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 Quarter Ended September 30, 2020
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 001-16197
PEAPACK-GLADSTONE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
New Jersey
22-3537895
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
500 Hills Drive, Suite 300
Bedminster, New Jersey 07921-0700
(Address of principal executive offices, including zip code)
(908) 234-0700
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, no par value
PGC
The NASDAQ Stock Market, LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement 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 Regulations 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).
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 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
Non-accelerated 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 ☒
Number of shares of Common Stock outstanding as of November 2, 2020: 18,934,649
PART 1 FINANCIAL INFORMATION
Item 1
Financial Statements
3
Consolidated Statements of Condition at September 30, 2020 and December 31, 2019
Consolidated Statements of Income for the three and nine months ended September 30, 2020 and 2019
4
Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2020 and 2019
5
Consolidated Statement of Changes in Shareholders’ Equity for the three and nine months ended September 30, 2020 and 2019
6
Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and 2019
8
Notes to Consolidated Financial Statements
9
Item 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations
44
Item 3
Quantitative and Qualitative Disclosures about Market Risk
65
Item 4
Controls and Procedures
67
PART 2 OTHER INFORMATION
Legal Proceedings
68
Item 1A
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5
Other Information
Item 6
Exhibits
69
2
Item 1. Financial Statements
CONSOLIDATED STATEMENTS OF CONDITION
(Dollars in thousands, except share and per share data)
(unaudited)
(audited)
September 30,
December 31,
2020
2019
ASSETS
Cash and due from banks
$
8,400
6,591
Federal funds sold
102
Interest-earning deposits
670,863
201,492
Total cash and cash equivalents
679,365
208,185
Securities available for sale
596,929
390,755
Equity security, at fair value
15,159
10,836
FHLB and FRB stock, at cost
18,433
24,068
Loans held for sale, at fair value
13,785
2,881
Loans held for sale, at lower of cost or fair value
14,455
14,667
Loans
4,430,651
4,394,137
Less: Allowance for loan and lease losses
66,145
43,676
Net loans
4,364,506
4,350,461
Premises and equipment
21,668
20,913
Other real estate owned
50
Accrued interest receivable
22,192
10,494
Bank owned life insurance
46,645
46,128
Goodwill
30,208
Other intangible assets
9,414
10,380
Finance lease right-of-use assets
4,517
5,078
Operating lease right-of-use assets
10,011
12,132
Other assets
110,770
45,643
TOTAL ASSETS
5,958,107
5,182,879
LIABILITIES
Deposits:
Noninterest-bearing demand deposits
838,307
529,281
Interest-bearing deposits:
Checking
1,858,529
1,510,363
Savings
127,737
112,652
Money market accounts
1,251,349
1,196,313
Certificates of deposit - retail
586,801
633,763
Certificates of deposit - listing service
32,677
47,430
Subtotal deposits
4,695,400
4,029,802
Interest-bearing demand - brokered
130,000
180,000
Certificates of deposit - brokered
33,750
33,709
Total deposits
4,859,150
4,243,511
Short-term borrowings
15,000
128,100
Federal Home Loan Bank advances
105,000
Paycheck Protection Program Liquidity Facility
183,790
—
Finance lease liabilities
6,976
7,598
Operating lease liabilities
10,318
12,423
Subordinated debt, net
83,585
83,417
Deferred tax liabilities, net
23,295
26,151
Due to brokers, securities settlements
15,088
7,951
Accrued expenses and other liabilities
133,177
65,076
TOTAL LIABILITIES
5,435,379
4,679,227
SHAREHOLDERS’ EQUITY
Preferred stock (no par value; authorized 500,000 shares; liquidation preference of $1,000 per share)
Common stock (no par value; stated value $0.83 per share; authorized 42,000,000 shares; issued
shares, 20,293,131 at September 30, 2020 and 20,074,766 at December 31, 2019; outstanding
shares, 18,924,953 at September 30, 2020 and 18,926,810 at December 31, 2019
16,916
16,733
Surplus
324,677
319,375
Treasury stock at cost, 1,368,178 shares at September 30, 2020 and 1,147,956 shares
at December 31, 2019
(36,477
)
(29,990
Retained earnings
219,359
199,029
Accumulated other comprehensive loss, net of income tax
(1,747
(1,495
TOTAL SHAREHOLDERS’ EQUITY
522,728
503,652
TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY
See accompanying notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except share data)
(Unaudited)
Three Months Ended
Nine Months Ended
INTEREST INCOME
Interest and fees on loans
37,704
42,006
119,330
123,113
Interest on investments:
Taxable
2,182
2,477
6,749
7,800
Tax-exempt
51
73
166
257
Interest on loans held for sale
78
30
153
47
Interest on interest-earning deposits
159
1,362
820
3,897
Total interest income
40,174
45,948
127,218
135,114
INTEREST EXPENSE
Interest on savings and interest-bearing deposit accounts
2,066
8,710
11,640
25,325
Interest on certificates of deposit
2,529
3,781
9,370
10,476
Interest on borrowed funds
1,221
886
3,360
2,558
Interest on finance lease liability
84
94
261
290
Interest on subordinated debt
1,222
1,224
3,667
3,671
Subtotal - interest expense
7,122
14,695
28,298
42,320
Interest on interest-bearing demand - brokered
636
901
2,259
2,476
Interest on certificates of deposits - brokered
267
794
958
Total interest expense
8,025
15,863
31,351
45,754
NET INTEREST INCOME BEFORE PROVISION FOR LOAN AND
LEASE LOSSES
32,149
30,085
95,867
89,360
Provision for loan and lease losses
5,150
800
30,050
2,050
NET INTEREST INCOME AFTER PROVISION FOR LOAN AND
26,999
29,285
65,817
87,310
OTHER INCOME
Wealth management fee income
10,119
9,501
30,070
28,243
Service charges and fees
785
882
2,296
2,595
314
332
960
996
Gain on loans held for sale at fair value (mortgage banking)
954
198
1,796
377
Gain/(loss) on loans held for sale at lower of cost or fair value
7,429
(6
7,426
Fee income related to loan level, back-to-back swaps
2,349
1,620
3,340
Gain on sale of SBA loans
79
224
1,391
1,216
Other income
531
902
1,472
2,248
Securities gains/(losses), net
34
323
162
Total other income
20,211
14,416
47,354
39,171
OPERATING EXPENSES
Compensation and employee benefits
19,202
17,476
57,614
52,175
4,109
3,849
12,188
10,837
FDIC insurance expense/(credit)
605
(277
1,310
277
Other operating expense
4,545
5,211
14,598
14,858
Total operating expenses
28,461
26,259
85,710
78,147
INCOME BEFORE INCOME TAX EXPENSE
18,749
17,442
27,461
48,334
Income tax expense
5,202
5,216
4,299
13,133
NET INCOME
13,547
12,226
23,162
35,201
EARNINGS PER SHARE
Basic
0.72
0.63
1.23
1.82
Diluted
0.71
1.22
1.81
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
18,908,337
19,314,666
18,879,688
19,370,627
19,132,650
19,484,905
19,052,605
19,496,721
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Net income
Comprehensive income:
Unrealized gains/(losses) on available for sale securities:
Unrealized holding gains/(losses) arising during the period
(1,029
769
6,801
5,928
Tax effect
252
(186
(1,649
(1,441
Net of tax
(777
583
5,152
4,487
Unrealized gains/(losses) on cash flow hedges:
1,439
(1,084
(7,249
(5,540
Reclassification adjustment for amounts included in net
income
(5
(80
(85
(142
1,434
(1,164
(7,334
(5,682
(408
356
1,930
1,711
1,026
(808
(5,404
(3,971
Total other comprehensive income/(loss)
249
(225
(252
516
Total comprehensive income
13,796
12,001
22,910
35,717
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Three Months Ended September 30, 2020 and September 30, 2019
Accumulated
Other
(In thousands, except share and
Preferred
Common
Treasury
Retained
Comprehensive
per share data)
Stock
Earnings
Loss
Total
Balance at July 1, 2020 18,905,135
common shares outstanding
16,900
322,796
206,757
(1,996
507,980
Comprehensive income
Amortization of restricted stock awards/units
1,798
Cash dividends declared on common stock
($0.05 per share)
(945
Issuance of shares for Employee Stock
Purchase Plan, 5,598 shares
95
99
Issuance of common stock for acquisition,
14,220 shares
12
(12
Balance at September 30, 2020 18,924,953
Balance at July 1, 2019 19,456,312
16,557
311,428
(8,988
176,495
(1,604
493,888
Comprehensive loss
1,509
(973
Share repurchase, (595,853) shares
(16,717
Common stock options exercised, 140 shares
1
138,642 shares
116
5,525
5,641
Balance at September 30, 2019 18,999,241
16,673
318,463
(25,705
187,748
(1,829
495,350
Nine Months Ended September 30, 2020 and September 30, 2019
Balance at January 1, 2020 18,926,810
Restricted stock units issued 157,690 shares
131
(131
Restricted stock units/awards repurchased on
vesting to pay taxes, (39,686) shares
(33
(610
(643
5,062
($0.15 per share)
(2,832
Share repurchase, (220,222) shares
(6,487
Common stock options exercised, 8,400 net of
2,149 shares used to exercise, 6,251 shares
7
76
Exercise of warrants, 20,000 net of 13,469
shares used to exercise, 6,531 shares
Purchase Plan, 52,533 shares
43
947
990
35,046 shares
29
(29
Balance at January 1, 2019 19,337,662
16,459
309,088
154,799
(2,345
469,013
Cumulative adjustment for leases (ASU 842)
661
Balance at January 1, 2019, adjusted
155,460
469,674
Restricted stock units issued 131,141 shares
109
(109
vesting to pay taxes, (35,949) shares
(30
(951
(981
4,374
(2,913
Common stock options exercised, 1,660 shares
22
23
Exercise of warrants 7,109 net of 4,218
shares used to exercise, 2,891 shares
(2
Purchase Plan, 18,740 shares
15
517
532
138,949 shares
117
5,524
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
2,312
2,342
Amortization of premium and accretion of discount on securities, net
3,216
1,165
Amortization of restricted stock
Amortization of intangible assets
966
688
Amortization of subordinated debt costs
168
Deferred tax (benefit)/expense
(2,336
3,719
Stock-based compensation and employee stock purchase plan expense
199
Fair value adjustment for equity security
(323
(162
Loans originated for sale (1)
(125,466
(40,561
Proceeds from sales of loans held for sale (1)
117,892
42,188
Gain on loans held for sale (1)
(3,188
(1,593
(Gain)/loss on loans held for sale at lower of cost or fair value
(7,426
Increase in cash surrender value of life insurance, net
(517
(587
Increase in accrued interest receivable
(11,674
(Increase)/decrease in other assets
(2,659
9,681
(Decrease)/increase in accrued expenses and other liabilities
(10,697
9,292
NET CASH PROVIDED BY OPERATING ACTIVITIES
18,741
67,143
INVESTING ACTIVITIES:
Principal repayments, maturities and calls of securities available for sale
152,273
170,247
Redemptions of FHLB and FRB stock
34,737
361
Purchase of securities available for sale
(339,797
(140,537
Purchase of equity securities
(4,000
Purchase of FHLB and FRB stock
(29,102
(3,231
Proceeds from sales of loans held for sale at lower of cost or fair value
372,406
Net increase in loans, net of participations sold
(409,005
(233,900
Purchase of premises and equipment
(2,506
(1,097
Purchase of wealth management company
(2,600
NET CASH USED IN INVESTING ACTIVITIES
(224,994
(210,763
FINANCING ACTIVITIES:
Net increase in deposits
615,639
166,016
Net (decrease)/increase in short-term borrowings
(113,100
52,000
Proceeds from Paycheck Protection Program Liquidity Facility
535,838
Repayments of Paycheck Protection Program Liquidity Facility
(352,048
Proceeds from Federal Home Loan Bank short term advances
Repayments of Federal Home Loan Bank advances
(3,000
Dividends paid on common stock
Exercise of Stock Options, net of stock swaps
Restricted stock repurchased on vesting to pay taxes
Issuance of shares for employee stock purchase plan
Purchase of treasury shares
NET CASH PROVIDED BY FINANCING ACTIVITIES
677,433
209,960
Net increase in cash and cash equivalents
471,180
66,340
Cash and cash equivalents at beginning of period
160,773
Cash and cash equivalents at end of period
227,113
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest
30,260
44,497
Income tax, net
551
1,047
Transfer of loans to loans held for sale
364,910
Transfer of loans to other real estate owned
336
Security purchases settled in subsequent period
Acquisition goodwill
9,400
(1)
Includes mortgage loans originated with the intent to sell which are carried at fair value. In addition, this includes the guaranteed portion of SBA loans which are carried at the lower of cost or fair value.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Certain information and footnote disclosures normally included in the audited consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2019 for Peapack-Gladstone Financial Corporation (the “Corporation” or the “Company”). In the opinion of the management of the Corporation, the accompanying unaudited Consolidated Interim Financial Statements contain all adjustments (consisting solely of normal and recurring accruals) necessary to present fairly the financial position as of September 30, 2020, the results of operations, comprehensive income, shareholders’ equity for the three and nine months ended September 30, 2020 and 2019 and cash flow statements for the nine months ended September 30, 2020 and 2019. The results of operations for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the full year or for any future period.
Principles of Consolidation and Organization: The consolidated financial statements of the Company are prepared on the accrual basis and include the accounts of the Company and its wholly-owned subsidiary, Peapack-Gladstone Bank (the “Bank”). The consolidated financial statements also include the Bank’s wholly-owned subsidiaries:
•
PGB Trust & Investments of Delaware
Peapack Capital Corporation (“PCC”) (formed in the second quarter of 2017)
Murphy Capital Management (“Murphy Capital”) (acquired in the third quarter of 2017)
Lassus Wherley and Associates (“Lassus Wherley”) (acquired in the third quarter of 2018)
Point View Wealth Management, Inc. (“Point View”) (acquired in the third quarter of 2019)
Peapack-Gladstone Mortgage Group, Inc. owns 99 percent of Peapack Ventures, LLC and 79 percent of Peapack-Gladstone Realty, Inc., a New Jersey real estate investment company
PGB Trust & Investments of Delaware owns one percent of Peapack Ventures, LLC
Peapack Ventures, LLC owns the remaining 21 percent of Peapack-Gladstone Realty, Inc.
PGB Securities, Inc. (formed in the second quarter of 2020)
While the following footnotes include the collective results of the Company, the Bank and their subsidiaries, these footnotes primarily reflect the Bank’s and its subsidiaries’ activities. All significant intercompany balances and transactions have been eliminated from the accompanying consolidated financial statements.
Basis of Financial Statement Presentation: The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. In preparing the financial statements, Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the statement of condition and revenues and expenses for the periods presented. Actual results could differ from those estimates.
Segment Information: The Company’s business is conducted through two business segments: its banking subsidiary, which involves the delivery of loan and deposit products to customers, and the Peapack Private Wealth Management Division (“Peapack Private”), which includes asset management services to individuals and institutions. Management uses certain methodologies to allocate income and expense to the business segments.
The Banking segment includes commercial (includes C&I and equipment financing), commercial real estate, multifamily, residential and consumer lending activities; treasury management services; C&I advisory services; escrow management; deposit generation; operation of ATMs; telephone and internet banking services; merchant credit card services and customer support services.
Peapack Private includes: investment management services for individuals and institutions; personal trust services, including services as executor, trustee, administrator and custodian; and other financial planning and advisory services. This segment also includes the activity from the Delaware subsidiary, PGB Trust & Investments of Delaware, Murphy Capital, Lassus Wherley, and Point View. Wealth management fees are primarily earned over time as the Company provides the contracted monthly or quarterly services and are generally assessed based on a tiered scale of the market value of AUM at month-end. Fees that are transaction based, including trade execution services, are recognized at the point in time that the transaction is executed (i.e. trade date).
Cash and Cash Equivalents: For purposes of the statements of cash flows, cash and cash equivalents include cash and due from banks, interest-earning deposits and federal funds sold. Generally, federal funds are sold for one-day periods. Cash equivalents are of original maturities of 90 days or less. Net cash flows are reported for customer loan and deposit transactions and short-term borrowings with original maturities of 90 days or less.
Interest-Earning Deposits in Other Financial Institutions: Interest-earning deposits in other financial institutions mature within one year and are carried at cost.
Securities: All debt securities are classified as available for sale and are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. The Company also has an investment in a CRA investment fund, which is classified as an equity security.
Interest income includes amortization of purchase premiums and discounts. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated, and premiums on callable debt securities, which are amortized to the earliest call date. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, Management considers the extent and duration of the unrealized loss and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) other-than-temporary impairment related to credit loss, which is recognized in the income statement and 2) other-than-temporary impairment related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB) Stock: The Bank is a member of the FHLB system. Members are required to own a certain amount of FHLB stock, based on the level of borrowings and other factors. FHLB stock is carried at cost, classified as a restricted security and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
The Bank is also a member of the Federal Reserve Bank of New York and required to own a certain amount of FRB stock. FRB stock is carried at cost and classified as a restricted security. Dividends are reported as income.
Loans Held for Sale: Mortgage loans originated with the intent to sell in the secondary market are carried at fair value, as determined by outstanding commitments from investors.
Mortgage loans held for sale are generally sold with servicing rights released; therefore, no servicing rights are recorded. Gains and losses on sales of mortgage loans, shown as gain on sale of loans on the Statement of Income, are based on the difference between the selling price and the carrying value of the related loan sold.
U.S. Small Business Administration (SBA) loans originated with the intent to sell in the secondary market are carried at the lower of cost or fair value. SBA loans are generally sold with the servicing rights retained. Gains and losses on the sale of SBA loans are based on the difference between the selling price and the carrying value of the related loan sold. Total SBA loans serviced totaled $63.1 million and $51.9 million as of September 30, 2020 and December 31, 2019, respectively. SBA loans held for sale totaled $4.5 million and $4.6 million at September 30, 2020 and December 31, 2019, respectively.
