Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2021
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 1-12431
Unity Bancorp, Inc.
(Exact name of registrant as specified in its charter)
New Jersey
22-3282551
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
64 Old Highway 22, Clinton, NJ
08809
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code (908) 730-7630
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common stock
UNTY
NASDAQ
Securities registered pursuant to Section 12(g) of the Exchange Act: None
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, as amended, during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes ⌧ No ☐
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.:
Large accelerated filer ◻
Accelerated filer ◻
Nonaccelerated filer ⌧
Smaller reporting company ☒
Emerging Growth Company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act: Yes ☐ No ⌧
The number of shares outstanding of each of the registrant’s classes of common equity stock, as of April 30, 2021 common stock, no par value: 10,417,385 shares outstanding.
Page #
PART I
CONSOLIDATED FINANCIAL INFORMATION
ITEM 1
Consolidated Financial Statements (Unaudited)
3
Consolidated Balance Sheets at March 31, 2021 and December 31, 2020
Consolidated Statements of Income for the three months ended March 31, 2021 and 2020
4
Consolidated Statements of Comprehensive Income for the three months ended March 31, 2021 and 2020
5
Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2021 and 2020
6
Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020
7
Notes to the Consolidated Financial Statements
8
ITEM 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations
45
ITEM 3
Quantitative and Qualitative Disclosures about Market Risk
66
ITEM 4
Controls and Procedures
PART II
OTHER INFORMATION
Legal Proceedings
ITEM 1A
Risk Factors
67
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults upon Senior Securities
Mine Safety Disclosures
ITEM 5
Other Information
ITEM 6
Exhibits
68
EXHIBIT INDEX
69
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
SIGNATURES
70
2
PART I CONSOLIDATED FINANCIAL INFORMATION
ITEM 1 Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets
(Unaudited)
(In thousands)
March 31, 2021
December 31, 2020
ASSETS
Cash and due from banks
$
25,911
22,750
Federal funds sold and interest-bearing deposits
213,666
196,561
Cash and cash equivalents
239,577
219,311
Securities:
Debt securities available for sale (amortized cost of $32,549 in 2021 and $45,921 in 2020)
32,330
45,617
Equity securities with readily determinable fair values (amortized cost of $2,112 in 2021 and $2,112 in 2020)
2,221
1,954
Total securities
34,551
47,571
Loans:
SBA loans held for sale
8,809
9,335
SBA loans held for investment
38,296
39,587
SBA PPP loans
169,117
118,257
Commercial loans
853,078
839,788
Residential mortgage loans
448,149
467,586
Consumer loans
60,502
66,100
Consumer construction loans
90,497
87,164
Total loans
1,668,448
1,627,817
Allowance for loan losses
(22,965)
(23,105)
Net loans
1,645,483
1,604,712
Premises and equipment, net
20,043
20,226
Bank owned life insurance ("BOLI")
26,535
26,514
Deferred tax assets
9,116
9,183
Federal Home Loan Bank ("FHLB") stock
9,269
10,594
Accrued interest receivable
9,831
10,429
Goodwill
1,516
Prepaid expenses and other assets
8,897
8,858
Total assets
2,004,818
1,958,914
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits:
Noninterest-bearing demand
465,511
459,677
Interest-bearing demand
217,714
204,236
Savings
502,300
455,449
Time, under $100,000
272,298
264,671
Time, $100,000 to $250,000
94,933
95,595
Time, $250,000 and over
75,637
78,331
Total deposits
1,628,393
1,557,959
Borrowed funds
170,000
200,000
Subordinated debentures
10,310
Accrued interest payable
255
248
Accrued expenses and other liabilities
14,674
16,486
Total liabilities
1,823,632
1,785,003
Shareholders’ equity:
92,180
91,873
Retained earnings
98,331
90,669
Treasury stock
(8,791)
(7,442)
Accumulated other comprehensive loss
(534)
(1,189)
Total shareholders’ equity
181,186
173,911
Total liabilities and shareholders’ equity
Shares issued
10,996
10,961
Shares outstanding
10,422
10,456
Treasury shares
574
505
The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.
Consolidated Statements of Income
For the three months ended March 31,
(In thousands, except per share amounts)
2021
2020
INTEREST INCOME
24
188
FHLB stock
63
109
Taxable
292
511
Tax-exempt
10
22
302
533
SBA loans
783
985
1,730
—
10,474
9,933
5,128
5,770
857
960
1,215
1,107
20,187
18,755
Total interest income
20,576
19,585
INTEREST EXPENSE
Interest-bearing demand deposits
309
378
Savings deposits
431
951
Time deposits
1,463
2,447
Borrowed funds and subordinated debentures
355
565
Total interest expense
2,558
4,341
Net interest income
18,018
15,244
Provision for loan losses
500
1,500
Net interest income after provision for loan losses
17,518
13,744
NONINTEREST INCOME
Branch fee income
295
317
Service and loan fee income
625
376
Gain on sale of SBA loans held for sale, net
245
473
Gain on sale of mortgage loans, net
1,750
1,051
BOLI income
129
173
Net security gains (losses)
310
(170)
Other income
372
325
Total noninterest income
3,726
2,545
NONINTEREST EXPENSE
Compensation and benefits
6,063
5,439
Processing and communications
807
708
Occupancy
706
624
Furniture and equipment
649
655
Professional services
380
269
Advertising
268
290
Deposit insurance
214
88
Director fees
208
200
BSA expenses
168
Other loan expenses
143
89
Loan collection and OREO (recoveries) expenses
(49)
186
Other expenses
712
Total noninterest expense
9,802
9,323
Income before provision for income taxes
11,442
6,966
Provision for income taxes
2,946
1,598
Net income
8,496
5,368
Net income per common share - Basic
0.81
0.49
Net income per common share - Diluted
0.80
Weighted average common shares outstanding – Basic
10,437
10,883
Weighted average common shares outstanding – Diluted
10,565
11,037
Consolidated Statements of Comprehensive Income
For the three months ended
March 31, 2020
Income tax
Before tax
Net of tax
expense
amount
(benefit)
Other comprehensive income (loss) income
Debt securities available for sale:
Unrealized holding gains (losses) on securities arising during the period
395
306
(166)
(35)
(131)
Less: reclassification adjustment for gains (losses) on securities included in net income
65
(36)
(134)
Total unrealized gains on securities available for sale
85
61
1
Adjustments related to defined benefit plan:
Amortization of prior service cost
21
15
Total adjustments related to defined benefit plan
Net unrealized gains (losses) from cash flow hedges:
Unrealized holding gains (losses) on cash flow hedges arising during the period
228
579
(1,410)
(406)
(1,004)
Total unrealized gains (losses) on cash flow hedges
Total other comprehensive income (loss)
913
258
(1,385)
(399)
(986)
Total comprehensive income
12,355
3,204
9,151
5,581
1,199
4,382
Consolidated Statements of Changes in Shareholders’ Equity
For the three months ended March 31, 2021 and 2020
Accumulated
other
Total
Stock
Retained
comprehensive
Treasury
shareholders’
Shares
Amount
earnings
(loss) income
aa
stock
equity
Balance, December 31, 2020
Other comprehensive income, net of tax
Dividends on common stock ($0.08 per share)
30
(834)
(804)
Common stock issued and related tax effects (1)
36
277
Treasury stock purchased, at cost
(70)
(1,349)
Balance, March 31, 2021
income (loss)
Balance, December 31, 2019
10,881
90,113
70,442
154
160,709
Other comprehensive loss, net of tax
(871)
(841)
13
227
Acquisition of treasury stock, at cost
(11)
(172)
Balance, March 31, 2020
90,370
74,939
(832)
164,305
Consolidated Statements of Cash Flows
OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of purchase premiums and discounts on securities
62
59
Depreciation and amortization
469
PPP deferred fees and costs
1,937
Deferred income tax benefit
(191)
(347)
Net security gains
(43)
(301)
Stock compensation expense
374
365
Valuation writedowns on OREO
(2,001)
(622)
(245)
(473)
Origination of mortgage loans sold
(101,869)
(38,562)
Origination of SBA loans held for sale
(1,312)
(2,595)
Proceeds from sale of mortgage loans, net
103,870
39,184
Proceeds from sale of SBA loans held for sale, net
2,416
5,850
(129)
(173)
Net change in other assets and liabilities
(685)
1,714
Net cash provided by operating activities
11,649
11,484
INVESTING ACTIVITIES
Purchases of FHLB stock, at cost
(16,450)
(22,275)
Maturities and principal payments on debt securities available for sale
6,305
2,198
Proceeds from sales of debt securities available for sale
7,048
6,029
Proceeds from sales of equity securities
111
Proceeds from redemption of FHLB stock
17,775
27,405
Net increase in SBA PPP loans
(52,492)
Net decrease (increase) in loans
8,364
(17,277)
Proceeds from BOLI
107
117
Purchases of premises and equipment
(224)
Net cash used in investing activities
(29,567)
(3,858)
FINANCING ACTIVITIES
Net increase in deposits
70,434
128,504
Proceeds from new borrowings
130,000
109,000
Repayments of borrowings
(160,000)
(223,000)
Proceeds from exercise of stock options
80
34
Fair market value of shares withheld to cover employee tax liability
(177)
Dividends on common stock
Purchase of treasury stock
Net cash provided by financing activities
38,184
13,353
Increase in cash and cash equivalents
20,266
20,979
Cash and cash equivalents, beginning of period
158,016
Cash and cash equivalents, end of period
178,995
SUPPLEMENTAL DISCLOSURES
Cash:
Interest paid
2,550
4,559
Income taxes paid
3,320
1,782
Noncash investing activities:
Transfer of SBA loans held for sale to held to maturity
1,024
Capitalization of servicing rights
19
486
Notes to the Consolidated Financial Statements (Unaudited)
NOTE 1. Significant Accounting Policies
The accompanying Consolidated Financial Statements include the accounts of Unity Bancorp, Inc. (the "Parent Company") and its wholly-owned subsidiary, Unity Bank (the "Bank" or when consolidated with the Parent Company, the "Company"), and reflect all adjustments and disclosures which are generally routine and recurring in nature, and in the opinion of management, necessary for a fair presentation of interim results. The Bank has multiple subsidiaries used to hold part of its investment and loan portfolios and OREO properties. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior period amounts to conform to the current year presentation, with no impact on current earnings or shareholders’ equity. The financial information has been prepared in accordance with U.S. generally accepted accounting principles and has not been audited. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenues and expenses during the reporting periods. Actual results could differ from those estimates. Amounts requiring the use of significant estimates include the allowance for loan losses, valuation of deferred tax and servicing assets, the carrying value of loans held for sale and other real estate owned, the valuation of securities and the determination of other-than-temporary impairment for securities and fair value disclosures. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. The markets served by the Company have been significantly impacted by the COVID-19 pandemic, which started during the first quarter of 2020. The Company continues to assess the financial impact of the COVID-19 pandemic.
The interim unaudited Consolidated Financial Statements included herein have been prepared in accordance with instructions for Form 10-Q and the rules and regulations of the Securities and Exchange Commission (“SEC”) and consist of normal recurring adjustments necessary for the fair presentation of interim results. The results of operations for the three months ended March 31, 2021 are not necessarily indicative of the results which may be expected for the entire year. As used in this Form 10-Q, “we” and “us” and “our” refer to Unity Bancorp, Inc., and its consolidated subsidiary, Unity Bank, depending on the context. Certain information and financial disclosures required by U.S. generally accepted accounting principles have been condensed or omitted from interim reporting pursuant to SEC rules. Interim financial statements should be read in conjunction with the Company’s Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
Risks and Uncertainties
On March 11, 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic. The COVID-19 pandemic has adversely affected local, national and global economic activity. Actions taken to help mitigate the spread of COVID-19 include restrictions on travel, localized quarantines, and government-mandated closures of certain businesses. The spread of the outbreak has caused significant disruptions to the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates.
On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00 percent to 1.25 percent. This range was further reduced to 0 percent to 0.25 percent on March 16, 2020. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted to, among other provisions, provide emergency assistance for individuals, families and businesses affected by the COVID-19 pandemic. These reductions in interest rates and other effects of the COVID-19 pandemic may materially and adversely affect the Company’s financial condition and results of operations in future periods. It is unknown how long the adverse conditions associated with the COVID-19 pandemic will last and what the complete financial effect will be to the Company. It is possible that estimates made in the financial statements could be materially and adversely impacted as a result of these conditions.
On July 27, 2017, the U.K. Financial Conduct Authority, which regulates LIBOR, announced that it will no longer persuade or compel banks to submit rates for the calculation of LIBOR to the LIBOR administrator after 2021. The announcement also indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. Consequently, at this time, it is not possible to predict whether and to what extent banks will continue to provide LIBOR submissions to the LIBOR administrator or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable benchmark for certain loans and liabilities including our subordinated notes, what rate or rates may become accepted alternatives to LIBOR or the effect of any such changes in views or alternatives on the values of the loans and liabilities, whose interest rates are tied to LIBOR. Uncertainty as to the nature of such potential changes, alternative reference rates, the elimination or replacement of LIBOR, or other reforms may adversely affect the value of, and the return on our loans and our investment securities.
Other-Than-Temporary Impairment
The Company has a process in place to identify securities that could potentially incur credit impairment that is other-than-temporary. This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation. This evaluation considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, the intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, our ability and intent to hold the security for a forecasted period of time that allows for the recovery in value.
Management assesses its intent to sell or whether it is more likely than not that it will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired with no intent to sell and no requirement to sell prior to recovery of its amortized cost basis, the amount of the impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income. For debt securities where management has the intent to sell, the amount of the impairment is reflected in earnings as realized losses.
The present value of expected future cash flows is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best estimate cash flows vary depending on the type of security. The asset-backed securities cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees. The corporate bond cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond specific facts and circumstances including timing, security interests and loss severity.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
9
Loans
Loans Held for Sale
Loans held for sale represent the guaranteed portion of Small Business Administration (“SBA”) loans, excluding loans originated under the Paycheck Protection Program, and are reflected at the lower of aggregate cost or market value. The Company originates loans to customers under an SBA program that historically has provided for SBA guarantees of up to 90 percent of each loan. The Company generally sells the guaranteed portion of its SBA loans to a third party and retains the servicing, holding the nonguaranteed portion in its portfolio. The net amount of loan origination fees on loans sold is included in the carrying value and in the gain or loss on the sale. When sales of SBA loans do occur, the premium received on the sale and the present value of future cash flows of the servicing assets are recognized in income. All criteria for sale accounting must be met in order for the loan sales to occur; see details under the “Transfers of Financial Assets” heading above.
Servicing assets represent the estimated fair value of retained servicing rights, net of servicing costs, at the time loans are sold. Servicing assets are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on stratifying the underlying financial assets by date of origination and term. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment, if temporary, would be reported as a valuation allowance.
