
34,249
15,864
Capital Ratios
Common equity to assets
13.59
8.59
Tangible common equity to tangible assets(2)
11.73
7.04
Leverage ratio
9.29
Common equity tier 1 capital ratio
13.93
10.22
Tier 1 capital ratio
15.38
12.84
Total capital ratio
16.08
13.22
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Represents non-interest expense less amortization of intangible assets divided by net interest income and non-interest income.
(2)
Represents a non-GAAP financial measure. See “Reconciliation of non-GAAP Financial Measures” for a reconciliation of our non-GAAP measures to the most directly comparable GAAP financial measure.
(3)
Represents the remaining unamortized premium or unaccreted discount as a result of applying the fair value adjustment at the time of the business combination on acquired loans.
We reported consolidated net income for the three months ended September 30, 2017 of $9.8 million compared to net income of $1.6 million for the three months ended September 30, 2016, an increase of $8.2 million. Consolidated net income for the three months ended September 30, 2017, includes three months of our Small Business Capital operations, which was established with our acquisition of Ridgestone on October 14, 2016. The increase in earnings was due to a $10.5 million increase in net interest income, a $7.1 million increase in non-interest income, and a $1.4 million decrease in provision for income taxes, offset by an $8.7 million increase in non-interest expense and a $2.2 million increase in provision for loan and lease losses. The increase in non-interest expense was primarily due to increases in salaries and employee benefits of $5.0 million as a result of our expanded employee base resulting from the Ridgestone acquisition, a $543,000 increase in legal, audit and other professional fees, primarily due to the increased costs associated with being a public company, and an increase of $2.0 million in other non-interest expense, which included impairment charges on assets held for sale of $951,000. This charge was primarily related to the planned disposition of the former headquarters of Byline Bank. Benefit for income taxes recognized was $1.4 million during the three months ended September 30, 2017 compared to a provision for income taxes of $9,000 for same period in 2016. The decrease in income tax provision was primarily due to a state income tax benefit of $4.6 million during the quarter ended September 30, 2017, as a result of increased value to the deferred tax asset related to the Company’s Illinois net loss deduction.
For the three months ended September 30, 2017, net income available to common stockholders was $9.6 million or $0.33 per basic and $0.32 per diluted common share.
Our results of operations for the three months ended September 30, 2017 produced an annualized return on average assets of 1.17% and a return on average stockholders’ equity of 8.44%, compared to returns for the three months ended September 30, 2016 of 0.23% and 2.63%, respectively.
We reported consolidated net income for the nine months ended September 30, 2017 of $22.5 million compared to net income of $2.8 million for the nine months ended September 30, 2016, an increase of $19.7 million. Consolidated net income for the nine months ended September 30, 2017, includes nine months of our Small Business Capital operations. The increase in earnings was due to a $28.4 million increase in net interest income and a $22.1 million increase in non-interest income offset by a $19.5 million increase in non-interest expense and a $4.0 million increase in provision for loan and lease losses. The increase in non-interest expense was primarily due to increases in salaries and employee benefits of $16.0 million as a result of the Ridgestone acquisition, which was partially offset by lower net loss recognized on the sale of other real estate owned and related expenses of $1.3 million. Provision for income taxes recognized was $7.2 million for the nine months ended September 30, 2017 compared to a benefit for income taxes of $222,000 for same period in 2016.
During the second quarter of 2017, and in connection with our initial public offering, we agreed to repurchase all $15.0 million of our outstanding shares of Series A Preferred Stock for $25.5 million. The $10.5 million excess of consideration paid over the $15.0 million carrying amount of the Series A Preferred Stock was treated as a one-time dividend declaration on the Series A Preferred Stock. Both the dividend declared on the Series A Preferred Stock and the regular quarterly dividends paid on our Series B Preferred Stock are reflected in the reported net income available to common stockholders for the nine months ended September 30, 2017, which was $11.4 million, or $0.43 per basic and diluted common share. There were no preferred dividends declared or paid for the nine months ended September 30, 2016.
Our results of operations for the nine months ended September 30, 2017 produced an annualized return on average assets of 0.91% and a return on average shareholders’ equity of 7.23%, compared to returns for the nine months ended September 30, 2016 of 0.14% and 1.70%, respectively.
Net Interest Income
Net interest income, representing interest income less interest expense, is a significant contributor to our revenues and earnings. We generate interest income from interest and dividends on interest-earning assets, which include loans, leases and investment securities we own. We incur interest expense from interest paid on interest-bearing liabilities, which include
54
interest-bearing deposits, FHLB advances, junior subordinated debentures and other borrowings. To evaluate net interest income, we measure and monitor (i) yields on our loans and other interest-earning assets, (ii) the costs of our deposits and other funding sources, (iii) our net interest spread, and (iv) our net interest margin. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities. Net interest margin is calculated as the annualized net interest income divided by average interest-earning assets. Because non-interest-bearing sources of funds, such as non-interest-bearing deposits and stockholders’ equity, also fund interest-earning assets, net interest margin includes the benefit of these non-interest-bearing sources.
We also recognize income from the accretable discounts associated with the purchase of interest-earning assets. Because of the Recapitalization and the acquisition of Ridgestone, we derive a portion of our interest income from the accretable discounts on acquired loans. The accretion is recognized over the life of the loan and is impacted by changes in expected cash flows on the loan. This accretion will continue to have an impact on our net interest income as long as loans acquired with evidence of credit deterioration at acquisition represent a meaningful portion of our interest-earning assets. As of September 30, 2017, acquired loans with evidence of credit deterioration accounted for under ASC Topic 310-30, Accounting for Purchased Loans with Deteriorated Credit Quality, represented 15.4% of our total loan portfolio.
Changes in the market interest rates and interest rates 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 non-interest-bearing liabilities, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income. In addition, our interest income includes the accretion of the discounts on our acquired loans, which will also affect our net interest spread, net interest margin and net interest income.
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The following tables present, for the periods indicated, information about (i) average balances, the total dollar amount of interest income from interest-earning assets and the resultant average yields; (ii) average balances, the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rates; (iii) net interest income; (iv) the interest rate spread; and (v) the net interest margin. Yields have been calculated on a pre-tax basis (dollars in thousands).
For the Three Months Ended September 30,
Balance(5)
Inc / Exp
Yield /
Rate
48,354
106
0.87
31,794
0.31
Loans and leases(1)
2,193,076
5.60
1,660,323
4.57
Securities available-for-sale(2)
602,146
3,181
2.10
614,285
2,750
1.78
111,345
650
2.32
134,989
649
1.91
Tax-exempt securities
26,166
19,953
3.03
Total interest-earning assets
2,981,087
4.66
2,461,344
3.66
(14,570
(6,938
All other assets
340,669
220,494
TOTAL ASSETS
3,307,186
2,674,900
LIABILITIES AND STOCKHOLDERS’
EQUITY
Interest checking
186,447
0.06
185,583
0.07
Money market accounts
388,365
406,531
261
0.27
Savings
441,096
79
442,269
76
758,518
1,729
0.90
507,570
693
0.54
Total interest bearing deposits
1,774,426
0.47
1,541,953
222,800
1.51
173,141
Other borrowed funds
60,418
4.40
38,482
5.46
Total borrowings
283,218
1,520
2.13
211,623
729
1.37
Total interest bearing liabilities
2,057,644
0.70
1,753,576
0.41
Non-interest checking
748,523
653,642
Other liabilities
42,577
30,913
458,442
236,769
TOTAL LIABILITIES AND STOCKHOLDERS’
Net interest spread(3)
3.96
3.25
Net interest margin(4)
Net loan accretion impact on margin
2,166
1,185
Net interest margin excluding loan accretion(6)
3.89
3.18
Loan and lease balances are net of deferred origination fees and costs and initial direct costs. Non-accrual loans and leases are included in total loan and lease balances.
Interest income and rates exclude the effects of a tax equivalent adjustment to adjust tax exempt investment income on tax exempt investment securities to a fully taxable basis due to immateriality.
Represents the average rate earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.
(4)
Represents net interest income (annualized) divided by total average earning assets.
(5)
Average balances are average daily balances.
(6)
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For the Nine Months Ended September 30,
54,894
0.80
29,954
2,180,507
5.43
1,543,948
4.87
610,249
9,525
2.09
676,334
8,647
1.71
116,764
2,027
136,127
2,033
1.99
22,033
2.78
20,932
2,984,447
4.52
2,407,295
(12,715
(7,525
330,209
225,316
3,301,941
2,625,086
185,409
187,159
97
376,751
712
0.25
399,240
445,082
237
441,773
227
782,672
4,482
0.77
526,516
2,210
1,789,914
1,554,688
249,630
1.22
124,277
68,803
4.44
37,620
5.58
318,433
1.92
161,897
1,942
1.60
2,108,347
0.64
1,716,585
736,982
650,803
41,393
37,249
415,219
220,449
3.88
3.34
6,347
1,502
3.79
3.38
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Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following table sets forth the effects of changing rates and volumes on our net interest income during the periods shown. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Changes applicable to both volume and rate have been allocated to volume. Yields have been calculated on a pre-tax basis. The table below is a summary of increases and decreases in interest income and interest expense resulting from changes in average balances (volume) and changes in average interest rates (dollars in thousands):
Three Months Ended September 30, 2017
compared to Three Months Ended
Increase (Decrease) Due to
Volume
Interest income
81
7,567
4,285
11,852
Securities available for sale
(57
431
Securities held to maturity
(137
138
(20
Total interest income
7,451
4,936
12,387
Interest expense
(4
(12
462
1,036
562
487
1,049
244
(103
141
434
791
996
844
1,840
6,455
4,092
10,547
Includes loans and leases on non-accrual status.