Loans originated with the intent to hold and subsequently transferred to loans held for sale are carried at the lower of cost or fair value. These are loans that the Company no longer has the intent to hold for the foreseeable future.
Loans: Loans that Management has the intent and ability to hold for the foreseeable future or until maturity are stated at the principal amount outstanding. Interest on loans is recognized based upon the principal amount outstanding. Loans are stated at face value, less purchased premium and discounts and net deferred fees. Loan origination fees and certain direct loan origination costs are deferred and recognized on a level-yield method, over the life of the loan as an adjustment to the loan’s yield. The definition of recorded investment in loans includes accrued interest receivable and deferred fees/cost, however, for the Company’s loan disclosures, accrued interest and deferred fees/cost were excluded as the impact was not material.
Loans are considered past due when they are not paid within 30 days in accordance with contractual terms. The accrual of income on loans, including impaired loans, is discontinued if, in the opinion of Management, principal or interest is not likely to be paid
10
in accordance with the terms of the loan agreement, or when principal or interest is past due 90 days unless the asset is both well secured and in the process of collection. All interest accrued but not received for loans placed on nonaccrual are reversed against interest income. Payments received on nonaccrual loans are recorded as principal payments. A nonaccrual loan is returned to accrual status only when interest and principal payments are brought current and future payments are reasonably assured, generally when the Bank receives contractual payments for a minimum of six consecutive months. Commercial loans are generally charged off after an analysis is completed which indicates that collectability of the full principal balance is in doubt. Consumer closed-end loans are generally charged off after they become 120 days past due and open-end loans after 180 days. Subsequent payments are credited to income only if collection of principal is not in doubt. If principal and interest payments are brought contractually current and future collectability is reasonably assured, loans may be returned to accrual status. Nonaccrual mortgage loans are generally charged off to the extent that the value of the underlying collateral does not cover the outstanding principal balance. The majority of the Company’s loans are secured by real estate in New Jersey, New York and Pennsylvania.
Allowance for Loan and Lease Losses: The allowance for loan and lease losses is a valuation allowance for credit losses that is Management’s estimate of probable losses in the loan portfolio. The process to determine reserves utilizes analytic tools and Management judgment and is reviewed on a quarterly basis. When Management is reasonably certain that a loan balance is not fully collectable, an impairment analysis is completed whereby a specific reserve may be established or a full or partial charge off is recorded against the allowance. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the size and composition of the portfolio, information about specific borrower situations, estimated collateral values, level of and trends in delinquent, classified and nonperforming loans, economic conditions and other factors. Allocations of the allowance may be made for specific loans via a specific reserve, but the entire allowance is available for any loan that, in Management’s judgment, should be charged off.
The allowance consists of specific and general components. The specific component of the allowance relates to loans that are individually classified as impaired.
A loan is impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors considered by Management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Loans are individually evaluated for impairment when they are classified as substandard by Management. If a loan is considered impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or if repayment is expected solely from the underlying collateral, the loan principal balance is compared to the fair value of collateral less estimated disposition costs to determine the need, if any, for a charge off.
The general component of the allowance covers non-impaired loans and is based primarily on the Company’s historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experience by the Company on a weighted average basis over the previous three years. This actual loss experience is adjusted by other qualitative factors based on the risks present for each portfolio segment. As a result of the effects of the COVID-19 pandemic, the Company increased certain qualitative factors related to elevated levels of unemployment, economic forecasts and approved loan deferral payment requests as businesses both locally and nationally were shut down and have only gradually and partially reopened. The Company also considered qualitative factors related to the following: levels of and trends in delinquencies and impaired loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures and practices; experience, ability and depth of lending management and other relevant staffing and experience; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. For loans that are graded as non-impaired, the Company allocates a higher general reserve percentage than pass-rated loans using a multiple that is calculated annually through a migration analysis. At both September 30, 2020 and December 31, 2019, the multiple was 2.25 times for non-impaired loans and 3.25 times for non-impaired substandard loans.
A troubled debt restructuring (“TDR”) is a modified loan with concessions made by the lender to a borrower who is experiencing financial difficulty. TDRs are impaired and are generally measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a TDR is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral, less estimated disposition costs. For TDRs that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan and lease losses.
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On March 27, 2020, the President of the United States signed the Coronavirus Aid, Relief, and Economic Security ("CARES“) Act, which provides entities with optional temporary relief from certain accounting and financial reporting requirements under U.S. GAAP.
The CARES Act allows financial institutions to suspend application of certain current TDR accounting guidance under Accounting Standards Codification ("ASC") 310-40 for loan modifications related to the COVID-19 pandemic made between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the end of the COVID-19 national emergency, provided certain criteria are met. This relief can be applied to loan modifications for borrowers that were not more than 30 days past due as of December 31, 2019 and to loan modifications that defer or delay the payment of principal or interest or change the interest rate on the loan. In April 2020, federal and state banking regulators issued the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus to provide further interpretation of when a borrower is experiencing financial difficulty, specifically indicating that if the modification is either short-term (e.g., six months) or mandated by a federal or state government in response to the COVID-19 pandemic, the borrower is not experiencing financial difficulty under ASC 310-40. The Company continues to prudently work with borrowers negatively impacted by the COVID-19 pandemic while managing credit risks and recognizing an appropriate allowance for loan and lease losses on its loan portfolio. The Company approved total loan modifications under the CARES Act of $940.2 million, of which $827.8 million remain as of September 30, 2020.
Another key program under the CARES Act is the Paycheck Protection Program (“PPP”) administered by the SBA which has provided much needed funding to qualifying businesses and organizations. Under this program, the Company has provided fundings of approximately $600 million. In the third quarter of 2020, the Company sold approximately $355.0 million of such loans, servicing released to a third party. The Company has approximately $202.0 million of PPP loans remaining on our balance sheet as of September 30, 2020 and believes that the majority of these loans will be forgiven by the SBA.
In determining an appropriate amount for the allowance, the Bank segments and evaluates the loan portfolio based on Federal call report codes, which are based on collateral or purpose. The following portfolio classes have been identified:
Primary Residential Mortgages. The Bank originates one to four family residential mortgage loans in the Tri-State area (New York, New Jersey and Connecticut), Pennsylvania and Florida. Loans are secured by first liens on the primary residence or investment property. Primary risk characteristics associated with residential mortgage loans typically involve major living or lifestyle changes to the borrower, including unemployment or other loss of income; unexpected significant expenses, such as for major medical issues or catastrophic events; and divorce or death. In addition, residential mortgage loans that have adjustable rates could expose the borrower to higher debt service requirements in a rising interest rate environment. Further, real estate values could drop significantly and cause the value of the property to fall below the loan amount, creating additional potential loss exposure for the Bank.
Home Equity Lines of Credit. The Bank provides revolving lines of credit against one to four family residences in the Tri-State area. Primary risk characteristics associated with home equity lines of credit typically involve major living or lifestyle changes to the borrower, including unemployment or other loss of income; unexpected significant expenses, such as for major medical issues or catastrophic events; and divorce or death. In addition, home equity lines of credit typically are made with variable or floating interest rates, which could expose the borrower to higher debt service requirements in a rising interest rate environment. Further, real estate values could drop significantly and cause the value of the property to fall below the loan amount, creating additional potential loss exposure for the Bank.
Junior Lien Loan on Residence. The Bank provides junior lien loans (“JLL”) against one to four family properties in the Tri-State area. JLLs can be either in the form of an amortizing home equity loan or a revolving home equity line of credit. These loans are subordinate to a first mortgage which may be from another lending institution. Primary risk characteristics associated with JLLs typically involve major living or lifestyle changes to the borrower, including unemployment or other loss of income; unexpected significant expenses, such as for major medical issues or catastrophic events; and divorce or death. Further, real estate values could drop significantly and cause the value of the property to fall below the loan amount, creating additional potential loss exposure for the Bank.
Multifamily and Commercial Real Estate Loans. The Bank provides mortgage loans for multifamily properties (i.e. buildings which have five or more residential units) and other commercial real estate that is either owner occupied or managed as an investment property (non-owner occupied) in the Tri-State area and Pennsylvania. Commercial real estate properties primarily include retail buildings/shopping centers, hotels, office/medical buildings and industrial/warehouse space. Some properties are considered “mixed use” as they are a combination of building types, such as a building with retail space on the ground floor and either residential apartments or office suites on the upper floors. Multifamily loans are expected to be repaid from the cash flows of the underlying property so the collective amount of rents must be sufficient to cover all operating expenses, property management and
maintenance, taxes and debt service. Increases in vacancy rates, interest rates or other changes in general economic conditions can have an impact on the borrower and its ability to repay the loan. Commercial real estate loans are generally considered to have a higher degree of credit risk than multifamily loans as they may be dependent on the ongoing success and operating viability of a fewer number of tenants who are occupying the property and who may have a greater degree of exposure to economic conditions.
Commercial and Industrial Loans. The Bank provides lines of credit and term loans to operating companies for business purposes. The loans are generally secured by business assets such as accounts receivable, inventory, business vehicles and equipment as well as the stock of a company, if privately held. Commercial and industrial loans are typically repaid first by the cash flows generated by the borrower’s business operation. The primary risk characteristics are specific to the underlying business and its ability to generate sustainable profitability and resulting positive cash flow. Factors that may influence a business’ profitability include, but are not limited to, demand for its products or services, quality and depth of management, degree of competition, regulatory changes, and general economic conditions. Commercial and industrial loans are generally secured by business assets; however, the ability of the Bank to foreclose and realize sufficient value from the assets is often highly uncertain. To mitigate the risk characteristics of commercial and industrial loans, these loans often include commercial real estate as collateral to strengthen the Bank’s position and the Bank will often require more frequent reporting requirements from the borrower in order to better monitor its business performance.
Leasing and Equipment Finance. PCC offers a range of finance solutions nationally. PCC provides term loans and leases secured by assets financed for U.S. based mid-size and large companies. Facilities tend to be fully drawn under fixed rate terms. PCC serves a broad range of industries including transportation, manufacturing, heavy construction and utilities.
Asset risk in PCC’s portfolio is generally recognized through changes to loan income, or through changes to lease related income streams due to fluctuations in lease rates. Changes to lease income can occur when the existing lease contract expires, the asset comes off lease or the business seeks to enter a new lease agreement. Asset risk may also change depreciation, resulting from changes in the residual value of the operating lease asset or through impairment of the asset carrying value, which can occur at any time during the life of the asset.
Credit risk in PCC’s portfolio generally results from the potential default of borrowers or lessees, which may be driven by customer specific or broader industry related conditions. Credit losses can impact multiple parts of the income statement including loss of interest/lease/rental income and/or higher costs and expenses related to the repossession, refurbishment, re-marketing and or re-leasing of assets.
Consumer and Other. These are loans to individuals for household, family and other personal expenditures as well as obligations of states and political subdivisions in the U.S. This also represents all other loans that cannot be categorized in any of the previous mentioned loan segments. Consumer loans generally have higher interest rates and shorter terms than residential loans but tend to have higher credit risk due to the type of collateral securing the loan or in some cases the absence of collateral.
Leases: At inception, contracts are evaluated to determine whether the contract constitutes a lease agreement. For contracts that are determined to be an operating lease, a corresponding right-of-use (“ROU”) asset and operating lease liability are recorded in separate line items on the statement of condition. A ROU asset represents the Company’s right to use an underlying asset during the lease term and a lease liability represents the Company’s commitment to make contractually obligated lease payments. Operating lease ROU assets and liabilities are recognized at the commencement date of the lease and are based on the present value of lease payments over the lease term. The measurement of the operating lease ROU asset includes any lease payments made.
If the rate implicit in the lease is not readily determinable, the incremental collateralized borrowing rate is used to determine the present value of lease payments. This rate gives consideration to the applicable FHLB collateralized borrowing rates and is based on the information available at the commencement date. The Company has elected to apply the short-term lease measurement and recognition exemption to leases with an initial term of 12 months or less; therefore, these leases are not recorded on the Company’s statement of condition, but rather, lease expense is recognized over the lease term on a straight-line basis. The Company’s lease agreements may include options to extend or terminate the lease. The Company’s decision to exercise renewal options is based on an assessment of its current business needs and market factors at the time of the renewal. The Company maintains certain property and equipment under direct financing and operating leases. Substantially all of the leases in which the Company is the lessee are comprised of real estate property for branches and office space and are classified as operating leases.
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The ROU asset is measured at the amount of the lease liability adjusted for lease incentives received, any cumulative prepaid or accrued rent if the lease payments are uneven throughout the lease term, any unamortized initial direct costs, and any impairment of the ROU asset. Operating lease expense consists of: a single lease cost allocated over the remaining lease term on a straight-line basis, variable lease payments not included in the lease liability, and any impairment of the ROU asset.
There are no terms or conditions related to residual value guarantees and no restrictions or covenants that would impact the Company’s ability to pay dividends or to incur additional financial obligations.
Derivatives: At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to likely effectiveness as a hedge. These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation. For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item, are recognized in current earnings as fair values change. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. For cash flow hedges, changes in the fair value of derivatives that are not highly effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as non-interest income. When hedge accounting is discontinued on a fair value hedge that no longer qualifies as an effective hedge, the derivative continues to be reported at fair value in the statement of condition, but the carrying amount of the hedged item is no longer adjusted for future changes in fair value. The adjustment to the carrying amount of the hedged item that existed at the date hedge accounting is discontinued is amortized over the remaining life of the hedged item into earnings.
Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in non-interest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.
The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminated, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.
When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as non-interest income. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.
The Company also offers facility specific / loan level swaps to its customers and offsets its exposure from such contracts by entering into mirror image swaps with a financial institution / swap counterparty (loan level / back to back swap program). The customer accommodations and any offsetting swaps are treated as non-hedging derivative instruments which do not qualify for hedge accounting (“standalone derivatives”). The notional amount of the swaps does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual contracts. The fair value of the swaps is recorded as both an asset and a liability, in other assets and other liabilities, respectively, in equal amounts for these transactions. The Company is exposed to losses if a customer counterparty fails to make its payments under a contract in which the Company is in a net receiving position. At this time, the Company anticipates that our counterparties will be able to fully satisfy their obligations under the agreements. All of the contracts to which the Company is a party settle monthly. Further, the Company has netting agreements with the dealers with which it does business.
Stock-Based Compensation: The Company’s 2006 Long-Term Stock Incentive Plan and 2012 Long-Term Stock Incentive Plan allow the granting of shares of the Company’s common stock as incentive stock options, nonqualified stock options, restricted stock awards, restricted stock units and stock appreciation rights to directors, officers and employees of the Company and its subsidiaries. The options granted under these plans are, in general, exercisable not earlier than one year after the date of grant, at a price equal to the fair value of common stock on the date of grant and expire not more than ten years after the date of grant. Stock options may vest during a period of up to five years after the date of grant. Some options granted to officers at or above the senior vice president level were immediately exercisable at the date of grant. The Company has a policy of using authorized but unissued shares to satisfy option exercises.
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The Company accounts for forfeitures as they occur, rather than estimate expected forfeitures.
For the Company’s stock option plans, changes in options outstanding during the nine months ended September 30, 2020 were as follows:
Weighted
Average
Aggregate
Remaining
Intrinsic
Number of
Exercise
Contractual
Value
Options
Price
Term
(In thousands)
Balance, January 1, 2020
71,420
13.57
Exercised during 2020
(8,400
13.84
Expired during 2020
Forfeited during 2020
(400
11.01
Balance, September 30, 2020
62,620
13.55
1.51 years
113
Vested and expected to vest
Exercisable at September 30, 2020
The aggregate intrinsic value represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the third quarter of 2020 and the exercise price, multiplied by the number of in-the-money options). The Company’s closing stock price on September 30, 2020 was $15.15.
There were no stock options granted during the three or nine months ended September 30, 2020.
The Company has previously granted performance-based and service-based restricted stock awards/units. Service-based awards/units vest ratably over a three- or five-year period. There were no service-based restricted stock units granted during the third quarter of 2020.
The performance-based awards are dependent upon the Company meeting certain performance criteria and, to the extent the performance criteria are met, will cliff vest at the end of the performance period which is generally three years. There were no performance-based restricted stock units granted in the third quarter of 2020.
Changes in non-vested shares dependent on performance criteria for the nine months ended September 30, 2020 were as follows:
Grant Date
Shares
Fair Value
90,768
30.60
Granted during 2020
130,832
13.44
221,600
20.47
Changes in service-based restricted stock awards/units for the nine months ended September 30, 2020 were as follows:
432,728
29.65
528,038
14.08
Vested during 2020
(160,884
29.16
(8,349
31.22
791,533
19.35
As of September 30, 2020, there was $13.8 million of total unrecognized compensation cost related to service-based and performance-based units. That cost is expected to be recognized over a weighted average period of 1.61 years. Stock compensation expense recorded for the third quarters of 2020 and 2019 totaled $1.8 million and $1.5 million, respectively. Stock compensation expense recorded for the nine months ended September 30, 2020 and 2019 totaled $5.1 million and $4.4 million, respectively.
Employee Stock Purchase Plan (“ESPP”): On April 22, 2014, the shareholders of the Company approved the ESPP. In July 2019, the Board appointed ESPP “Committee” revised the ESPP. The ESPP provides for the granting of purchase rights of up to 150,000 shares of Peapack-Gladstone Financial Corporation common stock. In May 2020, shareholders approved an increase of 200,000 shares of Peapack-Gladstone Financial Corporation common stock to be issued under the ESPP.
Subject to certain eligibility requirements and restrictions, the ESPP provided for a single Offering Period of twelve months in duration, which commenced on May 16, 2019 and ended on May 15, 2020.
During the second quarter of 2020, the ESPP was revised to allow for the purchase of shares during four three-month Offering Periods. The first Offering Period under this revised plan commenced on May 16, 2020. The next three future Offering Periods will commence on August 16, November 16 and February 16.