Serviced loans sold to others are not included in the accompanying Consolidated Balance Sheets. Income and fees collected for loan servicing are credited to noninterest income when earned, net of amortization on the related servicing assets.
Loans Held for Investment
Loans held for investment are stated at the unpaid principal balance, net of unearned discounts and deferred loan origination fees and costs. In accordance with the level yield method, loan origination fees, net of direct loan origination costs, are deferred and recognized over the estimated life of the related loans as an adjustment to the loan yield. Interest is credited to operations primarily based upon the principal balance outstanding.
Loans are reported as past due when either interest or principal is unpaid in the following circumstances: fixed payment loans when the borrower is in arrears for two or more monthly payments; open end credit for two or more billing cycles; and single payment notes if interest or principal remains unpaid for 30 days or more.
Nonperforming loans consist of loans that are not accruing interest as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt (nonaccrual loans). When a loan is classified as nonaccrual, interest accruals are discontinued and all past due interest previously recognized as income is reversed and charged against current period earnings. Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income. Loans may be returned to an accrual status when the ability to collect is reasonably assured and when the loan is brought current as to principal and interest.
Loans are charged off when collection is sufficiently questionable and when the Company can no longer justify maintaining the loan as an asset on the balance sheet. Loans qualify for charge-off when, after thorough analysis, all possible sources of repayment are insufficient. These include: 1) potential future cash flows, 2) value of collateral, and/or 3) strength of co-makers and guarantors. All unsecured loans are charged off upon the establishment of the loan’s nonaccrual status. Additionally, all loans classified as a loss or that portion of the loan classified as a loss is charged off. All loan charge-offs are approved by the Board of Directors.
Troubled debt restructurings ("TDRs") occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. Interest income on
accruing TDRs is credited to operations primarily based upon the principal amount outstanding, as stated in the paragraphs above.
The Company evaluates its loans for impairment. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company has defined impaired loans to be all TDRs and nonperforming loans individually evaluated for impairment. Impairment is evaluated in total for smaller-balance loans of a similar nature (consumer and residential mortgage loans), and on an individual basis for all other loans. Impairment of a loan is measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or as a practical expedient, based on a loan’s observable market price or the fair value of collateral, net of estimated costs to sell, if the loan is collateral-dependent. If the value of the impaired loan is less than the recorded investment in the loan, the Company establishes a valuation allowance, or adjusts existing valuation allowances, with a corresponding charge to the provision for loan losses.
For additional information on loans, see Note 8 to the Consolidated Financial Statements and the section titled "Loan Portfolio" under Item 2. Management’s Discussion and Analysis.
Allowance for Loan Losses and Reserve for Unfunded Loan Commitments
The allowance for loan losses is maintained at a level management considers adequate to provide for probable loan losses as of the balance sheet date. The allowance is increased by provisions charged to expense and is reduced by net charge-offs.
The level of the allowance is based on management’s evaluation of probable losses in the loan portfolio, after consideration of prevailing economic conditions in the Company’s market area, the volume and composition of the loan portfolio, and historical loan loss experience. The allowance for loan losses consists of specific reserves for individually impaired credits and TDRs, reserves for nonimpaired loans based on historical loss factors and reserves based on general economic factors and other qualitative risk factors such as changes in delinquency trends, industry concentrations or local/national economic trends. This risk assessment process is performed at least quarterly, and, as adjustments become necessary, they are realized in the periods in which they become known.
Although management attempts to maintain the allowance at a level deemed adequate to provide for probable losses, future additions to the allowance may be necessary based upon certain factors including changes in market conditions and underlying collateral values. In addition, various regulatory agencies periodically review the adequacy of the Company’s allowance for loan losses. These agencies may require the Company to make additional provisions based on their judgments about information available to them at the time of their examination.
The Company maintains an allowance for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the allowance are made through other expenses and applied to the allowance which is maintained in other liabilities.
For additional information on the allowance for loan losses and unfunded loan commitments, see Note 9 to the Consolidated Financial Statements and the sections titled "Asset Quality" and "Allowance for Loan Losses and Reserve for Unfunded Loan Commitments" under Item 2. Management’s Discussion and Analysis.
Income Taxes
The Company accounts for income taxes according to the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates applicable to taxable income for the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
11
Valuation reserves are established against certain deferred tax assets when it is more likely than not that the deferred tax assets will not be realized. Increases or decreases in the valuation reserve are charged or credited to the income tax provision. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that ultimately would be sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. The evaluation of a tax position taken is considered by itself and not offset or aggregated with other positions. Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
Interest and penalties associated with unrecognized tax benefits would be recognized in income tax expense on the income statement.
NOTE 2. Litigation
The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. In the best judgment of management, based upon consultation with counsel, the consolidated financial position and results of operations of the Company will not be affected materially by the final outcome of any pending legal proceedings or other contingent liabilities and commitments.
NOTE 3. Net Income per Share
Basic net income per common share is calculated as net income divided by the weighted average common shares outstanding during the reporting period.
Diluted net income per common share is computed similarly to that of basic net income per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares, principally stock options, were issued during the reporting period utilizing the Treasury stock method. However, when a net loss rather than net income is recognized, diluted earnings per share equals basic earnings per share.
The following is a reconciliation of the calculation of basic and diluted income per share:
Weighted average common shares outstanding - Basic
Plus: Potential dilutive common stock equivalents
128
Weighted average common shares outstanding - Diluted
Stock options and common stock excluded from the income per share calculation as their effect would have been anti-dilutive
363
12
NOTE 4. Income Taxes
The Company follows FASB ASC Topic 740, “Income Taxes,” which prescribes a threshold for the financial statement recognition of income taxes and provides criteria for the measurement of tax positions taken or expected to be taken in a tax return. ASC 740 also includes guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition of income taxes.
On July 1, 2018, New Jersey’s Assembly Bill 4202 was signed into law. The bill, effective January 1, 2018, imposed a temporary surtax on corporations earning New Jersey allocated taxable income in excess of $1 million at a rate of 2.5 percent for tax years beginning on or after January 1, 2018, through December 31, 2019, and at 1.5 percent for tax years beginning on or after January 1, 2020, through December 31, 2021. In addition, New Jersey adopted mandatory unitary combined reporting for its Corporation Business Tax, which became effective for periods on or after January 1, 2019.
On September 29, 2020, New Jersey’s Assembly Bill 4721 was signed into law. The bill, retroactively effective January 1, 2020, extends the 2.5% corporate income surtax until December 31, 2023. The Division of Taxation will waive any underpayment penalties on 2020 estimated tax payments related to the retroactive increase. In addition, if the federal corporate tax rate is increased to a rate of at least 35% of taxable income, the surtax will be suspended.
For the quarter ended March 31, 2021, the Company reported income tax expense of $2.9 million for an effective tax rate of 25.7 percent, compared to an income tax expense of $1.6 million and an effective tax rate of 22.9 percent for the prior year’s quarter. The Company did not recognize or accrue any interest or penalties related to income taxes during the three months ended March 31, 2021 or 2020. The Company did not have an accrual for uncertain tax positions as of March 31, 2021 or December 31, 2020, as deductions taken and benefits accrued are based on widely understood administrative practices and procedures and are based on clear and unambiguous tax law. Tax returns for all years 2016 and thereafter are subject to future examination by tax authorities.
NOTE 5. Other Comprehensive (Loss) Income
The following tables show the changes in other comprehensive (loss) income for the three months ended March 31, 2021 and 2020, net of tax:
For the three months ended March 31, 2021
Adjustments
Net unrealized
related to
(losses) gains
(losses) gains on
defined benefit
from cash flow
securities
plan
hedges
Balance, beginning of period (1)
(179)
(238)
(737)
(1,154)
Other comprehensive income before reclassifications
885
Less amounts reclassified from accumulated other comprehensive income (loss)
(15)
230
Period change
Balance, end of period (1)
(118)
(223)
(158)
(499)
For the three months ended March 31, 2020
gains (losses)
gains (losses) on
316
(295)
189
Other comprehensive loss before reclassifications
(1,135)
Less amounts reclassified from accumulated other comprehensive loss
(149)
320
(280)
(836)
(797)
NOTE 6. Fair Value
Fair Value Measurement
The Company follows FASB ASC Topic 820, “Fair Value Measurement and Disclosures,” which requires additional disclosures about the Company’s assets and liabilities that are measured at fair value. Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an 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 determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed as follows:
Level 1 Inputs
Level 2 Inputs
14
Level 3 Inputs
Fair Value on a Recurring Basis
The following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis:
Debt Securities Available for Sale
The fair value of available for sale ("AFS") debt securities is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
As of March 31, 2021, the fair value of the Company’s AFS debt securities portfolio was $32.3 million. Approximately 46 percent of the portfolio was made up of residential mortgage-backed securities, which had a fair value of $15.0 million at March 31, 2021. Approximately $14.8 million of the residential mortgage-backed securities are guaranteed by the Government National Mortgage Association ("GNMA"), the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC"). The underlying loans for these securities are residential mortgages that are geographically dispersed throughout the United States.
Most of the Company’s AFS debt securities were classified as Level 2 assets at March 31, 2021. The valuation of AFS debt securities using Level 2 inputs was primarily determined using the market approach, which uses quoted prices for similar assets or liabilities in active markets and all other relevant information. It includes model pricing, defined as valuing securities based upon their relationship with other benchmark securities.
Included in the Company’s AFS debt securities are two corporate bonds which are classified as Level 3 assets at March 31, 2021, which were previously classified as Level 2 assets. The valuation of these corporate bonds is determined using broker quotes, third-party vendor prices, or other valuation techniques, such as discounted cash flow techniques. Market inputs used in the other valuation techniques or underlying third-party vendor prices or broker quotes include benchmark and government bond yield curves, credit spreads, and trade execution data.
The following table presents a reconciliation of the Level 3 available for sale debt securities measured at fair value on a recurring basis for the three months ended March 31, 2021 and 2020:
Balance at beginning of period (1)
4,400
Purchases/additions
Sales/reductions
Realized gains (losses)
Unrealized gains
138
Balance at end of period
4,538
(1) Includes AFS debt securities classified as Level 2 at December 31, 2019, which were transferred to Level 3 during the year ended 2020.
Equity Securities with Readily Determinable Fair Values
The fair value of equity securities is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
As of March 31, 2021, the fair value of the Company’s equity securities portfolio was $2.2 million.
All of the Company’s equity securities were classified as Level 2 assets at March 31, 2021. The valuation of equity securities using Level 2 inputs was primarily determined using the market approach, which uses quoted prices for similar assets or liabilities in active markets and all other relevant information.
There were no changes in the inputs or methodologies used to determine fair value during the period ended March 31, 2021, as compared to the periods ended December 31, 2020 and March 31, 2020.
Fair Value for loans held for sale is derived from quoted market prices for similar loans, in which case they are characterized as Level 2 assets in the fair value hierarchy.
Interest Rate Swap Agreements
The fair value of interest rate swap agreements is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
The Company’s derivative instruments are classified as Level 2 assets, as the readily observable market inputs to these models are validated to external sources, such as industry pricing services, or are corroborated through recent trades, dealer quotes, yield curves, implied volatility or other market-related data.
16
The tables below present the balances of assets and liabilities measured at fair value on a recurring basis as of March 31, 2021 and December 31, 2020:
Fair Value Measurements at March 31, 2021 Using
Quoted Prices in
Assets/Liabilities
Active Markets
Significant Other
Significant
Measured at Fair
for Identical
Observable
Unobservable
Value
Assets (Level 1)
Inputs (Level 2)
Inputs (Level 3)
Measured on a recurring basis:
Assets:
State and political subdivisions
2,375
Residential mortgage-backed securities
15,013
Corporate and other securities
14,942
10,404
Total debt securities available for sale
27,792
Equity securities with readily determinable fair values
Total equity securities
Loans held for sale
10,392
Total loans held for sale
Interest rate swap agreements
(219)
Total swap agreements
Fair value Measurements at December 31, 2020 Using
U.S. Government sponsored entities
2,003
2,969
17,410
23,235
18,835
41,217
10,712
(1,026)
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Fair Value on a Nonrecurring Basis
The following tables present the assets and liabilities subject to fair value adjustments (impairment) on a non-recurring basis carried on the balance sheet by caption and by level within the hierarchy (as described above):
Quoted Prices
in Active
Other
Markets for
Net Credit
Identical Assets
Inputs
During
(Level 1)
(Level 2)
(Level 3)
Period
Measured on a non-recurring basis:
Financial assets:
Impaired collateral-dependent loans
12,591
(556)
Fair Value Measurements at December 31, 2020 Using
Net (Credit)
Provision
OREO
(225)
11,959
3,693
Certain assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following is a description of the valuation methodologies used for instruments measured at fair value on a nonrecurring basis:
Appraisal Policy
All appraisals must be performed in accordance with the Uniform Standards of Professional Appraisal Practice ("USPAP"). Appraisals are certified to the Company and performed by appraisers on the Company’s approved list of appraisers. Evaluations are completed by a person independent of Company management. The content of the appraisal depends on the complexity of the property. Appraisals are completed on a “retail value” and an “as is value.”
The fair value of OREO is determined using third party appraisals, which may be discounted based on management’s review and changes in market conditions (Level 3 Inputs).
Impaired Collateral-Dependent Loans
The fair value of impaired collateral-dependent loans is derived in accordance with FASB ASC Topic 310, “Receivables.” Fair value is determined based on the loan’s observable market price or the fair value of the collateral. Partially charged-off loans are measured for impairment based upon a third party appraisal for collateral-dependent loans. When an updated appraisal is received for a nonperforming loan, the value on the appraisal may be discounted in the manner discussed above. If there is a deficiency in the value after the Company applies these discounts, management applies a specific reserve and the loan remains in nonaccrual status. The receipt of an updated appraisal would not qualify as a reason to put a loan back into accruing status. The Company removes loans from nonaccrual status generally when the borrower makes three months of contractual payments and demonstrates the ability to service the debt going forward. Charge-offs are determined based upon the loss that management believes the Company will incur after evaluating collateral for impairment based upon the valuation methods described above and the ability of the borrower to pay any deficiency.
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The valuation allowance for impaired loans is included in the allowance for loan losses in the consolidated balance sheets. At March 31, 2021, the valuation allowance for impaired loans was $3.6 million, a decrease of $556 thousand from $4.1 million at December 31, 2020.
Fair Value of Financial Instruments
FASB ASC Topic 825, “Financial Instruments,” requires the disclosure of the estimated fair value of certain financial instruments, including those financial instruments for which the Company did not elect the fair value option. These estimated fair values as of March 31, 2021 and December 31, 2020 have been determined using available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data to develop estimates of fair value. The estimates presented are not necessarily indicative of amounts the Company could realize in a current market exchange. The use of alternative market assumptions and estimation methodologies could have had a material effect on these estimates of fair value. The methodology for estimating the fair value of financial assets and liabilities that are measured on a recurring or nonrecurring basis are discussed above.