Net interest income for the three months ended September 30, 2017 was $31.4 million compared to $20.9 million during the same period in 2016, an increase of $10.5 million, or 50.6%. The increase in interest income of $12.4 million was primarily a result of organic growth of the loan and lease portfolio and the Ridgestone acquisition. Interest expense increased by $1.8 million for the three months ended September 30, 2017 compared to the three months ended September 30, 2016, primarily due to additional FHLB advances and acquired time deposits, partially offset by fair value adjustments on time deposits as a result of the Ridgestone acquisition.
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Nine Months Ended September 30, 2017
compared to Nine Months Ended
149
25,787
6,389
32,176
(1,040
1,918
878
(338
332
(6
(51
24,580
8,678
33,258
(1
(44
(35
807
2,272
Total interest-bearing deposits
1,422
815
2,237
1,146
765
1,911
1,035
(320
715
2,181
2,626
3,603
1,260
4,863
20,977
7,418
28,395
Net interest income for the nine months ended September 30, 2017 was $90.8 million compared to $62.4 million during the same period in 2016, an increase of $28.4 million, or 45.5% . The increase in interest income of $33.2 million was primarily a result of organic growth of the loan and lease portfolio and the Ridgestone acquisition. Interest expense increased by $4.9 million for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016, primarily due to additional FHLB advances and acquired time deposits, partially offset by fair value adjustments on time deposits as a result of the Ridgestone acquisition.
The net interest margin for the three months ended September 30, 2017 was 4.18%, an increase of 81 basis points compared to 3.37% for the three months ended September 30, 2016. The net interest margin for the nine months ended September 30, 2017 was 4.07%, an increase of 61 basis points compared to 3.46% for the nine months ended September 30, 2016. The primary driver of the increase for the three and nine month periods was due to a favorable shift in the mix and yield of earning assets and an increase in loan accretion income. Net loan accretion income was $2.2 million for the three months ended September 30, 2017 compared to $1.2 million for the three months ended September 30, 2016. Net loan accretion income was $6.3 million for the nine months ended September 30, 2017 compared to $1.5 million for the nine months ended September 30, 2016.
Provision for Loan and Lease Losses
The provision for loan and lease losses represents a charge to earnings necessary to establish an allowance for loan and lease losses that, in management’s evaluation, is appropriate to provide coverage for probable losses incurred in the loan and lease portfolio. The allowance for loan and lease losses is increased by the provision for loan and lease losses and is decreased by charge-offs, net of recoveries on prior charge-offs.
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Provisions for loan and lease losses totaled $3.9 million and $1.7 million for the three months ended September 30, 2017 and 2016, respectively. Provisions for loan lease losses totaled $9.3 million and $5.3 million for the nine months ended September 30, 2017 and 2016, respectively. These increases reflect growth in the loan and lease portfolio during the periods as well as net impairment of certain acquired loans based on a periodic update of expected loan cash flows, which resulted in a reclassification of $6.9 million and $24.3 million from non-accretable to accretable yield that can be recognized over the life of the portfolio for the three and nine months ended September 30, 2017, respectively.
The ALLL as a percentage of loans and leases, net of acquisition accounting adjustments, increased from 0.51% at December 31, 2016, to 0.72% at September 30, 2017. The increase was primarily due to the change in loan and lease composition; the originated portfolio increased by $192.1 million to $1.5 billion at September 30, 2017 while the acquired portfolio decreased by $123.6 million for the same period.
Non-Interest Income
We reported non-interest income of $11.9 million and $4.8 million for the three months ended September 30, 2017 and 2016, respectively. The increase of $7.1 million was primarily due to gains on sales of government guaranteed loans through our Small Business Capital operation of $7.5 million. There were no gains on sales of government guaranteed loans during the three months ended September 30, 2016. This was partially offset by a decrease in gains on sales of securities available-for-sale of $802,000 during the three months ended September 30, 2016.
We reported non-interest income of $37.4 million and $15.3 million for the nine months ended September 30, 2017 and 2016, respectively. The increase of $22.1 million was primarily due to gains on sales of government guaranteed loans through our Small Business Capital operation of $24.0 million. There were no gains on sales of government guaranteed loans during the nine months ended September 30, 2016. This was partially offset by a decrease in gains on sales of securities available-for-sale of $3.2 million for the nine months ended September 30, 2016.
Fees and service charges on deposit
s
Net gains on sales of loans
Service charges and fees represent fees charged to customers for banking services, such as fees on deposit accounts, and include, but are not limited to, maintenance fees, insufficient fund fees, overdraft protection fees, wire transfer fees and other fees. Fees and service charges on deposits decreased $47,000 for the three months ended September 30, 2017 compared to the same period in 2016. Fees and service charges on deposits decreased $242,000 for the nine months ended September 30, 2017 compared to the same period in 2016.
ATM and interchange fee income increased by $25,000 for the three months ended September 30, 2017 versus the three months ended September 30, 2016 and decreased $50,000 for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016.
While portions of the loans that we originate are sold and generate gain on sale revenue, servicing rights for the majority of loans that we sell are retained by Byline Bank. In exchange for continuing to service loans that have been sold, Byline Bank receives a servicing fee paid from a portion of the interest cash flow of the loan. As a result of the Ridgestone acquisition, we received $959,000 in servicing fees on the sold portion of the government guaranteed portfolio for the three months ended September 30, 2017, and $3.0 million for the nine months ended September 30, 2017. We did not receive servicing fees during the three or nine months ended September 30, 2016.
We had no securities sales during the second or third quarters of 2017 and minimal securities sales during the first quarter of 2017. As a result, gains on sales of securities during the nine months ended September 30, 2017 were $8,000 compared to $3.2 million for the nine months ended September 30, 2016, and $802,000 for the three months ended September 30, 2016.
For the three and nine months ended September 30, 2017, net gains on sales of loans were $7.5 million and $24.0 million, respectively. We did not have a government guaranteed lending unit during the three and nine months ended September 30, 2016, prior to our acquisition of Ridgestone.
Other non-interest income was $547,000 for the three months ended September 30, 2017; a decrease of 48.0% compared to $1.1 million for the three months ended September 30, 2016. Other non-interest income was $2.1 million compared to $3.4 million for the nine months ended September 30, 2017 and 2016, respectively. The primary driver of the decrease was a decrease in gains on sales of assets held for sale of $778,000 and a decrease in customer swap fee income of $361,000, due to reduced volume.
Non-Interest Expense
Non-interest expense for the three months ended September 30, 2017 was $31.1 million compared to $22.4 million for the three months ended September 30, 2016, an increase of $8.7 million or 38.8%. Non-interest expense for the nine months ended September 30, 2017 was $89.2 million compared to $69.7 million for the nine months ended September 30, 2016, an increase of $19.5 million or 28.0%. These increases are primarily due to the additional expenses as a result of the acquisition of Ridgestone.
The following table presents the major components of our non-interest expense for the periods indicated (dollars in thousands):
Salaries and employee benefits, the single largest component of our non-interest expense, totaled $16.3 million for the three months ended September 30, 2017, an increase of $5.0 million compared to the three months ended September 30, 2016. Salaries and employee benefits totaled $50.2 million for the nine months ended September 30, 2017, an increase of $16.0 million increase compared to the nine months ended September 30, 2016. These increases are primarily due to an addition in the number of employees as a result of the Ridgestone acquisition. Our staffing increased from 682 full-time equivalent employees as of September 30, 2016 to 824 as of September 30, 2017.
Occupancy expense increased $14,000 for the nine months ended September 30, 2017 from the same period in 2016 and decreased $57,000 for the three months ended September 30, 2017 compared to the same period in 2016. The decrease in occupancy expense for the three months ended September 30, 2017, was primarily as a result of our branch optimization
strategy in which we consolidated 28 branches during 2016, partially offset by increased expenses as a result of the Ridgestone acquisition.
Equipment expense for three months ended September 30, 2017 was $630,000 compared to $516,000 for the three months ended September 30, 2016, an increase of $114,000. Equipment expense for the nine months ended September 30, 2017 was $1.8 million compared to $1.5 million for the nine months ended September 30, 2016, an increase of $290,000. These increases are primarily due to increased depreciation expense related to increased investment in equipment and technology assets.