Each participant in the Offering Period is granted an option to purchase a number of shares and may contribute between one percent and 15 percent of their compensation. At the end of each Offering Period on the purchase date, the number of shares to be purchased by the employee is determined by dividing the employee’s contributions accumulated during the Offering Period by the applicable purchase price. The purchase price is an amount equal to 85 percent of the closing market price of a share of common stock on the purchase date. Participation in the ESPP is entirely voluntary and employees can cancel their purchases at any time during the period without penalty. The fair value of each share purchase right is determined using the Black-Scholes option pricing model.
The Company recorded $9,000 and $41,000 of expense in salaries and employee benefits expense for the three months ended September 30, 2020 and 2019, respectively related to the ESPP. Total shares issued under the ESPP during the third quarters of 2020 and 2019 were 5,598 and 0, respectively.
The Company recorded $199,000 and $117,000 of expense in salaries and employee benefits expense for the nine months ended September 30, 2020 and 2019, respectively related to the ESPP. Total shares issued under the ESPP for the nine months ended September 30, 2020 and 2019 were 52,533 and 18,740, respectively.
Earnings per share – Basic and Diluted: The following is a reconciliation of the calculation of basic and diluted earnings per share. Basic net income per share is calculated by dividing net income available to shareholders by the weighted average shares outstanding during the reporting period. Diluted net income per share is computed similarly to that of basic net income per share, except that the denominator is increased to include the number of additional shares that would have been outstanding utilizing the Treasury Stock Method if all shares underlying potentially dilutive stock options were issued and all restricted stock, stock warrants or restricted stock units were to vest during the reporting period.
(Dollars in thousands, except per share data)
Net income available to common shareholders
Basic weighted-average shares outstanding
Plus: common stock equivalents
224,313
170,239
172,917
126,094
Diluted weighted-average shares outstanding
Net income per share
For the three months ended September 30, 2020 and 2019, stock options and restricted stock units totaling 374,366 and 27,497 were not included in the computation of diluted earnings per share because they were anti-dilutive. For the nine months ended September 30, 2020 and 2019, stock options and restricted stock units totaling 207,466 and 277,677 were not included in the computation of diluted earnings per share because they were anti-dilutive. For both the three and nine months ended September
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30, 2020, warrants of 109,860 were not included in the computation of diluted earnings per share because they were anti-dilutive. Anti-dilutive shares are common stock equivalents with weighted average exercise prices in excess of the average market value for the periods presented.
Income Taxes: The Company files a consolidated Federal income tax return. Separate state income tax returns are filed for each subsidiary based on current laws and regulations.
The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in its financial statements or tax returns. The measurement of deferred tax assets and liabilities is based on the enacted tax rates. Such tax assets and liabilities are adjusted for the effect of a change in tax rates in the period of enactment.
The Company recognizes a tax position as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50 percent likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
The Company is no longer subject to examination by the U.S. Federal tax authorities for years prior to 2016 or by New Jersey tax authorities for years prior to 2015.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are any such matters that will have a material effect on the financial statements.
Restrictions on Cash: A large portion of cash on hand or on deposit with the Federal Reserve Bank (“FRB”) was required to meet regulatory reserve and clearing requirements. Prior to March 2020, reserves were in the form of cash and balances with the FRB and included in interest-earning deposits in our statement of condition. The FRB suspended cash reserve requirements effective March 26, 2020.
Comprehensive Income/(Loss): Comprehensive income/(loss) consists of net income and the change during the period in the Company’s net unrealized gains or losses on securities available for sale and unrealized gains and losses on cash flow hedge, net of tax, less adjustments for realized gains and losses.
Transfers of Financial Assets: Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, 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 the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Risks and Uncertainties: The COVID-19 pandemic has had a devastating effect on businesses both locally and nationally. As a result, Congress passed the CARES Act to provide fast and direct economic assistance to American workers, families and businesses. The CARES Act contains substantial tax and spending provisions including direct financial aid to American families, extensive emergency funding for hospitals and medical providers, and economic stimulus to significant impacted industry sectors.
The Company expects COVID-19 to have a significant impact on our operations but cannot determine or estimate the full impact at this time. It is possible that estimates made in the Company’s consolidated financial statements could be materially and adversely impacted as a result of the conditions created by COVID-19, including estimates regarding expected provision for loan and lease losses and impairment of goodwill.
Goodwill and Other Intangible Assets: Goodwill is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree (if any), over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized but tested for impairment at least annually or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed. As a result of the COVID-19 pandemic and the resulting effect on economic markets due to government shutdowns of businesses both locally and nationally, Management determined that the COVID-19 pandemic resulted in a triggering event and performed an interim evaluation to determine if a quantitative goodwill impairment test should be performed. Goodwill was primarily attributable to the Bank’s recent wealth acquisitions. Assets under management and/or administration (“AUM/AUA”) has recovered from the market volatility experienced during the first quarter of 2020 and increased to $7.6 billion at September 30, 2020 from $7.5 billion at
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December 31, 2019. Based on our assessment and the market recovery, Management concluded that a quantitative goodwill impairment test was not required as of September 30, 2020.
Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill and assembled workforce are the intangible assets with an indefinite life on our balance sheet.
Other intangible assets, which primarily consist of customer relationship intangible assets arising from acquisition, are amortized on an accelerated basis over their estimated useful lives, which range from 5 to 15 years. Management determined that there was no impairment of intangible assets related to the events created by the COVID-19 pandemic.
2. INVESTMENT SECURITIES AVAILABLE FOR SALE
A summary of amortized cost and approximate fair value of investment securities available for sale included in the consolidated statements of condition as of September 30, 2020 and December 31, 2019 follows:
September 30, 2020
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
U.S. treasuries
2,886
2,888
U.S government-sponsored agencies
79,424
62
(540
78,946
Mortgage-backed securities–residential
457,597
9,114
(416
466,295
SBA pool securities
37,312
(259
37,070
State and political subdivisions
8,578
8,694
Corporate bond
3,000
36
3,036
588,797
9,347
(1,215
December 31, 2019
U.S. government-sponsored agencies
34,961
37
(214
34,784
337,489
2,365
(950
338,904
2,799
(15
2,784
11,175
41
(1
11,215
3,068
389,424
2,511
(1,180
The following tables present the Company’s available for sale securities in a continuous unrealized loss position and the approximate fair value of these investments as of September 30, 2020 and December 31, 2019.
Duration of Unrealized Loss
Less Than 12 Months
12 Months or Longer
Approximate
49,411
Mortgage-backed securities-residential
47,995
(381
15,623
(35
63,618
26,160
(241
2,458
(18
28,618
123,566
(1,162
18,081
(53
141,647
18
19,758
78,982
(382
69,142
(568
148,124
783
99,523
(597
71,926
(583
171,449
Management believes that the unrealized losses on investment securities available for sale are temporary and are due to interest rate fluctuations and/or volatile market conditions rather than the credit-worthiness of the issuers. As of September 30, 2020, the Company does not intend to sell these securities nor is it likely that it will be required to sell the securities before their anticipated recovery; therefore, none of the securities in an unrealized loss position were determined to be other-than-temporarily impaired.
The Company has an investment in a CRA investment fund with a fair value of $15.2 million at September 30, 2020. The investment is classified as an equity security in our Consolidated Statements of Condition. This security had a gain of $323,000 for the nine months ended September 30, 2020. This amount is included in securities gains/(losses), net on the Consolidated Statements of Income.
3. LOANS AND LEASES
Loans outstanding, excluding those held for sale, by general ledger classification, as of September 30, 2020 and December 31, 2019, consisted of the following:
% of
Totals
Residential mortgage
518,335
11.70
%
549,138
12.50
Multifamily mortgage
1,168,796
26.38
1,210,003
27.54
Commercial mortgage
722,678
16.31
761,244
17.32
Commercial loans (including equipment financing) (A)
1,909,724
43.10
1,756,477
39.97
Commercial construction
6,805
0.15
5,306
0.12
Home equity lines of credit
52,194
1.18
57,248
1.30
Consumer loans, including fixed rate home equity loans
51,859
1.17
54,372
1.24
Other loans
260
0.01
349
Total loans
100.00
(A)
The September 30, 2020 balance includes PPP loans of $202.0 million
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In determining an appropriate amount for the allowance, the Bank segments and evaluates the loan portfolio based on federal Call Report codes. The following portfolio classes have been identified as of September 30, 2020 and December 31, 2019:
Primary residential mortgage
530,374
11.98
578,306
13.17
52,193
Junior lien loan on residence
5,401
7,011
0.16
Multifamily property
26.40
27.56
Owner-occupied commercial real estate
252,069
5.69
249,419
5.68
Investment commercial real estate
1,047,614
23.66
1,095,182
24.95
Commercial and industrial (A)
1,050,775
23.74
867,295
19.76
Lease financing
254,142
5.74
258,401
5.89
Farmland/agricultural production
1,081
0.02
3,043
0.07
Commercial construction loans
6,989
5,520
0.13
Consumer and other loans
57,711
1.31
58,213
1.33
4,427,145
4,389,641
Net deferred costs
3,506
4,496
Total loans including net deferred costs
The following tables present the loan balances by portfolio class, based on impairment method, and the corresponding balances in the allowance for loan and lease losses (ALLL) as of September 30, 2020 and December 31, 2019:
Ending ALLL
Attributable
Individually
To Loans
Collectively
Evaluated
For
Evaluated for
Ending
Impairment
ALLL
6,231
46
524,143
2,921
2,967
52,191
220
10,664
667
251,402
3,011
4,625
1,042,989
29,166
3,990
1,046,785
16,131
16,172
3,473
77
362
Total ALLL
15,515
87
4,411,630
66,058
20
The balance includes PPP loans of $202.0 million which have no reserve as these loans are guaranteed by the SBA.
6,890
215
571,416
1,875
2,090
57,245
128
6,992
6,037
379
249,040
2,064
22,605
1,000
1,072,577
14,988
15,988
Commercial and industrial
6,028
1,585
861,267
12,768
14,353
2,642
38
27
296
35,924
2,800
4,353,717
40,876
Impaired loans include nonaccrual loans of $8.6 million at September 30, 2020 and $28.9 million at December 31, 2019. The decrease in impaired loans was due to the transfer of one commercial loan with a balance of $10.0 million to held for sale at September 30, 2020. Impaired loans also include performing TDR loans of $2.3 million at September 30, 2020 and $2.4 million at December 31, 2019. At September 30, 2020, the allowance allocated to TDR loans totaled $87,000, of which $41,000 was allocated to nonaccrual loans. At December 31, 2019, the allowance allocated to TDR loans totaled $2.8 million, of which $2.7 million was allocated to nonaccrual loans. All accruing TDR loans were paying in accordance with restructured terms as of September 30, 2020. The Company has not committed to lend additional amounts as of September 30, 2020 to customers with outstanding loans that are classified as TDR loans.
The following tables present loans individually evaluated for impairment by class of loans as of September 30, 2020 and December 31, 2019 (The average impaired loans on the following tables represent year to date impaired loans.):
Unpaid
Principal
Recorded
Specific
Impaired
Balance
Investment
Reserves
With no related allowance recorded:
6,514
5,655
6,020
752
397
7,242
374
302
Total loans with no related allowance
12,269
11,310
13,963
With related allowance recorded:
576
582
6,129
3,629
4,965
Total loans with related allowance
6,705
4,205
5,547
Total loans individually evaluated for impairment
18,974
19,510
21
7,310
6,071
7,186
450
1,099
9,663
8,138
14,115
92
17,520
14,610
22,506
819
1,011
15,064
14,467
4,832
6,229
3,685
22,112
21,314
9,528
39,632
32,034
Interest income recognized on impaired loans for the quarters ended September 30, 2020 and 2019 was not material. The Company did not recognize any income on non-accruing impaired loans for the three and nine months ended September 30, 2020 and 2019.
The following tables present the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of September 30, 2020 and December 31, 2019:
Loans Past Due
Over 90 Days
And Still
Nonaccrual
Accruing Interest
3,992
3,951
8,611
4,533
17,919
28,881
The following tables present the aging of the recorded investment in past due loans as of September 30, 2020 and December 31, 2019 by class of loans, excluding nonaccrual loans:
30-59
60-89
Greater Than
Days
90 Days
Past Due
651
129
873
675
1,739
2,414
546
1,996
2,542
2,874
3,735
6,609
1,264
80
566
1,910
Credit Quality Indicators:
The Company places all commercial loans into various credit risk rating categories based on an assessment of the expected ability of the borrowers to properly service their debt. The assessment considers numerous factors including, but not limited to, current financial information on the borrower, historical payment experience, strength of any guarantor, nature of and value of any collateral, acceptability of the loan structure and documentation, relevant public information and current economic trends. This credit risk rating analysis is performed when the loan is initially underwritten and then annually based on set criteria in the loan policy.
In addition, the Bank has engaged an independent loan review firm to validate risk ratings and to ensure compliance with our policies and procedures. This review of the following types of loans is performed quarterly:
A large sample of relationships or new lending to existing relationships greater than $1,000,000 booked since the prior review;
All criticized and classified rated borrowers with relationship exposure of more than $500,000;
A large sample of Pass-rated (including Pass Watch) borrowers with total relationships in excess of $1,000,000 and a small sample of Pass related relationships less than $1,000,000;
All leveraged loans of $1,000,000 or greater;
At least two borrowing relationships managed by each commercial banker;
Any new Regulation “O” loan commitments over $1,000,000;
Exclude borrowers with commitments of less than $500,000;
Any other credits requested by Bank senior management or a member of the Board of Directors and any borrower for which the reviewer determines a review is warranted based upon knowledge of the portfolio, local events, industry stresses, etc.
The Company uses the following regulatory definitions for criticized and classified risk ratings:
Special Mention: These loans have a potential weakness that deserves Management’s close attention. If left uncorrected, the potential weaknesses may result in deterioration of the repayment prospects for the loans or of the institution’s credit position at some future date.
Substandard: These loans are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful: These loans have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable, based on currently existing facts, conditions and values.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans.
Loans that are considered to be impaired are individually evaluated for potential loss and allowance adequacy. Loans not deemed impaired are collectively evaluated for potential loss and allowance adequacy.
As of September 30, 2020, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:
Special
Pass
Mention
Substandard
Doubtful
523,415
521
6,438
1,162,650
5,466
680
246,989
2,388
2,692
966,193
67,057
14,364
979,502
54,186
17,087
6,907
82
4,256,182
129,700
41,263
As of December 31, 2019, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:
570,353
853
7,100
1,209,288
715
247,388
2,031
1,053,445
6,325
35,412
847,285
6,382
13,628
5,437
83
4,317,090
13,643
58,908
At September 30, 2020, $15.5 million of substandard loans were also considered impaired, compared to December 31, 2019, when $35.9 million of substandard loans were also impaired. The increase in special mention investment and owner-occupied commercial real estate classified loans was a result of the Bank’s credit analysis of sectors with COVID elevated residual risk
24
(Hospitality and Food Services and Retail – Non-Grocery Anchored) and the downgrade of several loans within these categories during the third quarter of 2020.
The activity in the allowance for loan and lease losses for the three months ended September 30, 2020 is summarized below:
July 1,
Beginning
Provision
Charge-offs
Recoveries
(Credit)
3,074
217
(324
244
(27
9,662
1,002
3,177
(166
29,866
(5,132
4,432
16,218
(164
112
3,349
124
(23
49
28
368
66,065
(5,298
228
The activity in the allowance for loan and lease losses for the three months ended September 30, 2019 is summarized below:
3,057
2,489
155
(13
145
5,744
491
6,235
2,497
(1,221
2,272
14,650
1,095
15,745
11,463
438
11,905
1,888
508
2,396
39
319
315
39,791
1,004
41,580
25
The activity in the allowance for loan and lease losses for the nine months ended September 30, 2020 is summarized below:
January 1,
330
547
4,627
(5,532
31
18,679
(2,418
4,226
831
(7,965
384
The activity in the allowance for loan and lease losses for the nine months ended September 30, 2019 is summarized below:
(988
164
(11
5,959
276
2,614
1,060
(1,402
14,248
1,497
9,839
2,053
1,772
624
(40
(32
38,504
(120
1,146
26
Loan Modifications:
The CARES Act allows financial institutions to suspend application of certain current TDR accounting guidance under ASC 310-40 for loan modifications related to the COVID-19 pandemic made between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the end of the COVID-19 national emergency, provided certain criteria are met. This relief can be applied to loan modifications for borrowers that were not more than 30 days past due as of December 31, 2019 and to loan modifications that defer or delay the payment of principal or interest or change the interest rate on the loan. In April 2020, federal and state banking regulators issued the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus to provide further interpretation of when a borrower is experiencing financial difficulty, specifically indicating that if the modification is either short-term (e.g., six months) or mandated by a federal or state government in response to the COVID-19 pandemic, the borrower is not experiencing financial difficulty under ASC 310-40.
As of September 30, 2020, the Bank has modified 515 loans with a balance of $940.2 million resulting in the deferral of principal and/or interest for periods ranging from 90 to 180 days. The table below summarizes the deferrals as of September 30, 2020. All of these loans were performing in accordance with their terms prior to modification, and are in conformance with the CARES Act. Included in the table below are 27 loans totaling $283.6 million of loan level swaps. Details with respect to loan modifications are as follows:
Post-Modification
Outstanding
170
69,941
4,094
248
70
263,877
33
30,058
71
400,425
28,370
26,360
133
4,311
403
827,817
The future performance of these loans, specifically beyond the term of the deferral, is uncertain. To recognize a credit allowance commensurate with the existing risk, the Company assigned qualitative factors for each of the above portfolio classes for allowance purposes.
Troubled Debt Restructurings:
The Company has allocated $87,000 and $2.8 million of specific reserves on TDRs to customers whose loan terms have been modified in TDRs as of September 30, 2020 and December 31, 2019, respectively. There were no unfunded commitments to lend additional amounts to customers with outstanding loans that are classified as TDRs.