The following methods and assumptions were used to estimate the fair value of other financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents
For these short-term instruments, the carrying value is a reasonable estimate of fair value.
Securities
The fair value of securities is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
SBA Loans Held for Sale
The fair value of SBA loans held for sale is estimated by using a market approach that includes significant other observable inputs.
The fair value of loans is estimated by discounting the future cash flows using current market rates that reflect the interest rate risk inherent in the loan, except for previously discussed impaired loans.
FHLB Stock
Federal Home Loan Bank stock is carried at cost. Carrying value approximates fair value based on the redemption provisions of the issues.
Servicing Assets
Servicing assets do not trade in an active, open market with readily observable prices. The Company estimates the fair value of servicing assets using discounted cash flow models incorporating numerous assumptions from the perspective of a market participant including market discount rates and prepayment speeds.
Accrued Interest
The carrying amounts of accrued interest approximate fair value.
Deposit Liabilities
The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date (i.e. carrying value). The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using current market rates.
Borrowed Funds and Subordinated Debentures
The fair value of borrowings is estimated by discounting the projected future cash flows using current market rates.
Standby Letters of Credit
At March 31, 2021, the Bank had standby letters of credit outstanding of $4.4 million, compared to $4.5 million at December 31, 2020. The fair value of these commitments is nominal.
The table below presents the carrying amount and estimated fair values of the Company’s financial instruments presented as of March 31, 2021 and December 31, 2020:
Fair value
Carrying
Estimated
level
fair value
Level 1
Securities (1)
Level 2
Loans, net of allowance for loan losses (2)
1,636,674
1,650,152
1,595,377
1,613,593
Servicing assets
Level 3
1,738
1,857
Financial liabilities:
Deposits
1,628,042
1,561,502
180,310
181,727
210
212,358
Limitations
Fair value estimates are made at a point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
20
Fair value estimates are based on existing on- and off-statement of condition financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the effect of fair value estimates have not been considered in the above estimates.
NOTE 7. Securities
This table provides the major components of debt securities available for sale ("AFS") and equity securities with readily determinable fair values ("equity securities") at amortized cost and estimated fair value at March 31, 2021 and December 31, 2020:
Gross
Amortized
unrealized
cost
gains
losses
Available for sale:
2,000
2,355
2,935
14,498
515
16,765
645
15,696
160
(914)
24,221
132
(1,118)
32,549
695
45,921
814
Equity securities:
2,112
184
(75)
This table provides the remaining contractual maturities and yields of securities within the investment portfolios. The carrying value of securities at March 31, 2021 is distributed by contractual maturity. Mortgage-backed securities and other securities, which may have principal prepayment provisions, are distributed based on contractual maturity. Expected maturities will differ materially from contractual maturities as a result of early prepayments and calls.
After one through
After five through
Total carrying
Within one year
five years
ten years
After ten years
value
(In thousands, except percentages)
Yield
Available for sale at fair value:
%
1,149
1.50
681
3.12
545
2.74
2.25
4.93
585
2.87
1,433
2.26
12,991
2.14
2.18
4.69
3.15
4.22
1,153
1.51
1,266
3.01
11,837
4.40
18,074
2.41
3.13
Equity Securities at fair value:
2.34
The fair value of securities with unrealized losses by length of time that the individual securities have been in a continuous unrealized loss position at March 31, 2021 and December 31, 2020 are as follows:
Less than 12 months
12 months and greater
number in a
Unrealized
(In thousands, except number in a loss position)
loss position
loss
2,382
7,759
(796)
10,141
Total temporarily impaired securities
4,793
(20)
9,157
(1,098)
13,950
Unrealized Losses
The unrealized losses in each of the categories presented in the tables above are discussed in the paragraphs that follow:
U.S. government sponsored entities and state and political subdivision securities: The unrealized losses on investments in these types of securities were caused by the increase in interest rate spreads or the increase in interest rates at the long end of the Treasury curve. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider these investments to be other-than temporarily impaired as of March 31, 2021 or December 31, 2020.
Residential and commercial mortgage-backed securities: The unrealized losses on investments in mortgage-backed securities were caused by increases in interest rate spreads or the increase in interest rates at the long end of the Treasury curve. The majority of contractual cash flows of these securities are guaranteed by the Federal National Mortgage Association (FNMA), the Government National Mortgage Association (GNMA) or the Federal Home Loan Mortgage Corporation (FHLMC). It is expected that the securities would not be settled at a price significantly less than the par value of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider these investments to be other-than-temporarily impaired as of March 31, 2021 or December 31, 2020.
Corporate and other securities: Included in this category are corporate and other debt securities. The unrealized losses on corporate and other debt securities were due to widening credit spreads. The Company evaluated the prospects of the issuers and forecasted a recovery period; and as a result determined it did not consider these investments to be other-than-temporarily impaired as of March 31, 2021 or December 31, 2020. The contractual terms do not allow the securities to be settled at a price less than the par value. Because the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before recovery of its amortized cost basis, which may be at maturity, the Company did not consider these securities to be other-than-temporarily impaired as of March 31, 2021 or December 31, 2020.
Realized Gains and Losses
Gross realized gains and losses on securities for the three months ended March 31, 2021 and 2020 are detailed in the table below:
Realized gains
43
296
Realized losses
Net gains on sales of securities
The net realized gains are included in noninterest income in the Consolidated Statements of Income as net security gains. There were $43 thousand of gross realized gains during the three months ended March 31, 2021, compared to $296 thousand during the same period a year ago. There were no gross realized losses for the three months ended March 31, 2021 or 2020.
For the three months ended March 31, 2021, the net gain is attributed to:
For the three months ended March 31, 2020, the net gain is attributed to:
Equity Securities
Included in this category are Community Reinvestment Act ("CRA") investments and the Company’s current other equity holdings of financial institutions. Equity securities are defined to include (a) preferred, common and other ownership interests in entities including partnerships, joint ventures and limited liability companies and (b) rights to acquire or dispose of ownership interest in entities at fixed or determinable prices.
The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three months ended March 31, 2021 and 2020:
Net gains (losses) recognized during the period on equity securities
267
(471)
Net gains recognized during the period on equity securities sold during the period
Unrealized gains (losses) recognized during the reporting period on equity securities still held at the reporting date
(466)
Pledged Securities
Securities with a carrying value of $1.5 million and $1.6 million at March 31, 2021 and December 31, 2020, respectively, were pledged to secure deposits, secure other borrowings and for other purposes required or permitted by law.
23
NOTE 8. Loans
The following table sets forth the classification of loans by class, including unearned fees, deferred costs and excluding the allowance for loan losses as of March 31, 2021 and December 31, 2020:
SBA 504 loans
21,255
19,681
Commercial other
113,982
118,280
Commercial real estate
650,869
630,423
Commercial real estate construction
66,972
71,404
Home equity
59,238
62,549
Consumer other
1,264
3,551
Total loans held for investment
1,659,639
1,618,482
Loans are made to individuals as well as commercial entities. Specific loan terms vary as to interest rate, repayment, and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Credit risk tends to be geographically concentrated in that a majority of the loan customers are located in the markets serviced by the Bank. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type. A description of the Company’s different loan segments follows:
SBA Loans: SBA 7(a) loans, on which the SBA has historically provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. The guaranteed portion of the Company’s SBA loans is generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment. SBA loans are for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans are guaranteed by the businesses’ major owners. SBA loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act includes a range of other provisions designed to support the U.S. economy and mitigate the impact of COVID-19 on financial institutions and their customers, including through the authorization of various relief programs and measures that the U.S. Department of the Treasury, the Small Business Administration, the Federal Reserve Board (“FRB”) and other federal banking agencies have implemented or may implement.
The CARES Act provides assistance to small businesses through the establishment of the SBA Paycheck Protection Program ("PPP"). The PPP generally provides small businesses with funds to pay up to 24 weeks of payroll costs, including certain benefits. The funds are provided in the form of loans that may be fully or partially forgiven when used for payroll costs, interest on mortgages, rent, and utilities. The payments on these loans will be deferred for up to six months. Loans made after June 5, 2020, mature in five years, and loans made prior to June 5, 2020, mature in two years but can be extended to five years if the lender agrees. Forgiveness of the PPP loans is based on the borrower maintaining or quickly rehiring employees and maintaining salary levels. Most small businesses with 500 or fewer employees are eligible. Applications for the PPP loans started on April 3, 2020 and the application period was extended through August 8, 2020. As an existing SBA 7(a) lender, the Company opted to participate in the program. In December
2020, legislation was adopted providing additional funding for the PPP program and reopening applications on January 13, 2021 through March 31, 2021.
Commercial Loans: Commercial credit is extended primarily to middle market and small business customers. Commercial loans are generally made in the Company’s market place for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. Loans will generally be guaranteed in full or for a meaningful amount by the businesses’ major owners. Commercial loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided. Generally, the Company has a 50 percent loan to value ratio on SBA 504 program loans at origination.
Residential Mortgage, Consumer and Consumer Construction Loans: The Company originates mortgage and consumer loans including principally residential real estate and home equity lines and loans and consumer construction lines. The Company originates qualified mortgages which are generally sold in the secondary market and nonqualified mortgages which are generally held for investment. Each loan type is evaluated on debt to income, type of collateral and loan to collateral value, credit history and the Company’s relationship with the borrower.
Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to credit administration policies and procedures. Due diligence on loans begins when we initiate contact regarding a loan with a borrower. Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval. The loan portfolio is then subject to on-going internal reviews for credit quality which in part is derived from ongoing collection and review of borrowers’ financial information, as well as independent credit reviews by an outside firm.
The Company’s extension of credit is governed by the Credit Risk Policy which was established to control the quality of the Company’s loans. This policy and the underlying procedures are reviewed and approved by the Board of Directors on a regular basis.
Credit Ratings
For SBA 7(a), SBA 504 and commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality. A loan’s internal risk rating is updated at least annually and more frequently if circumstances warrant a change in risk rating. The Company uses a 1 through 10 loan grading system that follows regulatory accepted definitions.
Pass: Risk ratings of 1 through 6 are used for loans that are performing, as they meet, and are expected to continue to meet, all of the terms and conditions set forth in the original loan documentation, and are generally current on principal and interest payments. These performing loans are termed “Pass”.
Special Mention: Criticized loans are assigned a risk rating of 7 and termed “Special Mention”, as the borrowers exhibit potential credit weaknesses or downward trends deserving management’s close attention. If not checked or corrected, these trends will weaken the Bank’s collateral and position. While potentially weak, these borrowers are currently marginally acceptable and no loss of interest or principal is anticipated. As a result, special mention assets do not expose an institution to sufficient risk to warrant adverse classification. Included in “Special Mention” could be turnaround situations, such as borrowers with deteriorating trends beyond one year, borrowers in startup or deteriorating industries, or borrowers with a poor market share in an average industry. "Special Mention" loans may include an element of asset quality, financial flexibility, or below average management. Management and ownership may have limited depth or experience. Regulatory agencies have agreed on a consistent definition of “Special Mention” as an asset with potential weaknesses which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. This definition is intended to ensure that the “Special Mention” category is
25
not used to identify assets that have as their sole weakness credit data exceptions or collateral documentation exceptions that are not material to the repayment of the asset.
Substandard: Classified loans are assigned a risk rating of an 8 or 9, depending upon the prospect for collection, and deemed “Substandard”. A risk rating of 8 is used for borrowers with well-defined weaknesses that jeopardize the orderly liquidation of debt. The loan is inadequately protected by the current paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified “Substandard”.
A risk rating of 9 is used for borrowers that have all the weaknesses inherent in a loan with a risk rating of 8, with the added characteristic that the weaknesses make collection of debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Serious problems exist to the point where partial loss of principal is likely. The possibility of loss is extremely high, but because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans’ classification as estimated losses is deferred until a more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures; capital injection; perfecting liens on additional collateral; and refinancing plans. Partial charge-offs are likely.
Loss: Once a borrower is deemed incapable of repayment of unsecured debt, the risk rating becomes a 10, the loan is termed a “Loss”, and charged-off immediately. Loans to such borrowers are considered uncollectible and of such little value that continuance as active assets of the Bank is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these basically worthless assets even though partial recovery may be affected in the future.
For residential mortgage, consumer and consumer construction loans, management uses performing versus nonperforming as the best indicator of credit quality. Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. These credit quality indicators are updated on an ongoing basis, as a loan is placed on nonaccrual status as soon as management believes there is sufficient doubt as to the ultimate ability to collect interest on a loan.
At March 31, 2021, there were $2.5 million of residential consumer loans in the process of foreclosure, compared to $4.8 million at December 31, 2020.
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The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of March 31, 2021:
SBA & Commercial loans - Internal risk ratings
Pass
Special mention
Substandard
35,932
532
1,832
105,509
5,413
3,060
623,270
22,519
5,080
Total commercial loans
817,006
27,932
8,140
Total SBA and commercial loans
1,022,055
28,464
9,972
1,060,491
Residential mortgage & Consumer loans - Performing/Nonperforming
Performing
Nonperforming
441,438
6,711
Total consumer loans
87,932
2,565
Total residential mortgage, consumer and consumer construction loans
589,872
9,276
599,148
The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of December 31, 2020:
36,991
525
2,071
109,672
5,533
3,075
603,482
25,206
1,735
804,239
30,739
4,810
959,487
31,264
6,881
997,632
462,369
5,217
61,254
1,295
64,805
85,414
612,588
8,262
620,850
27
Nonperforming and Past Due Loans
Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans and generally represent loans that are well collateralized and in the process of collection. The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.
The following tables set forth an aging analysis of past due and nonaccrual loans as of March 31, 2021 and December 31, 2020:
90+ days
30‑59 days
60‑89 days
and still
Nonaccrual
Total past
past due
accruing
(1)
due
Current
6,341
1,560
7,901
30,395
60
340
443
113,539
889
787
612
2,288
648,581
4,728
1,224
2,145
14,808
433,341
49
183
232
59,006
1,257
854
416
212
4,047
86,450
12,911
2,487
2,540
11,788
29,726
1,629,913
2,664
6,145
15,575
32,390
1,636,058
28
792
1,280
2,473
4,545
35,042
201
266
653
117,627
3,109
1,971
1,059
6,139
624,284
1,047
70,357
3,232
2,933
262
11,644
455,942
393
187
1,875
60,674
3,547
120
796
2,666
84,498
8,882
7,182
449
12,060
28,573
1,589,909
448
8,887
9,330
29,021
1,598,796
Impaired Loans
The Company has defined impaired loans to be all nonperforming loans individually evaluated for impairment and TDRs. Management considers a loan impaired when, based on current information and events, it is determined that the Company will not be able to collect all amounts due according to the loan contract. Impairment is evaluated on an individual basis for SBA and commercial loans.