Loan and lease related expenses for the three months ended September 30, 2017 were $891,000 compared to $443,000 for the three months ended September 30, 2016, an increase of $448,000. Loan and lease related expenses for the nine months ended September 30, 2017 were $2.6 million compared to $1.1 million for the nine months ended September 30, 2016, an increase of $1.5 million. These increases are primarily due to the increased lending activity resulting from our Small Business Capital operations, partially offset by lower loan real estate tax expense for problem loans.
Legal, audit and other professional fees for the three months ended September 30, 2017 were $1.6 million compared to $1.1 million for the three months ended September 30, 2016, an increase of $543,000 or 50.9%. Legal, audit and other professional fees for the nine months ended September 30, 2017 were $4.4 million compared to $3.8 million for the nine months ended September 30, 2016, an increase of $584,000. These increases are primarily driven by increased legal and professional fees related to our costs associated with becoming a public company at the end of the second quarter of 2017.
Data processing expense for the three months ended September 30, 2017 was $2.4 million compared to $2.0 million for the three months ended September 30, 2016, an increase of $409,000, or 20.6%, and was $7.3 million for the nine months ended September 30, 2017 compared to $5.8 million for the same period during 2016. These increases are primarily due to increased data processing expenses related to the Ridgestone acquisition.
Net loss recognized on other real estate owned and other related expenses were $565,000 for the three months ended September 30, 2017, an increase of $273,000 compared to the same period in 2016. The increase is primarily due to lower gains on sales of other real estate owned properties, partially offset by lower write-downs of values, subsequent to transfer to OREO. Net loss recognized on other real estate owned and other related expenses for the nine months ended September 30, 2017 were $136,000 compared to OREO expense of $1.4 million for the nine months ended September 30, 2016. This decrease in net loss recognized on other real estate owned and other related expenses was primarily attributed to reduced OREO related expenses and an increase in gains on sales of other real estate owned.
Regulatory assessments for the three months ended September 30, 2017 were $326,000 compared to $502,000 for the same period in 2016, a decrease of $176,000 or 34.9%. Regulatory assessments for the nine months ended September 30, 2017 were $894,000 compared to $1.9 million for the same period in 2016, a decrease of $1.0 million or 53.7%. These decreases are primarily due to our improved risk profile as a result of improved capital ratios, performance and asset quality.
Advertising and promotions for the three months ended September 30, 2017 were $196,000 compared to $156,000 for same period in 2016, an increase of $40,000 and were $803,000 for the nine months ended September 30, 2017 compared to $454,000 for the same period in 2016, an increase of $349,000, primarily due to increased advertising and promotions, attributable to our Small Business Capital operations.
Telecommunications expense was $351,000 for the three months ended September 30, 2017 compared to $370,000 for the three months ended September 30, 2016, a decrease of $19,000. Telecommunications expense was $1.2 million for the nine months ended September 30, 2017, a decrease of $119,000 or 9.2% compared to the same period in 2016. These decreases are a result of our ongoing cost savings initiatives.
Other non-interest expense for the three months ended September 30, 2017 was $3.7 million compared to $1.7 million for the three months ended September 30, 2016, an increase of $2.0 million. During the third quarter of 2017, we incurred impairment charges on assets held for sale of $951,000, primarily related to the planned disposition of the former headquarters of Byline Bank. Our provision for unfunded commitments was $299,000 for the three months ended September 30, 2017 compared to a benefit of $14,000 for the three months ended September 30, 2016. This increase of $313,000 is primarily due to growth in our unfunded loan and lease commitments. Directors fees were $406,000 for the three
62
months ended September 30, 2017 compared to $307,000 for the three months ended September 30, 2016, an increase of $99,000.
Other non-interest expense was $7.2 million for the nine months ended September 30, 2017 compared to $5.5 million for the same period in 2016. In addition to incurring impairment charges on assets held for sale, travel and entertainment related expenses increased $368,000 to $786,000 for the nine months ended September 30, 2017, over the comparable period in 2016, primarily attributable to our Small Business Capital operations. Our provision for unfunded commitments was $272,000 for the nine months ended September 30, 2017 compared to $56,000 for the nine months ended September 30, 2016, an increase of $216,000, primarily due to growth in our unfunded loan and lease commitments.
Our efficiency ratio was 69.92% for the three months ended September 30, 2017, compared to 84.38% for the three months ended September 30, 2016. Our efficiency ratio was 67.76% for the nine months ended September 30, 2017, compared to 86.88% for the comparable period in 2016. The improvement in our efficiency ratio is primarily attributable to increased revenues resulting from our acquisition of Ridgestone and the continued organic growth of our loan and lease portfolios over the last 12 months.
We recorded a benefit for income taxes of $1.4 million for the three months ended September 30, 2017 compared to expense of $9,000 for the three months ended September 30, 2016. As part of a budget package passed by the Legislature of the State of Illinois, the corporate income tax rate increased from 5.25% to 7.00% effective July 1, 2017. As a result of the increase in the corporate income tax rate, we recorded a state income tax benefit of $4.6 million due to increased value of our deferred tax asset related to our Illinois net loss deduction.
Our provision for income taxes for the nine months ended September 30, 2017 totaled $7.2 million compared to a benefit of $222,000 for the nine months ended September 30, 2016. The increase in income tax expense is primarily due to the reversal of our deferred tax asset valuation allowance at the end of 2016 and the increase in taxable income for the three and nine months ended September 30, 2017 compared to the same periods in 2016. Our effective tax rate was 24.4% for the nine months ended September 30, 2017.
Financial Condition
Balance Sheet Analysis
Our total assets increased by $9.6 million, or 0.3%, to $3.3 billion at September 30, 2017, compared to December 31, 2016. The increase in total assets includes an increase of $68.5 million, or 3.2%, in loans and leases from $2.1 billion at December 31, 2016 to $2.2 billion at September 30, 2017. The increase in loans and leases was offset by a decrease in investment securities of $41.3 million to fund loan and lease growth. Due from counterparty increased $21.1 million related to loan sales not settled offset by a decrease in loans held for sale of $21.9 million.
Investment Portfolio
The investment securities portfolio consists of securities classified as available-for-sale and held-to-maturity. There were no trading securities in our investment portfolio as of September 30, 2017 or December 31, 2016. All available-for sale securities are carried at fair value and may be used for liquidity purposes should management consider it to be in our best interest. Securities available-for-sale consist primarily of residential mortgage-backed securities, commercial mortgage backed securities and U.S. government agencies securities.
Securities available-for-sale decreased $23.9 million, from $608.6 million at December 31, 2016 to $584.7 million at September 30, 2017. The decrease was primarily due to the redeployment of liquidity into higher yielding loans and leases.
The held-to-maturity securities portfolio consists of mortgage-backed securities and obligations of states, municipalities and political subdivisions. We carry these securities at amortized cost. As of September 30, 2017 this portfolio totaled $121.5 million compared to $138.8 million at December 31, 2016.
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We had no securities that were classified as having other than temporary impairment as of September 30, 2017 or December 31, 2016.
The following table summarizes the fair value of the available-for-sale and held-to-maturity securities portfolio as of the dates presented (dollars in thousands):
We did not classify any securities as trading securities during 2017 or 2016.
Certain securities have fair values less than amortized cost and, therefore, contain unrealized losses. At September 30, 2017, we evaluated the securities which had an unrealized loss for other than temporary impairment and determined all declines in value to be temporary. There were 113 investment securities with unrealized losses at September 30, 2017, of which only one had a continuous unrealized loss position for 12 consecutive months or longer that is greater than 5% of amortized cost. We anticipate full recovery of amortized cost with respect to these securities by maturity, or sooner, in the event of a more favorable market interest rate environment. We do not intend to sell these securities and it is not more likely than not that we will be required to sell them before recovery of their amortized cost basis, which may be at maturity.
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The following table (dollars in thousands) sets forth certain information regarding contractual maturities and the weighted average yields of our investment securities as of the dates presented. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
Maturity as of September 30, 2017
Due in One Year or Less
Due from One to Five Years
Due from Five to Ten Years
Due after Ten Years
Yield(1)
4,999
1.04
9,999
1.21
U.S. government agencies
39,235
1.40
14,996
1.83
Obligations of states,
municipalities, and political
290
3.27
4,583
2.81
16,639
2.52
11,107
Residential mortgage-backed
securities
16,818
1.61
312,964
1.97
3.19
Commercial mortgage-backed
11,596
1.84
60,594
2.18
2.61
16,280
10,813
3.44
1.25
2.17
70,862
2.20
445,558
2.16
1.50
2.45
2.89
3.29
107,194
2.68
Maturity as of December 31, 2016
1.16
50,180
1.41
10,000
1.74
2.48
5,172
3.31
6,720
3.05
4,179
20,101
1.66
356,699
3.28
11,969
66,985
2.15
13,254
4.55
3,811
2.46
1.11
3,622
3.43
83,601
1.98
53,140
1.80
483,653
1,731
2.19
14,268
8,879
2.82
2.23
3.32
122,847
The weighted average yields are based on amortized cost.
