UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2023
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
For the transition period from: _____ to _____
Commission file number: 000-51018
(Exact name of registrant as specified in its charter)
Delaware
23-3016517
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
409 Silverside Road, Wilmington, DE 19809
(302) 385-5000
(Address of principal executive offices and zip code)
(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, par value $1.00 per share
TBBK
Nasdaq Global Select
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
Emerging growth company o
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. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of April 28, 2023, there were 54,691,405 outstanding shares of common stock, $1.00 par value.
THE BANCORP, INC
Form 10-Q Index
Page
Part I Financial Information
Item 1.
Financial Statements:
3
Consolidated Balance Sheets – March 31, 2023 (unaudited) and December 31, 2022
Unaudited Consolidated Statements of Operations – Three months ended March 31, 2023 and 2022
4
Unaudited Consolidated Statements of Comprehensive Income – Three months ended March 31, 2023 and 2022
5
Unaudited Consolidated Statements of Changes in Shareholders’ Equity – Three months ended March 31, 2023 and 2022
6
Unaudited Consolidated Statements of Cash Flows – Three months ended March 31, 2023 and 2022
8
Notes to Unaudited Consolidated Financial Statements
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
40
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
65
Item 4.
Controls and Procedures
Part II Other Information
Legal Proceedings
66
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
67
Signatures
68
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
THE BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31,
December 31,
2023
2022
(in thousands, except share data)
(unaudited)
ASSETS
Cash and cash equivalents
Cash and due from banks
$
13,736
24,063
Interest-earning deposits at Federal Reserve Bank
773,446
864,126
Total cash and cash equivalents
787,182
888,189
Investment securities, available-for-sale, at fair value
787,429
766,016
Commercial loans, at fair value
493,334
589,143
Loans, net of deferred loan fees and costs
5,354,347
5,486,853
Allowance for credit losses
(23,794)
(22,374)
Loans, net
5,330,553
5,464,479
Federal Home Loan Bank, Atlantic Central Bankers Bank, and Federal Reserve Bank stock
12,629
Premises and equipment, net
21,319
18,401
Accrued interest receivable
33,729
32,005
Intangible assets, net
1,950
2,049
Other real estate owned
21,117
21,210
Deferred tax asset, net
18,290
19,703
Other assets
99,427
89,176
Total assets
7,606,959
7,903,000
LIABILITIES
Deposits
Demand and interest checking
6,607,767
6,559,617
Savings and money market
96,890
140,496
Time deposits, $100,000 and over
—
330,000
Total deposits
6,704,657
7,030,113
Securities sold under agreements to repurchase
42
Senior debt
99,142
99,050
Subordinated debentures
13,401
Other long-term borrowings
9,972
10,028
Other liabilities
54,597
56,335
Total liabilities
6,881,811
7,208,969
SHAREHOLDERS' EQUITY
Common stock - authorized, 75,000,000 shares of $1.00 par value; 55,329,629 and 55,689,627
shares issued and outstanding at March 31, 2023 and December 31, 2022, respectively
55,330
55,690
Additional paid-in capital
277,814
299,279
Retained earnings
418,441
369,319
Accumulated other comprehensive loss
(26,437)
(30,257)
Total shareholders' equity
725,148
694,031
Total liabilities and shareholders' equity
The accompanying notes are an integral part of these consolidated statements.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three months ended March 31,
(Dollars in thousands, except per share data)
Interest income
Loans, including fees
106,259
50,591
Investment securities:
Taxable interest
9,300
4,891
Tax-exempt interest
32
25
Interest-earning deposits
6,585
347
122,176
55,854
Interest expense
34,460
1,606
Short-term borrowings
234
Long-term borrowings
126
1,279
261
116
36,360
3,001
Net interest income
85,816
52,853
Provision for credit losses
1,903
1,507
Net interest income after provision for credit losses
83,913
51,346
Non-interest income
ACH, card and other payment processing fees
2,171
1,984
Prepaid, debit card and related fees
23,323
18,652
Net realized and unrealized gains
on commercial loans, at fair value
1,725
3,383
Leasing related income
1,490
973
Other
280
120
Total non-interest income
28,989
25,112
Non-interest expense
Salaries and employee benefits
29,785
23,848
Depreciation and amortization
721
795
Rent and related occupancy cost
1,394
1,289
Data processing expense
1,321
1,189
Printing and supplies
145
86
Audit expense
392
362
Legal expense
958
794
Amortization of intangible assets
99
FDIC insurance
955
974
Software
4,237
3,864
Insurance
1,306
1,064
Telecom and IT network communications
376
374
Consulting
322
303
Writedown on other real estate owned
1,019
5,000
3,311
Total non-interest expense
48,030
38,352
Income before income taxes
64,872
38,106
Income tax expense
15,750
9,140
Net income
49,122
28,966
Net income per share - basic
0.89
0.51
Net income per share - diluted
0.88
0.50
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Other comprehensive income (loss), net of reclassifications into net income:
Other comprehensive income (loss)
Securities available-for-sale:
Change in net unrealized losses during the period
5,229
(21,686)
Reclassification adjustments for losses included in income
5,233
(21,680)
Income tax benefit related to items of other comprehensive income (loss)
1,412
(5,855)
1
2
Income tax expense (benefit) related to items of other comprehensive loss
1,413
(5,853)
Other comprehensive income (loss), net of tax and reclassifications into net income
3,820
(15,827)
Comprehensive income
52,942
13,139
UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the three months ended March 31, 2023
(Dollars in thousands, except share data)
Accumulated
Common
Additional
other
stock
paid-in
Retained
comprehensive
shares
capital
earnings
(loss) income
Total
Balance at January 1, 2023
55,689,627
Common stock issued from option exercises,
net of tax benefits
13,158
13
92
105
Common stock issued from restricted units,
405,286
405
(405)
Stock-based compensation
3,169
Common stock repurchases and excise tax
(778,442)
(778)
(24,321)
(25,099)
Other comprehensive income net of
reclassification adjustments and tax
Balance at March 31, 2023
55,329,629
For the three months ended March 31, 2022
income (loss)
Balance at January 1, 2022
57,370,563
57,371
349,686
239,106
6,291
652,454
27,818
27
57
84
284,040
284
(284)
1,618
Common stock repurchases
(527,393)
(527)
(14,473)
(15,000)
Other comprehensive loss net of
Balance at March 31, 2022
57,155,028
57,155
336,604
268,072
(9,536)
652,295
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months
ended March 31,
Operating activities
Adjustments to reconcile net income to net cash provided by operating activities
820
894
Net amortization of investment securities discounts/premiums
309
547
Stock-based compensation expense
Gain on commercial loans, at fair value
(2,407)
(3,337)
Writedown of other real estate owned
830
Change in fair value of commercial loans, at fair value
603
1,202
Change in fair value of derivatives
79
(1,068)
Loss on sales of investment securities
(Increase) decrease in accrued interest receivable
(1,724)
587
Increase in other assets
(7,835)
(1,369)
Decrease in other liabilities
(1,738)
(11,168)
Net cash provided by operating activities
43,135
18,385
Investing activities
Purchase of investment securities available-for-sale
(39,788)
(7,418)
Proceeds from redemptions and prepayments of securities available-for-sale
23,387
31,647
Sale of repossessed assets
1,527
Net decrease (increase) in loans
128,036
(353,817)
Commercial loans, at fair value drawn during the period
(35,962)
(5,826)
Payments on commercial loans, at fair value
132,782
153,709
Purchases of premises and equipment
(3,674)
(1,018)
Net cash provided by (used in) investing activities
206,308
(182,439)
Financing activities
Net (decrease) increase in deposits
(325,456)
251,412
Proceeds from the issuance of common stock
Repurchases of common stock and excise tax
Net cash (used in) provided by financing activities
(350,450)
236,496
Net (decrease) increase in cash and cash equivalents
(101,007)
72,442
Cash and cash equivalents, beginning of period
601,784
Cash and cash equivalents, end of period
674,226
Supplemental disclosure:
Interest paid
38,248
4,208
Taxes paid
1,944
1,946
Non-cash investing and financing activities
Transfer of loans from discontinued operations
61,580
Transfer of real estate owned from discontinued operations
17,343
Leased vehicles transferred to repossessed assets
4,022
687
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization and Nature of Operations
The Bancorp, Inc., or (“the Company”), is a Delaware corporation and a registered financial holding company. Its primary, wholly-owned subsidiary is The Bancorp Bank, National Association (“the Bank”). The Bank is a nationally chartered commercial bank located in Sioux Falls, South Dakota and is a Federal Deposit Insurance Corporation (“FDIC”) insured institution. As a nationally chartered institution, its primary regulator is the Office of the Comptroller of the Currency (“OCC”). The Bank has two primary lines of business consisting of its national specialty finance segment and its payments segment.