29
The following table provides detail on the Company’s impaired loans that are individually evaluated for impairment with the associated allowance amount, if applicable, as of March 31, 2021:
Unpaid
principal
Recorded
Specific
balance
investment
reserves
With no related allowance:
SBA loans held for investment (1)
1,138
1,037
1,920
6,090
5,985
427
1,780
Total impaired loans with no related allowance
11,355
11,149
With an allowance:
691
384
319
3,203
3,078
2,979
140
3,343
3,098
2,999
726
44
785
Total impaired loans with a related allowance
5,545
4,993
Total individually evaluated impaired loans:
1,829
1,421
2,060
1,940
5,263
5,018
6,816
Total individually evaluated impaired loans
16,900
16,142
The following table provides detail on the Company’s impaired loans that are individually evaluated for impairment with the associated allowance amount, if applicable, as of December 31, 2020:
1,799
1,698
1,462
4,080
3,975
10,386
6,205
434
404
324
3,160
3,106
1,080
576
4,890
4,240
3,682
1,242
101
6,566
5,886
4,107
2,233
2,102
3,192
2,542
6,352
5,702
5,322
16,952
16,066
31
The following table presents the average recorded investments in impaired loans and the related amount of interest recognized during the time period in which the loans were impaired for the three months ended March 31, 2021 and 2020. The average balances are calculated based on the month-end balances of impaired loans. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal under the cost recovery method, and therefore no interest income is recognized. The interest income recognized on impaired loans noted below represents primarily accruing TDRs and nominal amounts of income recognized on a cash basis for well-collateralized impaired loans.
Interest
income
Average
recognized
recorded
on impaired
loans
1,901
1,128
600
32
2,237
56
844
2,610
7,966
103
2,780
57
TDRs
The Company’s loan portfolio also includes certain loans that have been modified as TDRs. TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider, unless it results in a delay in payment that is insignificant. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. Under the CARES Act and regulatory guidance issued in regards to the COVID-19 pandemic, loan payment deferrals for periods of up to 180 days granted to borrowers adversely effected by the pandemic are not considered TDR’s if the borrower was current on its loan payments at year end 2019 or until the deferral was granted. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs if the loan is collateral-dependent. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.
TDRs of $1.1 million and $663 thousand are included in the impaired loan numbers as of March 31, 2021 and December 31, 2020, respectively. The increase in TDRs was due to the addition of two loans, partially offset by principal pay downs. At March 31, 2021 and December 31, 2020, there were no specific reserves on the TDRs. The TDRs are in accrual status since they are performing in accordance with the restructured terms. There are no commitments to lend additional funds on these loans.
There were two loans modified as TDRs during the three months ended March 31, 2021. There were no loans modified during the three months ended March 31, 2020 that were deemed to be TDRs. The following table details loans modified during the three months ended March 31, 2021, including the number of modifications and the recorded investment at the time of the modification:
Number of
Recorded investment
(In thousands, except number of contracts)
contracts
at time of modification
To date, the Company’s TDRs consisted of principal reduction, interest only periods and maturity extensions. There were no loans modified as a TDR within the previous 12 months that subsequently defaulted at some point during the three months ended March 31, 2021. In this case, the subsequent default is defined as 90 days past due or transferred to nonaccrual status.
NOTE 9. Allowance for Loan Losses and Reserve for Unfunded Loan Commitments
Allowance for Loan Losses
The Company has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. At a minimum, the adequacy of the allowance for loan losses is reviewed by management on a quarterly basis. For purposes of determining the allowance for loan losses, the Company has segmented the loans in its portfolio by loan type. Loans are segmented into the following pools: SBA 7(a), commercial, residential mortgages, consumer, and consumer construction loans. Certain portfolio segments are further broken down into classes based on the associated risks within those segments and the type of collateral underlying each loan. Commercial loans are divided into the following five classes: commercial real estate, commercial real estate construction, unsecured business line of credit, commercial other, and SBA 504. Consumer loans are divided into two classes as follows: home equity and other.
The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. The same standard methodology is used, regardless of loan type. Specific reserves are made to individual impaired loans and TDRs (see Note 1 for additional information on this term). The general reserve is set based upon a representative average historical net charge-off rate adjusted for the following environmental factors: delinquency and impairment trends, charge-off and recovery trends, volume and loan term trends, changes in risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes. Within the five-year historical net charge-off rate, the Company weights the past three years more heavily as it believes it is more indicative of future charge-offs. All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate and high risk. Each environmental factor is evaluated separately for each class of loans and risk weighted based on its individual characteristics.
33
According to the Company’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable. All credits which are 90 days past due must be analyzed for the Company’s ability to collect on the credit. Once a loss is known to exist, the charge-off approval process is immediately expedited. This charge-off policy is followed for all loan types.
The allocated allowance is the total of identified specific and general reserves by loan category. The allocation is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of the portfolio.
The following tables detail the activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2021 and 2020:
SBA held
for
Consumer
Commercial
Residential
construction
Balance, beginning of period
1,301
14,992
5,318
813
23,105
Charge-offs
(282)
(373)
(656)
Recoveries
Net charge-offs
(267)
(372)
(640)
Provision for (credit to) loan losses charged to expense
620
(309)
213
Balance, end of period
1,654
14,727
5,009
549
1,026
22,965
1,079
9,722
4,254
715
16,395
(25)
(300)
(200)
(525)
(299)
(519)
(54)
709
46
93
1,005
10,129
4,763
671
808
17,376
The following tables present loans and their related allowance for loan losses, by portfolio segment, as of March 31, 2021 and December 31, 2020:
Allowance for loan losses ending balance:
Individually evaluated for impairment
Collectively evaluated for impairment
1,335
11,728
4,965
837
19,414
Loan ending balances:
205,992
848,060
60,075
1,643,497
207,413
977
11,310
18,998
155,742
834,086
1,602,416
157,844
Changes in Methodology
The Company did not make any changes to its allowance for loan losses methodology in the current period.
Reserve for Unfunded Loan Commitments
In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the reserve are made through other expense and applied to the reserve which is classified as other liabilities. At March 31, 2021, a $310 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $288 thousand commitment reserve at December 31, 2020, due to a larger loan portfolio requiring a larger general reserve.
NOTE 10. New Accounting Pronouncements
ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 was issued to replace the incurred loss impairment methodology in current GAAP with an expected credit loss methodology and requires consideration of a broader range of information to determine credit loss estimates. Financial assets measured at amortized cost will be presented at the net amount expected to be collected by using an allowance for credit losses. Purchased credit impaired loans will receive an allowance account at the acquisition date that represents a component of the purchase price allocation. Credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses, with such allowance limited to the amount by which fair value is below amortized cost. For public business entities, ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019.
In May 2019, FASB issued ASU 2019-05, "Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief." ASU 2019-05 was issued to address concerns with the adoption of ASU 2016-13. ASU 2019-05 gives entities the ability to irrevocably elect the fair value option in Subtopic 825-10 for certain existing financial assets upon transition to ASU 2016-03. Financial assets that are eligible for this fair value election are those that qualify under Subtopic 825-10 and are within the scope of Subtopic 326-10, "Financial Instruments - Credit Losses - Measured at Amortized Costs." An exception to this is held-to-maturity debt securities, which do not qualify for this transition election. The effective date for the amendment is the same as the effective date in ASU 2016-03. In November 2019, FASB issued ASU 2019-10, "Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates." ASU 2019-10 was issued to defer the effective dates for certain guidance in its Accounting Standard Codification ("ASC") for certain entities. The amendments in this update amend the mandatory effective dates for ASC 326, "Financial Instruments - Credit Losses", for entities eligible to be smaller reporting companies as defined by the SEC for fiscal years beginning after December 15, 2022, including interim reporting periods within that reporting period. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its consolidated financial statements.
In November 2019, FASB issued ASU 2019-11, "Codification Improvements to Topic 326, Financial Instruments - Credit Losses." ASU 2019-11 was issued to address issues raised by stakeholders during the implementation of ASU
35
2016-13. ASU 2019-11 provides transition relief when adjusting the effective interest rate for troubled debt restructurings ("TDRs") that exist as of the adoption date, extends the disclosure relief in ASU 2019-04 to disclose accrued interest receivable balances separately from the amortized cost basis to additional disclosures involving amortized cost basis, and provides clarification regarding application of the guidance in paragraph 326-20-35-6 for financial assets secured by collateral maintenance provisions that provides a practical expedient to measure the estimate of expected credit losses by comparing the amortized cost basis of a financial asset and the fair value of collateral securing the financial asset as of the reporting date. The effective date and transition requirements for the amendment are the same as the effective date and transition requirements in ASU 2016-13.
ASU 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes." ASU 2019-12 removes the exception to the incremental approach for intraperiod tax allocation when there is a loss from continuing operations and income or a gain from other items and removes the exception to the interim period income tax accounting when a year-to-date loss exceeds the anticipated loss for the year. ASU 2019-12 also simplifies the accounting for income taxes by requiring that an entity recognize a franchise tax that is partially based on income as an income-based tax, that an entity evaluate when a step up in the tax basis of goodwill should be considered part of the business combination in which the book goodwill originally was recognized, and that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date. For public business entities, ASU 2019-12 is effective for interim and annual periods beginning after December 15, 2020. The Company adopted this standard as of January 1, 2021. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
ASU 2020-01, "Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 (a consensus of the Emerging Issues Task Force)." ASU 2020-01 clarifies that the observable price changes in orderly transactions that should be considered when applying the measurement alternative in accordance with ASC 321 include transactions that require it to either apply or discontinue the equity method of accounting under ASC 323. ASU 2020-01 also addresses questions about how to apply the guidance in Topic 815, “Derivatives and Hedging,” for certain forward contracts and purchased options to purchase securities that, upon settlement or exercise, would be accounted for under the equity method of accounting. The ASU clarifies that, for the purpose of applying ASC 815-10-15-141(a), an entity should not consider whether, upon the settlement of the forward contract or exercise of the purchased option, the underlying securities would be accounted for under the equity method in ASC 323 or the fair value option in accordance with the financial instruments guidance in Topic 825, “Financial Instruments.” For public business entities, ASU 2020-01 is effective for interim and annual periods beginning after December 15, 2020. The Company adopted this standard as of January 1, 2021. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
ASU 2020-03, "Codification Improvement to Financial Instruments." ASU 2020-03 clarifies that all entities are required to provide the fair value option disclosures in paragraphs 825-10-50-24 through 50-32 of the FASB’s Accounting Standards Codification (ASC). ASU 2020-03 also clarifies that the contractual term of a net investment in a lease determined in accordance with ASC 842, “Leases,” should be the contractual term used to measure expected credit losses under ASC 326, “Financial Instruments – Credit Losses.” ASU 2020-03 also addresses amendments to ASC 860-20, “Transfers and Servicing – Sales of Financial Assets,” clarify that when an entity regains control of financial assets sold, an allowance for credit losses should be recorded in accordance with ASC 326. The effective date and transition requirements for the amendment are the same as the effective date and transition requirements in ASU 2016-13. The Company is currently evaluating the impact of the adoption of ASU 2020-03 on its consolidated financial statements.
ASU 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting." ASU 2020-04 provides temporary optional guidance intended to ease the burden of reference rate reform on financial reporting. The guidance provides optional expedients and exceptions for applying existing guidance to contract modifications, hedging relationships and other transactions that are expected to be affected by reference rate reform and
meet certain scope guidance. ASU 2020-04 provides various optional expedients, including the following, for hedging relationships affected by reference rate reform, if certain criteria are met:
In addition, ASU 2020-04 permits an entity to make a one-time election to sell, transfer, or both sell and transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform and that were classified as held to maturity before January 1, 2020. ASU 2020-04 was effective upon its issuance on March 12, 2020. However, it cannot be applied to contract modifications that occur after December 31, 2022. With certain exceptions, the ASU also cannot be applied to hedging relationships entered into or evaluated after that date. The Company is currently evaluating the various optional expedients as well as impact of the adoption of ASU 2020-04 on its consolidated financial statements.
ASU 2020-06, “Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity's Own Equity.” ASU 2020-06 was issued to address the complexities of its guidance for certain financial instruments with characteristics of liabilities and equity, including:
For public business entities, ASU 2020-06 is effective for interim and annual periods beginning after December 15, 2021. The Company is currently evaluating the impact of the adoption of ASU 2020-06 on its consolidated financial statements.
ASU 2021-01, “Reference Rate Reform (Topic 848): Scope.” ASU 2021-01 was issued to clarify certain optional expedients and exceptions in ASC 848 for contract modifications and hedge accounting applied to derivatives that are affected by the discounting transition. In addition, the ASU clarifies that a receive-variable-rate, pay-variable-rate cross-currency interest rate swap may be considered eligible as a hedging instrument in a net investment hedge if both legs of the swap do not have the same repricing intervals and dates as a result of the reference rate reform. ASU 2021-01 became effective January 7, 2021.
NOTE 11. Derivative Financial Instruments and Hedging Activities
Derivative Financial Instruments
The Company has derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments, and the value of the derivatives are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Such difference, which represents the fair value of the derivative instrument, is reflected on the Company’s balance sheet as other assets or other liabilities.
The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to any derivative agreement. The Company controls the credit risk of its financial contracts through credit approvals, limits and
37
monitoring procedures, and does not expect any counterparties to fail their obligations. The Company deals only with primary dealers.
Derivative instruments are generally either negotiated OTC contracts or standardized contracts executed on a recognized exchange. Negotiated OTC derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise prices and maturity.
Risk Management Policies – Hedging Instruments
The primary focus of the Company’s asset/liability management program is to monitor the sensitivity of the Company’s net portfolio value and net income under varying interest rate scenarios to take steps to control its risks. On a quarterly basis, the Company evaluates the effectiveness of entering into any derivative agreement by measuring the cost of such an agreement in relation to the reduction in net portfolio value and net income volatility within an assumed range of interest rates.
Interest Rate Risk Management – Cash Flow Hedging Instruments
The Company has variable rate debt as a source of funds for use in the Company’s lending and investment activities and for other general business purposes. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases. Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore hedges its variable-rate interest payments. To meet this objective, management enters into interest rate swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments during the contract period.