Total non-taxable securities classified as obligations of states, municipalities and political subdivisions were $27.5 million at September 30, 2017, an increase of $8.5 million from December 31, 2016.
There were no holdings of securities of any one issuer, other than U.S. government-sponsored entities and agencies, with total outstanding balances greater than 10% of our stockholders’ equity as of September 30, 2017 or December 31, 2016.
Restricted Stock
As a member of the Federal Home Loan Bank system, our bank is required to maintain an investment in the capital stock of the FHLB. No market exists for this stock, and it has no quoted market value. The stock is redeemable at par by the FHLB and is, therefore, carried at cost. In addition, our bank owns stock of Bankers’ Bank that was acquired as part of the Ridgestone acquisition. The stock is redeemable at par and carried at cost. As of September 30, 2017 and December 31, 2016, we held approximately $10.6 million and $15.0 million, respectively, in FHLB and Bankers’ Bank stocks. We evaluate impairment of our investment in FHLB and Bankers’ Bank based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. We did not identify any indicators of impairment of FHLB and Bankers’ Bank stock as of September 30, 2017 and December 31, 2016.
Loan and Lease Portfolio
Lending-related income is the most important component of our net interest income and is the main driver of the results of our operations. Total loans and leases at September 30, 2017 were $2.2 billion, an increase of $68.5 million compared to December 31, 2016. Our originated loan and lease portfolio increased $192.1 million, offset by a decrease in the acquired loan and lease portfolio of $123.6 million, during the first nine months of 2017. The growth in the originated loan and lease portfolio was primarily driven by increases in commercial real estate loans, commercial and industrial loans and leases, partially offset by decreases in construction, land development and other land loans.
We strive to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral. The following table shows our allocation of originated, acquired impaired and acquired non-impaired loans as of the dates presented (dollars in thousands):
% of Total
Originated loans
20.9
15.8
18.0
18.3
3.9
5.6
17.6
14.4
0.1
Leasing financing receivables
6.0
5.5
Total originated loans
66.5
59.7
Acquired impaired loans
7.8
9.7
6.9
8.2
0.2
0.3
0.5
0.6
0.0
15.4
18.8
Acquired non-impaired loans
10.2
11.6
1.5
1.9
0.7
4.5
5.4
1.7
Total acquired non-impaired loans
18.1
21.5
100.0
Total loans and leases, net of allowance for loan and lease losses
Loans collateralized by real estate comprised 69.4% and 72.1% of the loan and lease portfolio at September 30, 2017 and December 31, 2016, respectively. Commercial real estate loans comprised the largest portion of the real estate loan portfolio as of September 30, 2017 and December 31, 2016 and totaled $861.9 million, or 56.0%, of real estate loans and 38.9% of the total loan and lease portfolio at September 30, 2017. At December 31, 2016, commercial real estate loans totaled $796.3 million and comprised 51.4% of real estate loans and 37.1% of the total loan and lease portfolio. Acquired impaired commercial real estate loans continue to decrease from $207.3 million as of December 31, 2016 to $173.1 million as of September 30, 2017, or 16.5%.
Residential real estate loans totaled $582.7 million at September 30, 2017 compared to $610.7 million at December 31, 2016, a decrease of $28.1 million or 4.6%. The residential real estate loan portfolio comprised 37.9% and 39.5% of real estate
67
loans as of September 30, 2017 and December 31, 2016, respectively, and 26.3% and 28.4% of total loans and leases at September 30, 2017 and December 31, 2016, respectively. Acquired impaired residential real estate loans continue to decrease from $175.7 million as of December 31, 2016 to $152.1 million as of September 30, 2017, or 13.4%.
Construction, land development and other land loans totaled $94.3 million at September 30, 2017 compared to $140.8 million at December 31, 2016, a decrease of $46.5 million or 33.0%. The construction, land development and other land loan portfolio comprised 6.1% and 9.1% of real estate loans as of September 30, 2017 and December 31, 2016, respectively, and 4.2% and 6.6% of the total loan and lease portfolio as of September 30, 2017 and December 31, 2016, respectively.
Commercial and industrial loans totaled $502.1 million and $438.2 million at September 30, 2017 and December 31, 2016, respectively, an increase of $63.9 million or 14.6% primarily due to organic growth. The commercial and industrial loan portfolio comprised 22.7% and 20.4% of the total loan and lease portfolio as of September 30, 2017 and December 31, 2016, respectively.
Lease financing receivables comprised 7.8% and 7.4% of the loan and lease portfolio as of September 30, 2017 and December 31, 2016, respectively. Total lease financing receivables were $172.3 million and $159.0 million at September 30, 2017 and December 31, 2016, respectively, an increase of $13.3 million, or 8.4%, due to continued growth in our small-ticket vendor sales channels, and our increased syndication activities.
Loan Portfolio Maturities and Interest Rate Sensitivity
The following table shows our loan and lease portfolio by scheduled maturity at September 30, 2017 (dollars in thousands):
Due after One Year
Through Five Years
Due after Five Years
Floating
Fixed
14,158
28,802
123,502
175,718
23,926
96,914
17,560
80,789
53,925
227,473
17,991
32,995
9,317
30,722
10,702
9,635
32,130
14,909
211,436
116,703
1,629
602
469
2,794
120,532
10,867
28,867
113,116
349,651
471,801
268,253
242,310
48,136
468
110,779
359
5,331
8,033
40,340
555
87,188
21,423
121
1,221
3,508
133
404
2,737
259
3,106
4,044
173
267
92,482
1,388
202,728
3,140
30,260
12,602
20,286
46,670
3,387
1,747
151,570
6,669
5,503
9,368
9,288
1,159
464
678
1,662
874
3,368
5,187
1,338
12,454
298
77,646
3,468
31,651
3,029
34,505
12,791
90,689
25,129
6,233
230,554
Total loans
155,854
127,295
643,068
500,070
304,746
485,466
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At September 30, 2017, 49.8% of the loan and lease portfolio bears interest at fixed rates and 50.2% at floating rates. The expected life of our loan portfolio will differ from contractual maturities because borrowers may have the right to curtail or prepay their loans with or without penalties. Because a portion of the portfolio is accounted for under ASC 310-30, the carrying value is significantly affected by estimates and it is impracticable to allocate scheduled payments for those loans based on those estimates. Consequently, the tables above include information limited to contractual maturities of the underlying loans.
Allowance for Loan and Lease Losses
The ALLL is determined by us on a quarterly basis, although we are engaged in monitoring the appropriate level of the allowance on a more frequent basis. The ALLL reflects management’s estimate of probable incurred credit losses inherent in the loan and lease portfolios. The computation includes element of judgement and high levels of subjectivity.
Factors considered by us include, but are not limited to, actual loss experience, peer loss experience, changes in size and risk profile of the portfolio, identification of individual problem loan and lease situations which may affect a borrower’s ability to repay, and evaluation of the prevailing economic conditions. Changes in conditions may necessitate revision of the estimate in future periods.
We assess the ALLL based on three categories: (i) originated loans and leases, (ii) acquired non-impaired loans and leases, and (iii) acquired impaired loans with further credit deterioration after the acquisition or recapitalization.
Total ALLL was $16.0 million at September 30, 2017 compared to $10.9 million at December 31, 2016, an increase of $5.1 million, or 46.3%. The increase was primarily due to the overall portfolio growth and increased weighting of our qualitative factors.
Total ALLL was 0.72% and 0.51% of total loans and leases at September 30, 2017 and December 31, 2016, respectively. This ratio is generally below the median of our peer banks, as we valued significant amounts of acquired loans at fair value at acquisition date as a result of the Recapitalization and the Ridgestone acquisition, which, management believes limits the amount of reserves needed to cover these loans as of September 30, 2017 and December 31, 2016, in accordance with applicable accounting guidance. Acquisition accounting adjustments remaining balances resulting from the Recapitalization and the Ridgestone acquisition totaled $34.2 million and $43.2 million as of September 30, 2017 and December 31, 2016, respectively.