There were no loans modified as TDRs during the three-month period ended September 30, 2020.
The following table presents loans by class modified as TDRs during the nine-month period ended September 30, 2020:
Pre-Modification
388
427
The following table presents loans by class modified as TDRs during both the three and nine-month periods ended September 30, 2019:
341
The identification of the TDRs did not have a significant impact on the allowance for loan and lease losses.
The following table presents loans by class modified as TDRs that failed to comply with the modified terms in the twelve months following modification and resulted in a payment default at September 30, 2020:
193
232
There were no loans that were modified as TDRs for which there was a payment default within twelve months of modification at September 30, 2019.
In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy. The modification of the terms of such loans may include one or more of the following: (1) a reduction of the stated interest rate of the loan to a rate that is lower than the current market rate for new debt with similar risk; (2) an extension of an interest only period for a predetermined period of time; (3) an extension of the maturity date; or (4) an extension of the amortization period over which future payments will be computed. At the time a loan is restructured, the Bank performs a full re-underwriting analysis, which includes, at a minimum, obtaining current financial statements and tax returns, copies of all leases, and an updated independent appraisal of the property. A loan will continue to accrue interest if it can be reasonably determined that the borrower should be able to perform under the modified terms, that the loan has not been chronically delinquent (both to debt service and real estate taxes) or in nonaccrual status since its inception, and that there have been no charge-offs on the loan. Restructured loans with previous charge-offs would not accrue interest at the time of the TDR. At a minimum, six consecutive months of contractual payments would need to be made on a restructured loan before returning it to accrual status. Once a loan is classified as a TDR, the loan is reported as a TDR until the loan is paid in full, sold or charged-off. In rare circumstances, a loan may be removed from TDR status if it meets the requirements of ASC 310-40-50-2.
4. DEPOSITS
Certificates of deposit, over $250,000, totaled $216.2 million and $223.7 million at September 30, 2020 and December 31, 2019, respectively. The above totals exclude brokered certificates of deposit.
The following table sets forth the details of total deposits as of September 30, 2020 and December 31, 2019:
17.25
12.47
Interest-bearing checking (1)
38.25
35.59
2.63
2.66
Money market
25.75
28.19
12.08
14.94
0.67
1.12
96.63
94.97
Interest-bearing demand - Brokered
2.68
4.24
Certificates of deposit - Brokered
0.69
0.79
Interest-bearing checking includes $658.0 million at September 30, 2020 and $423.8 million at December 31, 2019 of reciprocal balances in the Reich & Tang or Promontory Demand Deposit Marketplace program.
The scheduled maturities of certificates of deposit, including brokered certificates of deposit, as of September 30, 2020 are as follows:
163,537
2021
362,644
2022
60,270
2023
9,154
2024
28,379
Over 5 Years
29,244
653,228
5. FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS
Advances from the FHLB totaled $105.0 million with a weighted average interest rate of 3.20 percent at both September 30, 2020 and December 31, 2019, respectively.
The advances had fixed maturity dates and were secured by blanket pledges of certain 1-4 family residential mortgages totaling $344.6 million, multifamily mortgages totaling $770.9 million and securities totaling $311.6 million at September 30, 2020, while at December 31, 2019, the fixed rate advances were secured by blanket pledges of certain 1-4 family residential mortgages totaling $347.5 million, multifamily mortgages totaling $773.1 million and securities totaling $154.3 million.
The final maturity dates of the FHLB advances are scheduled as follows:
60,000
20,000
25,000
Short-term borrowings consisted of a one-month FHLB advance totaling $15.0 million with a rate of 0.39 percent. The one-month FHLB advance for $15.0 million is part of an interest rate swap designated as a cash flow hedge. The cash flow hedge has a term of four years. There were no overnight borrowings with the FHLB as of September 30, 2020 or December 31, 2019. At September 30, 2020, unused short-term overnight borrowing commitments totaled $1.7 billion from the FHLB, $22.0 million from correspondent banks and $1.0 billion at the Federal Reserve Bank of New York.
The Company had $183.8 million in borrowings from the Federal Reserve’s PPPLF as of September 30, 2020. The borrowings have a rate of 0.35 percent, primarily all of which have a 2-year maturity. The Company utilized the PPPLF to fund PPP loan production during the second quarter of 2020. The borrowings are fully pledged by PPP loans as of September 30, 2020.
6. BUSINESS SEGMENTS
The Company assesses its results among two operating segments, Banking and Peapack Private. Management uses certain methodologies to allocate income and expense to the business segments. A funds transfer pricing methodology is used to assign interest income and interest expense. Certain indirect expenses are allocated to segments. These include support unit expenses such as technology and operations and other support functions. Taxes are allocated to each segment based on the effective rate for the period shown. The Banking segment’s effective tax rate for the three and nine months ended September 30, 2020 was affected by a $3.34 million income tax benefit recorded during the first quarter of 2020. For additional information related to this income tax benefit refer to the Income Taxes section of Management’s Discussion and Analysis.
Banking
The Banking segment includes commercial (includes C&I and equipment finance), commercial real estate, multifamily, residential and consumer lending activities; treasury management services; C&I advisory services; escrow management; deposit generation; operation of ATMs; telephone and internet banking services; merchant credit card services and customer support and sales.
Peapack Private
Peapack Private includes PGB Trust & Investments of Delaware, Murphy Capital, Lassus Wherley and Point View, includes investment management services provided for individuals and institutions; personal trust services, including services as executor, trustee, administrator, custodian and guardian, and other financial planning, tax preparation and advisory services.
The following tables present the statements of income and total assets for the Company’s reportable segments for the three and nine months ended September 30, 2020 and 2019.
Three Months Ended September 30, 2020
Wealth
Management
Division
Net interest income
30,557
1,592
Noninterest income
9,451
10,760
Total income
40,008
12,352
52,360
Compensation and benefits
13,258
5,944
Premises and equipment expense
3,527
FDIC expense
Other noninterest expense
2,231
2,314
Total noninterest expense
24,771
8,840
33,611
Income before income tax expense
15,237
3,512
4,254
948
10,983
2,564
Three Months Ended September 30, 2019
28,836
1,249
4,561
9,855
33,397
11,104
44,501
11,776
5,700
3,294
555
FDIC insurance expense
2,985
2,226
Total operating expense
18,578
8,481
27,059
14,819
2,623
4,399
817
10,420
1,806
Nine Months Ended September 30, 2020
91,419
4,448
16,036
31,318
107,455
35,766
143,221
40,239
17,375
10,435
1,753
7,889
6,709
89,923
25,837
115,760
Income before income tax (benefit)/expense
17,532
9,929
Income tax (benefit)/expense
1,618
2,681
Net income/(loss)
15,914
7,248
Total assets at period end
5,878,481
79,626
Nine Months Ended September 30, 2019
85,336
4,024
9,991
29,180
95,327
33,204
128,531
36,458
15,717
9,265
1,572
8,296
6,562
56,346
23,851
80,197
38,981
9,353
10,592
2,541
28,389
6,812
4,840,002
85,407
4,925,409
7. FAIR VALUE
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1:
Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2:
Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3:
Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate the fair value:
Investment Securities: The fair values for investment securities are determined by quoted market prices (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).
Loans Held for Sale, at Fair Value: The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan or other observable market data, such as outstanding commitments from third party investors (Level 2).
Derivatives: The fair values of derivatives are based on valuation models using observable market data as of the measurement date (Level 2). Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.
Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan and lease losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
32
Other Real Estate Owned: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less estimated costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by Management. Once received, a third party conducts a review of the appraisal for compliance with the Uniform Standards of Professional Appraisal Practice and appropriate analysis methods for the type of property. Subsequently, a member of the Credit Department reviews the assumptions and approaches utilized in the appraisal, as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Appraisals on collateral dependent impaired loans and other real estate owned (consistent for all loan types) are obtained on an annual basis, unless a significant change in the market or other factors warrants a more frequent appraisal. On an annual basis, Management compares the actual selling price of any collateral that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value for other properties. The most recent analysis performed indicated that a discount up to 15 percent should be applied to appraisals on properties. The discount is determined based on the nature of the underlying properties, aging of appraisals and other factors. For each collateral-dependent impaired loan, we consider other factors, such as certain indices or other market information, as well as property specific circumstances to determine if an adjustment to the appraised value is needed. In situations where there is evidence of change in value, the Bank will determine if there is a need for an adjustment to the specific reserve on the collateral dependent impaired loans. When the Bank applies an interim adjustment, it generally shows the adjustment as an incremental specific reserve against the loan until it has received the full updated appraisal. All collateral-dependent impaired loans and other real estate owned valuations were supported by an appraisal less than 12 months old or in the process of obtaining an appraisal as of September 30, 2020.
The following table summarizes, for the periods indicated, assets measured at fair value on a recurring basis, including financial assets for which the Corporation has elected the fair value option:
Assets Measured on a Recurring Basis
Fair Value Measurements Using
Quoted
Prices in
Active
Significant
Markets For
Identical
Observable
Unobservable
Assets
Inputs
(Level 1)
(Level 2)
(Level 3)
Assets:
Available for sale:
CRA investment fund
Derivatives:
Loan level swaps
92,798
718,671
703,512
Liabilities:
Cash flow hedges
11,001
103,799
Securities available for sale:
121
32,381
436,974
426,138
3,788
36,169
The Company has elected the fair value option for certain loans held for sale. These loans are intended for sale and the Company believes that the fair value is the best indicator of the resolution of these loans. Interest income is recorded based on the contractual terms of the loan and in accordance with the Company’s policy on loans held for investment. None of these loans are 90 days or more past due nor on nonaccrual as of September 30, 2020 and December 31, 2019.
The following tables present residential loans held for sale, at fair value for the periods indicated:
Residential loans contractual balance
13,525
2,839
Fair value adjustment
42
Total fair value of residential loans held for sale
There were no transfers between Level 1 and Level 2 during the three and nine months ended September 30, 2020.
There were no loans measured for impairment using the fair value of collateral as of September 30, 2020.
The following tables summarize, for the periods indicated, assets measured at fair value on a non-recurring basis:
Impaired loans:
13,467
The carrying amounts and estimated fair values of financial instruments at September 30, 2020 are as follows:
Fair Value Measurements at September 30, 2020 using
Carrying
Amount
Level 1
Level 2
Level 3
Financial assets
Cash and cash equivalents
FHLB and FRB stock
N/A
14,943
Loans, net of allowance for loan and lease losses
4,493,612
1,807
20,385
Financial liabilities
Deposits
4,205,922
663,005
4,868,927
Federal home loan bank advances
109,908
Subordinated debt
84,215
Accrued interest payable
3,017
210
1,586
Loan level swap
The carrying amounts and estimated fair values of financial instruments at December 31, 2019 are as follows:
Fair Value Measurements at December 31, 2019 using
15,126
4,268,481
1,361
9,133
Cash flow Hedges
3,528,609
718,818
4,247,427
108,354
86,536
2,357
392
55
8. REVENUE FROM CONTRACTS WITH CUSTOMERS
All of the Company’s revenue from contracts with customers within the scope of ASC 606 is recognized within noninterest income.
The following tables present the sources of noninterest income for the periods indicated:
35
For the Three Months Ended September 30,
Service charges on deposits
Overdraft fees
88
176
Interchange income
378
383
Wealth management fees (a)
Other (b)
9,307
4,033
Total noninterest other income
For the Nine Months Ended September 30,
307
500
869
909
1,120
1,186
8,333
(a)
Includes investment brokerage fees.
(b)
All of the other category is outside the scope of ASC 606.
The following table presents the sources of noninterest income by operating segment for the periods indicated:
For the Three Months Ended
Revenue by Operating Segment
8,666
641
3,679
354
Total noninterest income
For the Nine Months Ended
Revenue by Operating
Segment
13,740
1,248
7,396
937
A description of the Company’s revenue streams accounted for under ASC 606 follows:
Service charges on deposit accounts: The Company earns fees from its deposits customers for transaction-based, account maintenance, and overdraft fees. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s account balance.
Interchange income: The Company earns interchange fees from debit cardholder transactions conducted through the Visa payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. Interchange income is presented gross of cardholder rewards. Cardholder rewards are included in other expenses in the statement of income. Cardholder rewards reduced interchange income for the third quarter of 2020 by $31,000 compared to $37,000 for same quarter of 2019. Cardholder rewards reduced interchange income by $86,000 and $105,000 for the nine months ended September 30, 2020 and 2019, respectively.
Wealth management fees (gross): The Company earns wealth management fees from its contracts with wealth management clients to manage assets for investment, and/or to transact on their accounts. These fees are primarily earned over time as the Company charges its clients on a monthly or quarterly basis in accordance with its investment advisory agreements. Fees are generally assessed based on a tiered scale of the market value of AUM at month end. Fees that are transaction based, including trade execution services, are recognized at the point in time that the transaction is executed (i.e. trade date).
Investment brokerage fees (net): The Company earns fees from investment brokerage services provided to its customers by a third-party service provider. The Company receives commissions from the third-party service provider twice a month based upon customer activity for the month. The fees are recognized monthly and a receivable is recorded until commissions are generally paid by the 15th of the following month. Because the Company (i) acts as an agent in arranging the relationship between the customer and the third-party service provider and (ii) does not control the services rendered to the customers, investment brokerage fees are presented net of related costs.
Gains/(losses) on sales of OREO: The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform its obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain/(loss) on sale if a significant financing component is present.
Other: All of the other income items are outside the scope of ASC 606.
9. OTHER OPERATING EXPENSES
The following table presents the major components of other operating expenses for the periods indicated:
Professional and legal fees
1,079
1,228
3,095
3,320
Telephone
370
346
1,089
1,003
Advertising
226
337
1,294
1,105
321
229
Branch restructure
278
Other operating expenses
2,549
3,071
7,876
8,742
Total other operating expenses
10. ACCUMULATED OTHER COMPREHENSIVE INCOME/(LOSS)
The following is a summary of the accumulated other comprehensive income/(loss) balances, net of tax, for the three months ended September 30, 2020 and 2019:
Reclassified
From
Income/(Loss)
Three Months
Balance at
Ended
Before
Reclassifications
Net unrealized holding gain/(loss) on
securities available for sale, net of tax
6,935
6,158
Gain/(loss) on cash flow hedges
(8,931
1,030
(4
(7,905
Accumulated other comprehensive
income/(loss), net of tax
253
898
1,481
(2,502
(752
(56
(3,310
(169
The following represents the reclassifications out of accumulated other comprehensive income/(loss) for the three months ended September 30, 2020 and 2019:
Affected Line Item in Income Statement
Unrealized gains on cash flow hedge
derivatives:
Reclassification adjustment for amounts
included in net income
Interest expense
Total reclassifications, net of tax
The following is a summary of the accumulated other comprehensive income/(loss) balances, net of tax, for the nine months ended September 30, 2020 and 2019:
Nine Months
1,006
(2,501
(5,341
(63
(189
(3,006
(3,872
(99
615
The following represents the reclassifications out of accumulated other comprehensive income/(loss) for the nine months ended September 30, 2020 and 2019:
Affected Line Item in Income
11. DERIVATIVES
The Company utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position. The notional amount of the interest rate swaps does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual interest rate swap agreements.
Interest Rate Swaps Designated as Cash Flow Hedges: Interest rate swaps with a notional amount of $270.0 million and $245.0 million as of September 30, 2020 and December 31, 2019, respectively, were designated as cash flow hedges of certain interest-bearing deposits and FHLB advances. On a quarterly basis, the Company performs a qualitative hedge effectiveness assessment. This assessment takes into consideration any adverse developments related to the counterparty’s risk of default and any negative events or circumstances that affect the factors that originally enabled the Company to assess that it could reasonably support, qualitatively, an expectation that the hedging relationship was and will continue to be highly effective. As of September 30, 2020, there were no events or market conditions that would result in hedge ineffectiveness. The aggregate fair value of the swaps is recorded in other assets/liabilities with changes in fair value recorded in other comprehensive income. The amount included in
accumulated other comprehensive income would be reclassified to current earnings should the hedges no longer be considered effective. The Company expects the hedges to remain fully effective during the remaining terms of the swaps.
The following table presents information about the interest rate swaps designated as cash flow hedges as of September 30, 2020 and December 31, 2019:
Notional amount
270,000
245,000
Weighted average pay rate
1.93
2.05
Weighted average receive rate
0.22
1.83
Weighted average maturity
2.27 years
2.45 years
Unrealized gain, net
(11,001
(3,667
Number of contracts
Net interest expense recorded on these swap transactions totaled $1.1 million and $2.4 million for the three and nine months ended September 30, 2020, respectively. Net interest income recorded on these swap transactions totaled $289,000 and $915,000 for the three and nine months ended September 30, 2019, respectively.
Cash Flow Hedges
The following table presents the net gain/(loss) recorded in accumulated other comprehensive income/(loss) and the consolidated financial statements relating to the cash flow derivative instruments for the three and nine months ended September 30, 2020 and 2019:
Interest rate contracts
Gain/(loss) recognized in OCI (effective portion)
Gain/(loss) reclassified from OCI to interest expense
56
Gain/(loss) recognized in other non-interest expense (ineffective portion)
During the first quarter of 2020, the Company recognized an unrealized after-tax gain of $26,000 in accumulated other comprehensive income/(loss) related to the termination of three interest rate swaps designated as cash flow hedges. During the second quarter of 2019, the Company recognized an unrealized after-tax gain of $189,000 in accumulated other comprehensive income/(loss) related to the termination of four interest rate swaps designated as cash flow hedges. These gains are being amortized into earnings over the remaining life of the terminated swaps. The Company recognized pre-tax interest income of $5,000 and $85,000 for the three and nine months ended September 30, 2020, respectively, and $81,000 and $142,000 for the three and nine months ended September 30, 2019, respectively, related to the amortization of the gain on the terminated interest rate swaps designated as cash flow hedges.