In the national specialty lending segment, the Bank makes the following types of loans: securities-backed lines of credit (“SBLOC”) and cash value of insurance-backed lines of credit (“IBLOC”), leases (direct lease financing), Small Business Administration (“SBA”) loans and non-SBA commercial real estate bridge loans (“REBL”).
While the national specialty finance segment generates the majority of the Company’s revenues, the payments segment also contributes significant revenues. In its payments segment, the Company provides payment and deposit services nationally, which include prepaid and debit card accounts, private label banking, deposit accounts to investment advisors’ customers, card payment and other payment processing services. Payments segment deposits fund the majority of the Company’s loans and securities and may result in lower costs than other funding sources. Most of the payments segment’s revenues and deposits, and SBLOC and IBLOC loans, result from relationships with third parties which market such products. Concentrations of loans and deposits are based upon the cumulative account balances generated by those third parties. Similar concentrations result in revenues in prepaid, debit card and related fees. These concentrations may also be reflected in a lower cost of funds compared to other funding sources. The Company sweeps certain deposits off its balance sheet to other institutions through intermediaries. Such sweeps are utilized to optimize diversity within its funding structure by managing the percentage of individual client deposits to total deposits.
The Company and the Bank are subject to regulation by certain state and federal agencies and, accordingly, they are examined periodically by those regulatory authorities. As a consequence of the extensive regulation of commercial banking activities, the Company’s and the Bank’s businesses may be affected by state and federal legislation and regulations.
Note 2. Significant Accounting Policies
Basis of Presentation
The financial statements of the Company, as of March 31, 2023 and for the three month periods ended March 31, 2023 and 2022, are unaudited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted in this Quarterly Report on Form 10-Q pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). However, in the opinion of management, these interim financial statements include all necessary adjustments to fairly present the results of the interim periods presented. The unaudited interim consolidated financial statements should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 Form 10-K”). The results of operations for the three month period ended March 31, 2023 may not necessarily be indicative of the results of operations for the full year ending December 31, 2023.
There have been no significant changes to the Company’s significant accounting policies as described in the 2022 Form 10-K.
The Company’s non-SBA commercial real estate bridge loans, at fair value, are primarily collateralized by multi-family properties (apartment buildings), and to a lesser extent, by hotel and retail properties. These loans were originally generated for sale through securitizations. In 2020, the Company decided to retain these loans on its balance sheet as interest-earning assets and resumed originating such loans in 2021. These new originations are identified as REBL and are held for investment in the loan portfolio. Prior originations initially intended for securitizations continue to be accounted for at fair value, and are included in the balance sheet in “Commercial loans, at fair value.”
The Company recognizes compensation expense for stock options in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification 718 Stock Based Compensation (“ASC 718”). The expense of the option is generally measured at fair value at the grant date with compensation expense recognized over the service period, which is typically the vesting period. For
grants subject to a service condition, the Company utilizes the Black-Scholes option-pricing model to estimate the fair value of each option on the date of grant. The Black-Scholes model takes into consideration the exercise price and expected life of the options, the current price of the underlying stock and its expected volatility, the expected dividends on the stock and the current risk-free interest rate for the expected life of the option. The Company’s estimate of the fair value of a stock option is based on expectations derived from historical experience and may not necessarily equate to its market value when fully vested. In accordance with ASC 718, the Company estimates the number of options for which the requisite service is expected to be rendered. At March 31, 2023, the Company had two active stock-based compensation plans.
During the three months ended March 31, 2023, the Company granted 57,573 stock options with a vesting period of four years and a weighted average grant-date fair value of $17.37. During the three months ended March 31, 2022, the Company granted 100,000 stock options with a vesting period of four years and a weighted average grant-date fair value of $14.01. There were 13,158 common stock options exercised in the three month period ended March 31, 2023. There were 27,818 common stock options exercised in the three month period ended March 31, 2022.
A summary of the Company’s stock options is presented below.
Weighted average
remaining
contractual
Aggregate
Options
exercise price
term (years)
intrinsic value
Outstanding at January 1, 2023
580,104
13.25
7.48
8,968,660
Granted
57,573
35.17
9.87
Exercised
(13,158)
10.45
278,450
Expired
Forfeited
(1,842)
Outstanding at March 31, 2023
622,677
15.35
7.66
8,453,205
Exercisable at March 31, 2023
290,104
11.33
7.13
4,854,205
During the three months ended March 31, 2023, the Company granted 514,785 restricted stock units (“RSUs”) with a vesting period of three years and a weighted average fair value of $35.17 per unit. During the three months ended March 31, 2022, the Company granted 219,311 RSUs with a vesting period of three years and a weighted average fair value of $30.32 per unit.
A summary of the Company’s RSUs is presented below.
Average remaining
grant date
RSUs
fair value
671,696
17.78
1.00
514,785
2.87
Vested
(405,286)
13.12
781,195
31.66
2.32
As of March 31, 2023, there was a total of $24.0 million of unrecognized compensation cost related to unvested awards under stock-based compensation plans. This cost is expected to be recognized over a weighted average period of approximately 2.0 years. Related compensation expense for the three months ended March 31, 2023 and 2022 was $3.2 million and $1.6 million, respectively. The total issuance date fair value of RSUs vested and options exercised during the three months ended March 31, 2023 and 2022 was $5.4 million and $4.0 million, respectively. The total intrinsic value of the options exercised and RSUs vested in those respective periods was $15.0 million and $9.4 million, respectively.
For the periods ended March 31, 2023 and 2022, the Company estimated the fair value of each stock option grant on the date of grant using the Black-Scholes options pricing model with the following weighted average assumptions:
Risk-free interest rate
3.67%
1.94%
Expected dividend yield
Expected volatility
45.21%
45.14%
Expected lives (years)
6.3
Expected volatility is based on the historical volatility of the Company’s stock and peer group comparisons over the expected life of the option. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury strip rate in effect at the time of the grant. The life of the option is based on historical factors which include the contractual term, vesting period, exercise behavior
and employee terminations. In accordance with ASC 718, stock based compensation expense for the period ended March 31, 2023 is based on awards that are ultimately expected to vest and has been reduced for estimated forfeitures. The Company estimates forfeitures using historical data or acceptable expedients.
The Company calculates earnings per share in accordance with ASC 260, Earnings Per Share. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities, including stock options and RSUs or other contracts to issue common stock were exercised and converted into common stock. Stock options are dilutive if their exercise prices are less than the current stock price. RSUs are dilutive because they represent grants over vesting periods which do not require employees to pay exercise prices. The dilution shown in the tables below includes the potential dilution from both stock options and RSUs.
The following tables show the Company’s earnings per share for the periods presented:
For the three months ended
March 31, 2023
Income
Shares
Per share
(numerator)
(denominator)
amount
(Dollars in thousands except share and per share data)
Basic earnings per share
Net earnings available to common shareholders
55,452,815
Effect of dilutive securities
Common stock options and RSUs
595,327
(0.01)
Diluted earnings per share
56,048,142
Stock options for 465,104 shares, exercisable at prices between $6.87 and $18.81 per share, were outstanding at March 31, 2023, and included in the diluted earnings per share computation because the exercise price per share was less than the average market price. Stock options for 157,573 shares were anti-dilutive and not included in the earnings per share calculation.
March 31, 2022
57,115,903
980,077
58,095,980
Stock options for 515,104 shares, exercisable at prices between $6.87 and $18.81 per share, were outstanding at March 31, 2022, and included in the diluted earnings per share computation because the exercise price per share was less than the average market price. Stock options for 100,000 shares were anti-dilutive and not included in the earnings per share calculation.