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The following table presents an analysis of the allowance of the loan and lease losses for the periods presented (dollars in thousands):
Real
Estate
Balance at June 30, 2017
Provision for acquired impaired loans
375
954
Provision for acquired non-impaired loans and leases
818
(18
613
78
1,592
Provision for originated loans
266
(89
(129
452
851
1,354
Total provision
Charge-offs for acquired impaired loans
(136
(395
Charge-offs for acquired non-impaired loans and leases
(627
(33
(1,075
Charge-offs for originated loans and leases
(829
Total charge-offs
Recoveries for acquired impaired loans
Recoveries for acquired non-impaired loans and leases
Recoveries for originated loans and leases
Total recoveries
Net charge-offs
186
161
763
1,889
Acquired non-impaired loans and leases
942
400
1,615
3,520
Originated loans and leases
2,088
1,013
3,359
Balance at September 30, 2017
Ending ALLL balance
Acquired non-impaired loans and leases and originated loans individually evaluated for impairment
Acquired non-impaired loans and leases and originated loans and leases collectively evaluated for impairment
Loans and leases ending balance
Total loans and leases at September 30, 2017, gross
Ratio of net charge-offs to average loans and leases outstanding during the period
0.03
0.02
0.11
Loans and leases ending balance as a percentage of total loans and leases, gross
7.81
6.86
0.24
0.52
15.46
0.67
0.09
1.06
30.40
19.34
3.98
21.86
0.12
7.78
83.48
70
Balance at December 31, 2016
2,017
1,039
3,229
827
(7
2,500
519
4,026
(679
(580
393
2,167
2,051
(321
(1,027
(128
(959
(500
(1,914
(482
(1,899
(2,381
814
477
1,762
1,326
4,249
0.10
71
Balance at June 30, 2016
205
(48
(1,307
(16
(5
(1,655
1,129
146
119
633
1,255
3,280
(64
(50
(42
(1,011
(1,738
144
Net charge-offs (recoveries)
1,078
513
1,672
448
494
74
203
989
546
549
451
1,407
952
3,906
Balance at September 30, 2016
Total loans and leases at September 30, 2016, gross
-0.01
10.91
10.83
0.44
22.59
0.37
0.55
21.96
25.53
6.08
14.24
9.00
76.86
72
Balance at December 31, 2015
2,965
(935
2,111
(1,117
(834
1,202
314
689
1,824
4,071
(3,251
(461
(74
(3,795
(171
(454
(629
(1,480
(2,586
143
388
4,262
632
77
6,479
0.04
73
Non-Performing Assets
Non-performing loans and leases include loans and leases 90 days past due and still accruing, loans and leases accounted for on a non-accrual basis and accruing restructured loans. Non-performing assets consist of non-performing loans and leases plus other real estate owned. Non-accrual loans and leases as of September 30, 2017 and December 31, 2016 totaled $15.1 million and $6.8 million, respectively. The increase of non-performing assets from December 31, 2016 to September 30, 2017 was primarily due to an increase in non-accrual loans of $8.3 million, primarily in the government guaranteed loan portfolio, partially offset by a decrease in other real estate owned of $2.7 million.
Total OREO held by us was $13.9 million as of September 30, 2017, a decrease of $2.7 million from December 31, 2016. The decrease in OREO resulted from dispositions of $8.0 million and valuation adjustments of $367,000, offset by additions to OREO through loan foreclosures totaling $5.7 million.
The following table sets forth the amounts of non-performing loans and leases, non-performing assets, and OREO at the dates indicated (dollars in thousands):
Non-accrual loans and leases(1)(2)(3)
Past due loans and leases 90 days or more and still
accruing interest
Accruing troubled debt restructured loans
1,631
Total non-performing loans and leases
16,752
7,386
Total non-performing assets
30,611
23,956
Total non-performing loans as a percentage of total loans
and leases
Total non-performing assets as a percentage of
total assets
0.93
Allowance for loan and lease losses as a percentage of
non-performing loans and leases
95.39
147.89
Includes $656,000 and $552,000 of non-accrual restructured loans at September 30, 2017 and December 31, 2016.
For the nine months ended September 30, 2017, $977,000 in interest income would have been recorded had non-accrual loans been current; the amount of interest we recorded on these loans was $186,000.
For the nine months ended September 30, 2017, $49,000 in interest income would have been recorded had troubled debt restructurings included within non-accrual loans been current.
Acquired impaired loans (accounted for under ASC 310-30) that are delinquent and/or on non-accrual status continue to accrue income provided the respective pool in which those assets reside maintains a discount and recognizes accretion income. The aforementioned loans are characterized as performing loans based on contractual delinquency. If the pool no longer has a discount and accretion income can no longer be recognized, any loan within that pool on non-accrual status will be classified as non-accrual for presentation purposes.
Total non-accrual loans increased by $8.3 million between December 31, 2016 and September 30, 2017 due to additional non-accrual loans primarily from the government guaranteed loan portfolio. The government guaranteed portion on non-accrual loans totaled $4.1 million at September 30, 2017.
Total accruing loans past due decreased from $14.1 million at December 31, 2016 to $7.5 million at September 30, 2017. The following table summarizes the recorded investment, unpaid principal balance, related allowance, average recorded investment, and interest income recognized for loans and leases considered impaired as of the periods indicated (dollars in thousands):
of
Non-ASC
310-30
with a
Specific
with no
Allocated
to
in
on
15,670
11,648
706
2,976
2,142
288
6,586
4,064
753
Total impaired loans held in portfolio,
net
8,366
15,152
8,975
305
2,527
1,346
1,393
1,430
Total impaired loans held in
portfolio, net
1,685
10,241
12,079
365
Total deposits at September 30, 2017 were $2.5 billion, representing an increase of $30.5 million, or 1.2%, compared to December 31, 2016. Non-interest bearing deposits were $753.7 million or 29.9% of total deposits, at September 30, 2017, an increase of $29.2 million or 4.0% compared to $724.5 million at December 31, 2016 or 29.1% of total deposits. Interest bearing transaction accounts increased $51.4 million for the first nine months of 2017. Time deposits decreased $50.0 million, or 6.4%, from $776.5 million at December 31, 2016 to $726.5 million at September 30, 2017. Core deposits remained stable at 86.2% of total deposits at September 30, 2017.
The increase in non-interest bearing deposits was driven by new deposit relationships. Our cost of deposits was 33 basis points during the third quarter of 2017 compared to 19 basis points during the third quarter of 2016, and 30 basis points during the second quarter of 2017. These increases are primarily attributed to an increase in interest rates on our time deposits. We had no brokered time deposits as of September 30, 2017 compared to $30.8 million at December 31, 2016.
As the time deposits we acquired as part of the Ridgestone acquisition mature, the acquisition accounting benefit to our cost of deposits declines. We anticipate a further decline in the fair value accounting adjustment benefit on our time deposits in the fourth quarter of 2017, although to a lesser extent than the impact in the third quarter 2017.
We gather deposits primarily through each of our 56 branch locations in the Chicago metropolitan area and one branch in Brookfield, Wisconsin. Through our branch network, online, mobile and direct banking channels, we offer a variety of deposit products including demand deposit accounts, interest-bearing products, savings accounts, and certificates of deposit.
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We offer competitive online, mobile and direct banking channels. Small businesses are a significant source of low cost deposits as they value convenience, flexibility and access to local decision makers that are responsive to their needs.
The following table shows the average balance amounts and the average rates paid on our deposits for the periods indicated (dollars in thousands):
For the Three Months
Ended September 30, 2017
Ended September 30, 2016
Non-interest-bearing deposits
Interest-bearing checking accounts
394,984
288,682
363,534
1.05
218,888
2,522,949
2,195,595
For the Nine Months
400,927
304,697
381,745
0.84
221,819
2,526,896
2,205,491
The following table shows time deposits and other time deposits of $100,000 or more by time remaining until maturity:
At September 30, 2017
Time Deposits
Three months or less
89,480
Over three months through six months
33,170
Over six months through 12 months
172,639
Over 12 months
53,275
Borrowed Funds
In addition to deposits, we also utilize FHLB advances as a supplementary funding source to finance our operations. The Bank’s advances from the FHLB are collateralized by residential, multi-family real estate loans and securities. At September 30, 2017 and December 31, 2016, our bank had borrowing capacity from the FHLB of $913.0 million and $961.8 million, respectively, subject to the availability of collateral. During the nine months ended September 30, 2017, outstanding FHLB advances decreased to $234.6 million, from $313.7 million at December 31, 2016.
The following table sets forth certain information regarding our short-term borrowings at the dates and for the periods indicated (dollars in thousands):
Federal Home Loan Bank advances:
Average balance outstanding
Maximum outstanding at any month-end period during
the year
374,487
190,000
Balance outstanding at end of period
183,000
Weighted average interest rate during period
Weighted average interest rate at end of period
Line of credit:
12,287
n/a
3.92
4.25
The following table shows the scheduled maturities of our Bank’s FHLB advances and weighted average interest rates at September 30, 2017 (dollars in thousands):
Scheduled Maturities
Average Rates
1.24
3.21
Customer Repurchase Agreements (Sweeps)
Securities sold under agreements to repurchase represent a demand deposit product offered to customers that sweep balances in excess of the FDIC insurance limit into overnight repurchase agreements. We pledge securities as collateral for the repurchase agreements. Securities sold under agreements to repurchase totaled $30.8 million at September 30, 2017, an increase of $13.6 million compared to December 31, 2016.
Liquidity
We manage liquidity based upon factors that include the amount of core deposits as a percentage of total deposits, the level of diversification of our funding sources, 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 undue loss, the amount of cash and liquid securities we hold and the re-pricing characteristics and maturities of our assets when compared to the re-pricing characteristics of our liabilities, the ability to securitize and sell certain pools of assets and other factors.