Notional
Interest rate swaps related to interest-bearing deposits and FHLB advances
Total included in other assets
Total included in other liabilities
40
Interest rate swaps related to interest-bearing deposits
70,000
175,000
(3,788
Derivatives Not Designated as Accounting Hedges: The Company offers facility specific / loan level swaps to its customers and offsets its exposure from such contracts by entering into mirror image swaps with a financial institution / swap counterparty (loan level / back to back swap program). The customer accommodations and any offsetting swaps are treated as non-hedging derivative instruments which do not qualify for hedge accounting (“standalone derivatives”). The notional amount of the swaps does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual contracts. The fair value of the swaps is recorded as both an asset and a liability, in other assets and other liabilities, respectively, in equal amounts for these transactions.
Information about these swaps is as follows:
853,532
793,875
Fair value
92,238
Weighted average pay rates
4.02
4.12
Weighted average receive rates
1.92
3.54
6.7 years
7.3 years
98
91
12. SUBORDINATED DEBT
During June 2016, the Company issued $50.0 million in aggregate principal amount of fixed-to-floating subordinated notes (the “2016 Notes”) to certain institutional investors. The 2016 Notes are non-callable for five years, have a stated maturity of June 30, 2026, and bear interest at a fixed rate of 6.0% per year until June 30, 2021. From June 30, 2021 to the maturity date or early redemption date, the interest rate will reset quarterly to a level equal to the then current three-month LIBOR rate plus 485 basis points, payable quarterly in arrears. Debt issuance costs incurred totaled $1.3 million and are being amortized to maturity.
Approximately $40.0 million of the net proceeds from the sale of the 2016 Notes were contributed by the Company to the Bank in the second quarter of 2016. The remaining funds (approximately $10 million) were retained by the Company for operational purposes.
During December 2017, the Company issued $35.0 million in aggregate principal amount of fixed-to-floating subordinated notes (the “2017 Notes”) to certain institutional investors. The 2017 Notes are non-callable for five years, have a stated maturity of December 15, 2027, and bear interest at a fixed rate of 4.75% per year until December 15, 2022. From December 16, 2022 to the maturity date or early redemption date, the interest rate will reset quarterly to a level equal to the then current three-month LIBOR rate plus 254 basis points, payable quarterly in arrears. Debt issuance costs incurred totaled $875 thousand and are being amortized to maturity.
Approximately $29.1 million of the net proceeds from the sale of the 2017 Notes were contributed by the Company to the Bank in the fourth quarter of 2017. The remaining funds of approximately $5 million, representing three years of interest payments, were retained by the Company for operational purposes.
Subordinated debt is presented net of issuance costs on the Consolidated Statements of Condition. The subordinated debt issuances are included in the Company’s regulatory total capital amount and ratio.
In connection with the issuance of the 2017 Notes, the Company obtained ratings from Kroll Bond Rating Agency (“KBRA”). KBRA an assigned investment grade rating of BBB- for the Company’s subordinated debt.
13. LEASES
On January 1, 2019, the Company adopted FASB issued ASU No. 2016-02, “Leases” (Topic 842), which establishes a right of use model that requires a lessee to record a ROU asset and a lease liability for all leases with terms longer than 12 months. The Company adopted the new lease guidance using the modified retrospective approach and elected the transition option issued
under ASU 2018-11, Leases (Topic 842) Targeted Improvements, which allows entities to continue to apply the legacy guidance in ASC 840, Leases, to prior periods, including disclosure requirements. Accordingly, prior period financial results and disclosures have not been adjusted.
The Company maintains certain property and equipment under direct financing and operating leases. Upon adoption of the new lease guidance, on January 1, 2019, the Company recorded a ROU asset and corresponding lease liability of $7.9 million and $8.2 million, respectively, on the consolidated statement of condition. As of September 30, 2020, the Company's operating lease ROU asset and operating lease liability totaled $10.0 million and $10.3 million, respectively. As of December 31, 2019, the Company's operating lease ROU asset and operating lease liability totaled $12.1 million and $12.4 million, respectively. A weighted average discount rate of 3.09% and 3.05% was used in the measurement of the ROU asset and lease liability as of September 30, 2020 and December 31, 2019, respectively.
The Company's leases have remaining lease terms between three months to 16 years, with a weighted average lease term of 5.99 years at September 30, 2020. The Company's leases had remaining lease terms between five months to 17 years, with a weighted average lease term of 6.33 years, at December 31, 2019. The Company’s lease agreements may include options to extend or terminate the lease. The Company’s decision to exercise renewal options is based on an assessment of its current business needs and market factors at the time of the renewal.
Total operating lease costs were $789,000 and $756,000 for the three months ended September 30, 2020 and 2019, respectively. The variable lease costs were $82,000 and $83,000 for the three months ended September 30, 2020 and 2019, respectively.
Total operating lease costs were $2.4 million and $2.1 million for the nine months ended September 30, 2020 and 2019, respectively. The variable lease costs were $259,000 and $238,000 for the nine months ended September 30, 2020 and 2019, respectively.
The following is a schedule of the Company's operating lease liabilities by contractual maturity as of September 30, 2020:
2,262
1,849
1,382
1,196
Thereafter
2,087
Total lease payments
11,697
Less: imputed interest
1,379
Total present value of lease payments
The following table shows the supplemental cash flow information related to the Company’s direct finance and operating leases for the nine months ended September 30, 2020 and 2019:
Right-of-use asset obtained in exchange for lease obligation
455
7,862
Operating cash flows from operating leases
2,139
1,844
Operating cash flows from direct finance leases
Financing cash flows from direct finance leases
561
14. ACCOUNTING PRONOUNCEMENTS
In February 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-02, “Leases (Topic 842)”. The standard requires a lessee to recognize assets and liabilities on the balance sheet for leases with lease terms greater than 12 months. For lessees, virtually all leases will be required to be recognized on the balance sheet by recording a right-of-use asset and lease liability. Subsequent accounting for leases varies depending on whether the lease is an operating lease or a finance lease. The ASU requires additional qualitative and quantitative disclosures with the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.
In July 2018, the FASB issued ASU 2018-11 “Leases (Topic 842) Targeted Improvements” which allows entities adopting ASU No. 2016-02 to choose an additional transition method, under which an entity to initially applies the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The amendment in this update becomes effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. The Company has elected the transition method permitted by ASU No. 2018-11 under which an entity shall recognize and measure leases that exist at the application date and prior comparative periods are not adjusted. Upon adoption of the new lease guidance on January 1, 2019, the Company recorded a lease liability of approximately $8.2 million, a right-of-use-asset of approximately $7.9 million and a cumulative effect adjustment to retained earnings of $661,000.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. This ASU replaces the incurred loss model with an expected loss model, referred to as “current expected credit loss” (CECL) model. It will change estimates for credit losses related to financial assets measured at amortized cost, including loans receivable, held-to-maturity (HTM) debt securities and certain other contracts. Due to the uncertainty created by the current environment under a provision provided by the CARES Act, the Company elected to delay the adoption of FASB’s new rule covering the CECL standard until the earlier of the termination date of the national emergency declared by President Trump under the National Emergencies Act on March 13, 2020, related to the outbreak of COVID-19, or December 31, 2020. Once the delay provision has been terminated, adoption will be retroactive to January 1, 2020. The largest impact will be on the allowance for loan and lease losses (ALLL). The impact to the Company’s ALLL has not yet been calculated. The Company has reviewed the potential impact to our securities portfolio, which primarily consists of U.S. government sponsored entities, mortgage-backed securities and municipal securities which have no history of credit loss and have strong credit ratings. The Company does not expect the standard to have a material impact on its financial statements as it relates to the Company’s securities portfolio. The Company has formed a CECL committee comprised of finance, accounting, and credit members. The Company has evaluated and selected a third-party firm to assist in the development of a CECL program, selected portfolio segmentations, loss methodologies and the probability of default/loss given default model to assist in the calculation of the ALLL in preparation for the change to the expected loss model. The Company continues to work towards implementing the accounting, reporting and governance processes required under the new standard and completing the model implementation and validation. The Company expects to recognize a one-time cumulative-effect adjustment to our ALLL through retained earnings as of the January 1, 2020. The Company cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on our consolidated financial condition or results of operations.
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes”. The amendments in this Update simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. This ASU removes the following exceptions: exception to the incremental approach for intra-period tax allocation when there is a loss from continuing operations and income or a gain from other items; exception to the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment; exception to the ability not to recognize a deferred tax liability for a foreign subsidiary when a foreign equity method investment becomes a subsidiary; and the exception to the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption is permitted. The Company is assessing ASU 2019-12 and its impact on its financial statements.
In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting”. The amendments in this Update provide optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this Update apply only to contracts and hedging relationships that reference LIBOR or another reference rate expected to be discontinued due to reference rate reform. The expedients and exceptions provided by the amendments do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022. The amendments in this ASU can be adopted immediately and are effective through December 31, 2020. The Company is evaluating alternative reference rates including the Secured Overnight Financing Rate (SOFR) in preparation for a rate index replacement and the adoption of this ASU.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS: This Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about Management’s confidence and strategies and Management’s expectations about new and existing programs and products, investments, relationships, opportunities and market conditions. These statements may be identified by such forward-looking terminology as “expect”, “look”, “believe”, “anticipate”, “may”, or similar statements or variations of such terms. Actual results may differ materially from such forward-looking statements. Factors that may cause results to differ materially from those contemplated by such forward-looking statements include, among others, those risk factors identified in the Company’s Form 10-K for the year ended December 31, 2019, in addition to/which include the following:
our inability to successfully grow our business and implement our strategic plan, including an inability to generate revenues to offset the increased personnel and other costs related to the strategic plan;
the impact of anticipated higher operating expenses in 2020 and beyond;
our inability to successfully integrate wealth management firm acquisitions;
our inability to manage our growth;
our inability to successfully integrate our expanded employee base;
an unexpected decline in the economy, in particular in our New Jersey and New York market areas;
declines in our net interest margin caused by the interest rate environment and/or our highly competitive market;
declines in value in our investment portfolio;
impact on our business from a pandemic event on our business, operations, customers, allowance for loan losses and capital levels;
higher than expected increases in our allowance for loan and lease losses;
higher than expected increases in loan and lease losses or in the level of nonperforming loans;
changes in interest rates;
decline in real estate values within our market areas;
legislative and regulatory actions (including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Basel III and related regulations) that may result in increased compliance costs;
successful cyberattacks against our IT infrastructure and that of our IT and third party providers;
higher than expected FDIC insurance premiums;
adverse weather conditions;
our inability to successfully generate new business in new geographic markets;
our inability to execute upon new business initiatives;
our lack of liquidity to fund our various cash obligations;
reduction in our lower-cost funding sources;
our inability to adapt to technological changes;
claims and litigation pertaining to fiduciary responsibility, environmental laws and other matters;
our inability to retain key employees;
demands for loans and deposits in our market areas;
adverse changes in securities markets;
changes in accounting policies and practices; and
other unexpected material adverse changes in our operations or earnings.
Further, given its ongoing and dynamic nature, it is difficult to predict the full impact of the COVID-19 outbreak on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated and when and whether the gradual reopening of businesses will result in a meaningful increase in economic activity. As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:
demand for our products and services may decline, making it difficult to grow assets and income;
if the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income;
collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;
our allowance for loan losses may have to be increased if borrowers experience financial difficulties, which will adversely affect our net income;
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;
as the result of the decline in the Federal Reserve Board’s target federal funds rate to near 0%, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income;
a material decrease in net income or a net loss over several quarters could result in a decrease in the rate of our quarterly cash dividend;
our wealth management revenues may decline with continuing market turmoil;
a worsening of business and economic conditions or in the financial markets could result in an impairment of certain intangible assets, such as goodwill;
the unanticipated loss or unavailability of key employees due to the outbreak, which could harm our ability to operate our business or execute our business strategy, especially as we may not be successful in finding and integrating suitable successors;
we may face litigation, regulatory enforcement and reputation risk as a result of our participation in the PPP and the risk that the SBA may not fund some or all PPP loan guaranties;
our cyber security risks are increased as the result of an increase in the number of employees working remotely; and
FDIC premiums may increase if the agency experience additional resolution costs.
Moreover, our operations depend on the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. The unanticipated loss or unavailability of key employees due to the pandemic could hinder our ability to operate our business or execute our business strategy.
Except as may be required by applicable law or regulation, the Company undertakes no duty to update any forward-looking statements to conform the statement to actual results or change in the Company’s expectations. Although we believe that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance, or achievements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES: Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon the Company’s consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Company’s Audited Consolidated Financial Statements for the year ended December 31, 2019 contains a summary of the Company’s significant accounting policies.
Management believes that the Company’s policy with respect to the methodology for the determination of the allowance for loan and lease losses involves a higher degree of complexity and requires Management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. This critical policy and its application are periodically reviewed with the Audit Committee and the Board of Directors.
The provision for loan and lease losses is based upon Management’s evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated fair value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although Management uses the best information available, the level of the allowance for loan and lease losses remains an estimate, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan and lease losses. Such agencies may require the Company to make additional provisions for loan and lease losses based upon information available to them at the time of their examination. Furthermore, the majority of the Company’s loans are secured by real estate in New Jersey and, to a lesser extent, New York City. Accordingly, the collectability of a substantial portion of the carrying value of the Company’s loan portfolio is susceptible to changes in local market conditions and any adverse economic conditions. Future adjustments to the provision for loan and lease losses and allowance for loan and lease losses may be necessary due to economic, operating, regulatory and other conditions beyond the Company’s control.
The Company accounts for its debt securities in accordance with “Accounting Standards Codification (“ASC”) 320, “Investments - Debt Securities” and its equity security in accordance with ASC 321, “Investments – Equity Securities”. All securities are classified as available for sale and are carried at fair value, with unrealized holding gains and losses reported in other
45
comprehensive income/(loss), net of tax, with the exception of the Company’s investment in a CRA investment fund which is classified as an equity security. In accordance with ASU 2016-01, “Financial Instruments” unrealized holding gains and losses are marked to market through the income statement.
EXECUTIVE SUMMARY: The following table presents certain key aspects of our performance for the three months ended September 30, 2020 and 2019.
Change
2020 vs 2019
Results of Operations:
Provision for loan and lease losses (1)
4,350
Net interest income after provision for loan and lease losses
(2,286
Wealth management fee income (2)
618
Other income (3)
10,092
4,915
5,177
Operating expense
2,202
1,307
(14
1,321
Total revenue (Net interest income plus wealth
management fee income and other income)
7,859
Diluted average shares outstanding
(352,255
Diluted earnings per share
0.08
Return on average assets annualized (ROAA)
0.89
1.00
(0.11
)%
Return on average equity annualized (ROAE)
10.53
9.87
0.66
The September 2020 quarter included a provision for loan and lease losses of $5.2 million. The increase in the provision for loan and lease losses was primarily due to the current environment created by the COVID-19 pandemic.
(2)
The September 2020 quarter included a full quarter of wealth management fee income and expense related to Point View, which was acquired effective September 1, 2019.
(3)
The September 2020 quarter included a $7.4 million gain on sale of $355 million of PPP loans.
The following table presents certain key aspects of our performance for the nine months ended September 30, 2020 and 2019.
6,507
28,000
(21,493
1,827
17,284
10,928
6,356
7,563
(20,873
Income tax expense (4)
(8,834
(12,039
14,690
(444,116
(0.59
0.54
0.99
(0.45
6.07
9.67
(3.60
Selected Balance Sheet Ratios:
Total capital (Tier I + II) to risk-weighted assets
15.04
14.20
0.84
Tier I leverage ratio
8.54
9.33
(0.79
Loans to deposits
91.18
103.55
(12.37
Allowance for loan and lease losses to total loans (5)
1.49
0.50
Allowance for loan and lease losses to nonperforming loans
768.15
151.23
616.92
Nonperforming loans to total loans
0.19
(0.47
The nine months ended September 30, 2020 included a provision for loan and lease losses of $30.1 million. The increase in the provision for loan and lease losses was primarily due to the current environment created by the COVID-19 pandemic.
The nine months ended September 30, 2020 included wealth management fee income and expense related to Point View, which was acquired effective September 1, 2019.
The nine months ended September 30, 2020 included a $7.4 million gain on sale of $355 million of PPP loans.
(4)
The 2020 year included a $3.2 million tax benefit related to the carryback of tax NOLs to prior years when the Federal tax rate was 14% higher.
For the quarter ended September 30, 2020, the Company recorded revenue of $52.36 million, pretax income of $18.75 million, net income of $13.55 million and diluted earnings per share of $0.71, compared to revenue of $44.50 million, pretax income of $17.44 million, net income of $12.23 million and diluted earnings per share of $0.63 for the same three month period last year. The 2020 quarter net interest income and noninterest income reflected earnings from the PPP and increased wealth management income (primarily due to the acquisition of Point View in September 2019), which was partially offset by increased operating expenses (due in part to the wealth management firm acquired September 2019) and an increase in the provision for loan and lease losses to $5.15 million. The increased provision for loan losses was due to increased qualitative factors associated with the increased unemployment rate, economic forecasts and the level of loan payment deferral requests created by the COVID-19 pandemic. In comparing the third quarter of 2020 to the third quarter of 2019, revenue increased by 18%. Net interest income benefitted from an increase in our average interest-earning assets partially offset by a decline in our net interest margin for the quarter ended September 30, 2020. Capital markets activity (which includes loan level back-to-back swap activities, the SBA lending and sale program and mortgage banking activities) resulted in $1.03 million of revenue for the third quarter of 2020 a
decline of $1.74 million from $2.77 million for the same period in 2019. Income from these programs are not linear each quarter, as some quarters will be higher than others.