Note 5. Investment Securities
The amortized cost, gross unrealized gains and losses, and fair values of the Company’s investment securities classified as available-for-sale at March 31, 2023 and December 31, 2022 are summarized as follows (in thousands):
Available-for-sale
Gross
Amortized
unrealized
Fair
cost
gains
losses
value
U.S. Government agency securities
37,907
69
(1,247)
36,729
Asset-backed securities(1)
341,240
(8,182)
333,058
Tax-exempt obligations of states and political subdivisions
5,200
48
(38)
5,210
Taxable obligations of states and political subdivisions
45,426
(1,287)
44,187
Residential mortgage-backed securities
174,161
161
(9,629)
164,693
Collateralized mortgage obligation securities
41,909
(1,669)
40,240
Commercial mortgage-backed securities
167,278
(11,766)
155,512
Corporate debt securities
10,000
(2,200)
7,800
823,121
326
(36,018)
(1)Asset-backed securities as shown above
Federally insured student loan securities
7,662
(110)
7,552
Collateralized loan obligation securities
333,578
(8,072)
325,506
December 31, 2022
29,859
17
(1,495)
28,381
343,885
(9,876)
334,009
3,560
(61)
3,499
45,668
52
(1,709)
44,011
150,135
148
(10,463)
139,820
43,858
(2,075)
41,783
179,977
(13,164)
166,813
(2,300)
7,700
806,942
217
(41,143)
8,488
(144)
8,344
335,397
(9,732)
325,665
Investments in Federal Home Loan Bank (“FHLB”) stock, Atlantic Central Bankers Bank (“ACBB”) stock, and Federal Reserve Bank stock are recorded at cost and amounted to $12.6 million and $12.6 million at March 31, 2023 and December 31, 2022, respectively. At each of those dates, ACBB stock amounted to $40,000. The Bank’s conversion to a national charter required the purchase of $11.0 million of Federal Reserve Bank stock in September 2022. The amount of FHLB stock required to be held is based on the amount of borrowings, and after repayment thereof, the stock may be redeemed.
The amortized cost and fair value of the Company’s investment securities at March 31, 2023, by contractual maturity, are shown below (in thousands). Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
Due before one year
12,325
12,157
Due after one year through five years
149,952
144,275
Due after five years through ten years
256,556
249,466
Due after ten years
404,288
381,531
In 2020, the Company began pledging loans to collateralize its line of credit with the FHLB, as described in “Note 6. Loans.” The Company had no securities pledged against that line at March 31, 2023 and December 31, 2022. There were no gross realized gains on sales of securities for the three months ended March 31, 2023 and the year ended December 31, 2022. Realized losses on securities sales were $4,000 and $6,000, respectively, for the three months ended March 31, 2023 and the year ended December 31, 2022.
Fair values of available-for-sale securities are based on the fair market values supplied by a third-party market data provider, or where such third-party market data is not available, fair values are based on discounted cash flows. The third-party market data provider uses a pricing matrix which it creates daily, taking into consideration actual trade data, projected prepayments, and when relevant, projected credit defaults and losses.
The table below indicates the length of time individual securities had been in a continuous unrealized loss position at March 31, 2023 (dollars in thousands):
Less than 12 months
12 months or longer
Number of securities
Fair Value
Unrealized losses
Description of Securities
2,875
(31)
19,825
(1,216)
22,700
Asset-backed securities
55
526
(2)
332,532
(8,180)
Tax-exempt obligations of states and
political subdivisions
2,069
(5)
1,126
(33)
3,195
Taxable obligations of states and
26
10,453
(343)
29,436
(944)
39,889
136
42,243
(860)
111,919
(8,769)
154,162
22
2,658
(78)
37,582
(1,591)
19,144
(158)
136,369
(11,608)
155,513
Total unrealized loss position
investment securities
297
79,968
(1,477)
676,589
(34,541)
756,557
The table below indicates the length of time individual securities had been in a continuous unrealized loss position at December 31, 2022 (dollars in thousands):
12
19,523
(1,461)
2,269
(34)
21,792
125,938
(3,027)
208,071
(6,849)
39,710
135
101,685
(6,198)
28,843
(4,265)
130,528
41,456
(2,057)
327
(18)
43
124,953
(7,683)
41,860
(5,481)
298
456,764
(22,196)
289,070
(18,947)
745,834
The Company owns one single issuer trust preferred security issued by an insurance company. The security is not rated by any bond rating service. At March 31, 2023, this security had a book value of $10.0 million and a fair value of $7.8 million. This security is presented in the corporate debt securities classification in the tables above.
The Company has evaluated the securities in the above tables as of March 31, 2023 and has concluded that none of these securities required an allowance for credit losses (“ACL”). The Company previously evaluated the securities in the above tables as of December 31, 2022 and concluded that none of these securities required an ACL. The Company evaluates whether an ACL is required by considering primarily the following factors: (a) the extent to which the fair value is less than the amortized cost of the security, (b) changes in the financial condition, credit rating and near-term prospects of the issuer, (c) whether the issuer is current on contractually obligated interest and principal payments, (d) changes in the financial condition of the security’s underlying collateral and (e) the payment structure of the security. The Company’s determination of the best estimate of expected future cash flows, which is used to determine the credit loss amount, is a quantitative and qualitative process that incorporates information received from third-party sources along with internal assumptions and judgments regarding the future performance of the security. The Company concluded that the securities that are in an unrealized loss position are in a loss position because of changes in market interest rates after the securities were purchased. The Company’s unrealized loss for corporate debt securities, resulted from one single issuer trust preferred security, and is primarily related to general market conditions, including a lack of liquidity in the market. The severity of the impact of fair value in relation to the carrying amounts of the individual investments is consistent with market developments. The Company’s analysis of each investment is performed at the security level.
Note 6. Loans
The Company has several lending lines of business including: small business loans (“SBLs”), comprised primarily of SBA loans; direct lease financing primarily for commercial vehicles and to a lesser extent equipment; SBLOC collateralized by marketable securities; IBLOC collateralized by the cash value of eligible life insurance policies; and investment advisor financing for purposes of debt refinance, acquisition of another firm or internal succession. Prior to 2020, the Company also originated commercial real estate bridge loans for sale into securitizations. At origination, the Company elected fair value treatment for these loans as they were originally held-for-sale, to better reflect the economics of the transactions. In 2020, the Company decided to retain these loans on its balance sheet and currently intends to continue to do so. Therefore, these loans are no longer accounted for as held-for-sale, but the Company continues to present them at fair value. At March 31, 2023, such loans comprised $352.4 million of the $493.3 million of commercial loans, at fair value, with the balance comprised of SBA loans also previously held for sale. The amortized cost of the $493.3 million commercial loans at fair value was $494.6 million. Included in “Net realized and unrealized gains (losses) on commercial loans, at fair value” in the consolidated statements of operations are changes in the fair value of such loans. For the three months ended March 31, 2023, related net unrealized losses recognized for changes in fair value were $603,000, none of which reflected losses attributable to credit weaknesses. For the three months ended March 31, 2022, net unrealized losses recognized for such changes in fair value were $1.2 million, which reflected $164,000 of loss attributable to credit weaknesses. In the third quarter of 2021, the Company resumed the origination of commercial real estate bridge loans which it also intends to hold for investment and which are accounted for at amortized cost. They are captioned as REBLs as they are transitional commercial mortgage loans which are made to improve and rehabilitate existing properties which already have cash flow.
The Bank has pledged the majority of its loans held for investment at amortized cost and commercial loans at fair value to either the FHLB or the Federal Reserve Bank for lines of credit with those institutions. The FHLB line is periodically utilized to manage liquidity, but the Federal Reserve Bank line was not generally used prior to the pandemic. However, in response to the COVID-19 pandemic, the Federal Reserve Bank has encouraged banks to utilize their lines to maximize the amount of funding available for credit markets. Accordingly, the Bank has periodically borrowed against its Federal Reserve Bank line on an overnight basis. The amount of loans pledged varies and the collateral may be unpledged at any time to the extent the collateral exceeds advances. The lines are maintained consistent with the Bank’s liquidity policy which maximizes potential liquidity. At March 31, 2023, $2.84 billion of loans were pledged to the Federal Reserve Bank and $1.25 billion of loans were pledged to the FHLB. There were no balances against these lines at March 31, 2023.