At March 31, 2021, the Company had a total of 4 interest rate swaps designated as cash flow hedging instruments with a notional amount of $70.0 million, compared to 5 with a notional amount of $80.0 million at December 31, 2020. At March 31, 2021 and December 31, 2020, the Company had $1.5 million in cash collateral pledged for these derivatives which was included in federal funds sold and interest-bearing deposits. A summary of the Company’s outstanding interest rate swap agreements used to hedge variable rate debt at March 31, 2021 and December 31, 2020, respectively is as follows:
(In thousands, except percentages and years)
Notional amount
70,000
80,000
Weighted average pay rate
1.05
1.19
Weighted average receive rate
0.23
0.89
Weighted average maturity in years
2.06
2.20
Number of contracts
During the three months ended March 31, 2021, the Company received variable rate London Interbank Offered Rate ("LIBOR") payments from and paid fixed rates in accordance with its interest rate swap agreements. At March 31, 2021, the unrealized loss relating to interest rate swaps was recorded as a derivative liability, whereas at December 31, 2020, the unrealized gain relating to interest rate swaps was recorded as a derivative asset. Changes in the fair value of the interest rate swaps designated as hedging instruments of the variability of cash flows associated with long-term debt are reported in other comprehensive income. The following table presents the net gains and losses recorded in other comprehensive income and the consolidated financial statements relating to the cash flow derivative instruments at March 31, 2021 and 2020, respectively:
Gain (loss) recognized in OCI on derivatives
38
NOTE 12. Employee Benefit Plans
Stock Option Plans
The Company has incentive and nonqualified option plans, which allow for the grant of options to officers, employees and members of the Board of Directors. Grants under the Company’s incentive and nonqualified option plans generally vest over 3 years and must be exercised within 10 years of the date of grant. Transactions under the Company’s stock option plans for the three months ended March 31, 2021 are summarized in the following table:
Weighted
average
remaining
Aggregate
exercise
contractual
intrinsic
price
life in years
Outstanding at December 31, 2020
672,800
16.42
6.8
1,952,568
Options granted
89,000
19.21
Options exercised
(12,467)
6.43
Options forfeited
Options expired
Outstanding at March 31, 2021
749,333
16.91
7.1
3,858,402
Exercisable at March 31, 2021
471,179
15.18
5.9
3,228,220
On April 25, 2019, the Company adopted the 2019 Equity Compensation Plan providing for grants of up to 500,000 shares to be allocated between incentive and non-qualified stock options, restricted stock awards, performance units and deferred stock. The Plan replaced all previously approved and established equity plans then currently in effect. As of March 31, 2021, 281,500 options and 73,150 shares of restricted stock have been awarded from the plan leaving 145,350 shares available for future grants.
The fair values of the options granted during the three months ended March 31, 2021 and 2020 were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
Number of options granted
101,000
Weighted average exercise price
20.39
Weighted average fair value of options
7.72
5.54
Expected life in years (1)
8.38
8.66
Expected volatility (2)
43.69
27.13
Risk-free interest rate (3)
1.14
1.55
Dividend yield (4)
1.68
1.61
39
Upon exercise, the Company issues shares from its authorized but unissued common stock to satisfy the options. The following table presents information about options exercised during the three months ended March 31, 2021 and 2020:
Number of options exercised
12,467
5,500
Total intrinsic value of options exercised
170,023
86,241
Cash received from options exercised
80,113
34,265
Tax deduction realized from options
51,151
25,264
The following table summarizes information about stock options outstanding and exercisable at March 31, 2021:
Options outstanding
Options exercisable
Weighted average
Options
remaining contractual
Range of exercise prices
outstanding
life (in years)
exercise price
exercisable
$0.00 - $6.00
33,000
1.4
5.59
$6.01 - $12.00
146,800
4.2
8.95
$12.01 - $18.00
132,533
7.8
16.37
69,201
15.72
$18.01 - $24.00
437,000
8.3
20.61
222,178
20.56
367,869
Financial Accounting Standards Board Accounting Standards Codification ("FASB ASC") Topic 718, “Compensation - Stock Compensation,” requires an entity to recognize the fair value of equity awards as compensation expense over the period during which an employee is required to provide service in exchange for such an award (vesting period). Compensation expense related to stock options and the related income tax benefit for the three months ended March 31, 2021 and 2020 are detailed in the following table:
Compensation expense
207,602
192,489
Income tax benefit
59,997
55,629
As of March 31, 2021, unrecognized compensation costs related to nonvested share-based compensation arrangements granted under the Company’s stock option plans totaled approximately $1.7 million. That cost is expected to be recognized over a weighted average period of 2.3 years.
Restricted Stock Awards
Restricted stock is issued under the 2019 Equity Compensation Plan to reward employees and directors and to retain them by distributing stock over a period of time. Restricted stock awards granted to date vest over a period of 4 years and are recognized as compensation to the recipient over the vesting period. The awards are recorded at fair market value at the time of grant and amortized into salary expense on a straight line basis over the vesting period. The following table summarizes nonvested restricted stock activity for the three months ended March 31, 2021:
Average grant
date fair value
Nonvested restricted stock at December 31, 2020
87,972
19.26
Granted
30,000
19.46
Cancelled
Vested
(26,633)
18.76
Nonvested restricted stock at March 31, 2021
91,339
19.47
40
Restricted stock awards granted during the three months ended March 31, 2021 and 2020 were as follows:
Number of shares granted
15,000
Average grant date fair value
16.63
Compensation expense related to restricted stock for the three months ended March 31, 2021 and 2020 is detailed in the following table:
166,349
172,904
48,075
49,969
As of March 31, 2021, there was approximately $1.6 million of unrecognized compensation cost related to nonvested restricted stock awards granted under the Company’s stock incentive plans. That cost is expected to be recognized over a weighted average period of 2.9 years.
401(k) Savings Plan
The Bank has a 401(k) savings plan covering substantially all employees. Under the Plan, an employee can contribute up to 80 percent of their salary on a tax deferred basis. The Bank may also make discretionary contributions to the Plan. The Bank contributed $261 thousand and $185 thousand to the Plan during the three months ended March 31, 2021 and 2020, respectively.
Deferred Fee Plan
The Company has a deferred fee plan for Directors and eligible management. Directors of the Company have the option to elect to defer up to 100 percent of their respective retainer and Board of Director fees, and each eligible member of management has the option to elect to defer up to 100 percent of their total compensation. Director and officer deferred fees totaled $128 thousand and $491 thousand during the three months ended March 31, 2021 and 2020, respectively. The interest paid on the deferred balances totaled $28 thousand during the three months ended March 31, 2021 and 2020, respectively. The deferred balances distributed totaled $3 thousand during the three months ended March 31, 2021 and 2020, respectively.
Benefit Plans
In addition to the 401(k) savings plan which covers substantially all employees, in 2015 the Company established an unfunded supplemental defined benefit plan to provide additional retirement benefits for the President and Chief Executive Officer (“CEO”) and unfunded, non-qualified deferred retirement plans for certain other key executives.
On June 4, 2015, the Company approved the Supplemental Executive Retirement Plan (“SERP”) pursuant to which the President and CEO is entitled to receive certain supplemental nonqualified retirement benefits. The retirement benefit under the SERP is an amount equal to sixty percent (60%) of the average of the President and CEO’s base salary for the thirty-six (36) months immediately preceding the executive’s separation from service after age 66, adjusted annually thereafter by two percent (2%). The total benefit is to be made payable in fifteen annual installments. The future payments are estimated to total $6.2 million. A discount rate of four percent (4%) was used to calculate the present value of the benefit obligation.
The President and CEO commenced vesting in this retirement benefit on January 1, 2014, and vests an additional three percent (3%) each year until fully vested on January 1, 2024. In the event that the President and CEO’s separation from service from the Company were to occur prior to full vesting, the President and CEO would be entitled to and shall be paid the vested portion of the retirement benefit calculated as of the date of separation from service. Notwithstanding
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the foregoing, upon a Change in Control, and provided that within 6 months following the Change in Control the President and CEO is involuntarily terminated for reasons other than “cause” or the President and CEO resigns for “good reason,” as such is defined in the SERP, or the President and CEO voluntarily terminates his employment after being offered continued employment in a position that is not a “Comparable Position,” as such is also defined in the SERP, the President and CEO shall become one hundred percent (100%) vested in the full retirement benefit.
No contributions or payments have been made during the three months ended March 31, 2021. The following table summarizes the components of the net periodic pension cost of the defined benefit plan recognized during the three months ended March 31, 2021 and 2020:
Service cost (1)
(34)
Interest cost
Net periodic benefit cost
(1) Reduction in service cost totaling $137 thousand to be recognized over one year due to the recalculation of the President and CEO’s salary projection.
The following table summarizes the changes in benefit obligations of the defined benefit plan during the three months ended March 31, 2021 and 2020:
Benefit obligation, beginning of year
3,845
3,571
Benefit obligation, end of period
3,639
On October 22, 2015, the Company entered into an Executive Incentive Retirement Plan (the “Plan”) with key executive officers. The Plan has an effective date of January 1, 2015.
The Plan is an unfunded, nonqualified deferred compensation plan. For any Plan Year, a guaranteed annual Deferral Award percentage of seven and one half percent (7.5%) of the participant’s annual base salary will be credited to each Participant’s Deferred Benefit Account. A discretionary annual Deferral Award equal to seven and one half percent (7.5%) of the participant’s annual base salary may be credited to the Participant’s account in addition to the guaranteed Deferral Award, if the Bank exceeds the benchmarks set forth in the Annual Executive Bonus Matrix. The total Deferral Award shall never exceed fifteen percent (15%) of the participant’s base salary for any given Plan Year. Each Participant shall be one hundred percent (100%) vested in all Deferral Awards as of the date they are awarded.
As of March 31, 2021, the Company had total year to date expenses of $35 thousand related to the Plan. The Plan is reflected on the Company’s balance sheet as accrued expenses.
Certain members of management are also enrolled in a split-dollar life insurance plan with a post retirement death benefit of $250 thousand. Total expenses related to this plan were $1 thousand for the three months ended March 31, 2021 and 2020, respectively.
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NOTE 13. Regulatory Capital
On September 17, 2019, the federal banking agencies issued a final rule providing simplified capital requirements for certain community banking organizations (banks and holding companies) with less than $10 billion in total consolidated assets, implementing provisions of The Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”). Under the proposal, a qualifying community banking organization would be eligible to elect the community bank leverage ratio framework, or continue to measure capital under the existing Basel III requirements. The new rule was effective beginning January 1, 2020, and qualifying community banking organizations may elect to opt into the new community bank leverage ratio (“CBLR”) in their call report beginning in the first quarter of 2020.
A qualifying community banking organization (“QCBO”) is defined as a bank, a savings association, a bank holding company or a savings and loan holding company with:
On April 6, 2020, the federal banking regulators, implemented the applicable provisions of the CARES Act, which modified the CBLR framework so that: (i) beginning in the second quarter 2020 and until the end of 2020, a banking organization that has a leverage ratio of 8% or greater and meets certain other criteria may elect to use the CBLR framework; and (ii) community banking organizations will have until January 1, 2022, before the CBLR requirement is re-established at greater than 9%. Under the interim rules, the minimum CBLR will be 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. The numerator of the CBLR is Tier 1 capital, as calculated under the Basel III rules. The denominator of the CBLR is the QCBO’s average assets, calculated in accordance with the QCBO’s Call Report instructions less assets deducted from Tier 1 capital.
The Bank has opted into the CBLR, and will therefore not be required to comply with the Basel III capital requirements.
The following table shows the CBLR ratio for the Company and the Bank for the period ended March 31, 2021 and December 31, 2020:
At March 31, 2021
At December 31, 2020
Company
Bank
CBLR
10.19
9.85
10.09
9.80
NOTE 14. Leases
The Company follows ASU 2016-02, "Leases (Topic 842)," which revised certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. ASU 2016-02 requires that a lessee recognize the assets and liabilities on its balance sheet that arise from all leases with a term greater than 12 months. The core principle requires the lessee to recognize a liability to make lease payments and a "right-of-use" asset.
Operating leases in which the Bank is the lessee are recorded as right-of-use ("ROU") assets and lease liabilities and are included in Prepaid expenses and other assets and Accrued expenses and other liabilities, respectively, on the Bank’s Consolidated Balance Sheets. The Bank does not currently have any finance leases in which it is the lessee.
Operating lease ROU assets represent the Bank’s right to use an underlying asset during the lease term and operating lease liabilities represent its obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate. The incremental borrowing rate was calculated for each lease by taking a variable rate FHLB ARC product (based on Libor plus a spread) and then swapping it to a fixed rate borrowing by adding a fixed mid swap rate for the desired term. The borrowing rate for each lease is unique based on the lease term.
Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded in Occupancy expense in the Consolidated Statements of Income.
The Bank’s leases relate primarily to bank branches, office space and equipment with remaining lease terms of generally 1 to 10 years. Certain lease arrangements contain extension options which typically range from 1 to 5 years at the then fair market rental rates. As these extension options are not generally considered reasonably certain of exercise, they are not included in the lease term.
Certain real estate leases have lease payments that adjust based on annual changes in the Consumer Price Index ("CPI"). The leases that are dependent upon CPI are initially measured using the index or rate at the commencement date and are included in the measurement of the lease liability.
Operating lease ROU assets totaled $2.2 million at March 31, 2021, compared to $2.4 million at December 31, 2020. As of March 31, 2021, operating lease liabilities totaled $2.3 million, compared to $2.4 million at December 31, 2020.
The table below summarizes our net lease cost:
Operating lease cost
149
148
Net lease cost
The table below summarizes the cash and non-cash activities associated with our leases:
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
145
141
ROU assets obtained in exchange for new operating lease liabilities
The table below summarizes other information related to our operating leases:
Weighted average remaining lease term in years
5.81
5.96
Weighted average discount rate
5.47
5.45
Operating lease right-of-use assets
2,247
2,365
The table below summarizes the maturity of remaining lease liabilities:
2021 (excluding the three months ended March 31, 2021)
411
2022
477
2023
410
2024
361
2025
371
2026 and thereafter
664
Total lease payments
2,694
Less: Interest
(392)
Present value of lease liabilities
2,302
As of March 31, 2021, the Company had not entered into any material leases that have not yet commenced.
ITEM 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2020 consolidated audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2020. When necessary, reclassifications have been made to prior period data throughout the following discussion and analysis for purposes of comparability. This Quarterly Report on Form 10-Q contains certain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which may be identified by the use of such words as “believe”, “expect”, “anticipate”, “should”, “planned”, “estimated” and “potential”. Examples of forward looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of Unity Bancorp, Inc. that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, in addition to those items contained in the Company’s Annual Report on Form 10-K under Item IA-Risk Factors, as updated by our subsequent filings with the Securities and Exchange Commission, the following: changes in general, economic, and market conditions, legislative and regulatory conditions, the development of an interest rate environment that adversely affects Unity Bancorp, Inc.’s interest rate spread or other income anticipated from operations and investments and the impact of the COVID-19 pandemic on our employees, operations and customers.