Our liquidity needs are primarily met by cash and investment securities positions, growth in deposits, cash flow from amortizing loan portfolios, and borrowings from the FHLB. For additional information regarding our operating, investing, and financing cash flows, see “Consolidated Statements of Cash Flows” in our Unaudited Interim Condensed Consolidated Financial Statements included elsewhere in this report.
As of September 30, 2017, we held $62.2 million in cash and cash equivalents. We maintain an investment securities portfolio of various holdings, types and maturities. We had securities available for sale of $584.7 million and securities held-to-maturity of $121.5 million as of September 30, 2017, including total unpledged securities of $480.9 million.
As of September 30, 2017, Byline Bank had maximum borrowing capacity from the FHLB of $1.1 billion and from the Federal Reserve Bank of $135.3 million. As of September 30, 2017, Byline Bank had open advances of $234.5 million and open letters of credit of $300,000, leaving us with available aggregate borrowing capacity of $1.0 billion. In addition, Byline Bank had uncommitted federal funds lines available of $40.0 million.
As of December 31, 2016, Byline Bank had maximum borrowing capacity from the FHLB of $961.8 million and from the Federal Reserve Bank of $110.6 million. As of December 31, 2016, Byline Bank had open advances of $313.5 million and open letters of credit of $400,000, leaving us with available aggregate borrowing capacity of $758.5 million. In addition, Byline Bank had an uncommitted federal funds line available of $20.0 million.
On October 13, 2016, we entered into a $30.0 million revolving credit agreement with The PrivateBank and Trust Company, now known as CIBC Bank USA (“CIBC”). As of December 31, 2016, this revolving line of credit had an outstanding balance of $20.7 million. On April 13, 2017, the revolving line of credit was amended to a non-revolving line of credit as long as the outstanding balance exceeds $5.0 million. When the outstanding balance reaches $5.0 million, the line of credit will be converted to a revolving line of credit with credit availability up to $5.0 million until maturity on October 12, 2017. On October 12, 2017 we amended the credit agreement, which extended the maturity date to October 11, 2018. The amended revolving line of credit bears interest at either LIBOR Rate plus 250 basis points or the Prime Rate minus 25 basis points, based on our election. As of September 30, 2017, the Company had no balance outstanding on the line of credit. We repaid the amount outstanding on the line of credit with a portion of the proceeds from our initial public offering during July 2017.
There are regulatory limitations that affect the ability of Byline Bank to pay dividends to the Company. See Note 21 of Byline’s Consolidated Financial Statements as of December 31, 2016 and 2015, included in our prospectus in connection with our initial public offering that we filed with the SEC on July 3, 2017, for additional information. Management believes that such limitations will not impact our ability to meet our ongoing short-term cash obligations.
Capital Resources
Stockholders’ equity at September 30, 2017 was $459.5 million compared to $382.7 million at December 31, 2016, an increase of $76.9 million, or 20.1%. The increase was primarily driven by the issuance of common stock, net of issuance costs of $76.8 million, in connection with our initial public offering on June 30, 2017 as well as retained earnings, offset by the repurchase of our Series A Preferred Stock totaling $25.5 million.
The Company and Byline Bank are subject to various regulatory capital requirements administered by federal banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by federal banking regulators that, if undertaken, could have a direct material effect on our financial statements.
Under applicable bank regulatory capital requirements, each of the Company and Byline Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Byline Bank must also meet certain specific capital guidelines under the prompt corrective action framework. The capital amounts and classification are subject to qualitative judgments by the federal banking regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and Byline Bank to maintain minimum amounts and ratios of CET1 Capital, Tier 1 capital and total capital to risk-weighted assets and of Tier 1 capital to average consolidated assets, (referred to as the “leverage ratio”), as defined under these capital requirements.
As of September 30, 2017, Byline Bank exceeded all applicable regulatory capital requirements and was considered “well-capitalized”. There have been no conditions or events since September 30, 2017 that management believes have changed Byline Bank’s classifications.
The regulatory capital ratios for the Company and Byline Bank to meet the minimum capital adequacy standards and for Byline Bank to be considered well capitalized under the prompt corrective action framework and the Company’s and Byline Bank’s actual capital amounts and ratios are set forth in the following tables as of the periods indicated (dollars in thousands).
Actual
Minimum Capital
Required
Required for the Bank
to be Considered
Well Capitalized
Ratio
Total capital to risk weighted assets:
Company
399,542
198,807
8.00
Bank
356,132
14.30
199,306
249,133
10.00
Tier 1 capital to risk weighted assets:
381,934
15.37
149,105
6.00
338,524
149,480
Common Equity Tier 1 (CET1) to risk weighted
assets:
346,052
111,829
4.50
112,110
161,937
6.50
Tier 1 capital to average assets:
127,796
4.00
10.57
128,135
160,169
5.00
316,314
13.28
190,257
325,465
13.61
191,267
239,084
304,324
12.78
142,895
313,474
13.11
143,450
266,760
11.20
107,171
107,588
155,404
10.07
120,850
10.35
121,169
151,461
The Company and Byline Bank must maintain a capital conservation buffer consisting of CET1 capital greater than 2.5% of risk-weighted assets above the required minimum risk-based capital levels in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. The capital conservation buffer requirement began to be phased in on January 1, 2016 when a buffer greater than 0.625% of risk-weighted assets was required, which amount increases each year until the buffer requirement is fully implemented on January 1, 2019. As of January 1, 2017 the capital conservation buffer requirement was 1.25%. The conservation buffers for the Company and Byline Bank exceed the fully phased in minimum capital requirement as of September 30, 2017.
Provisions of state and federal banking regulations may limit, by statute, the amount of dividends that may be paid to the Company by Byline Bank without prior approval of Byline Bank’s regulatory agencies. The Company is economically dependent on the cash dividends received from Byline Bank. These dividends represent the primary cash flow from operating activities used to service obligations. For the nine months ended September 30, 2017, the Company received $2.2 million in cash dividends from Byline Bank to pay the line of credit interest, the trust preferred securities interest and preferred dividends. There were no cash dividends received by the Company from Byline Bank for the year ended December 31, 2016.
Contractual Obligations
FHLB advances are fully described in Note 12 of our Unaudited Interim Condensed Consolidated Financial Statements, included elsewhere in this report. Operating lease obligations are in place for facilities and land on which banking facilities are located. See Note 15 of our Interim Unaudited Condensed Consolidated Financial Statements for additional information.
Off-Balance Sheet Items and Other Financing Arrangements
We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit, commercial letters of credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. The contractual or notional amounts of those instruments reflect the extent of involvement we have in particular classes of financial instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Byline Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral is primarily obtained in the form of commercial and residential real estate (including income producing commercial properties).
Standby letters of credit are conditional commitments issued by Byline Bank to guarantee to a third-party the performance of a customer. Those guarantees are primarily issued to support public and private borrowing arrangements, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Our exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. We use the same credit policies in making commitments and conditional obligations as for funded instruments. We do not anticipate any material losses as a result of the commitments and standby letters of credit.
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The following table summarizes commitments as of the dates presented (dollars in thousands).
During the nine months ended September 30, 2017 and for the year ended December 31, 2016, we entered into interest rate swaps that are used to manage differences in the amount, timing, and duration of our known or expected cash receipts and its known or expected cash payments principally related to certain variable rate borrowings. We also entered into interest rate swaps with certain qualified borrowers to facilitate the borrowers’ risk management strategies and concurrently entered into mirror-image derivatives with a third party counterparty.
We recognize derivative financial instruments at fair value regardless of the purpose or intent for holding the instrument. We record derivative assets and derivative liabilities on the Consolidated Statements of Financial Condition within other assets and other liabilities, respectively. Because the derivative assets and liabilities recorded on the balance sheet at September 30, 2017 do not represent the amounts that may ultimately be paid under these contracts, these assets and liabilities are listed in the table below (dollars in thousands):
Asset
Liability
Interest rate contracts—pay fixed, receive floating
Other interest rate swaps—pay fixed, receive floating
Non-GAAP Financial Measures
This report contains certain financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These measures include net interest margin excluding accretion income, non-interest income to total revenues, pre-tax pre-provision return on average assets, tangible book value per share, and tangible common equity to tangible assets. Management believes that these non-GAAP financial measures provide useful information to management and investors that is supplementary to the Company’s financial condition, results of operations and cash flows computed in accordance with GAAP; however, management acknowledges that our non-GAAP financial measures have a number of limitations. As such, these disclosures should not be viewed as a substitute for results determined in accordance with GAAP financial measures that we and other companies use. Management also uses these measures for peer comparison. See “Reconciliation of Non-GAAP Financial Measures” in the following schedule for a reconciliation of the non-GAAP financial measures to the comparable GAAP financial measures.
Management uses the net interest margin excluding accretion income to assess the impact of acquisition accounting adjustment on the net interest margin. Management uses this to better assess the impact of acquisition accounting adjustment on net interest margin, as the effect of the loan discount accretion over the life of the loan may fluctuate based on the size of the acquisition, the decrease of acquired loan balances, or changes in cash flows.