Prior to 2020, the Company sponsored the structuring of commercial mortgage loan securitizations, and in 2020, the Company decided not to pursue additional securitizations. The loans previously sold to the commercial mortgage-backed securitizations were transitional commercial mortgage loans made to improve and rehabilitate existing properties which already had cash flow. Servicing rights were not retained. Each of the securitizations is considered a variable interest entity of which the Company is not the primary beneficiary. Further, true sale accounting has been applicable to each of the securitizations, as supported by a review performed by an independent third-party consultant. In each of the securitizations, the Company obtained a tranche of certificates which are accounted for as available-for-sale debt securities. The securities were recorded at fair value at acquisition, which was determined by an independent third-party based on the discounted cash flow method using unobservable (level 3) inputs. Of the six securities resulting from our securitizations all have been repaid except that issued by CRE-2. As of March 31, 2023, the principal balance of the Company’s CRE-2-issued security was $12.6 million. Repayment is expected from the workout or disposition of commercial real estate collateral, after repayment of one remaining senior tranche. The Company’s $12.6 million CRE-2 security has 50% excess credit support; thus, losses of 50% of remaining security balances would have to be incurred, prior to any loss on it. Additionally, the commercial real estate collateral supporting the three remaining loans which collateralize the remaining CRE-2 security balances was re-appraised between 2020 and 2022. The updated appraised value is approximately $56.9 million, which is net of $2.1 million due to the servicer. The remaining principal to be repaid on all securities is approximately $58.1 million and, as noted, the Company’s security is scheduled to be repaid prior to 50% of the outstanding securities. However, any future reappraisals could result in further decreases in credit enhancement, and if such decreases exceed such credit enhancements, losses could result. While available information indicates that the value of existing collateral will be adequate to repay the Company’s security, there can be no assurance that such valuations will be realized upon loan resolutions, and that deficiencies will not exceed the 50% credit support. Of the remaining three loans, the property collateral for two of the loans is expected to be liquidated through sale. The third loan was originally extended two years to June 2022 and terms have not yet been reached for another extension, thus putting the loan in maturity default. If not extended by the special servicer, the property will be foreclosed and sold. The property was appraised at $25.9 million in July 2022 with total exposure in the security of $25.0 million. A recent broker opinion of property liquidation value was $20.9 million. The existing 50% credit enhancement continues to provide repayment protection for the Bank owned tranche.
The Company analyzes credit risk prior to making loans on an individual loan basis. The Company considers relevant aspects of the borrowers’ financial position and cash flow, past borrower performance, management’s knowledge of market conditions, collateral and the ratio of loan amounts to estimated collateral value in making its credit determinations.
Major classifications of loans, excluding commercial loans at fair value, are as follows (in thousands):
SBL non-real estate
114,334
108,954
SBL commercial mortgage
492,798
474,496
SBL construction
33,116
30,864
SBLs
640,248
614,314
Direct lease financing
652,541
632,160
SBLOC / IBLOC(1)
2,053,450
2,332,469
Advisor financing(2)
189,425
172,468
Real estate bridge loans
1,752,322
1,669,031
Other loans(3)
60,210
61,679
5,348,196
5,482,121
Unamortized loan fees and costs
6,151
4,732
Total loans, including unamortized loan fees and costs
SBLs, including costs net of deferred fees of $8,610 and $7,327
for March 31, 2023 and December 31, 2022, respectively
648,858
621,641
SBLs included in commercial loans, at fair value
140,909
146,717
Total SBLs(4)
789,767
768,358
(1)SBLOC are collateralized by marketable securities, while IBLOC are collateralized by the cash surrender value of insurance policies. At March 31, 2023 and December 31, 2022, respectively, IBLOC loans amounted to $921.3 million and $1.12 billion.
(2)In 2020 the Company began originating loans to investment advisors for purposes of debt refinancing, acquisition of another firm or internal succession. Maximum loan amounts are subject to loan-to-value ratios of 70%, based on third-party business appraisals, but may be increased depending upon the debt service coverage ratio. Personal guarantees and blanket business liens are obtained as appropriate.
(3)Includes demand deposit overdrafts reclassified as loan balances totaling $4.8 million and $2.6 million at March 31, 2023 and December 31, 2022, respectively. Estimated overdraft charge-offs and recoveries are reflected in the ACL and have been immaterial.
(4)The SBLs held at fair value are comprised of the government guaranteed portion of 7(a) Program (as defined below) loans at the dates indicated.
The following table provides information about loans individually evaluated for credit loss at March 31, 2023 and December 31, 2022 (in thousands). Legacy commercial real estate is comprised of commercial loans made by the Philadelphia commercial loan division which was discontinued.
Recordedinvestment
Unpaidprincipalbalance
RelatedACL
Averagerecordedinvestment
Interestincomerecognized
Without an ACL recorded
241
2,787
250
456
53
Legacy commercial real estate
3,552
Consumer - home equity
286
290
With an ACL recorded
919
(458)
947
2,492
(481)
1,957
3,385
(44)
1,328
1,977
(689)
2,439
Other loans
550
(12)
621
1,160
3,706
1,197
2,948
2,255
1,381
2,030
2,466
Legacy commercial real estate and Other loans
4,102
4,173
13,262
16,457
(1,684)
13,766
400
2,762
388
45
1,421
150
295
306
(525)
1,237
7
1,423
(441)
1,090
3,386
(153)
1,245
3,550
(933)
710
692
(15)
1,923
1,374
3,736
1,625
1,135
762
4,244
3,344
14,272
16,634
(2,067)
8,417
166
The loan review department recommends non-accrual status for loans to the surveillance committee, where interest income appears to be uncollectible or a protracted delay in collection becomes evident. The surveillance committee further vets and approves the non-accrual status.
The following table summarizes non-accrual loans with and without an ACL as of the periods indicated
(in thousands):
Non-accrual loans with a related ACL
Non-accrual loans without a related ACL
Total non-accrual loans
831
1,072
1,249
Direct leasing
50
56
8,586
4,352
12,938
10,356
The Company had $21.1 million of other real estate owned (“OREO”) at March 31, 2023 and $21.2 million of OREO at December 31, 2022. The following table summarizes the Company’s non-accrual loans, loans past due 90 days or more, and OREO at March 31, 2023 and December 31, 2022, respectively:
Non-accrual loans
Loans past due 90 days or more and still accruing
873
7,775
Total non-performing loans
13,811
18,131
OREO
Total non-performing assets
34,928
39,341
Interest which would have been earned on loans classified as non-accrual for the three months ended March 31, 2023 and 2022, was $194,000 and $49,000, respectively. No income on non-accrual loans was recognized during the three months ended March 31, 2023. In the three months ended March 31, 2023, $89,000 of legacy commercial real estate, $89,000 of SBL commercial real estate, $3,000 of SBL non-real estate, and $26,000 of direct leasing were reversed from interest income, which represented interest accrued on loans placed into non-accrual status during the period. In the three months ended March 31, 2022, $55,000 of SBL non-real estate was reversed from interest income, which represented interest accrued on loans placed into non-accrual status during the period. Material amounts of non-accrual interest reversals are charged to the ACL, but such amounts were not material in either the three months ended March 31, 2023 or 2022.
Effective January 1, 2023 loan modifications to borrowers experiencing financial difficulty are required to be disclosed by type of modification and by type of loan. Prior accounting guidance classified loans which were modified as troubled debt restructurings only if the modification reflected a concession from the lender in the form of a below market interest rate or other concession in addition to borrower financial difficulty. Under the new guidance, loans with modifications will be reported whether a concession is made or not. Loans previously classified as troubled debt restructurings will continue to be reported in the following tables and loans with modifications made after January 1, 2023 will be reported under the new loan modification guidance. In the quarter ended March 31, 2023 there were no loan modifications reportable under the new guidance.
The Company’s loans that were modified as of March 31, 2023 and December 31, 2022 and considered troubled debt restructurings are as follows (dollars in thousands):
Number
Pre-modification recorded investment
Post-modification recorded investment
610
650
834
236
239
Total(1)
10
5,232
11
5,275
(1)Troubled debt restructurings include non-accrual loans of $4.9 million and $1.4 million at March 31, 2023 and December 31, 2022, respectively.
The balances below provide information as to how the loans were modified as troubled debt restructuring loans as of March 31, 2023 and December 31, 2022 (in thousands):
Adjusted interest rate
Extended maturity
Combined rate and maturity
The Company had no commitments to extend additional credit to loans classified as troubled debt restructurings as of March 31, 2023 or December 31, 2022.