The Company recorded revenue of $143.22 million, pretax income of $27.46 million, net income of $23.16 million and diluted earnings per share of $1.22 for the nine months ended September 30, 2020 compared to revenue of $128.53 million, pretax income of $48.33 million, net income of $35.20 million and diluted earnings per share of $1.81 for the same 2019 period. The 2020 nine-month period net interest income and noninterest income reflected earnings from the PPP and increased wealth management income (primarily due to the acquisition of Point View in September 2019), which was partially offset by increased operating expenses (due in part to the previous mentioned firm acquired in September 2019). Net interest income benefitted from an increase in our average interest-earning assets partially offset by a decline in our net interest margin for the nine months ended September 30, 2020. Capital markets activity (which includes loan level back-to-back swap activities, the SBA lending and sale program and mortgage banking activities) resulted in $4.81 million of revenue for the nine months ended September 30, 2020, a decline of $126 thousand from $4.93 million for the same period in 2019. Income from these programs are not linear each quarter, as some quarters will be higher than others.
The 2020 nine-month period also included a tax benefit of $3.2 million recorded in the first quarter of 2020 caused by the changes in the treatment of tax net operating losses (“NOL”) under the CARES Act. The decrease in net income and EPS for the 2020 nine-month period was the result of a $30.05 million provision for loan losses due to the current environment due to the COVID-19 pandemic, as compared to a $2.05 million provision for the 2019 nine-month period.
COVID-19 UPDATE: The COVID-19 pandemic has continued to have a devastating effect on businesses both locally and nationally. As a result, Congress passed the CARES Act to provide fast and direct economic assistance to American workers, families and businesses. The CARES Act contains substantial tax and spending provisions including direct financial aid to American families, extensive emergency funding for hospitals and medical providers, and economic stimulus to significant impacted industry sectors. Below are some of the measures the Company has implemented in response to COVID-19.
The Company has an Incident Response Team comprised of senior and departmental leaders that meet frequently to monitor and address the ongoing developments and challenges presented by the COVID-19 pandemic. The following represent responses by Management as a result of COVID-19:
The Company’s branch offices remain open via drive-thru facilities, ATM access, and on-line banking;
Management has leveraged technology to support employees that are working remotely;
Retail client initiatives have been introduced including:
1)
90-day or 180-day payment deferral period. The Company has approved deferral requests under the CARES Act of approximately $940.2 million of which $827.8 million remain as of September 30, 2020. The Company expects $247 million to come off deferral status in October with an additional $449 million scheduled to come off in November.
2)
Waived all late fees for April/May/June;
3)
Not reporting payment deferrals or late payments to credit bureaus through September; and
4)
Utilized the PPP to assist both clients and community organizations with funding needs related to the pandemic (processed approximately 2,500 applications with approximately $600 million of approved loans and have a balance of $202.0 million as of September 30, 2020). The Bank sold $355 million of PPP loans during the third quarter of 2020.
The Company has identified several industry sectors within the loan portfolio that are most impacted by COVID-19 and include but are not limited to: manufacturing, transportation, accommodation and food services, retail trade, real estate – retail and arts, entertainment and recreation. Management has performed portfolio reviews related to these sectors in the second and third quarters of 2020. There are approximately $95 million or 2% of loans with COVID related residual risk as of September 30, 2020. Management will continue to monitor these sectors closely and evaluate for potential impact on our ALLL.
The Company will continue to prudently extend credit to our clients. The Company expects COVID-19 to have a significant impact on our operations but cannot determine or estimate the impact at this time.
CONTRACTUAL OBLIGATIONS: For a discussion of our contractual obligations, see the information set forth in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations.”
OFF-BALANCE SHEET ARRANGEMENTS: For a discussion of our off-balance sheet arrangements, see the information set forth in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Off-Balance Sheet Arrangements.”
48
EARNINGS ANALYSIS
NET INTEREST INCOME (“NII”) / NET INTEREST MARGIN (“NIM”) / AVERAGE BALANCE SHEET:
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, investment securities, interest-earning deposits and federal funds sold. Interest-bearing liabilities include interest-bearing checking, savings and time deposits, Federal Home Loan Bank advances, subordinated debt and other borrowings. Net interest income is determined by the difference between the average yields earned on earning assets and the average cost of interest-bearing liabilities (“net interest spread”) and the relative amounts of earning assets and interest-bearing liabilities. Net interest margin is calculated as net interest income as a percent of total interest earning assets on an annualized basis. The Company’s net interest income, spread and margin are affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows and general levels of nonperforming assets.
The following table summarize the Company’s net interest income and margin for the periods indicated:
September 30, 2019
NII
NIM
NII/NIM excluding the below
30,327
2.45
29,896
2.67
Prepayment premiums received on loan paydowns
104
236
Effect of maintaining excess interest earning cash
(266
-0.24
(47
-0.09
Effect of PPP loans
1,984
-0.02
0.00
NII/NIM as reported
2.20
2.60
91,901
2.51
88,762
2.70
1,005
914
0.03
(1,000
-0.19
(316
-0.08
3,961
-0.01
2.33
2.65
Net interest income, on a fully tax-equivalent basis, increased $1.7 million, or 6 percent, for the third quarter of 2020 to $32.5 million from net interest income of $30.8 million for the same quarter in 2019. The net interest margin was 2.20 percent and 2.60 percent for the three months ended September 30, 2020 and 2019, respectively, a decrease of 40 basis points. Net interest income, on a fully tax-equivalent basis, increased $5.9 million, or 6 percent, for the first nine months ended September 30, 2020 to $97.2 million from net interest income of $91.3 million for the same period in 2019. The net interest margin was 2.33 percent and 2.65 percent for the nine months ended September 30, 2020 and 2019, respectively, a decrease of 32 basis points. As shown above, the Company’s reported NIM declined 40 basis points compared to the September 30, 2019 quarter, while core NIM declined only 22 basis points compared to the September 30, 2019 quarter. As a commercial bank, the Company is asset sensitive with a large portion of its commercial loan portfolio tied to one-month LIBOR. The decline in the NIM was a function of the large decline in one-month LIBOR which occurred during the second quarter of 2020 and higher levels of interest-earning assets with lower yields.
The growth in net interest income for the three and nine months ended September 30, 2020 was due to increases in the average balance of interest-earning assets and a decrease in the average cost of interest-bearing liabilities, offset by an increase in the average balance of interest-bearing liabilities and by a decrease in the average yield on interest-earning assets. The Company continues to be impacted by competitive pressures in attracting new loans and deposits.
Net interest income has benefitted from interest and fees from PPP loans for both the three and nine months ended September 30, 2020. As of September 30, 2020, the Company had $202.0 million of PPP loans, with net deferred fees of $1.5 million that will be amortized to net interest income over the life of the loans, which have a stated maturity of two to five years. However, these loans may be eligible for loan forgiveness by the SBA at an earlier date, which would accelerate the amortization of the net deferred fees.
Future net interest income will be benefitted by the repricing of the Company’s time certificates of deposit (“CDs”). Over the twelve-month period ending September 30, 20201, approximately $510 million of CDs with an average rate of approximately 1.35% will mature.
The following table summarizes the loans that the Company closed during the periods indicated:
Residential mortgage loans originated for portfolio
32,599
19,073
Residential mortgage loans originated for sale
54,521
15,846
Total residential mortgage loans
87,120
34,919
Commercial real estate loans
1,613
43,414
Multifamily properties
1,500
77,138
C&I loans (A) (B)
118,048
228,903
Small business administration
4,962
3,510
Wealth Lines of Credit (A)
2,000
6,980
Total commercial loans
128,123
359,945
Installment loans
Home equity lines of credit (A)
4,759
5,631
Total loans closed
220,255
400,857
66,057
51,910
110,973
28,721
177,030
80,631
11,219
98,643
75,458
156,864
260,250
513,975
Small business administration (C)
614,443
16,300
5,750
21,085
967,120
806,867
1,459
2,417
12,671
10,864
1,158,280
900,779
Includes loans and lines of credit that closed in the period but were not necessarily funded.
(B)
Includes equipment finance leases and loans.
(C) Includes PPP loans of $596 million for the nine months ended September 30, 2020.
The Company manages its origination levels in conjunction with anticipated paydowns and payoffs. The Company has managed its balance sheet such that multifamily and 1-4 family residential loans declined as a percentage of the overall loan portfolio and C&I loans became a larger percentage of the overall loan portfolio. Commercial real estate loan originations declined by $41.8 million and $81.4 million for the three and nine months ended September 30, 2020, respectively. C&I loan originations declined by $110.9 million and $253.7 million for the three and nine months ended September 30, 2020, respectively. Multifamily originations also declined by $75.6 million to $1.5 million for the three months ended September 30, 2020 as compared to the prior year. The decreases in originations were due to the Company’s focused efforts on PPP production and loan deferral requests during the second and third quarters of 2020. Residential mortgage loan originations increased by $52.2 million and $96.4 million for the three and nine months ended September 30, 2020, respectively. The increase was primarily due to an increased demand by residential customers reflective of the low interest rate environment and the ability of the Company to sell these mortgages in the secondary market to generate noninterest income.
At September 30, 2020, December 31, 2019 and September 30, 2019, the Bank had a concentration in commercial real estate (“CRE”) loans as defined by applicable regulatory guidance as follows:
Multifamily mortgage loans as a percent of
total regulatory capital of the Bank
195
212
208
Non-owner occupied commercial real estate
loans as a percent of total regulatory capital
of the Bank
192
182
Total CRE concentration
371
404
390
The Bank believes it addresses the key elements in the risk management framework laid out by its regulators for the effective management of CRE concentration risks.
The following table reflects the components of the average balance sheet and of net interest income for the periods indicated:
Average Balance Sheet
Unaudited
Income/
Expense
Yield
ASSETS:
Interest-earning assets:
Investments:
Taxable (1)
553,607
1.58
393,386
2.52
Tax-exempt (1) (2)
9,127
5.08
13,497
165
4.89
Loans (2) (3):
Residential mortgages
529,500
4,437
3.35
567,097
4,811
3.39
Commercial mortgages
1,929,319
15,115
3.13
1,856,216
17,870
3.85
Commercial
2,134,399
17,653
3.31
1,530,131
18,605
4.86
4,395
5.01
2,619
7.79
Installment
52,659
2.86
53,891
560
4.16
Home equity
53,373
444
3.33
58,573
736
5.03
283
9.89
396
11.11
4,703,928
38,088
3.24
4,068,923
42,644
4.19
0.25
101
652,832
0.10
256,865
2.12
Total interest-earning assets
5,919,596
40,545
2.74
4,732,772
46,648
3.94
Noninterest-earning assets:
7,479
5,628
Allowance for loan and lease losses
(68,110
(40,806
21,511
21,121
242,017
151,265
Total noninterest-earning assets
202,897
137,208
Total assets
6,122,493
4,869,980
LIABILITIES:
1,828,780
1,130
1,410,837
4,467
1.27
Money markets
1,235,040
920
0.30
1,184,589
4,227
1.43
125,016
0.05
113,961
0.06
642,732
1.57
649,393
Subtotal interest-bearing deposits
3,831,568
4,595
0.48
3,358,780
12,491
1.96
2.00
33,742
3.17
33,688
Total interest-bearing deposits
3,995,310
5,498
0.55
3,572,468
13,659
1.53
FHLB advances and borrowings
475,465
1.03
114,584
3.09
7,054
4.76
7,866
4.78
83,552
5.85
83,329
5.88
Total interest-bearing liabilities
4,561,381
0.70
3,778,247
1.68
Noninterest-bearing liabilities:
Demand deposits
872,560
512,497
173,816
83,554
Total noninterest-bearing liabilities
1,046,376
596,051
Shareholders’ equity
514,736
495,682
Total liabilities and shareholders’ equity
Net interest income (tax-equivalent basis)
32,520
30,785
Net interest spread
2.04
2.26
Net interest margin (4)
Tax equivalent adjustment
(371
(700
Average balances for available for sale securities are based on amortized cost.
Interest income is presented on a tax-equivalent basis using a 21 percent federal tax rate.
Loans are stated net of unearned income and include nonaccrual loans.
Net interest income on a tax-equivalent basis as a percentage of total average interest-earning assets.
52
467,881
391,032
9,930
376
5.05
15,904
581
4.87
531,563
13,510
568,902
14,541
3.41
1,989,256
49,745
1,822,341
53,472
3.91
1,977,597
54,450
3.67
1,442,827
4,440
187
5.62
883
7.70
53,165
1,212
3.04
54,552
1,722
4.21
54,627
1,512
3.69
60,695
2,319
5.09
9.55
394
10.83
4,610,969
120,639
3.49
3,950,594
124,796
468,064
0.23
245,153
5,556,946
128,584
4,602,784
137,074
3.97
6,149
5,436
(58,896
(39,638
21,373
21,253
212,716
133,830
181,342
120,881
5,738,288
4,723,665
1,706,558
6,219
0.49
1,321,248
12,299
1,211,720
5,374
0.59
1,196,778
12,978
1.45
118,291
113,552
672,308
1.86
622,509
2.24
3,708,877
21,010
0.76
3,254,087
35,801
1.47
153,358
33,729
3.14
45,412
2.81
3,895,964
24,063
0.82
3,479,499
39,235
1.50
330,324
1.36
108,526
7,266
4.79
8,052
4.80
83,496
5.86
83,272
4,317,050
0.97
3,679,349
1.66
763,414
494,023
149,187
64,806
912,601
558,829
508,637
485,487
97,233
91,320
2.31
(1,366
(1,960
53
The effect of volume and rate changes on net interest income (on a tax-equivalent basis) for the periods indicated are shown below:
For the Three Months Ended September 30, 2020
Difference due to
Change In
Change In:
(In Thousands):
Volume
Rate
Investments
734
(1,078
(344
6,336
(10,892
(4,556
860
(2,063
(1,203
7,930
(14,033
(6,103
Interest-bearing checking
632
(3,969
(3,337
130
(3,437
(3,307
(38
(1,214
(1,252
-
Interest bearing demand brokered
(247
(265
Borrowed funds
339
335
Capital lease obligation
(10
809
(8,647
(7,838
7,121
(5,386
1,735
For the Nine Months Ended September 30, 2020
1,017
(2,273
(1,256
20,070
(24,227
(4,157
1,956
(5,033
(3,077
23,043
(31,533
(8,490
2,379
(8,459
(6,080
(7,656
(7,604
(9
(1,889
(1,106
(267
103
(384
167
(217
802
3,367
(17,770
(14,403
19,676
(13,763
5,913
Interest income on interest-earning assets, on a fully tax-equivalent basis, totaled $40.5 million for the third quarter of 2020 compared to $46.6 million for the same quarter of 2019, reflecting a decrease of $6.1 million, or 13 percent. Interest income on interest-earning assets, on a fully tax-equivalent basis, totaled $128.6 million for the nine months ended September 30, 2020 compared to $137.1 million for the same period of 2019, reflecting a decrease of $8.5 million, or 6 percent. The decrease in both the three and nine months ended September 30, 2020, as compared to the comparable periods in 2019 reflects a decrease in the average yield on interest-earnings assets, partially offset by an increase in the average balance of interest-earning assets.
54
Average interest-earning assets totaled $5.92 billion for the third quarter of 2020, an increase of $1.19 billion, or 25 percent, from the same period of 2019. Average interest-earning assets totaled $5.56 billion for the nine months ended September 30, 2020, an increase of $954.2 million, or 21 percent, from the same period of 2019. The increase in the average balance of interest-earning assets for the three and nine months ended September 30, 2020, as compared to the comparable periods in 2019 reflects an increase in the average balance of loans, particularly, in the average balance of C&I and commercial mortgage portfolios. The average balance of the C&I loan portfolio increased $604.3 million to $2.13 billion, or 39 percent, for the third quarter of 2020, as compared to $1.53 billion for the three months ended September 30, 2019. The average balance of the C&I loan portfolio increased $534.8 million, or 37 percent, to $1.98 billion for the nine months ended September 30, 2020 as compared to $1.44 billion for the same period in 2019. The increase in this portfolio for the three and nine months ended September 30, 2020 was primarily attributable to the Company’s participation in the PPP program. The Company originated $596 million of PPP loans during the second quarter of 2020, which was partially offset by the sale of $355 million of PPP loans in the third quarter of 2020. The Company has also supported growth in the C&I portfolio through: the addition of seasoned bankers including a new EVP, Head of Commercial Banking, in 2019 and an equipment finance team in 2017; a continued focus on client service and value-added aspects of the lending process; and a continued focus on markets outside of the immediate branch service area, including markets around the Teaneck and Princeton, New Jersey private banking offices. The average balance of the commercial mortgage portfolio increased $73.1 million to $1.93 billion, or 4 percent, from $1.86 billion for the third quarter of 2019. The average balance of the commercial mortgage portfolio was $1.99 billion for the nine months ended September 30, 2020 an increase of $166.9 million, or 9 percent, from the same period in 2019. The increase in the commercial mortgage portfolio for the three and nine months ended September 30, 2020 were to maintain the size of the portfolio in anticipation of maturities in the portfolio in the latter part of 2020. These increases were partially offset by decreases in the average balance of the residential mortgage portfolio of $37.6 million, or 7 percent, and $37.3 million, or 7 percent to $529.5 million and $531.6 million for the three and nine months ended September 30, 2020, respectively, when compared to the same periods in 2019. The Company continued to manage its balance sheet such that lower-yielding, primarily fixed rate multifamily loans declined as a percentage of the overall loan portfolio and higher-yielding, primarily floating rate or short duration C&I loans became a larger percentage of the overall loan portfolio.
The average balance of investment securities totaled $562.7 million for the third quarter of 2020 compared to $406.9 million for the same quarter of 2019, reflecting an increase of $155.9 million, or 38 percent. The average balance of investment securities totaled $477.8 million for the nine months ended September 30, 2020 as compared to $406.9 million for the same period of 2019 reflecting an increase of $70.9 million, or 17 percent. The increase in the average balance of investment securities was due to the re-purchase of securities to maintain the size of the portfolio in anticipation of maturities for the fourth quarter of 2020 and to utilize excess liquidity generated by the sale of PPP loans in the third quarter of 2020.