Non-interest income to total revenues is non-interest income divided by net interest income plus non-interest income. Management believes that it is standard practice in the industry to present non-interest income as a percentage of total revenue. Accordingly, management believes providing these measures may be useful for peer comparison.
Pre-tax pre-provision return on average assets is pre-tax income plus the provision for loan and lease losses, divided by average assets. Management believes this metric is important due to the tax benefit resulting from the reversal of the net deferred tax asset valuation allowance and demonstrates profitability excluding the tax benefit and excludes the provision for loan and lease losses.
Tangible book value per share is calculated as tangible common equity, which is stockholders’ equity reduced by preferred stock and goodwill and other intangible assets, divided by total shares of common stock outstanding. Management
believes this metric is important due to the relative changes in the book value per share exclusive of changes in intangible assets.
Tangible common equity to tangible assets is calculated as tangible common equity divided by tangible assets, which is total assets reduced by goodwill and other intangible assets. Management believes this measure is important to investors and analysts interested in relative changes in the ratio of total stockholders’ equity to total assets, each exclusive of changes in intangible assets.
Reconciliations of Non-GAAP Financial Measures
As of or For the Three Months
Ended September 30,
As of or For the Nine Months
Net interest margin:
Reported net interest margin
Effect of accretion income on acquired loans
(0.29
)%
(0.19
(0.28
(0.08
Net interest margin excluding accretion
Total revenues:
Add: Non-interest income
Total revenues
43,330
25,641
128,180
77,628
Non-interest income to total revenues:
Non-interest income to total revenues
18.63
Pre-tax pre-provision net income:
Pre-tax income
Add: Provision for loan and lease losses
Pre-tax pre-provision net income
12,265
3,257
39,015
7,940
Pre-tax pre-provision return on average assets:
Total average assets
Pre-tax pre-provision return on average assets
Tangible common equity:
Total stockholders' equity
Less: Preferred stock
Less: Goodwill
Less: Core deposit intangibles and other intangibles
20,100
Tangible common equity
379,598
190,313
Tangible assets:
2,747,929
Tangible assets
3,235,945
2,702,141
Tangible book value per share:
Shares of common stock outstanding
Tangible book value per share
Tangible common equity to tangible assets:
Tangible common equity to tangible assets
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Forward-Looking Statements
Statements contained in this Quarterly Report on Form 10-Q and in other documents we file with or furnish to the SEC that are not historical facts may constitute forward-looking statements within the meaning of the federal securities laws. Forward-looking statements include, without limitation, statements concerning plans, estimates, calculations, forecasts and projections with respect to the anticipated future performance of the Company and our business. These statements are often, but not always, made through the use of words or phrases such as ‘‘may’’, ‘‘might’’, ‘‘should’’, ‘‘could’’, ‘‘predict’’, ‘‘potential’’, ‘‘believe’’, ‘‘expect’’, ‘‘continue’’, ‘‘will’’, ‘‘anticipate’’, ‘‘seek’’, ‘‘estimate’’, ‘‘intend’’, ‘‘plan’’, ‘‘projection’’, ‘‘would’’, ‘‘annualized’’, “target” and ‘‘outlook’’, or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. Forward-looking statements represent management’s current beliefs and expectations regarding future events, such as our anticipated future financial results, credit quality, liquidity, revenues, expenses, or other financial items, and the impact of business plans and strategies or legislative or regulatory actions.
Our ability to predict results or the actual effects of future plans, strategies or events is inherently uncertain. Factors which could cause actual results or conditions to differ materially from those reflected in forward-looking statements include:
uncertainty regarding geopolitical developments and the U.S. and global economic outlook that may continue to impact market conditions or affect demand for certain banking products and services;
unforeseen credit quality problems or changing economic conditions that could result in charge-offs greater than we have anticipated in our allowance for loan and lease losses or changes in the value of our investments;
commercial real estate market conditions in the Chicago metropolitan area and southern Wisconsin;
deterioration in the financial condition of our borrowers resulting in significant increases in our loan and lease losses and provisions for those losses and other related adverse impacts to our results of operations and financial condition;
estimates of fair value of certain of our assets and liabilities, which could change in value significantly from period to period;
competitive pressures in the financial services industry relating to both pricing and loan structures, which may impact our growth rate;
unanticipated developments in pending or prospective loan and/or lease transactions or greater-than-expected paydowns or payoffs of existing loans;
inaccurate assumptions in our analytical and forecasting models used to manage our loan and lease portfolio;
unanticipated changes in monetary policies of the Federal Reserve or significant adjustments in the pace of, or market expectations for, future interest rate changes;
availability of sufficient and cost-effective sources of liquidity or funding as and when needed;
our ability to retain or the loss of key personnel or an inability to recruit appropriate talent cost-effectively;
adverse effects on our information technology systems resulting from failures, human error or cyberattack, including the potential impact of disruptions or security breaches at our third-party service providers, any of which could result in an information or security breach, the disclosure or misuse of confidential or proprietary information, significant legal and financial losses and reputational harm;
greater-than-anticipated costs to support the growth of our business, including investments in technology, process improvements or other infrastructure enhancements, or greater-than-anticipated compliance or regulatory costs and burdens;
83
the impact of possible future acquisitions, if any, including the costs and burdens of integration efforts;
the ability of the Company to receive dividends from its subsidiaries;
changes in SBA rules, regulations and loan products, including specifically the Section 7(a) program, changes in SBA standard operating procedures or changes to the status of Byline Bank as an SBA Preferred Lender;
changes in accounting principles, policies and guidelines applicable to bank holding companies and banking generally; or
the impact of a possible change in the Federal income tax rate on our deferred tax assets and provision for income tax expense.
These factors should be considered in evaluating forward-looking statements, and you should not place undue reliance on any forward-looking statements, which speak only as of the date they are made. You should also consider the risks, assumptions and uncertainties set forth in the “Risk Factors” section of this Form 10-Q and in our prospectus in connection with our initial public offering that we filed with the SEC on July 3, 2017, and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this Form 10-Q, as well as those set forth in our subsequent periodic and current reports filed with the SEC. We assume no obligation to update any of these statements in light of new information, future events or otherwise unless required under the federal securities laws.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Our primary market risk is interest rate risk, which is defined as the risk of loss of net interest income or net interest margin because of changes in interest rates.
We seek to measure and manage the potential impact of interest rate risk. Interest rate risk occurs when interest-earning assets and interest-bearing liabilities mature or re-price at different times, on a different basis or in unequal amounts. Interest rate risk also arises when our assets, liabilities and off-balance sheet contracts each respond differently to changes in interest rates, including as a result of explicit and implicit provisions in agreements related to such assets and liabilities and in off-balance sheet contracts that alter the applicable interest rate and cash flow characteristics as interest rates change. The two primary examples of such provisions that we are exposed to are the duration and rate sensitivity associated with indeterminate-maturity deposits (e.g., non-interest-bearing checking accounts, negotiable order of withdrawal (“NOW”) accounts, savings accounts and money market deposits accounts (“MMDAs”) and the rate of prepayment associated with fixed-rate lending and mortgage-backed securities. Interest rates may also affect loan demand, credit losses, mortgage origination volume and other items affecting earnings.
We are also exposed to interest rate risk through the retained portion of the SBA loans we make and the related servicing rights. Our SBA loan portfolio is comprised primarily of SBA 7(a) loans, virtually all of which are quarterly or monthly adjustable with the prime rate. The SBA portfolio reacts differently in a rising rate environment than our other non-guaranteed portfolios. Generally, when interest rates rise, the prepayments in the SBA portfolio tend to increase.
Our management of interest rate risk is overseen by our bank’s asset liability committee, and is chaired by Byline Bank’s Treasurer, based on a risk management infrastructure approved by our board of directors that outlines reporting and measurement requirements. In particular, this infrastructure sets limits and management targets, calculated monthly, for various metrics, including our economic value sensitivity, our economic value of equity and net interest income simulations involving parallel shifts in interest rate curves, steepening and flattening yield curves, and various prepayment and deposit duration assumptions. Our risk management infrastructure also requires a periodic review of all key assumptions used, such as identifying appropriate interest rate scenarios, setting loan prepayment rates based on historical analysis, non-interest-bearing and interest-bearing demand deposit durations based on historical analysis and the targeted investment term of capital.
We manage the interest rate risk associated with our interest-bearing liabilities by managing the interest rates and tenors associated with our borrowings from the FHLB and deposits from our customers that we rely on for funding. In particular, from time to time we use special offers on deposits to alter the interest rates and tenors associated with our interest-bearing liabilities. We manage the interest rate risk associated with our interest-earning assets by managing the interest rates and tenors associated with our investment and loan portfolios, from time to time purchasing and selling investment securities and selling residential mortgage loans in the secondary market.