Under the previous accounting guidance explained above, when loans were classified as troubled debt restructurings, the Company estimated the value of underlying collateral and repayment sources. A specific reserve in the ACL was established if the collateral valuation, less estimated disposition costs, was lower than the recorded loan value. The amount of the specific reserve served to increase the provision for credit losses in the quarter the loan was classified as a troubled debt restructuring. As of March 31, 2023, there were ten troubled debt restructured loans with an aggregate balance of $5.2 million which had specific reserves of $587,000. As of December 31, 2022, there were eleven troubled debt restructured loans with an aggregate balance of $5.3 million which had specific reserves of $637,000. Substantially all of these reserves related to the non-guaranteed portion of SBA loans for start-up businesses. While the new guidance eliminates the troubled debt restructuring classification, loans previously classified as such will now be reported as loans with modifications, whether or not the modification reflected a lender concession. Specific reserves for loans with balances which exceed collateral values will continue to be required in the ACL.
The following table summarizes loans that were restructured within the twelve months ended March 31, 2023 that have subsequently defaulted (in thousands):
174
3,726
Management estimates the ACL using relevant available internal and external historical loan performance information, current economic conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the initial basis for the estimation of expected credit losses over the estimated remaining life of the loans. The methodology used in the estimation of the ACL, which is performed at least quarterly, is also designed to be responsive to changes in portfolio credit quality and the impact of current and future economic conditions on loan performance. The review of the appropriateness of the ACL is performed by the Chief Credit Officer and presented to the Audit Committee of the Company’s Board of Directors (the “Board”) for their review. With the exception of SBLOC and IBLOC, which utilize probability of loss/loss given default, and the other loan category, which uses discounted cash flow to determine a reserve, the ACLs for other categories are determined by establishing reserves on loan pools with similar risk characteristics based on a lifetime loss-rate model, or vintage analysis, as described in the following paragraph. Loans that do not share risk characteristics are evaluated on an individual basis. If foreclosure is believed to be probable or repayment is expected from the sale of the collateral, a reserve for deficiency is established within the ACL. Those reserves are estimated based on the difference between loan principal and the estimated fair value of the collateral, adjusted for estimated disposition costs.
Except for SBLOC, IBLOC and other loans as noted above, for purposes of determining the pool-basis reserve, the loans not assigned an individual reserve are segregated by product type, to recognize differing risk characteristics within portfolio segments, and an average historical loss rate is calculated for each product type. Loss rates are computed by classifying net charge-offs by year of loan origin, and dividing into total originations for that specific year. This methodology is referred to as vintage analysis. The average loss rate is then projected over the estimated remaining loan lives unique to each loan pool, to determine estimated lifetime losses. For SBLOC and IBLOC, since losses have not been incurred, probability of loss/loss given default considerations are utilized. For the other loan category discounted cash flow is utilized to determine a reserve. For all loan pools the Company considers the need for an additional ACL based upon qualitative factors such as the Company’s current loan performance statistics by pool. These qualitative factors are intended to account for forward looking expectations over a twelve to eighteen month period not reflected in historical loss rates and otherwise unaccounted for in the quantitative process. Accordingly, such factors may increase or decrease the allowance compared to historical
loss rates as the Company’s forward looking expectations change. The qualitative factor percentages are applied against the pool balances as of the end of the period. Aside from the qualitative adjustments to account for forward looking expectations of loss over a twelve to eighteen month projection period, the balance of the ACL reverts directly to the Company’s quantitative analysis derived from its historical loss rates. The qualitative and historical loss rate component, together with the allowances on specific loans, comprise the total ACL.
A similar process is employed to calculate an ACL assigned to off-balance sheet commitments, which are comprised of unfunded loan commitments and letters of credit. That ACL for unfunded commitments is recorded in other liabilities. Even though portions of the ACL may be allocated to loans that have been individually measured for credit deterioration, the entire ACL is available for any credit that, in management’s judgment, should be charged off.
At March 31, 2023, the ACL for off-balance sheet commitments amounted to $2.5 million and the ACL for outstanding loans amounted to $23.8 million for total allowances of $26.3 million. Of the $26.3 million, $11.3 million of allowances resulted from the Company’s historical charge-off ratios, $1.7 million from reserves on specific loans, with the balance comprised of the qualitative component. The $11.3 million resulted primarily from SBA non-real estate and leasing charge-offs. The higher proportion of qualitative reserve compared to charge-off history related reserves reflects that charge-offs have not been experienced in the Company’s largest loan portfolios consisting of SBLOC and IBLOC and real estate bridge lending. The absence of significant charge-offs reflects, at least in part, the nature of related collateral respectively consisting of marketable securities, the cash value of life insurance and workforce apartment buildings. As charge-offs are nonetheless possible, significant subjectivity is required to consider qualitative factors to derive the related component of the allowance.
The Company ranks its qualitative factors in five levels: minimal, low, moderate, moderate-high and high risk. The individual qualitative factors for each portfolio segment have their own scale based on an analysis of that segment. A high risk ranking has the greatest impact on the ACL calculation with each level below having a lesser impact on a sliding scale. The qualitative factors used for each portfolio are described below in the description of each portfolio segment. When the Company adopted current expected credit loss accounting (“CECL”) methodology as of January 1, 2020, the management assumption was that some degree of economic slowdown should be considered over the next eighteen months. That belief reflected the length of the current economic expansion and the relatively high level of unsustainable U.S. government deficit spending. Accordingly, certain of the Company’s qualitative factors were set at moderate as of January 1, 2020. Based on the uncertainty as to how the COVID-19 pandemic would impact the Company’s loan pools, the Company increased other qualitative factors to moderate and moderate high in 2020. In the second quarter of 2021, the Company reassessed these factors and reversed increases to moderate-high for certain pools, based upon increased vaccination rates and significant reopening of the economy. As a result of continuing economic uncertainty, including heightened inflation and increased risks of recession, the qualitative factors which had been set in anticipation of a downturn at January 1, 2020, were maintained through the third quarter of 2022. In the fourth quarter of 2022, as risks of a recession increased, the economic qualitative risk factor was increased for non-real estate SBL and leasing. Those higher qualitative allocations were retained in the first quarter of 2023, as negative economic indications persisted. The Company has not increased qualitative risk levels for SBLOC or IBLOC because of the nature of related collateral. SBLOC loans are subject to maximum loan to marketable securities value, and notwithstanding historic drops in the stock market in recent years, losses have not been realized. IBLOC loans are limited to borrowers with insurance companies which exceed credit requirements, and are limited to life insurance cash values. The Company also decided not to increase the economic factor for real estate bridge lending. While Federal Reserve rate increases directly increase real estate bridge loan floating rate borrowing costs, those borrowers are required to purchase interest rate caps that will partially limit the increase in borrowing costs during the term of the loan. Additionally, there continues to be several additional mitigating factors within the multifamily sector that will continue to fuel demand. Higher interest rates are increasing the cost to purchase a home, which in turn is increasing the number of renters and subsequent demand for multifamily. The softening demand for new homes should continue to exacerbate the current housing shortage, and therefore continue to fuel demand for multifamily apartment homes. Additionally, higher rents in the multifamily sector are causing renters to be more price sensitive, which is driving demand for most of the apartment buildings within the company’s loan portfolio which management considers “workforce” housing. As a result, the REBL qualitative economic factor was not increased. Officers and lenders have considered potential risks resulting from inflation and identified a risk specific to the leasing function. Inflation in fuel prices poses a risk to the Company’s vehicle fleet leases, specifically for less fuel efficient vehicles for which demand and values may decrease. However, used vehicle prices are anticipated to be sustained for an additional twelve to eighteen months, impacted by chip shortages which may persist into 2024.