The average balance of interest-earning deposits totaled $652.8 million for the three months ended September 30, 2020 when compared to $256.9 million for the same period in 2019, reflecting an increase of $396.0 million or 154 percent. The average balance of interest-earning deposits increased to $468.1 million for the nine months ended September 30, 2020 when compared to $245.2 million for the same period in 2019 reflecting an increase of $222.9 million or 91 percent. The increase in the average balance of interest-earning deposits for the three and nine months ended September 30, 2020 was primarily to increase the Company’s balance sheet liquidity in the event of significant depositor withdrawals and/or significant borrower draws on existing unused credit lines due to the current environment created by the COVID-19 pandemic.
For the quarters ended September 30, 2020 and 2019, the average yields earned on interest-earning assets were 2.74 percent and 3.94 percent, respectively, a decrease of 120 basis points. The nine months ended September 30, 2020 had a decrease of 88 basis points on the average yields earned on interest-earning assets to 3.09 percent from 3.97 percent when compared to the same period of 2019. The decrease in average yields on loans for the three- and nine-month periods was due to a declining rate environment and elevated levels of interest-bearing cash and investment securities at lower yields. The one-month London Interbank Offered Rate (“LIBOR”) has declined by approximately 150 basis points from the beginning of the year. The Federal Open Market Committee also reduced the target Federal Funds rate to 0 percent to 0.25 percent in March 2020 due to the economic disruption caused by COVID-19. With the transformation to a commercial bank balance sheet and business model, the Company’s interest rate sensitivity models indicate the Company is asset sensitive as of September 30, 2020, and that net interest income would improve in both a rising rate environment and a falling rate environment as our adjustable rate assets have little room to re-price in this low rate environment. We saw a slight decline in net interest income during the third quarter of 2020 as the full effect of rate decreases on our adjustable rate assets occurred in the middle of the second quarter of 2020. The Company believes that our adjustable rate assets will not reprice lower given the floors instituted on our portfolio.
For the third quarter of 2020, the average balance of interest-bearing deposits was $4.00 billion, an increase of $422.8 million, or 12 percent, from $3.57 billion for the same period of 2019. The average balance of interest-bearing deposits totaled $3.90 billion for the nine months ended September 30, 2020 which is an increase of $416.5 million, or 12 percent, from the same 2019 period. The growth in customer deposits (excluding brokered CDs and brokered interest-bearing demand deposits, but including reciprocal funds discussed below) has come from an increase in retail deposits from our branch network; a focus on providing
high-touch client service; new deposit relationships related to PPP; and a full array of treasury management products that support core deposit growth. The growth was partially offset by a decline of $23.0 million in the average balance of listing service deposits from September 30, 2019 as the Company has chosen not to participate in such programs for the foreseeable future, so maturing listing service deposits are not replaced with new listing service deposits.
Average rates paid on total interest-bearing deposits were 0.55 percent and 1.53 percent for the third quarters of 2020 and 2019, respectively, a decrease of 98 basis points. Average rates paid on total interest-bearing deposits were 0.82 percent and 1.50 percent for the nine months ended September 30, 2020 and 2019, respectively, a decrease of 68 basis points. The decrease in the average rate paid on deposits was principally due to repricing of our deposit base to align with the recent Fed rate decreases.
For the third quarter of 2020, the average balance of borrowings was $475.5 million, an increase of $360.9 million when compared to the same period in 2019. The average rate paid on borrowings was 1.03 percent for the three months ended September 30, 2020 as compared to 3.09 percent for the same period in 2019. For the nine months ended September 30, 2020, the average balance of borrowings was $330.3 million, an increase of $221.8 million when compared to the same period in 2019. The average rate paid on borrowings was 1.36 percent for the nine months ended September 30, 2020 as compared to 3.14 percent for the same period in 2019. The increase in borrowings was principally due to the Company’s participation in the PPPLF as well, for the nine months ended September 30, 2020 as a $500.0 million one-month FHLB advance entered in March 2020, which matured in April 2020. The average rate paid on borrowings was lower for both the three and nine months ended September 30, 2020 as the PPPLF borrowings rate was 0.35 percent.
The Company is a participant in the Reich & Tang Demand Deposit Marketplace (“DDM”) program and the Promontory Program. The Company uses these deposit sweep services to place customer funds into interest-bearing demand (checking) accounts issued by other participating banks. Customer funds are placed at one or more participating banks to ensure that each deposit customer is eligible for the full amount of FDIC insurance. As a program participant, the Company receives reciprocal amounts of deposits from other participating banks. Such reciprocal deposit balances are included in the Company’s interest-bearing checking balances. The average balance of reciprocal deposits was $663.6 million and $596.3 million for the three and nine months ended September 30, 2020, respectively, compared to $470.9 million and $447.0 million for the same three and nine months ended September 30, 2019, respectively.
The average balance of brokered interest-bearing demand deposits was $130.0 million and $153.4 million for the three and nine months ended September 30, 2020, respectively, compared to $180.0 million for the three and nine months ended September 30, 2019. The Company has transacted $130.0 million of interest rate swaps against these deposits as part of the Company’s interest rate risk management program.
INVESTMENT SECURITIES AVAILABLE FOR SALE: Investment securities available for sale are purchased, sold and/or maintained as a part of the Company’s overall balance sheet, liquidity and interest rate risk management strategies. These securities are carried at estimated fair value, and unrealized changes in fair value are recognized as a separate component of shareholders’ equity, net of income taxes. Realized gains and losses are recognized in income at the time the securities are sold. Equity securities are carried at fair value with unrealized gains and losses recorded in noninterest income.
At September 30, 2020, the Company had investment securities available for sale with a fair value of $596.9 million compared with $390.8 million at December 31, 2019. The increase was due to purchases of residential mortgage-backed securities with excess liquidity as deposits and borrowings exceeded loan growth. A net unrealized gain (net of income tax) of $6.2 million and a net unrealized gain (net of income tax) of $1.0 million were included in shareholders’ equity at September 30, 2020 and December 31, 2019, respectively.
The Company has one equity security (a CRA investment security) with a fair value of $15.2 million at September 30, 2020 compared with $10.8 million at December 31, 2019, with changes in fair value recognized in the Consolidated Statements of Income. The Company recorded a $323,000 unrealized gain on the Consolidated Statements of Income for the nine months ended September 30, 2020, respectively, as compared to an unrealized gain of $34,000 and $162,000 for the three and nine months ended September 30, 2019, respectively. There was no change in the unrealized gain/(loss) on our equity security during the three months ended September 30, 2020.
The carrying value of investment securities available for sale as of September 30, 2020 and December 31, 2019 are shown below:
Mortgage-backed securities-residential (principally
U.S. government-sponsored entities)
The following table presents the contractual maturities and yields of debt securities available for sale, stated at fair value, as of September 30, 2020:
After 1
After 5
But
After
Within
1 Year
5 Years
10 Years
Years
0.38
44,339
34,607
Mortgage-backed securities-residential (1)
13,184
56,451
396,640
2.01
1.67
2.06
1.41
8,998
28,072
1.64
1.07
1.21
State and political subdivisions (2)
2,657
571
2.48
4.72
2.83
5.25
5,565
18,650
113,395
459,319
1.70
1.88
1.40
1.52
Shown using stated final maturity.
Yields presented on a fully tax-equivalent basis.
Federal funds sold and interest-earning deposits are an additional part of the Company’s liquidity and interest rate risk management strategies. The combined average balance of these investments during the nine months ended September 30, 2020 was $468.2 million compared to $223.7 million for the year ended December 31, 2019. The increase represented excess cash as deposit and borrowing growth and cash from maturing securities exceeded loan growth.
OTHER INCOME: The following table presents other income, excluding income from wealth management, which is summarized and discussed subsequently:
57
(97
Gain on sale of loans (mortgage banking)
756
7,435
(2,349
(145
Securities gains, net
(34
(299
(36
1,419
7,432
(1,720
175
(776
161
The Company recorded total other income, excluding wealth management fee income, of $10.1 million for the third quarter of 2020, reflecting an increase of $5.2 million, or 105 percent, compared to the same period in 2019. For the nine months ended September 30, 2020 the Company recorded total other income, excluding wealth management fee income, of $17.3 million reflecting an increase of $6.4 million, or 58 percent from the same period in 2019. The increase in other income for the three and nine months ended September 30, 2020 was primarily attributable to a gain of $7.4 million on the sale of $354.9 million of PPP loans during the third quarter of 2020.
For the third quarter of 2020, income from the sale of newly originated residential mortgage loans was $954,000 compared to $198,000 for the same period in 2019. For the nine months ended September 30, 2020 and 2019, income from the sale of newly originated residential mortgage loans was $1.8 million and $377,000 respectively. Such income was the result of an increase in the residential mortgage loan volume during the first nine months of 2020 due to the low interest rate environment.
For the quarter ended September 30, 2020, the Company did not record any loan level, back-to-back swap income compared to $2.3 million for the same quarter of 2019. The nine months ended September 30, 2020 included $1.6 million of loan level, back-to-back swap income compared to $3.3 million for the same period of 2019. The program provides a borrower with a degree of interest rate protection on a variable rate loan, while still providing an adjustable rate to the Company, thus helping to manage the Company’s interest rate risk, while contributing to income.
The third quarter of 2020 included $79,000 of income, on sales of $825,000, related to the Company’s SBA lending and sale program compared to $224,000 of income, on sales of $2.2 million, for the same quarter in 2019. The nine months ended September 30, 2020 included $1.4 million of income, on sales of $14.8 million, related to the Company’s SBA lending and sale program compared to $1.2 million of income, on sales of $12.1 million, for the same period in 2019.
Income from the back-to-back swap and SBA programs are dependent on volume, and thus are not linear from quarter to quarter, as some quarters will be higher than others.
The Company recorded a $323,000 mark to market gain on its equity security investment for the nine months ended September 30, 2020, respectively, compared to a $34,000 and $162,000 mark to market gain on its equity security investment for the three and nine months ended September 30, 2019, respectively. There was no change in the unrealized gain/(loss) of our equity investment for the three months ended September 20, 2020.
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Other income was $531,000 for the quarter ended September 30, 2020 compared to $902,000 for the same quarter in 2019. For the nine months ended September 30, 2020 other income was $1.5 million compared to $2.2 million for the same period in 2019. The decrease in other income for the three and nine months ended September 30, 2020 was primarily due to decreases in commercial lending fees, particularly unused credit line fees, income related to our corporate advisory program, and loan servicing income.
OPERATING EXPENSES: The following table presents the components of operating expenses for the periods indicated:
For the Three Months Ended Sept 30,
1,726
FDIC assessment
Other Operating Expenses:
(149
(111
(522
For the Nine Months Ended Sept 30,
5,439
1,351
1,033
86
189
(866
Increased operating expenses in the three month and nine month period ended September 30, 2020 was principally attributable to: (1) an increase in compensation and employee benefits of $1.7 million to $19.2 million for the third quarter of 2020 and a $5.4 million increase to $57.6 million for the nine months ended September 30, 2020, which includes expenses related to the Point View acquisition completed on September 1, 2019, hiring in line with the Company’s strategic plan; and normal salary increases; (2) additional premises and equipment expenses, which includes expenses related to Point View; and (3) ongoing operating expenses including amortization of intangibles. Further, the three and nine months ended September 30, 2020 included increased medical insurance costs when compared to the same 2019 period. During the nine months ended September 30, 2020 the Company also incurred one-time expenses of $278,000 related to the closure of one branch office and $225,000 of increased marketing expense directly related to the COVID-19 pandemic and the Company’s participation in the PPP program. The Company anticipates the branch closure will lower future expenses. FDIC expense increased for the three and nine months ended September 30, 2020 by $882,000 and $1.0 million, respectively. During 2019, the FDIC provided a small bank assessment credit as the FDIC had met its reserve ratio. The increase in FDIC expense for three and nine month periods ended September 30, 2020 were also impacted by asset growth which negatively affected certain ratios used in calculating the assessment rate.
PEAPACK PRIVATE: This division includes: investment management services provided for individuals and institutions; personal trust services, including services as executor, trustee, administrator, custodian and guardian, and other financial planning, tax preparation and advisory services. Officers from Peapack Private are available to provide wealth management, trust and investment services at the Bank’s headquarters in Bedminster, at private banking locations in Morristown, Princeton and Teaneck, New Jersey and at the Bank’s subsidiaries, PGB Trust & Investments of Delaware, in Greenville, Delaware, Murphy Capital, in Gladstone, New Jersey, Lassus Wherley, in New Providence, New Jersey and Bonita Springs, Florida and Point View, in Summit, New Jersey.
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The market value of the assets under management and/or administration (“AUM/AUA”) of the Peapack Private Wealth Management Division was $7.6 billion at September 30, 2020, reflecting a 2% increase from $7.5 billion at December 31, 2019 and a recovery of 19% from $6.4 billion at March 31, 2020.
In the September 2020 quarter, Peapack Private generated $10.1 million in fee income compared to $9.5 million for the September 2019 quarter, reflecting a 7% increase. For the nine months ended September 30, 2020, the Private Wealth Management Division generated $30.1 million in fee income compared to $28.2 million for the same period in 2019, reflecting a 6% increase. The growth in fee income was primarily due to the acquisition of Point View on September 1, 2019.
Operating expenses relative to Peapack Private reflected increases due to overall growth in the business, new hires and select third party expenditures. The nine months ended September 30, 2020 also included a full nine months of expense from Point View. Remaining expenses are in line with the Company’s Strategic Plan, particularly the hiring of key management and revenue-producing personnel.
The Peapack Private Wealth Management Division currently generates adequate revenue to support the salaries, benefits and other expenses of the Division and Management believes it will continue to do so as the Company grows organically and/or by acquisition. Management believes that the Bank generates adequate liquidity to support the expenses of the Peapack Private Wealth Management Division should it be necessary.
NONPERFORMING ASSETS: OREO, loans past due in excess of 90 days and still accruing, and nonaccrual loans are considered nonperforming assets.
The following table sets forth asset quality data on the dates indicated:
As of
Sept 30,
June 30,
March 31,
Dec 31,
Loans past due over 90 days and still accruing
Nonaccrual loans (1)
26,697
29,324
29,383
Total nonperforming assets
8,661
26,747
29,374
28,931
29,719
Performing TDRs
2,278
2,376
2,389
2,527
Loans past due 30 through 89 days and still accruing (2)
3,785
8,261
6,333
Loans subject to special mention
27,922
13,222
21,870
Classified loans (1)
63,562
58,938
53,882
Impaired loans (1)
15,514
33,708
36,369
36,627
Nonperforming loans as a % of total loans (3)
Nonperforming assets as a % of total assets (3)
0.43
0.56
0.60
Nonperforming assets as a % of total loans
plus other real estate owned (3)
0.20
Excludes one commercial loan held for sale of $10.0 million at September 30, 2020.
Includes a non-owner occupied CRE loan with a balance of $3.5 million at March 31, 2020. This loan was brought fully current in early April. The $6.3 million at September 30, 2019 included one $4.3 million commercial real estate loan that was in process of a rate modification (not a TDR modification). The loan was brought current in early October 2019.
Nonperforming loans/assets do not include performing TDRs.
The increase in special mention loans primarily relates to investment and owner-occupied commercial real estate classified loans and was the result of the Bank’s credit analysis of sectors with COVID elevated residual risk (Hospitality and Food Services and Retail – Non-Grocery Anchored) and the downgrade of several loans within these categories during the third quarter of 2020.
PROVISION FOR LOAN AND LEASE LOSSES: The provision for loan and lease losses was $5.2 million and $800,000 for the third quarters of 2020 and 2019, respectively. For the nine months ended September 30, 2020 and 2019, the provision for
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loan losses was $30.1 million and $2.1 million, respectively. The increased provision for loan and lease losses for the three and nine months ended September 30, 2020 was primarily due to the current environment created by the COVID-19 pandemic and was driven principally by increased qualitative factors. The increase in qualitative factors was primarily related to elevated levels of unemployment and approved loan deferral requests partially offset by a decrease in non-PPP loan production for those same periods. For additional details, see the provision for loan and lease losses table below. The Company’s provision for loan and lease losses and the level of the allowance for loan and lease losses also reflect several other factors including Management’s evaluation of probable losses inherent in the portfolio, after consideration of appraised collateral values, financial condition and past credit history of the borrowers, type of and amount of loan growth, asset quality metrics, net charge-off activity, and the composition of the loan portfolio. Commercial credits generally carry a higher risk profile compared to some of the other credits, which is reflected in Management’s determination of the adequacy of the allowance for loan and lease losses.
The allowance for loan and lease losses was $66.1 million as of September 30, 2020, compared to $43.7 million at December 31, 2019. As a percentage of loans (excluding PPP loans), the allowance for loan and lease losses was 1.56 percent at September 30, 2020 and 0.99 percent at December 31, 2019. The specific reserves recorded on impaired loans were $87,000 at September 30, 2020 compared to $2.8 million as of December 31, 2019. Specific reserves declined by $4.2 million during the third quarter of 2020 largely due to the release of reserves on a senior living facility relationship and subsequent charge-off of this credit upon transfer to held for sale. Total impaired loans were $15.5 million and $35.9 million as of September 30, 2020 and December 31, 2019, respectively. The general component of the allowance increased from $40.9 million at December 31, 2019 to $66.1 million at September 30, 2020 due to the reasons noted above.