We utilize interest rate swaps to hedge our interest rate exposure on commercial loans when it meets our client and Byline Bank needs. Typically, customer interest rate swaps are for terms of more than 5 years. As of September 30, 2017, we had a notional amount of $331.7 million of interest rate swaps outstanding which includes customer swaps and those on Byline Bank’s balance sheet. The overall effectiveness of our hedging strategies is subject to market conditions, the quality of our execution, the accuracy of our valuation assumptions, the associated counterparty credit risk and changes in interest rates.
We do not engage in speculative trading activities relating to interest rates, foreign exchange rates, commodity prices, equities or credit.
We are also subject to credit risk. Credit risk is the risk that borrowers or counterparties will be unable or unwilling to repay their obligations in accordance with the underlying contractual terms. We manage and control credit risk in the loan and lease portfolio by adhering to well-defined underwriting criteria and account administration standards established by management. Written credit policies document underwriting standards, approval levels, exposure limits and other limits or standards deemed necessary and prudent. Portfolio diversification at the obligor, industry, product and/or geographic location levels is actively managed to mitigate concentration risk. In addition, credit risk management also includes an independent credit review process that assesses compliance with commercial, real estate and other credit policies, risk ratings and other critical credit information. In addition to implementing risk management practices that are based upon established and sound
lending practices, we adhere to sound credit principles. We understand and evaluate our customers’ borrowing needs and capacity to repay, in conjunction with their character and history.
Evaluation of Interest Rate Risk
We use a net interest income simulation model to measure and evaluate potential changes in our net interest income. We run various hypothetical interest rate scenarios at least monthly and compare these results against a scenario with no changes in interest rates. Our net interest income simulation model incorporates various assumptions, which we believe are reasonable but which may have a significant impact on results such as: (1) the timing of changes in interest rates, (2) shifts or rotations in the yield curve, (3) re-pricing characteristics for market-rate-sensitive instruments on and off balance sheet, (4) differing sensitivities of financial instruments due to differing underlying rate indices, (5) the effect of interest rate limitations in our assets, such as floors and caps, (6) the effect of our interest rate swaps and (7) overall growth and repayment rates and product mix of assets and liabilities. Because of limitations inherent in any approach used to measure interest rate risk, simulation results are not intended as a forecast of the actual effect of a change in market interest rates on our results but rather as a means to better plan and execute appropriate asset-liability management strategies and manage our interest rate risk.
Potential changes to our net interest income in hypothetical rising and declining rate scenarios calculated as of September 30, 2017 is presented in the following table. The projections assume (1) immediate, parallel shifts downward of the yield curve of 100 basis points and immediate, parallel shifts upward of the yield curve of 100, 200, 300 and 400 basis points and (2) gradual shifts downward of 100 basis points over 12 months and gradual shifts upward of 100 and 200 basis points over 12 months. In the current interest rate environment, a downward shift of the yield curve of 200, 300 and 400 basis points does not provide us with meaningful results. In a downward parallel shift of the yield curve, interest rates at the short-end of the yield curve are not modeled to decline any further than 0%. For the dynamic balance sheet and rate shift scenarios, we assume interest rates follow a forward yield curve and then ramp it up by 1/12th of the total change in rates each month for twelve months.
Estimated Increase (Decrease) in Net Interest Income
Twelve Months Ending
Change in Market Interest Rates as of September 30, 2017
September 30, 2018
September 30, 2019
Immediate Shifts
+400 basis points
12.2
11.1
+300 basis points
10.4
+200 basis points
7.5
+100 basis points
4.0
-100 basis points
(6.4
(7.9
Dynamic Balance Sheet and Rate Shifts
3.6
(5.4
The results of this simulation analysis are hypothetical, and a variety of factors might cause actual results to differ substantially from what is depicted. For example, if the timing and magnitude of interest rate changes differ from those projected, our net interest income might vary significantly. Non-parallel yield curve shifts such as a flattening or steepening of the yield curve or changes in interest rate spreads, would also cause our net interest income to be different from that depicted. An increasing interest rate environment could reduce projected net interest income if deposits and other short-term liabilities re-price faster than expected or faster than our assets re-price. Actual results could differ from those projected if we grow assets and liabilities faster or slower than estimated, if we experience a net outflow of deposit liabilities or if our mix of assets and liabilities otherwise changes. Actual results could also differ from those projected if we experience substantially different repayment speeds in our loan portfolio than those assumed in the simulation model. Finally, these simulation results do not contemplate all the actions that we may undertake in response to potential or actual changes in interest rates, such as changes to our loan, investment, deposit, funding or hedging strategies.
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Item 4. Controls and Procedures.
The Company’s management, including our President and Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)), as of the end of the period covered by this report. Based on such evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that, as of September 30, 2017, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and is accumulated and communicated to the Company’s management, including our President and Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting during the quarter ended September 30, 2017, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
PART II-OTHER INFORMATION
Item 1. Legal Proceedings.
We operate in a highly regulated environment. From time to time we are a party to various litigation matters incidental to the conduct of our business. We are not presently party to any legal proceedings the resolution of which we believe would have a material adverse effect on our business, prospects, financial condition, liquidity, results of operation, cash flows or capital levels.
Item 1A. Risk Factors.
There have been no material changes from the risk factors previously disclosed in the “Risk Factors” section included in our prospectus dated June 29, 2017 that was filed with the SEC on July 3, 2017 pursuant to Rule 424(b)(4) under the Securities Act.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Unregistered Sales of Equity Securities
None.
Use of Proceeds from Registered Securities
On June 29, 2017, the Company sold 4,630,194 shares of its common stock in its initial public offering, including 855,000 shares of common stock pursuant to the underwriters’ exercise of their option to purchase additional shares to cover over-allotments. The aggregate offering price for the shares sold by the Company was $88.0 million, and after deducting $6.2 million of underwriting discounts and $5.0 million of offering expenses paid to third parties, the Company received total net proceeds of $76.8 million. In addition, certain selling stockholders participated in the offering and sold an aggregate of 1,924,806 shares of our common stock at an aggregate offering price of $36.6 million. All of the shares were sold pursuant to our Registration Statement on Form S-1, as amended (File No. 333- 218362) (the “Registration Statement”), which was declared effective by the SEC on June 29, 2017 and registered shares of our common stock with a maximum aggregate offering price of $137.7 million. Merrill Lynch, Pierce, Fenner & Smith Incorporated and Keefe, Bruyette & Woods, Inc. acted as joint book-running managers for the offering, and Piper Jaffray & Co., Sandler O’Neill + Partners, L.P. and Stephens Inc. acted as co-managers. Our common stock is currently traded on the New York Stock Exchange under the symbol “BY”.
There has been no material change in the planned use of proceeds from our initial public offering as described in our prospectus dated June 29, 2017 that was filed with the SEC on July 3, 2017 pursuant to Rule 424(b)(4) under the Securities Act. From the effective date of the Registration Statement through the date of the filing of this report, the Company used $25.5 million to repurchase all of its outstanding Noncumulative Perpetual Preferred Stock, Series A, on July 14, 2017 and $16.2 million to pay down its line of credit on July 6, 2017.
Item 3. Defaults Upon Senior Securities.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Item 6. Exhibits.
Exhibit No.
Description of Exhibit
3.1
Amended and Restated Certificate of Incorporation of Byline Bancorp, Inc. (incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1, as amended (File No. 333- 218362) filed on June 19, 2017)
3.2
Amended and Restated Bylaws of Byline Bancorp, Inc. (incorporated herein by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1, as amended (File No. 333- 218362) filed on June 19, 2017)
3.3
Certificate of Designations of Noncumulative Perpetual Preferred Stock, Series A (incorporated herein by reference to Exhibit 3.3 to the Company’s Registration Statement on Form S-1, as amended (File No. 333- 218362) filed on June 19, 2017)
3.4
Certificate of Designations of 7.50% Fixed-to-Floating Noncumulative Perpetual Preferred Stock, Series B (incorporated herein by reference to Exhibit 3.4 to the Company’s Registration Statement on Form S-1, as amended (File No. 333- 218362) filed on June 19, 2017)
4.1
Certain instruments defining the rights of holders of long-term debt securities of the registrant and its subsidiaries are omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K. The registrant hereby undertakes to furnish to the SEC, upon request, copies of any such instruments.
10.1
Form of Repurchase Agreement for Noncumulative Perpetual Preferred Stock, Series A (incorporated herein by reference to Exhibit 10.1 to the Company’s Form 8-K (File No. 001-38139) filed on July 17, 2017)
31.1
Certification of the Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, and Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of the Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, and Section 302 of the Sarbanes-Oxley Act of 2002
32.1(a)
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Financial information from the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2017, formatted in XBRL interactive data files pursuant to Rule 405 of Regulation S-T: (i)
Consolidated Statements of Condition; (ii) Consolidated Statements of Operations; (iii) Consolidated Statements of Comprehensive Income (Loss); (iv) Consolidated Statements of Changes in Stockholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements
(a) This exhibit shall not be deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 14, 2017
By:
/s/
Alberto J. Paracchini
President and Chief Executive Officer
(Principal Executive Officer)
Lindsay Corby
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
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