The economic qualitative factor is based on the estimated impact of economic conditions on the loan pools, as distinguished from the economic factors themselves, for the following reasons. The Company has not experienced multi-family (apartment building) loan charge-offs, despite stressed economic conditions. Additionally, there have been no losses for multi-family (apartment buildings) in the Company’s securitizations. Accordingly, the estimated credit losses for this pool were derived purely from industry loss information for multi-family housing. The estimated reserve on the multi-family portfolio is currently derived from that industry qualitative factor. Similarly, the Company’s charge-offs have been virtually non-existent for SBLOC and IBLOC notwithstanding stressed economic periods. Investment advisor loans were first offered in 2020 with limited performance history, during which charge-offs have not been experienced. For investment advisor loans, the nature of the underlying ultimate repayment source was considered, namely the fee-based advisory income streams resulting from investment portfolios under management and the impact changes in economic conditions would
have on those payment streams. Additionally, the Company’s charge-off histories for SBLs, primarily SBA, and leases have not correlated with economic conditions, including trends in unemployment. While specific economic factors did not correlate with actual historical losses, multiple economic factors are considered. For the non-guaranteed portion of SBA loans, leases, real estate bridge lending and investment advisor financing the Company’s loss forecasting analysis included a review of industry statistics. However, the Company’s own charge-off history and average life estimates, for categories in which the Company has experienced charge-offs, was the primary quantitatively derived element in the forecasts. The qualitative component results from management’s qualitative assessments. In the second quarter of 2022, the Company adjusted its collateral qualitative factor for SBLs downward to account for a greater percentage of government guaranteed balances in applicable pools as compared to prior periods. Additionally, in the second quarter of 2022, allowances on credit deteriorated loans were reduced. The largest reduction was $1.0 million which resulted when single family units from a construction loan were sold for higher than expected prices. That loan had been included in discontinued loans prior to first quarter 2022, when discontinued assets were reclassified to continuing operations. The Company no longer engages in new construction residential lending.
Below are the portfolio segments used to pool loans with similar risk characteristics and align with the Company’s methodology for measuring expected credit losses. These pools have similar risk and collateral characteristics, and certain of these pools are broken down further in determining and applying the vintage loss estimates previously discussed. For instance, within the direct lease financing pool, government and public institution leases are considered separately. Additionally, the Company evaluates its loans under an internal loan risk rating system as a means of identifying problem loans. The special mention classification indicates weaknesses that may, if not cured, threaten the borrower’s future repayment ability. A substandard classification reflects an existing weakness indicating the possible inadequacy of net worth and other repayment sources. These classifications are used both by regulators and peers, as they have been correlated with an increased probability of credit losses. A summary of the Company’s primary portfolio pools and loans accordingly classified, by year of origination, at March 31, 2023 and December 31, 2022 are as follows (in thousands):
As of March 31, 2023
2021
2020
2019
Prior
Revolving loans at amortized cost
SBL non real estate
Non-rated(1)
2,301
3,771
240
6,312
Pass
3,953
37,634
29,569
12,550
5,410
7,538
96,654
Special mention
267
51
906
1,224
Substandard
320
586
1,147
Total SBL non-real estate
6,254
33,607
13,161
5,651
9,030
105,337
Non-rated
14,996
10,061
127,815
95,091
63,592
64,364
106,558
467,481
453
1,853
4,801
Total SBL commercial mortgage
25,057
64,048
66,217
109,503
487,731
4,832
11,733
9,806
3,360
29,731
2,675
Total SBL construction
14,408
450
88,720
300,253
140,497
69,563
33,495
13,286
645,814
1,450
232
357
41
63
2,143
2,180
918
294
435
307
4,134
Total direct lease financing
89,170
303,883
141,647
70,214
33,971
13,656
SBLOC
16,298
1,115,868
Total SBLOC
1,132,166
IBLOC
806
920,478
Total IBLOC
921,284
Advisor financing
8,500
1,647
889
11,036
20,103
67,157
60,001
31,128
178,389
Total advisor financing
28,603
68,804
60,890
104
94,753
1,011,665
645,800
1,752,218
Total real estate bridge loans
94,857
5,723
23
21
14,315
466
20,548
263
364
2,610
2,632
42,536
1,219
49,624
Total other loans(2)
387
2,631
60,953
1,685
74,274
249,664
1,554,896
991,830
190,988
111,831
193,852
2,055,135
(1)Included in the SBL non real estate non-rated total of $6.3 million was $4.0 million of SBA Paycheck Protection Program (“PPP”) loans, which are guaranteed by the U.S. government.
(2)Included in Other loans are $14.1 million of SBA loans purchased for Community Reinvestment Act (“CRA”) purposes as of March 31, 2023. These loans are classified as SBL in the Company’s loan table, which classifies loans by type, as opposed to risk characteristics.
As of December 31, 2022
2018
2,075
4,266
273
6,614
32,402
30,388
13,432
5,599
3,931
4,555
90,307
585
869
242
15
642
34,477
34,654
14,025
5,841
4,531
5,481
99,009
10,600
116,647
97,968
64,388
64,692
42,461
68,193
454,349
630
2,483
141
589
1,564
127,247
64,529
66,545
43,295
69,412
468,996
3,153
11,650
9,712
2,964
27,479
2,676
14,326
30,865
.
73,424
30,900
8,245
1,153
429
108
114,259
254,063
129,763
71,043
38,038
13,722
4,291
510,920
61
2,854
2,324
1,658
6,920
330,341
162,987
81,007
39,275
14,151
4,399
4,284
1,205,098
1,209,382
555,219
567,868
1,123,087
3,318
909
4,227
68,078
64,498
35,665
168,241
71,396
65,407
1,009,708
659,323
4,374
29
37
16,326
488
21,254
264
366
2,611
2,750
2,820
41,571
1,187
51,569
748
4,638
395
2,648
62,141
1,731
77,123
1,580,960
1,035,060
207,586
117,375
64,797
142,143
2,334,200
(1)Included in the SBL non real estate non-rated total of $6.6 million was $4.5 million of SBA PPP loans, which are guaranteed by the U.S. government.
(2)Included in Other loans are $15.4 million of SBA loans purchased for CRA purposes as of December 31, 2022. These loans are classified as SBL in the Company’s loan table, which classifies loans by type, as opposed to risk characteristics.
SBL. Substantially all SBLs consist of SBA loans. The Bank participates in loan programs established by the SBA, including the 7(a) Loan Guarantee Program (the “7(a) Program”), the 504 Fixed Asset Financing Program (the “504 Program”), and the discontinued PPP. The 7(a) Program is designed to help small business borrowers start or expand their businesses by providing partial guarantees of loans made by banks and non-bank lending institutions for specific business purposes, including long or short term working capital; funds for the purchase of equipment, machinery, supplies and materials; funds for the purchase, construction or renovation of real estate; and funds to acquire, operate or expand an existing business or refinance existing debt, all under conditions established by the SBA. The 504 Program includes the financing of real estate and commercial mortgages. In 2020 and 2021, the Company also participated in the PPP, which provided short-term loans to small businesses. PPP loans are fully guaranteed by the U.S. government. This program was a specific response to the COVID-19 pandemic, and the vast majority of these loans have been reimbursed by the U.S. government, with $4.0 million remaining to be reimbursed as of March 31, 2023. The Company segments the SBL portfolio into four pools: non-real estate, commercial mortgage and construction to capture the risk characteristics of each pool, and the PPP loans discussed above. PPP loans are not included in the risk pools because they have inherently different risk characteristics due to the U.S. government guarantee. In the table above, the PPP loans are included in non-rated SBL non-real estate. The qualitative factors for SBL loans focus on pool loan performance, underlying collateral for collateral dependent loans and changes in economic conditions. Additionally, the construction segment adds a qualitative factor for general construction risk, such as construction delays resulting from labor shortages or availability/pricing of construction materials.
Direct lease financing. The Company provides lease financing for commercial and government vehicle fleets and, to a lesser extent, provides lease financing for other equipment. Leases are either open-end or closed-end. An open-end lease is one in which, at the end of the lease term, the lessee must pay the difference between the amount at which the Company sells the leased asset and the stated termination value. Termination value is a contractual value agreed to by the parties at the inception of a lease as to the value of the leased asset at the end of the lease term. A closed-end lease is one for which no such payment is due on lease termination. In a closed-end lease, the risk that the amount received on a sale of the leased asset will be less than the residual value is assumed by the Bank, as lessor. The qualitative factors for direct lease financing focus on underlying collateral for collateral dependent loans, portfolio loan performance, loan concentrations and changes in economic conditions.