A summary of the allowance for loan and lease losses for the quarterly periods indicated follows:
Allowance for loan and lease losses:
Beginning of period
63,783
4,900
1,950
Recoveries/(charge-offs), net
(5,070
(2,618
107
146
989
End of period
Allowance for loan and lease losses as a % of
total loans (A)
1.493
1.359
1.447
0.994
1.000
General allowance for loan and lease losses as
a % of total loans (A)
1.491
1.270
1.303
0.930
0.934
non-performing loans
247.46
217.51
141.51
The June 30, 2020 and September 30, 2020 ALLL coverage ratios include PPP loans of $521.6 million and $202.0 million, respectively, from total loans
The following table details the Company’s provision for loan and lease losses for the quarter ended September 30, 2020:
Percentage
of Total Loans (A)
Allowance for loan and lease losses at July 1, 2020
Net charge-offs
Provision for loan and lease losses:
Release of reserves associated with current criticized and classified credits
(4,234
Based on qualitative factors related to decreasing consumer confidence, approved
loan payment deferrals, and other qualitative factors related to this environment
1,616
Based on Q3 loan originations and migration
7,768
Allowance for loan and lease losses at September 30, 2020
(A)The September 30, 2020 ALLL ratio exclude PPP loans of $202.0 million from total loans
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The following table details the Company’s provision for loan and lease losses for the nine months ended September 30, 2020:
Allowance for loan and lease losses at January 1, 2020
(7,581
Additional reserves associated with current criticized and classified credits
3,700
(6,255
21,579
Based on loan originations and migration
11,026
INCOME TAXES: Income tax expense for both the three months ended September 30, 2020 and September 30, 2019, respectively, was $5.2 million. The effective tax rate for the three months ended September 30, 2020 was 27.75% as compared to 29.90% for the September 2019 quarter. The slightly higher rate in the September 2019 quarter included higher NJ State Income Tax due to the change in NJ tax law noted below.
Income tax expense for the nine months ended September 30, 2020 was $4.3 million as compared to income tax expense of $13.1 million for the same period in 2019. The effective tax rate for the nine months ended September 30, 2020 was 15.65% as compared to 27.17% for the same period in 2019. The lower effective rate for the nine months ended September 30, 2020 was due to a $3.34 million tax benefit recorded during the first quarter of 2020. The tax benefit was primarily due to a $3.2 million Federal income tax benefit that resulted from a tax NOL carryback. The Company had a $23 million operating loss for tax purposes in 2018 (when the Federal tax rate was 21%) resulting from accelerated tax depreciation. Under the CARES Act, the Company was allowed to carry this NOL back to a period when the Federal tax rate was 35%, generating a permanent tax benefit.
On July 1, 2018, the 2019 New Jersey Budget (“Budget”) was passed, which established a 2.5 percent surtax on businesses that have New Jersey allocated net income in excess of $1.0 million and was in place for 2019. In September 2020, New Jersey made the surtax a permanent increase to the corporate state tax rate. In addition, effective for taxable years beginning on or after January 1, 2019, banks will be required to file combined reports of taxable income including their parent holding company. New Jersey requires entities to report their real estate investment trust, registered investment company and investment company on a separate entity basis.
CAPITAL RESOURCES: A solid capital base provides the Company with the ability to support future growth and financial strength and is essential to executing the Company’s Strategic Plan – “Expanding Our Reach.” The Company’s capital strategy is intended to provide stability to expand its business, even in stressed environments. Quarterly stress testing is integral to the Company’s capital management process.
The Company strives to maintain capital levels in excess of internal “triggers” and in excess of those considered to be well capitalized under regulatory guidelines applicable to banks. Maintaining an adequate capital position supports the Company’s goal of providing shareholders an attractive and stable long-term return on investment.
Capital was benefitted by net income of $23.2 million for the nine months ended September 30, 2020, which was partially offset by the purchase of shares through the Company’s stock repurchase program. Early in the first quarter, the Company purchased 220,222 shares, at an average price of $29.45, for a total cost of $6.5 million.
The Company employs quarterly capital stress testing – adverse case and severely adverse case. In the June 30, 2020 severely, adverse case, no growth scenario, the Bank remains well capitalized over a two-year stress period. With a Pandemic stress overlay, the Bank still remains well capitalized over the two-year stress period.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Total, Common Equity Tier 1 and Tier 1 capital (each as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). At September 30, 2020 and December 31, 2019, all of the Bank’s capital ratios remain above the levels required to be considered “well capitalized” and the Company’s capital ratios remain above regulatory requirements. The Company’s capital ratios were not affected by our
participation in the PPP. The Company pledged its PPP loans as collateral and utilized funding provided by the FRB’s PPPLF. PPP loans funded by the PPPLF are risk-weighted at 0 percent for regulatory risk-based capital ratios and are excluded from average assets in the calculation of the regulatory leverage ratio.
To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, common equity Tier I and Tier I leverage ratios as set forth in the table.
As a result of the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act, the federal banking agencies are required to develop a “Community Bank Leverage Ratio” (the ratio of a bank’s tangible equity capital to average total consolidated assets) for financial institutions with assets of less than $10 billion. A “qualifying community bank” that exceeds this ratio will be deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under Prompt Corrective Action statutes. The federal banking agencies set the minimum capital for the Community Bank Leverage Ratio (“CBLR”) at 9 percent, effective January 1, 2020. Under the CARES Act, the Community Bank Leverage Ratio was temporarily lowered to 8 percent. The Bank did not opt into the CBLR and will continue to comply with the requirements under Basel III. The Bank’s leverage ratio was 9.68 percent at September 30, 2020.
The Bank’s regulatory capital amounts and ratios are presented in the following table:
To Be Well
For Capital
Capitalized Under
Adequacy Purposes
Prompt Corrective
Adequacy
Including Capital
Actual
Action Provisions
Purposes
Conservation Buffer (A)
Ratio
As of September 30, 2020:
Total capital
(to risk-weighted assets)
599,314
14.58
410,967
10.00
328,774
8.00
431,515
10.50
Tier I capital
547,761
13.33
246,580
6.00
349,322
8.50
Common equity tier I
547,726
267,129
6.50
184,935
4.50
287,677
7.00
(to average assets)
9.68
282,899
5.00
226,319
4.00
As of December 31, 2019:
571,509
13.76
415,487
332,389
436,261
527,833
12.70
249,292
353,164
527,832
270,066
186,969
290,841
10.63
248,252
198,602
See footnote on following table
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The Company’s regulatory capital amounts and ratios are presented in the following table:
618,993
329,249
432,139
483,782
11.76
246,937
349,827
483,747
11.75
185,202
288,093
226,547
590,614
332,783
436,778
463,521
11.14
249,587
353,582
463,520
187,190
291,185
198,792
The Basel Rules require the Company and the Bank to maintain a 2.5% “capital conservation buffer” on top of the minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of (i) CET1 to risk-weighted assets, (ii) Tier 1 capital to risk-weighted assets or (iii) total capital to risk-weighted assets above the respective minimum but below the capital conservation buffer face constraints on dividends, equity repurchases and discretionary bonus payments to executive officers based on the amount of the shortfall.
The Company’s regulatory total risk-based capital ratio was benefitted by the $48.7 million (net) subordinated debt issuance that closed in June 2016. At that time, the Company down-streamed approximately $40.0 million of proceeds to the Bank as capital, benefitting the Bank’s regulatory capital ratios.
In addition, on December 12, 2017, the Company issued $35.0 million in aggregate principal amount of Fixed-to-Floating Subordinated Notes due December 15, 2027. The Company down-streamed approximately $29.1 million of those proceeds to the Bank as capital.
The Dividend Reinvestment Plan of Peapack-Gladstone Financial Corporation, or the “Reinvestment Plan,” allows shareholders of the Company to purchase additional shares of common stock using cash dividends without payment of any brokerage commissions or other charges. Shareholders may also make voluntary cash payments of up to $200 thousand per quarter to purchase additional shares of common stock, which up to January 30, 2019 were purchased at a 3 percent discount to market. On January 30, 2019, the Company filed a Registration Statement on Form S-3 eliminating the feature in our “Reinvestment Plan” under which participants could purchase shares of our common stock through the Plan at a 3 percent discount to market price. Voluntary share purchases in the “Reinvestment Plan” can be filled from the Company’s authorized but unissued shares and/or in the open market, at the discretion of the Company. All shares purchased during the quarter ended September 30, 2020 were in the open market.
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On October 27, 2020, the Board of Directors declared a regular cash dividend of $0.05 per share payable on November 25, 2020 to shareholders of record on November 10, 2020.
Management believes the Company’s capital position and capital ratios are adequate. Further, Management believes the Company has sufficient capital to support its planned balance sheet growth for the immediate future. The Company continually assesses other potential sources of capital to support future growth.
LIQUIDITY: Liquidity refers to an institution’s ability to meet short-term requirements including funding of loans, deposit withdrawals and maturing obligations, as well as long-term obligations, including potential capital expenditures. The Company’s liquidity risk management is intended to ensure the Company has adequate funding and liquidity to support its assets across a range of market environments and conditions, including stressed conditions. Principal sources of liquidity include cash, temporary investments, securities available for sale, customer deposit inflows, loan repayments and secured borrowings. Other liquidity sources include loan sales and loan participations.
Management actively monitors and manages the Company’s liquidity position and believes it is sufficient to meet future needs. Cash and cash equivalents, including federal funds sold and interest-earning deposits, totaled $679.4 million at September 30, 2020. In addition, the Company had $596.9 million in securities designated as available for sale at September 30, 2020. These securities can be sold, or used as collateral for borrowings, in response to liquidity concerns. Securities available for sale with a fair value of $463.3 million as of September 30, 2020 were pledged to secure public funds and for other purposes required or permitted by law. In addition, the Company generates significant liquidity from scheduled and unscheduled principal repayments of loans and mortgage-backed securities.
For the quarter ended September 30, 2020, the Company’s balance sheet liquidity was funded by increased client deposits of $615.6 million and $183.8 million in borrowings through the PPPLF. The Company approved loans of approximately $600 million under the PPP and have a balance of $202.0 million at September 30, 2020. The Federal Reserve has supplied a source of liquidity for the PPP to participating financial institutions through the PPPLF, which extends credit to eligible financial institutions, at a rate of 0.35 percent, that originate PPP loans, taking the loans as collateral at face value. The Company utilized this facility to fund its PPP loans.
As of September 30, 2020, in addition to the $1.3 billion of balance sheet liquidity, the Company also had approximately $1.8 billion of secured funding available from the Federal Home Loan Bank, of which $120.0 million was drawn as of September 30, 2020. Additionally, the Company also had $1.0 billion of secured funding available from the Federal Reserve Discount Window, none of which was drawn.
Brokered interest-bearing demand (“overnight”) deposits were $130.0 million at September 30, 2020. The interest rate paid on these deposits allows the Bank to fund at attractive rates and engage in interest rate swaps to hedge its asset-liability interest rate risk. The Company ensures ample available collateralized liquidity as a backup to these short-term brokered deposits. As of September 30, 2020, the Company had transacted pay fixed, receive floating interest rate swaps totaling $270.0 million in notional amount.
The Company has a Board-approved Contingency Funding Plan in place. This plan provides a framework for managing adverse liquidity stress and contingent sources of liquidity. The Company conducts liquidity stress testing on a regular basis to ensure sufficient liquidity in a stressed environment. The Company believes it has sufficient liquidity given the current environment created by the COVID-19 pandemic.
Management believes the Company’s liquidity position and sources are adequate.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
ASSET/LIABILITY MANAGEMENT: The Company’s Asset/Liability Committee (“ALCO”) is responsible for developing, implementing and monitoring asset/liability management strategies and advising the Board of Directors on such strategies, as well as the related level of interest rate risk. In this regard, interest rate risk simulation models are prepared on a quarterly basis. These models demonstrate balance sheet gaps and predict changes to net interest income and economic/market value of portfolio equity under various interest rate scenarios. In addition, these models, as well as ALCO processes and reporting, are subject to annual independent third-party review.
ALCO is generally authorized to manage interest rate risk through the management of capital, cash flows and duration of assets and liabilities, including sales and purchases of assets, as well as additions of wholesale borrowings and other sources of medium/longer-term funding. ALCO is authorized to engage in interest rate swaps as a means of extending the duration of shorter term liabilities.
The following strategies are among those used to manage interest rate risk:
Actively market C&I loans, which tend to have adjustable-rate features, and which generate customer relationships that can result in higher core deposit accounts;
Actively market equipment finance leases and loans, which tend to have shorter terms and higher interest rates than real estate lending;
Manage residential mortgage portfolio originations to adjustable-rate and/or shorter-term and/or “relationship” loans that result in core deposit and/or wealth management relationships;
Actively market core deposit relationships, which are generally longer duration liabilities;
Utilize medium to longer term certificates of deposit and/or wholesale borrowings to extend liability duration;
Utilize interest rate swaps to extend liability duration;
Utilize a loan level / back-to-back interest rate swap program, which converts a borrower’s fixed rate loan to adjustable rate for the Company;
Closely monitor and actively manage the investment portfolio, including management of duration, prepayment and interest rate risk;
Maintain adequate levels of capital; and
Utilize loan sales.
The interest rate swap program is administered by the ALCO and follows procedures and documentation in accordance with regulatory guidance and standards as set forth in ASC 815 for cash flow hedges. The program incorporates pre-purchase analysis, liability designation, sensitivity analysis, correlation analysis, daily mark-to-market analysis and collateral posting as required. The Board is advised of all swap activity. In all of these swaps, the Company is receiving floating and paying fixed interest rates with total notional value of $270.0 million as of September 30, 2020.
In addition, the Company initiated a loan level / back-to-back swap program in support of its commercial lending business. Pursuant to this program, the Company extends a floating rate loan and executes a floating to fixed swap with the borrower. At the same time, the Company executes a third-party swap, the terms of which fully offset the fixed exposure and, result in a final floating rate exposure for the Company. As of September 30, 2020, $853.5 million of notional value in swaps were executed and outstanding with borrowers under this program.
As noted above, the ALCO uses simulation modeling to analyze the Company’s net interest income sensitivity, as well as the Company’s economic value of portfolio equity under various interest rate scenarios. The models are based on the actual maturity and repricing characteristics of rate sensitive assets and liabilities. The models incorporate certain prepayment and interest rate assumptions, which management believes to be reasonable as of September 30, 2020. The models assume changes in interest rates without any proactive change in the balance sheet by management. In the models, the forecasted shape of the yield curve remained static as of September 30, 2020.
In an immediate and sustained 100 basis point increase in market rates at September 30, 2020, net interest income would increase approximately 10.0 percent for year 1 and 13.4 percent for year 2, compared to a flat interest rate scenario.
In an immediate and sustained 200 basis point increase in market rates at September 30, 2020, net interest income for year 1 would increase approximately 17.7 percent, when compared to a flat interest rate scenario. In year 2 net interest income would increase 24.0 percent, when compared to a flat interest rate scenario.
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The table below shows the estimated changes in the Company’s economic value of portfolio equity (“EVPE”) that would result from an immediate parallel change in the market interest rates at September 30, 2020.
Estimated Increase/
EVPE as a Percentage of
Decrease in EVPE
Present Value of Assets (2)
Rates
Estimated
EVPE
Increase/(Decrease)
(Basis Points)
EVPE (1)
Percent
Ratio (3)
(basis points)
+200
647,904
74,588
13.01
11.15
+100
615,359
42,043
7.33
10.44
Flat interest rates
573,316
9.60
-100
519,955
(53,361
(9.31
8.70
(90
EVPE is the discounted present value of expected cash flows from assets and liabilities.
Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.
EVPE ratio represents EVPE divided by the present value of assets.
Certain shortcomings are inherent in the methodologies used in determining interest rate risk. Simulation modeling requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the modeling assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the information provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
The Company’s interest rate sensitivity models indicate the Company is asset sensitive as of September 30, 2020, and that net interest income would improve in a both rising rate environment and a falling rate environment. Over the past quarter, the Company has been managing its balance sheet to be closer to interest rate neutral.
ITEM 4. Controls and Procedures
The Corporation’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer have concluded that the Corporation’s disclosure controls and procedures are effective as of the end of the period covered by this Quarterly Report on Form 10-Q.
The Corporation’s Chief Executive Officer and Chief Financial Officer have also concluded that there have not been any changes in the Corporation’s internal control over financial reporting during the quarter ended September 30, 2020 that have materially affected, or are reasonable likely to materially affect, the Corporation’s internal control over financial reporting.
The Corporation’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures of our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, provides reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system reflects resource constraints; the benefits of controls must be considered relative to their costs. Because there are inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Corporation have been or will be detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns occur because of simple error or mistake. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all future conditions; over time, control may become inadequate because of changes in conditions or deterioration in the degree of compliance with the policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
In the normal course of its business, lawsuits and claims may be brought against the Company and its subsidiaries. There is no currently pending or threatened litigation or proceedings against the Company or its subsidiaries, which if adversely decided, we believe would have a material adverse effect on the Company.
ITEM 1A. Risk Factors
There have been no material changes in risk factors applicable to the Company from those disclosed in “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2020.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3. Defaults Upon Senior Securities
ITEM 4. Mine Safety Disclosures
Not applicable.
ITEM 5. Other Information
ITEM 6. Exhibits
Articles of Incorporation and By-Laws:
A. Certificate of Incorporation of the Registrant, as amended, incorporated herein by reference to Exhibit 3 of the Registrant’s Quarterly Report on Form 10-Q filed on November 9, 2009 (File No. 001-16197).
B. By-Laws of the Registrant, incorporated herein by reference to Exhibit 3.2 of the Registrant’s Current Report on Form 8-K filed on December 20, 2017 (File No. 001-16197).
31.1
Certification of Douglas L. Kennedy, Chief Executive Officer of the Corporation, pursuant to Securities Exchange Act Rule 13a-14(a).
31.2
Certification of Jeffrey J. Carfora, Chief Financial Officer of the Corporation, pursuant to Securities Exchange Act Rule 13a-14(a).
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Douglas L. Kennedy, Chief Executive Officer of the Corporation and Jeffrey J. Carfora, Chief Financial Officer of the Corporation.
101.INS
Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because iXBRL tags are embedded within the Inline XBRL 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.
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
DATE: November 9, 2020
By:
/s/ Douglas L. Kennedy
Douglas L. Kennedy
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Jeffrey J. Carfora
Jeffrey J. Carfora
Senior Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
/s/ Francesco S. Rossi
Francesco S. Rossi
Chief Accounting Officer
(Principal Accounting Officer)