Overview
Unity Bancorp, Inc. (the “Parent Company”) is a bank holding company incorporated in New Jersey and registered under the Bank Holding Company Act of 1956, as amended. Its wholly-owned subsidiary, Unity Bank (the “Bank” or, when consolidated with the Parent Company, the “Company”) is chartered by the New Jersey Department of Banking and Insurance and commenced operations on September 13, 1991. The Bank provides a full range of commercial and retail banking services through the Internet and its nineteen branch offices located in Bergen, Hunterdon, Middlesex, Somerset, Union and Warren counties in New Jersey, and Northampton County in Pennsylvania. These services include the acceptance of demand, savings, and time deposits and the extension of consumer, real estate, Small Business Administration ("SBA") and other commercial credits. The Bank has multiple subsidiaries used to hold part of its investment and loan portfolios and OREO properties.
The Company has two other wholly-owned subsidiaries: Unity (NJ) Statutory Trust II and Unity Risk Management, Inc. On July 24, 2006, the Trust issued $10.0 million of trust preferred securities to investors. These floating rate securities are treated as subordinated debentures on the Company’s financial statements. However, they qualify as Tier I Capital for regulatory capital compliance purposes, subject to certain limitations. Unity Risk Management, Inc. is the Company’s captive insurance company that insures risks to the Bank not covered by the traditional commercial insurance market. The Company does not consolidate the accounts and related activity of Unity (NJ) Statutory Trust II, but it does consolidate the accounts of Unity Risk Management, Inc.
COVID-19
On March 13, 2020, the Coronavirus Disease (“COVID-19”) pandemic was declared a national emergency by the President of the United States. The spread of COVID-19 has negatively impacted the national and local economy, disrupted supply chains and increased unemployment levels. In response to the COVID-19 pandemic, many businesses have been faced with restrictions in an effort to prioritize public health. The initial temporary closure and gradual reopening of many businesses and the implementation of social distancing and stay-at-home policies has and will continue to impact many of the Company’s customers. COVID-19 continues to aggressively spread globally and in the United States, despite increasing rates of vaccination in the United States.
The Company is committed to supporting its customers, employees and communities during this difficult time and has adapted to the changing environment. We have taken and continue taking steps to protect the health and safety of our employees and to work with our customers experiencing economic consequences from the epidemic. The Company has and is working with its loan customers to provide short term payment deferrals and to waive certain fees. These accommodations are likely to have a negative impact on the Company’s results of operations during the duration of the
epidemic, and, depending on how quickly the businesses of our customers rebound after the emergency, could lead to an increase in nonperforming assets.
The full impact of the pandemic is unknown and rapidly evolving. The outbreak is having a significant adverse impact on certain industries the Company serves, including retail, accommodations, and restaurants and food services. While most states have re-opened, it is under limited capacities and under other social-distancing restrictions, which have resulted in lower commercial activity and consumer spending. This decrease in commercial activity may result in our customers' inability to meet their loan obligations to us. In addition, the economic pressures and uncertainties related to the COVID-19 pandemic have resulted in changes in consumer spending behaviors, which may negatively impact the demand for loans and other services we offer. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on our customers and prospects, and on the local and national economy, there can be no assurances as to how the crisis may ultimately affect the Company's loan portfolio, and business as a whole. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated and whether the gradual reopening of businesses will result in a meaningful increase in economic activity. As such, the Company could be subject to certain risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations.
CARES Act
The CARES Act provides assistance to small businesses through the establishment of the Paycheck Protection Program ("PPP"). The PPP generally provides small businesses with funds to pay up to 24 weeks of payroll costs, including certain benefits. The funds are provided in the form of loans that may be fully or partially forgiven when used for payroll costs, interest on mortgages, rent, and utilities. The payments on these loans will be deferred for up to six months. Loans made after June 5, 2020, mature in five years, and loans made prior to June 5, 2020, mature in two years but can be extended to five years if the lender agrees. Forgiveness of the PPP loans is based on the employer maintaining or quickly rehiring employees and maintaining salary levels. Most small businesses with 500 or fewer employees are eligible. Applications for the PPP loans started on April 3, 2020 and the application period was extended to August 8, 2020, and then reopened pursuant to the terms of the Economic Aid Act discussed below. As an existing SBA 7(a) lender, the Company opted to participate in the program.
The Company approved 1,224 applications and provided fundings of approximately $143.0 million during the year ended December 31, 2020. The Company has $83.5 million of PPP loans remaining on our balance sheet as of March 31, 2021 and believes that the majority of these loans will be forgiven by the SBA.
Economic Aid Act
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues (“Economic Aid”) Act was signed into law. It provides additional assistance to the hardest-hit small businesses, nonprofits, and venues that are struggling to recover from the impact of the COVID-19 pandemic. The Economic Aid Act provides funding for a second round of PPP loans for small businesses and nonprofits experiencing significant revenue losses, makes programmatic improvements to PPP, funds grants to shuttered venues, and enacts emergency enhancements to other SBA lending programs.
The PPP now allows certain eligible borrowers that previously received a PPP loan to apply for a Second Draw PPP Loan with the same general loan terms as their First Draw PPP Loan, and for borrowers that did not initially receive a PPP loan to apply for one. Most small businesses with 300 or fewer employees that can demonstrate at least a 25% reduction in gross receipts between comparable quarters in 2019 and 2020 are eligible. Applications for PPP loans under the Economic Aid Act started on January 13, 2021 and were available until March 31, 2021. The Company is participating in the re-opened PPP loan process.
As of March 31, 2021, the Company provided fundings for 723 PPP loans under the Economic Aid Act totaling $85.6 million.
Deferrals
On March 22, 2020, the federal bank regulatory agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus.” This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19. The guidance goes on to explain that, in consultation with the FASB staff, the federal bank regulatory agencies concluded that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a relief program are not TDRs. Section 4013 of the CARES Act also addresses COVID-19 related modifications and specifies that COVID-19 related modifications on loans that were current as of December 31, 2019, are not TDRs.
Beginning in March 2020, the Company proactively communicated with its customers to address their financial needs. The Company worked closely with its customers to educate and guide them on their options for financial assistance, including disaster loans, the PPP and payment relief through deferrals and waived fees. As a result of our proactive approach to provide financial assistance to our customers, loans have been modified through payment deferrals and are not categorized as TDRs, in accordance with regulatory guidance and the CARES Act. The table below summarizes the loans that are in deferral as of March 31, 2021:
Total loan portfolio balance
Unpaid principal balance of full deferrals
Unpaid principal balance of principal only deferrals
Unpaid principal balance of deferrals
% total deferrals to total loans
0.00
342
2,918
15,503
18,421
2.16
1,400
0.31
4,318
15,845
20,163
1.21
Consent Order
In July 2020, Unity Bank agreed to the issuance of a Consent Order by the Federal Deposit Insurance Corporation (“FDIC”) and agreed to an Acknowledgement and Consent of the FDIC Consent Order with the Commissioner of Banking and Insurance for the State of New Jersey. The Consent Order requires the Bank to strengthen its Bank Secrecy Act (“BSA”)/anti-money laundering (“AML”) program, and to address related matters. The Bank hired a consulting firm to assist management in effectively addressing all matters pertaining to the order. Although the Bank believes it is complying with all requirements of the Consent Order, we can give no assurance that the FDIC and the NJDOBI will agree that the Bank is fully complying or that the Bank will not incur material additional expense in complying with the Consent Order.
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Earnings Summary
Net income totaled $8.5 million, or $0.80 per diluted share for the quarter ended March 31, 2021, compared to $5.4 million, or $0.49 per diluted share for the same period a year ago. Return on average assets and average common equity for the quarter were 1.85 percent and 19.51 percent, respectively, compared to 1.32 percent and 13.23 percent for the same period a year ago.
Quarterly highlights include:
The Company’s performance ratios may be found in the table below.
Net income per common share - Basic (1)
Net income per common share - Diluted (2)
Return on average assets
1.85
1.32
Return on average equity (3)
19.51
13.23
Efficiency ratio (4)
45.74
51.92
Net Interest Income
The primary source of the Company’s operating income is net interest income, which is the difference between interest and dividends earned on earning assets and fees earned on loans, and interest paid on interest-bearing liabilities. Earning assets include loans to individuals and businesses, investment securities, interest-earning deposits and federal funds sold. Interest-bearing liabilities include interest-bearing demand, savings and time deposits, FHLB advances and other borrowings. Net interest income is determined by the difference between the yields earned on earning assets and the rates paid on interest-bearing liabilities (“net interest spread”) and the relative amounts of earning assets and interest-bearing liabilities. The Company’s net interest spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand, deposit flows and general levels of nonperforming assets.
COVID-19 has adversely affected, and may continue to adversely affect economic activity globally, nationally and locally. Following the COVID-19 outbreak, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time. Additionally, the Federal Open Market Committee reduced the target federal funds rate to 0% to 0.25% on March 16, 2020. These reductions in interest rates and other effects of the COVID-19 outbreak may adversely affect the Company’s financial condition and results of operations.
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During the quarter ended March 31, 2021, tax-equivalent net interest income amounted to $18.0 million, an increase of $2.8 million or 18.1 percent when compared to the same period in 2020. The net interest margin increased 17 basis points to 4.09 percent for the three months ended March 31, 2021, compared to 3.92 percent for the same period in 2020. The net interest spread was 3.82 percent for the first quarter of 2021, a 28 basis point increase compared to the same period in 2020.
During the three months ended March 31, 2021, tax-equivalent interest income was $20.6 million, an increase of $984 thousand or 5.0 percent when compared to the same period in the prior year. This increase was mainly driven by the increase in the balance of average loans, partially offset by a decrease in the yield on loans, the rates on federal funds sold and interest-bearing deposits, and the decrease in the balance of average securities.
Total interest expense was $2.6 million for the three months ended March 31, 2021, a decrease of $1.8 million or 41.1 percent compared to the same period in 2020. This decrease was driven by the decreased rates on interest-bearing deposits and decreased rates on borrowed funds and subordinated debentures, partially offset by the increased volume of interest-bearing deposits and increased volume of borrowed funds and subordinated debentures compared to a year ago:
The following table reflects the components of net interest income, setting forth for the periods presented herein: (1) average assets, liabilities and shareholders’ equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) net interest spread, and (5) net interest income/margin on average earning assets. Rates/Yields are computed on a fully tax-equivalent basis, assuming a federal income tax rate of 21 percent in 2021 and 2020.
Consolidated Average Balance Sheets
(Dollar amounts in thousands, interest amounts and interest rates/yields on a fully tax-equivalent basis)
Balance
Rate/Yield
Interest-earning assets:
90,830
0.11
69,076
1.10
5,167
4.98
6,883
6.37
38,741
3.06
60,363
3.40
2,405
2.03
3,783
3.35
Total securities (A)
41,146
304
3.00
64,146
542
48,845
6.50
50,528
7.84
142,581
4.92
-
849,065
5.00
769,497
5.19
455,782
4.56
462,748
5.02
63,440
5.48
72,394
5.33
88,992
69,890
Total loans (B)
1,648,705
4.97
1,425,057
5.29
Total interest-earning assets
1,785,848
20,578
4.67
1,565,162
19,594
5.04
Noninterest-earning assets:
23,781
21,942
(23,308)
(16,698)
Other assets
76,309
70,381
Total noninterest-earning assets
76,782
75,625
1,862,630
1,640,787
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
209,020
0.60
162,193
0.94
476,463
0.37
424,905
0.90
438,250
1.35
435,705
Total interest-bearing deposits
1,123,733
2,203
1,022,803
3,776
1.47
89,699
131,057
1.73
Total interest-bearing liabilities
1,213,432
0.85
1,153,860
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits
455,146
307,683
Other liabilities
17,418
16,101
Total noninterest-bearing liabilities
472,564
323,784
Total shareholders' equity
176,634
163,143
Total liabilities and shareholders' equity
Net interest spread
18,020
3.82
15,253
3.54
Tax-equivalent basis adjustment
(2)
(9)
Net interest margin
4.09
3.92
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The rate volume table below presents an analysis of the impact on interest income and expense resulting from changes in average volume and rates over the periods presented. Changes that are not due to volume or rate variances have been allocated proportionally to both, based on their relative absolute values. Amounts have been computed on a tax-equivalent basis, assuming a federal income tax rate of 21 percent in 2021 and 2020.
For the three months ended March 31, 2021 versus March 31, 2020
Increase (decrease) due to change in:
(In thousands on a tax-equivalent basis)
Volume
Rate
Net
Interest income:
(209)
(164)
(24)
(22)
(46)
(180)
(58)
2,678
(1,246)
1,432
2,519
(1,535)
984
Interest expense:
Demand deposits
90
(159)
(69)
(621)
(520)
(998)
(984)
205
(1,778)
(1,573)
(38)
(210)
(1,816)
(1,783)
Net interest income - fully tax-equivalent
2,486
281
2,767
Decrease in tax-equivalent adjustment
2,774
Provision for Loan Losses
The provision for loan losses totaled $500 thousand for the three months ended March 31, 2021, compared to $1.5 million for the three months ended March 31, 2020. The $1.0 million decrease in provision for loan losses was primarily due to increased provisions in 2020 due to the increased risk of loan defaults as a result of COVID-19.
Each period’s loan loss provision is the result of management’s analysis of the loan portfolio and reflects changes in the size and composition of the portfolio, the level of net charge-offs, delinquencies, current economic conditions and other internal and external factors impacting the risk within the loan portfolio. Additional information may be found under the captions “Financial Condition - Asset Quality” and “Financial Condition - Allowance for Loan Losses and Reserve for Unfunded Loan Commitments.” The current provision is considered appropriate under management’s assessment of the adequacy of the allowance for loan losses.
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Noninterest Income
The following table shows the components of noninterest income for the three months ended March 31, 2021 and 2020:
For the three months ended March 31, 2021, noninterest income increased $1.2 million to $3.7 million, compared to the same period last year. Quarterly noninterest income increased primarily due to increased gains on mortgage loan sales and increased net gains on securities.
Changes in our noninterest income for the three months ended March 31, 2021 compared to the prior year period reflect:
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Noninterest Expense
The following table presents a breakdown of noninterest expense for the three months ended March 31, 2021 and 2020:
Loan collection & OREO (recoveries) expenses
Noninterest expense increased $479 thousand to $9.8 million for the three months ended March 31, 2021.
Changes in noninterest expense for the three months ended March 31, 2021 versus 2020 reflect:
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Income Tax Expense
For the quarter ended March 31, 2021, the Company reported income tax expense of $2.9 million for an effective tax rate of 25.7 percent, compared to income tax expense of $1.6 million and an effective tax rate of 22.9 percent for the prior year’s quarter.
On July 1, 2018, New Jersey’s Assembly Bill 4202 was signed into law. The bill, effective January 1, 2018, imposed a temporary surtax on corporations earning New Jersey allocated income in excess of $1 million at a rate of 2.5% for tax years beginning on or after January 1, 2018 through December 31, 2019, and at a rate of 1.5% for years beginning on or after January 1, 2020, through December 31, 2021. In addition, New Jersey adopted mandatory unitary combined reporting for its Corporation Business Tax, which became effective for periods on or after January 1, 2019.