SBLOC. SBLOC loans are made to individuals, trusts and entities and are secured by a pledge of marketable securities maintained in one or more accounts for which the Company obtains a securities account control agreement. The securities pledged may be either debt or equity securities or a combination thereof, but all such securities must be listed for trading on a national securities exchange or automated inter-dealer quotation system. SBLOCs are typically payable on demand. Maximum SBLOC line amounts are calculated by applying a standard “advance rate” calculation against the eligible security type depending on asset class: typically, up to 50% for equity securities and mutual fund securities and 80% for investment grade (Standard & Poor’s rating of BBB- or higher, or Moody’s rating of Baa3 or higher) municipal or corporate debt securities. Substantially all SBLOCs have full recourse to the borrower. The underlying securities collateral for SBLOC loans is monitored on a daily basis to confirm the composition of the client portfolio and its daily market value. The primary qualitative factor in the SBLOC analysis is the ratio of loans outstanding to market value. This factor has been maintained at low levels, which has remained appropriate as losses have not materialized despite the historic declines in the equity markets during 2020, during which there were no losses. Significant losses have not been incurred since inception of this line of business. Additionally, the advance rates noted above were established to provide the Company with protection from declines in market conditions from the origination date of the lines of credit.
IBLOC. IBLOC loans are collateralized by the cash surrender value of eligible insurance policies. Should a loan default, the primary risks for IBLOCs are if the insurance company issuing the policy were to become insolvent, or if that company would fail to recognize the Bank’s assignment of policy proceeds. To mitigate these risks, insurance company ratings are periodically evaluated for compliance with Bank standards. Additionally, the Bank utilizes assignments of cash surrender value, which legal counsel has concluded are enforceable. The qualitative factors for IBLOC primarily focus on the concentration risk with insurance companies.
Investment advisor financing. In 2020, the Bank began originating loans to investment advisors for purposes of debt refinancing, acquisition of another firm or internal succession. Maximum loan amounts are subject to loan-to-value ratios of 70%, based on third party business appraisals, but may be increased depending upon the debt service coverage ratio. Personal guarantees and blanket business liens are obtained as appropriate. As credit losses have not been experienced, the ACL is determined by qualitative factors. The qualitative factors for investment advisor financing focus on historical industry losses, changes in lending policies and procedures, portfolio performance and economic conditions.
Real estate bridge loans. Real estate bridge loans are transitional commercial mortgage loans which are made to improve and rehabilitate existing properties which already have cash flow, and which are securitized by those properties. The portfolio is comprised primarily of apartment buildings. Prior to 2020, such loans were originated for securitization and loans which had been originated but not securitized continue to be accounted for at fair value in “Commercial loans, at fair value”, on the balance sheet. In 2021, originations resumed and are being held for investment in “Loans, net of deferred fees and costs”, on the balance sheet. As credit losses have not been experienced
for multi-family (apartment building loans) which comprise the REBL portfolio, the ACL is determined by qualitative factors. Qualitative factors focus on historical industry losses, changes in economic conditions, underlying collateral and portfolio performance.
Other loans. Other loans include commercial and consumer loans including home equity lines of credit which the Company generally no longer offers. Qualitative factors focus on changes in the underlying collateral for collateral dependent loans, portfolio loan performance, loan concentrations and changes in economic conditions.
Expected credit losses are estimated over the estimated remaining lives of loans. The estimate excludes possible extensions, renewals and modifications unless either of the following applies: management has a reasonable expectation that a loan will be restructured, or the extension or renewal options are included in the borrower contract and are not unconditionally cancellable by us.
The Company does not measure an ACL on accrued interest receivable balances, because these balances are written off in a timely manner as a reduction to interest income when loans are placed on non-accrual status.
ACL on off-balance sheet credit exposures. The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The ACL on off-balance sheet credit exposures is adjusted through the provision for credit losses. The estimate considers the likelihood that funding will occur over the estimated life of the commitment. The amount of the ACL account as of March 31, 2023 and as of December 31, 2022 was $2.5 million and $2.8 million, respectively.
A detail of the changes in the ACL by loan category and summary of loans evaluated individually and collectively for credit deterioration is as follows (in thousands):
SBLOC / IBLOC
Deferred fees and costs
Beginning 1/1/2023
5,028
2,585
565
7,972
1,167
1,293
3,121
643
22,374
Charge-offs
(214)
(905)
(3)
(1,122)
Recoveries
202
75
344
Provision (credit)(1)
(179)
(75)
2,054
(140)
128
156
(36)
2,198
Ending balance
5,306
2,481
490
9,188
1,027
3,277
604
23,794
Ending balance: Individually evaluated for expected credit loss
458
481
44
689
1,684
Ending balance: Collectively evaluated for expected credit loss
4,848
2,000
446
8,499
592
22,110
Loans:
4,388
113,174
489,850
651,160
55,822
5,341,085
Beginning 1/1/2022
5,415
2,952
432
5,817
964
868
1,181
177
17,806
(885)
(576)
140
124
24
288
358
(367)
133
2,607
203
425
1,940
442
5,741
525
441
153
933
2,067
4,503
2,144
412
7,039
628
20,307
4,539
107,580
473,073
27,478
628,610
57,140
5,472,581
(98)
(191)
(289)
19
31
323
176
319
70
230
346
(24)
1,503
5,652
3,128
495
5,964
1,034
1,098
19,051
1,338
34
1,488
4,314
3,012
461
17,563
122,387
385,559
31,432
538,616
2,067,233
146,461
803,477
61,096
8,037
4,164,298
2,346
4,483
8,136
120,041
384,970
30,722
538,608
56,613
4,156,162
(1)The amount shown as the provision for credit losses for the period reflects the provision on credit losses for loans, while the consolidated statements of operations provision for credit losses includes provisions for unfunded commitments as follows: a $295,000 provision reversal and provisions of $4,000 and $1.4 million, respectively, for the three months ended March 31, 2023 and March 31, 2022, and for full year 2022.
A summary of the Company’s net charge-offs accordingly classified, by year of origination, at March 31, 2023 and December 31, 2022 are as follows (in thousands):
Current period charge-offs
Current period recoveries
Current period SBL non-real estate net charge-offs
Current period SBL commercial mortgage net charge-offs
Current period SBL construction net charge-offs
(363)
(350)
(154)
20
Current period direct lease financing net charge-offs
(358)
(330)
(112)
(838)
Current period SBLOC net charge-offs
Current period IBLOC net charge-offs
Current period advisor financing net charge-offs
Current period real estate bridge loans net charge-offs
Current period other loans net recoveries
(217)
277
Current period net charge-offs
60
(17)
(868)
130
(738)
(745)
(93)
(308)
(150)
(25)
117
(307)
(19)
(452)
Current period other loans net charge-offs
(167)
119
154
(48)
(714)
(1,173)
The Company did not have loans acquired with deteriorated credit quality at either March 31, 2023 or December 31, 2022. In the first quarter of 2023, the Company purchased $1.5 million of lease receivables and $15.7 million of SBLs, none of which were credit deteriorated. Additionally, in the first quarter of 2023 the Company participated in SBLs with other institutions in the amount of $3.0 million.
The delinquent loans in the following table are treated as collateral dependent to the extent they have resulted from borrower financial difficulty (and not from administrative delays or other mitigating factors), and are not brought current. For loans 90 days or more delinquent and non-accrual loans, the Company establishes a reserve in the allowance for credit losses for deficiencies between estimated collateral and loan carrying values. During the three months ended March 31, 2023, the Company did not have any significant changes to the extent to which collateral secures its collateral dependent loans due to general collateral deterioration or from other factors. SBL non-real estate are collateralized by business assets, which may include certain real estate. SBL commercial mortgage and construction are collateralized by real estate for small businesses, while real estate bridge lending is primarily collateralized by apartment buildings, or other commercial real estate. SBLOC is collateralized by marketable investment securities while IBLOC is collateralized by the cash value of life insurance. Advisor financing is collateralized by investment advisors’ business franchises. Direct lease financing is collateralized primarily by vehicles, or equipment.
A detail of the Company’s delinquent loans by loan category is as follows (in thousands):
30-59 Days
60-89 Days
90+ Days
past due
still accruing
Non-accrual
Current
loans
513
601
2,581
111,753
355
3,306
489,492
3,312
854
94
5,641
646,900
25,599
5,509
31,108
2,022,342
4,152
4,462
55,748
29,664
7,008
50,483
5,303,864
1,312
543
3,450
105,504
3,578
470,918
4,035
2,053
539
10,177
621,983
14,782
343
2,869
17,994
2,314,475
330
90
3,724
4,892
56,787
22,312
3,034
43,477
5,443,376
The scheduled maturities of the direct financing leases reconciled to the total lease receivables in the consolidated balance sheet, are as follows (in thousands):
Remaining 2023
149,735
2024
148,560
2025
131,877
2026
68,981
2027
33,114
2028 and thereafter
6,040
Total undiscounted cash flows
538,307
Residual value(1)
189,636
Difference between undiscounted cash flows and discounted cash flows
(75,402)
Present value of lease payments recorded as lease receivables
(1)Of the $189,636,000, $31,855,000 is not guaranteed by the lessee or other guarantors.