For additional information on income taxes, see Note 4 to the Consolidated Financial Statements.
Financial Condition at March 31, 2021
Total assets increased $45.9 million or 2.3 percent, to $2.0 billion at March 31, 2021, when compared to year end 2020. This increase was primarily due to increases of $40.8 million in net loans, primarily due to the funding of SBA PPP loans and strong commercial loan growth, and $20.3 million in cash and cash equivalents, partially offset by a decrease of $13.0 million in investments.
Total deposits increased $70.4 million, primarily due to increases of $46.9 million in savings deposits, $13.5 million in interest-bearing demand deposits, $5.9 million in noninterest-bearing demand deposits, and $4.3 million in time deposits. Borrowed funds decreased $30.0 million due to a $20.0 million reduction in overnight borrowings and the maturity of a $10.0 million FHLB adjustable rate advance.
Total shareholders’ equity increased $7.3 million over year end 2020, primarily due to earnings, accumulated other comprehensive income, and an increase in common stock, partially offset by treasury stock purchases and dividends paid during the three months ended March 31, 2021.
These fluctuations are discussed in further detail in the paragraphs that follow.
Securities Portfolio
The Company’s securities portfolio consists of AFS debt securities and equity investments. The investment securities portfolio is maintained for asset-liability management purposes, as well as for liquidity and earnings purposes.
AFS debt securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. AFS debt securities consist primarily of obligations of U.S. Government sponsored entities, obligations of state and political subdivisions, mortgage-backed securities, and corporate and other securities.
AFS debt securities totaled $32.3 million at March 31, 2021, a decrease of $13.3 million or 29.1 percent, compared to $45.6 million at December 31, 2020. This net decrease was the result of:
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The weighted average life of AFS debt securities, adjusted for prepayments, amounted to 5.7 years and 4.6 years at March 31, 2021 and December 31, 2020, respectively.
Equity securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. Equity securities consist of Community Reinvestment Act ("CRA") investments and the equity holdings of financial institutions.
Equity securities totaled $2.2 million at March 31, 2021, an increase of $267 thousand or 13.7 percent, compared to $2.0 million at December 31, 2020. This net increase was the result of:
The average balance of taxable securities amounted to $38.9 million for the three months ended March 31, 2021, compared to $60.2 million for the same period in 2020. The average yield earned on taxable securities decreased 36 basis points, to 3.05 percent for the three months ended March 31, 2021, from 3.41 percent for the same period in the prior year. The average balance of tax-exempt securities amounted to $2.4 million for the three months ended March 31, 2021, compared to $3.8 million for the same period in 2020. The average yield earned on tax-exempt securities decreased 128 basis points, to 2.02 percent for the three months ended March 31, 2021, from 3.30 percent for the same period in 2020.
Securities with a carrying value of $1.5 million and $1.6 million at March 31, 2021 and December 31, 2020, respectively, were pledged to secure other borrowings, to collateralize hedging instruments and for other purposes required or permitted by law.
Approximately 51 percent of the total investment portfolio had a fixed rate of interest at March 31, 2021.
See Note 7 to the accompanying Consolidated Financial Statements for more information regarding Securities.
Loan Portfolio
The loan portfolio, which represents the Company’s largest asset group, is a significant source of both interest and fee income. The portfolio consists of SBA, commercial, residential mortgage, consumer, and consumer construction loans. Each of these segments is subject to differing levels of credit and interest rate risk.
Total loans increased $40.6 million or 2.5 percent to $1.7 billion at March 31, 2021, compared to year end 2020. The increase was primarily driven by the funding of SBA Paycheck Protection Program (“PPP”) loans. As of March 31, 2021, the Company had PPP loans totaling $169.1 million. SBA PPP, commercial, and consumer construction loans increased $50.9 million, $13.3 million and $3.3 million respectively, partially offset by decreases of $19.4 million, $5.6 million and $1.8 million in residential mortgage, consumer, and SBA loans, respectively.
55
The following table sets forth the classification of loans by major category, including unearned fees and deferred costs and excluding the allowance for loan losses as of March 31, 2021 and December 31, 2020:
% of
total
2.3
2.4
10.1
7.3
51.2
51.6
26.9
28.7
3.6
4.0
5.4
99.5
99.4
0.5
0.6
100.0
Average loans increased $223.6 million or 15.7 percent to $1.6 billion for the three months ended March 31, 2021 from $1.4 billion for the same period in 2020. The increase in average loans was due to increases in average PPP, commercial, and consumer construction loans, partially offset by decreases in average consumer, residential mortgage, and SBA loans. The yield on the overall loan portfolio decreased 32 basis points to 4.97 percent for the three months ended March 31, 2021 when compared to the same period in the prior year.
SBA 7(a) loans, on which the SBA historically has provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. These loans are made for the purposes of providing working capital or financing the purchase of equipment, inventory or commercial real estate. Generally, an SBA 7(a) loan has a deficiency in its credit profile that would not allow the borrower to qualify for a traditional commercial loan, which is why the SBA provides the guarantee. The deficiency may be a higher loan to value (“LTV”) ratio, lower debt service coverage (“DSC”) ratio or weak personal financial guarantees. In addition, many SBA 7(a) loans are for start up businesses where there is no history or financial information. Finally, many SBA borrowers do not have an ongoing and continuous banking relationship with the Bank, but merely work with the Bank on a single transaction. The guaranteed portion of the Company’s SBA loans are generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment.
SBA 7(a) loans held for sale, carried at the lower of cost or market, amounted to $8.8 million at March 31, 2021, a decrease of $526 thousand from $9.3 million at December 31, 2020. SBA 7(a) loans held to maturity amounted to $38.3 million at March 31, 2021, a decrease of $1.3 million from $39.6 million at December 31, 2020. The yield on SBA loans, which are generally floating and adjust quarterly to the Prime rate, was 6.50 percent for the three months ended March 31, 2021, compared to 7.84 percent in the prior year.
The guarantee rates on SBA 7(a) loans range from 50 percent to 90 percent, with the majority of the portfolio having a guarantee rate of 75 percent at origination. The guarantee rates are determined by the SBA and can vary from year to year depending on government funding and the goals of the SBA program. The carrying value of SBA loans held for sale represents the guaranteed portion to be sold into the secondary market. The carrying value of SBA loans held to maturity represents the unguaranteed portion, which is the Company’s portion of SBA loans originated, reduced by the guaranteed portion that is sold into the secondary market. Approximately $97.9 million and $98.9 million in SBA loans were sold but serviced by the Company at March 31, 2021 and December 31, 2020, respectively, and are not included on the Company’s balance sheet. There is no relationship or correlation between the guarantee percentages and the level of charge-offs and recoveries on the Company’s SBA 7(a) loans. Charge-offs taken on SBA 7(a) loans effect the unguaranteed portion of the loan. SBA loans are underwritten to the same credit standards irrespective of the guarantee percentage.
The CARES Act provides assistance to small businesses through the establishment of the SBA Paycheck Protection Program ("PPP"). The PPP generally provides small businesses with funds to pay up to 24 weeks of payroll costs, including certain benefits. The funds are provided in the form of loans that may be fully or partially forgiven when used
for payroll costs, interest on mortgages, rent, and utilities. The payments on these loans will be deferred for up to six months. Loans made after June 5, 2020, mature in five years, and loans made prior to June 5, 2020, mature in two years and can be extended to five years if the lender agrees. Forgiveness of the PPP loans is based on the employer maintaining or quickly rehiring employees and maintaining salary levels. Most small businesses with 500 or fewer employees are eligible. Applications for the PPP loans started on April 3, 2020 and the application period was extended through August 8, 2020. As an existing SBA 7(a) lender, the Company opted to participate in the program. Applications for PPP loans were restarted under the Economic Aid Act on January 13, 2021 and were available until March 31, 2021.
Commercial loans are generally made in the Company’s marketplace for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. These loans amounted to $853.1 million at March 31, 2021, an increase of $13.3 million from year end 2020. The yield on commercial loans was 5.00 percent for the three months ended March 31, 2021, compared to 5.19 percent for the same period in 2020. Loans under the SBA 504 program, which consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property, are included in the Commercial loan portfolio. Generally, the Company has a 50 percent LTV ratio on SBA 504 program loans at origination.
Residential mortgage loans consist of loans secured by 1 to 4 family residential properties. These loans amounted to $448.1 million at March 31, 2021, a decrease of $19.4 million from year end 2020. Sales of mortgage loans totaled $101.9 million for the three months ended March 31, 2021. The yield on residential mortgages was 4.56 percent for the three months ended March 31, 2021, compared to 5.02 percent in the 2020 period. Residential mortgage loans maintained in portfolio are generally to individuals that do not qualify for conventional financing. In extending credit to this category of borrowers, the Bank considers other mitigating factors such as credit history, equity and liquid reserves of the borrower. As a result, the residential mortgage loan portfolio of the Bank includes adjustable rate mortgages with rates that exceed the rates on conventional fixed-rate mortgage loan products but which are not considered high priced mortgages.
Consumer loans consist of home equity loans and loans for the purpose of financing the purchase of consumer goods, home improvements, and other personal needs, and are generally secured by the personal property being purchased. These loans amounted to $60.5 million, a decrease of $5.6 million from year end 2020. The yield on consumer loans was 5.48 percent for the three months ended March 31, 2021, compared to 5.33 percent for the same period in 2020.
Consumer construction loans consist of short-term loans for the purpose of funding the costs of building a home. These loans amounted to $90.5 million, an increase of $3.3 million from year end 2020. The yield on consumer construction loans was 5.54 percent for the three months ended March 31, 2021, compared to 6.37 for the same period in 2020.
There are no concentrations of loans to any borrowers or group of borrowers exceeding 10 percent of the total loan portfolio and no foreign loans in the portfolio.
In the normal course of business, the Company may originate loan products whose terms could give rise to additional credit risk. Interest-only loans, loans with high LTV or debt service ratios, construction loans with payments made from interest reserves and multiple loans supported by the same collateral (e.g. home equity loans) are examples of such products. However, these products are not material to the Company’s financial position and are closely managed via credit controls that mitigate their additional inherent risk. Management does not believe that these products create a concentration of credit risk in the Company’s loan portfolio. The Company does not have any option adjustable rate mortgage loans.
The majority of the Company’s loans are secured by real estate. Declines in the market values of real estate in the Company’s trade area impact the value of the collateral securing its loans. This could lead to greater losses in the event of defaults on loans secured by real estate. At March 31, 2021 approximately 84 percent of the Company’s loan portfolio was secured by real estate compared to 87 percent at December 31, 2020.
TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. Deferrals complying with the terms of the CARES Act and regulatory guidance (i.e., deferrals of up to six months to borrowers impacted by the COVID-19 pandemic, where the borrower was current at either December 31, 2019 or prior to the deferral being granted) are not considered TDR’s. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.
At March 31, 2021, there were three loans totaling $1.1 million that were classified as TDRs and deemed impaired, compared to one loan totaling $663 thousand at December 31, 2020. Restructured loans that are placed in nonaccrual status may be removed after six months of contractual payments and the borrower showing the ability to service the debt going forward. The TDRs are in accrual status since they are performing in accordance with the restructured terms. There are no commitments to lend additional funds on these loans.
The following table presents a breakdown of performing and nonperforming TDRs by class of as March 31, 2021 and December 31, 2020:
652
663
Through March 31, 2021, TDRs consisted of principal reduction, interest only periods and maturity extensions. The following table shows the types of modifications done by date by class through March 31, 2021:
Home
real estate
Type of modification:
Principal reduction
Interest only with nominal principal
Total TDRs
Asset Quality
Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to strict credit administration policies and procedures. Due diligence on loans begins when we initiate contact regarding a loan with a borrower. Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval.
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The loan portfolio is then subject to on-going internal reviews for credit quality, as well as independent credit reviews by an outside firm.
The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. In some cases, these factors have also resulted in significant impairment to the value of loan collateral. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.
Nonperforming assets consist of nonperforming loans and OREO. Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being delinquent for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. When a loan is classified as nonaccrual, interest accruals discontinue and all past due interest previously recognized as income is reversed and charged against current period income. Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal, until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans. Loans past due 90 days or more and still accruing generally represent loans that are well secured and in process of collection.
The following table sets forth information concerning nonperforming assets and loans past due 90 days or more and still accruing interest at each of the periods presented:
Nonperforming by category:
1,627
952
1,325
613
6,910
Total nonperforming loans
9,655
1,523
Total nonperforming assets
11,178
Past due 90 days or more and still accruing interest:
Total past due 90 days or more and still accruing interest
Nonperforming loans to total loans
0.71
0.74
0.67
Nonperforming loans and TDRs to total loans (2)
0.77
0.78
0.72
Nonperforming assets to total loans and OREO
Nonperforming assets to total assets
0.59
0.62
0.64
(1) Guaranteed SBA loans included above
139
(2) Performing TDRs
694
Nonperforming loans were $11.8 million at March 31, 2021, a $272 thousand decrease from $12.1 million at December 31, 2020 and a $2.1 million increase from $9.7 million at March 31, 2020. Since year end 2020, nonperforming loans in the SBA, consumer, and commercial loan segments decreased, partially offset by an increase in the residential and consumer construction loan segments. Included in nonperforming loans at March 31, 2021 are approximately $139 thousand of loans guaranteed by the SBA, compared to $371 thousand at December 31, 2020, and $427 thousand at March 31, 2020, respectively. In addition, there were $2.5 million loans past due 90 days or more and still accruing interest at March 31, 2021, compared to $449 thousand at December 31, 2020 and none as of March 31, 2020.
The Company also monitors potential problem loans. Potential problem loans are those loans where information about possible credit problems of borrowers causes management to have doubts as to the ability of such borrowers to comply with loan repayment terms. These loans are categorized by their non-passing risk rating and performing loan status.
Potential problem loans totaled $37.5 million at March 31, 2021, an increase of $791 thousand from $36.7 million at year end.
See Note 8 to the accompanying Consolidated Financial Statements for more information regarding Asset Quality.
Management reviews the level of the allowance for loan losses on a quarterly basis. The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. Specific reserves are made to individual impaired loans, which have been defined to include all nonperforming loans and TDRs.
The general reserve is set based upon a representative average historical net charge-off rate adjusted for certain environmental factors such as: delinquency and impairment trends, charge-off and recovery trends, volume and loan term trends, risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes.
When calculating the five-year historical net charge-off rate, the Company weights the past three years more heavily. The Company believes using this approach is more indicative of future charge-offs. All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate, and high risk. The factors are evaluated separately for each type of loan. For example, commercial loans are broken down further into commercial and industrial loans, commercial mortgages, construction loans, etc. Each type of loan is risk weighted for each environmental factor based on its individual characteristics.
According to the Company’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable. All credits which are 90 days past due must be analyzed for the Company’s ability to collect on the credit. Once a loss is known to exist, the charge-off approval process is immediately expedited.
The allowance for loan losses totaled $23.0 million at March 31, 2021, compared to $23.1 million at December 31, 2020, and $17.4 million at March 31, 2020, with a resulting allowance to total loan ratio of 1.38 percent at March 31, 2021, 1.42 percent at December 31, 2020, and 1.21 percent at March 31, 2020. Net charge-offs amounted to $640 thousand for the three months ended March 31, 2021, compared to $519 thousand for the same period in 2020. Net charge-offs to average loan ratios are shown in the table below for each major loan category.
Provision for loan losses charged to expense
Less: Chargeoffs
282
373
300
Total chargeoffs
656
Add: Recoveries
Total recoveries
640
519
Selected loan quality ratios:
Net chargeoffs to average loans:
0.57
0.16
0.18
0.17
0.01
0.15
Allowance to total loans
1.38
Allowance to nonperforming loans
194.82
179.97
In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses.
Adjustments to the reserve are made through other expense and applied to the reserve which is maintained in other liabilities. At March 31, 2021, a $310 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $288 thousand commitment reserve at December 31, 2020.
See Note 9 to the accompanying Consolidated Financial Statements for more information regarding the Allowance for Loan Losses and Reserve for Unfunded Loan Commitments.
Deposits, which include noninterest-bearing demand deposits, interest-bearing demand deposits, savings deposits and time deposits, are the primary source of the Company’s funds. The Company offers a variety of products designed to attract and retain customers, with primary focus on building and expanding relationships. The Company continues to focus on establishing a comprehensive relationship with business borrowers, seeking deposits as well as lending relationships.
Total deposits increased $70.4 million to $1.6 billion at March 31, 2021, from year-end 2020. This increase in deposits was due to increases of $46.9 million in savings deposits, $13.5 million in interest-bearing demand deposits, $5.8 million in noninterest-bearing demand deposits, and $4.3 million in time deposits.
The Company’s deposit composition at March 31, 2021, consisted of 30.8 percent savings deposits, 28.6 percent noninterest-bearing demand deposits, 27.2 percent time deposits, and 13.4 percent interest-bearing demand deposits.
Borrowed funds consist primarily of adjustable and fixed rate advances from the Federal Home Loan Bank of New York. These borrowings are used as a source of liquidity or to fund asset growth not supported by deposit generation. Residential mortgages and commercial loans collateralize the borrowings from the FHLB.
Borrowed funds and subordinated debentures totaled $180.3 million and $210.3 million at March 31, 2021 and December 31, 2020, respectively, and are broken down in the following table:
FHLB borrowings:
Fixed rate advances
40,000
Adjustable rate advances
20,000
Overnight advances
110,000
Total borrowed funds and subordinated debentures
210,310
The $30.0 million decrease in total borrowed funds and subordinated debentures was due to a $20.0 million decrease in FHLB overnight advances and a $10.0 million decrease in FHLB adjustable rate advances. The following transactions impacted borrowed funds and subordinated debentures:
FHLB Borrowings
At March 31, 2021 and December 31, 2020, the Company had $40.0 million in fixed rate advances. The terms of this transaction are as follows:
At March 31, 2021, the $20 million FHLB adjustable rate (“ARC ) advances consisted of one $20.0 million advance. At December 31, 2020, the $30.0 million FHLB adjustable rate ("ARC") advances consisted of one $20.0 million advance and one $10.0 million advance. The ARC advance rolls over every six months. The Company has opted to use swap instruments to control the uncertainty from variable rate instruments. The ARC advance has a swap instrument which modifies the borrowing to a 5 year fixed rate borrowing. The terms of this transaction are as follows:
At March 31, 2021, there were FHLB overnight borrowings of $110.0 million at a rate of 0.320%, compared to $130.0 million at a rate of 0.340% at December 31, 2020.
In March 2021, the FHLB issued a $20.0 million municipal deposit letter of credit in the name of Unity Bank naming the New Jersey Department of Banking and Insurance as beneficiary, to secure municipal deposits as required under New Jersey law.
At March 31, 2021, the Company had $366.7 million of additional credit available at the FHLB. Pledging additional collateral in the form of 1 to 4 family residential mortgages, commercial loans and investment securities can increase the line with the FHLB.
Subordinated Debentures
On July 24, 2006, Unity (NJ) Statutory trust II, a statutory business trust and wholly-owned subsidiary of Unity Bancorp, Inc., issued $10.0 million of floating rate capital trust pass through securities to investors due on July 24, 2036. The subordinated debentures are redeemable in whole or part, prior to maturity but after July 24, 2011. The floating interest rate on the subordinated debentures is three-month LIBOR plus 159 basis points and reprices quarterly. The floating interest rate was 1.787% at March 31, 2021 and 1.835% at December 31, 2020. At March 31, 2021 and December 31, 2020, the subordinated debentures had a swap instrument which modified the borrowing to a 3 year fixed rate at 3.435%.
Interest Rate Sensitivity
The principal objectives of the asset and liability management function are to establish prudent risk management guidelines, evaluate and control the level of interest-rate risk in balance sheet accounts, determine the level of appropriate risk given the business focus, operating environment, capital, and liquidity requirements, and actively manage risk within the Board approved guidelines. The Company seeks to reduce the vulnerability of operations to changes in interest rates, and actions in this regard are taken under the guidance of the Asset/Liability Management Committee (“ALCO”) of the Board of Directors. The ALCO reviews the maturities and re-pricing of loans, investments, deposits and borrowings, cash flow needs, current market conditions, and interest rate levels.
The Company utilizes Modified Duration of Equity and Economic Value of Portfolio Equity (“EVPE”) models to measure the impact of longer-term asset and liability mismatches beyond two years. The modified duration of equity measures the potential price risk of equity to changes in interest rates. A longer modified duration of equity indicates a greater degree of risk to rising interest rates. Because of balance sheet optionality, an EVPE analysis is also used to dynamically model the present value of asset and liability cash flows with rate shocks of 200 basis points. The economic value of equity is likely to be different as interest rates change. Results falling outside prescribed ranges require action by the ALCO. The Company’s variance in the economic value of equity, as a percentage of assets with rate shocks of 200 basis points at March 31, 2021, is an increase of 4.2 percent in a rising-rate environment and a decrease of 10.7 percent in a falling-rate environment. The variances in the EVPE at March 31, 2021 are within the Board-approved guidelines of +/- 20.0 percent. In a falling rate environment with a rate shock of 200 basis points, benchmark interest rates are assumed to have floors of 0.00%. At December 31, 2020, the economic value of equity as a percentage of assets with rate shocks of 200 basis points was an increase of 4.1 percent in a rising-rate environment and a decrease of 7.5 percent in a falling-rate environment.
Liquidity
Consolidated Bank Liquidity
Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A bank’s liquidity reflects its ability to meet loan demand, to accommodate possible outflows in deposits and to take advantage of interest rate opportunities in the marketplace. Our liquidity is monitored by management and the Board of Directors, which reviews historical funding requirements, our current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments. Our goal is to maintain sufficient asset-based liquidity to cover potential funding requirements in order to minimize our dependence on volatile and potentially unstable funding markets.
The principal sources of funds at the Bank are deposits, scheduled amortization and prepayments of investment and loan principal, sales and maturities of investment securities, additional borrowings and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit inflows and outflows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Consolidated Statement of Cash Flows provides detail on the Company’s sources and uses of cash, as well as an indication of the Company’s ability to maintain an adequate level of liquidity. At March 31, 2021, the balance of cash and cash equivalents was $239.6 million, an increase of $20.3 million from December 31, 2020. A discussion of the cash provided by and used in operating, investing and financing activities follows.
Operating activities provided $11.6 million and $11.5 million of net cash for the three months ended March 31, 2021 and 2020, respectively. The primary sources of funds were net income from operations and adjustments to net income, such as the proceeds from the sale of mortgage and SBA loans held for sale, partially offset by originations of mortgage and SBA loans held for sale.
Investing activities used $29.6 million and $3.9 million in net cash for the three months ended March 31, 2021 and 2020, respectively. Cash was primarily used to fund new loans, primarily SBA PPP loans, and purchase FHLB stock, partially offset by proceeds from the redemption of FHLB stock.
Financing activities provided $38.2 million and $13.4 million in net cash for the three months ended March 31, 2021 and 2020, respectively, primarily due to proceeds from new borrowings and an increase in the Company’s deposits, partially offset by repayments of borrowings and the purchase of treasury stock.
Parent Company Liquidity
The Parent Company’s cash needs are funded by dividends paid and rental payments on corporate headquarters by the Bank. Other than its investment in the Bank, Unity Risk Management, Inc. and Unity Statutory Trust II, the Parent Company does not actively engage in other transactions or business. Only expenses specifically for the benefit of the Parent Company are paid using its cash, which typically includes the payment of operating expenses, cash dividends on common stock and payments on trust preferred debt.
At March 31, 2021, the Parent Company had $1.2 million in cash and cash equivalents and $1.3 million in investment securities valued at fair market value, compared to $640 thousand and $1.0 million at December 31, 2020.
Regulatory Capital
On September 17, 2019, the federal banking agencies issued a final rule providing simplified capital requirements for certain community banking organizations (banks and holding companies) with less than $10 billion in total consolidated
64
assets, implementing provisions of The Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”). Under the proposal, a qualifying community banking organization would be eligible to elect the community bank leverage ratio framework, or continue to measure capital under the existing Basel III requirements. The new rule was effective beginning January 1, 2020, and qualifying community banking organizations may elect to opt into the new community bank leverage ratio (“CBLR”) in their call report beginning in the first quarter of 2020.
On April 6, 2020, the federal banking regulators implemented the applicable provisions of the CARES Act, which modified the CBLR framework so that: (i) beginning in the second quarter 2020 and until the end of 2020, a banking organization that has a leverage ratio of 8% or greater and meets certain other criteria may elect to use the CBLR framework; and (ii) community banking organizations will have until January 1, 2022, before the CBLR requirement is re-established at greater than 9%. Under the interim rules, the minimum CBLR will be 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. The numerator of the CBLR is Tier 1 capital, as calculated under the Basel III rules. The denominator of the CBLR is the QCBO’s average assets, calculated in accordance with the QCBO’s Call Report instructions less assets deducted from Tier 1 capital.
The Bank has opted into the CBLR, and is therefore not be required to comply with the Basel III capital requirements.
For additional information on regulatory capital, see Note 13 to the Consolidated Financial Statements.
Shareholders’ Equity
Shareholders’ equity increased $7.3 million to $181.2 million at March 31, 2021 compared to $173.9 million at December 31, 2020, primarily due to net income of $8.5 million. Other items impacting shareholders’ equity included $1.3 million in treasury stock purchased at cost, $804 thousand in dividends paid on common stock, $655 thousand in accumulated other comprehensive income net of tax, and $277 thousand from the issuance of common stock under employee benefit plans. The issuance of common stock under employee benefit plans includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised.
Repurchase Plan
On February 4, 2021, the Company authorized the repurchase of up to 750 thousand shares, or approximately 7.5 percent of its outstanding common stock. The plan took effect after the Company’s prior share repurchase program was completed and all authorized shares repurchased on February 16, 2021. A total of 70 thousand shares were repurchased at an average price of $19.29 during the three months ended March 31, 2021, of which 20 thousand shares were repurchased from the prior repurchase plan, leaving 701 thousand shares available for repurchase. The timing and amount of additional purchases, if any, will depend upon a number of factors including the Company’s capital needs, the performance of its loan portfolio, the need for additional provisions for loan losses, whether related to the COVID-19 pandemic or otherwise, the market price of the Company’s stock and the general impact of the COVID-19 pandemic on
the economy. A total of 11 thousand shares were repurchased for the same period in 2020. The table below sets forth information regarding our repurchases during the quarter:
Total Number of
Maximum Number
Shares Purchased
of Shares that may
as Part of Publicly
yet be Purchased
Price Paid
Announced Plans
Under the Plans
Purchased
per Share
or Programs
January 1, 2021 through January 31, 2021
770,475
February 1, 2021 through February 28, 2021
60,095
19.18
710,380
March 1, 2021 through March 31, 2021
9,692
19.98
700,688
Impact of Inflation and Changing Prices
The financial statements and notes thereto, presented elsewhere herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the operations. Unlike most industrial companies, nearly all the Company’s assets and liabilities are monetary. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
ITEM 3 Quantitative and Qualitative Disclosures about Market Risk
During the three months ended March 31, 2021, there have been no significant changes in the Company’s assessment of market risk as reported in Item 6 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2020. (See Interest Rate Sensitivity in Management’s Discussion and Analysis herein.)
ITEM 4 Controls and Procedures
PART II OTHER INFORMATION
ITEM 1 Legal Proceedings
From time to time, the Company is subject to other legal proceedings and claims in the ordinary course of business. The Company currently is not aware of any such legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse effect on the business, financial condition, or the results of the operation of the Company.
ITEM 1A Risk Factors
Information regarding this item as of March 31, 2021 appears under the heading, “Risk Factors” within the Company’s Form 10-K for the year ended December 31, 2020.
ITEM 2 Unregistered Sales of Equity Securities and Use of Proceeds
See the discussion under the heading “Shareholders Equity - Repurchase Plan” under Item 2 “Management’s Discussion and Analysis of Financial Condition and results of Operations.”
ITEM 3 Defaults upon Senior Securities – None
ITEM 4 Mine Safety Disclosures - N/A
ITEM 5 Other Information – None
ITEM 6 Exhibits
(a) Exhibits
Description
Certification of Chief Executive Officer Pursuant to Rule 13a 14(a) or Rule 15d 14(a) and Section 302 of the Sarbanes-Oxley Act of 2002
Certification of Chief Financial Officer Pursuant to Rule 13a 14(a) or Rule 15d 14(a) and Section 302 of the Sarbanes-Oxley Act of 2002
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Rule 13a 14(b) or Rule 15d 14(b) and 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
QUARTERLY REPORT ON FORM 10-Q
Exhibit No.
31.1
Exhibit 31.1-Certification of James A. Hughes. Required by Rule 13a-14(a) or Rule 15d-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Exhibit 31.2-Certification of George Boyan. Required by Rule 13a-14(a) or Rule 15d-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Exhibit 32.1-Certification of James A. Hughes and George Boyan. Required by Rule 13a-14(b) or Rule 15d-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
**101.INS
Inline XBRL Instance Document
**101.SCH
Inline XBRL Taxonomy Extension Schema Document
**101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
**101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
**101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
**101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
**104
Cover Page Interactive Data File (formatted as Inline XBRL and contained as Exhibit 101)
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.
UNITY BANCORP, INC.
Dated:
May 5, 2021
/s/ George Boyan
George Boyan
Executive Vice President and Chief Financial Officer