Note 7. Transactions with Affiliates
The Bank did not maintain any deposits for various affiliated companies as of March 31, 2023 and December 31, 2022, respectively.
The Bank has entered into lending transactions in the ordinary course of business with directors, executive officers, principal stockholders and affiliates of such persons. All loans were made on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable loans with persons not related to the lender. At March 31, 2023, these loans were current as to principal and interest payments and did not involve more than normal risk of collectability. Loans to these related parties amounted to $4.5 million at March 31, 2023 and $5.5 million at December 31, 2022.
Mr. Hersh Kozlov, a director of the Company, is a partner at Duane Morris LLP, an international law firm. The Company paid Duane Morris LLP $2,700 and $356,000 for legal services for the three months ended March 31, 2023 and 2022, respectively.
Note 8. Fair Value Measurements
ASC 825, Financial Instruments, requires disclosure of the estimated fair value of an entity’s assets and liabilities considered to be financial instruments. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered to be financial instruments. However, many such instruments lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Accordingly, estimated fair values are determined by the Company using the best available data and an estimation methodology it believes to be suitable for each category of financial instruments. Also, it is the Company’s general practice and intent to hold its financial instruments to maturity whether or not categorized as available-for-sale and not to engage in trading or sales activities although it has sold loans in the past and may do so in the future. For fair value disclosure purposes, the Company utilized certain value measurement criteria required in accordance with ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), as discussed below.
Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.
Cash and cash equivalents, which are comprised of cash and due from banks and the Company’s balance at the Federal Reserve Bank, had recorded values of $787.2 million and $888.2 million as of March 31, 2023 and December 31, 2022, respectively, which approximated fair values.
The estimated fair values of investment securities are based on quoted market prices, if available, or estimated using a methodology based on management’s inputs. Level 3 investment security fair values are based on the present valuing of cash flows, which discounts expected cash flows from principal and interest using yield to maturity, or yield to call as appropriate, at the measurement date. In the first quarter of 2023 and 2022, there were no transfers between the three levels.
FHLB stock, ACBB stock and Federal Reserve Bank stock are held as required by those respective institutions and are carried at cost. Each of these institutions require their correspondent banking institutions to hold stock as a condition of membership. While a fixed stock amount is required by each of these institutions, the FHLB stock requirement increases or decreases with the level of borrowing activity.
Commercial loans held at fair value are comprised primarily of commercial real estate bridge loans and SBA loans which had been originated for sale or securitization in the secondary market, and which are now being held on the balance sheet. Commercial real estate bridge loans and SBA loans are valued using a discounted cash flow analysis based upon pricing for similar loans where market indications of the sales price of such loans are not available, on a pooled basis.
Loans, net have an estimated fair value using the present value of future cash flows. The discount rate used in these calculations is the estimated current market rate adjusted for credit risk. Accrued interest receivable has a carrying value that approximates fair value.
Loan fair values are based on “unobservable inputs” that are based on available information. Level 3 fair values are based on the present value of cash flows by unit of measurement. In the first quarter of 2022, discontinued loans were reclassified to loans held for investment, as efforts to sell the loans had concluded. Accordingly, these loans are accounted for as such, and included in related tables. Discontinued OREO, which constituted the remainder of discontinued assets, was reclassified to the OREO caption on the consolidated balance sheet.
For OREO, market value is based upon appraisals of the underlying collateral by third-party appraisers, reduced by 7% to 10% for estimated selling costs.
The estimated fair values of demand deposits (comprised of interest and non-interest bearing checking accounts, savings accounts, and certain types of money market accounts) are equal to the amount payable on demand at the reporting date (generally, their carrying amounts). The fair values of securities sold under agreements to repurchase and short-term borrowings, when outstanding, are equal to their carrying amounts as they are short-term borrowings.
Time deposits, when outstanding, senior debt and subordinated debentures have a fair value estimated using a discounted cash flow calculation that applies current interest rates to discount expected cash flows. The carrying amount of accrued interest payable approximates its fair value. Long term borrowings resulted from sold loans which did not qualify for true sale accounting. They are presented in the amount of the principal of such loans.
The fair values of interest rate swaps, recorded in other assets or other liabilities, are determined using models that use readily observable market inputs and a market standard methodology applied to the contractual terms of the derivatives, including the period to maturity and interest rate indices.
The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated cost to terminate the letters of credit. Fair values of unrecognized financial instruments, including commitments to extend credit, and the fair value of letters of credit are considered immaterial.
The following tables provide information regarding carrying amounts and estimated fair values (in thousands) as of the dates indicated:
Quoted prices in
Significant other
Significant
active markets for
observable
unobservable
Carrying
Estimated
identical assets
inputs
(Level 1)
(Level 2)
(Level 3)
Investment securities, available-for-sale
767,306
20,123
FHLB, ACBB, and Federal Reserve Bank stock
5,336,504
Interest rate swaps, asset
329
95,084
10,579
745,993
20,023
5,462,948
408
Time deposits
93,871
10,067
Other assets and liabilities measured at fair value on a recurring basis, segregated by fair value hierarchy, are summarized below (in thousands) as of the dates indicated:
Fair Value Measurements at Reporting Date Using
Fair value
Obligations of states and political subdivisions
49,397
143,189
12,323
Total investment securities, available-for-sale
1,281,092
767,635
513,457
47,510
154,490
1,355,567
746,401
609,166
In addition, ASC 820 establishes a common definition for fair value to be applied to assets and liabilities. It clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It also establishes a framework for measuring fair value and expands disclosures concerning fair value measurements. ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Level 1 valuation is based on quoted market prices for identical assets or liabilities to which the Company has access at the measurement date. Level 2 valuation is based on other observable inputs for the asset or liability, either directly or indirectly. This includes quoted prices for similar assets in active or inactive markets, inputs other than quoted prices that are observable for the asset or liability such as yield curves, volatilities, prepayment speeds, credit risks, default rates, or inputs that are derived principally from, or corroborated through, observable market data by market-corroborated reports. Level 3 valuation is based on “unobservable inputs” which the Company believes is the best information available in the circumstances. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The Company’s Level 3 asset activity for the categories shown are summarized below (in thousands):
Fair Value Measurements Using
Significant Unobservable Inputs
Commercial loans,
securities
at fair value
Beginning balance
19,031
1,388,416
Transfers to OREO
(737)
(61,580)
Total net (losses) or gains (realized/unrealized)
Included in earnings
1,804
12,570
Included in other comprehensive income/(loss)
100
992
Purchases, issuances, sales and settlements
Issuances
35,962
66,067
Settlements
(132,838)
(816,330)
Total losses year to date included
in earnings attributable to the change in
unrealized gains or losses relating to assets still
held at the reporting date as shown above.
(603)
(3,492)
Assets held-for-sale
from discontinued operations
3,268
(3,268)
The Company’s OREO activity is summarized below (in thousands) as of the dates indicated:
18,873
Transfer from commercial loans, at fair value
737
Writedowns
(830)
Sales
(2,343)
Transfers from commercial loans, at fair value
4,680
Information related to fair values of Level 3 balance sheet categories is as follows (dollars in thousands):
Level 3 instruments only
Weighted
Fair value at
Range at
average at
Valuation techniques
Unobservable inputs
Commercial mortgage-backed investment
security(1)
Discounted cash flow
Discount rate
13.00%
Insurance liquidating trust preferred security(2)
11.00%
FHLB, ACBB,
and Federal Reserve Bank stock
Cost
N/A
Loans, net of deferred loan fees and costs(3)
5.40%-13.00%
7.52%
Commercial - SBA(4)
5.91%-6.64%
6.57%
Non-SBA commercial real estate - fixed(5)
125,899
8.00%-11.90%
8.75%
Non-SBA commercial real estate - floating(6)
226,526
7.68%-17.30%
9.30%
Subordinated debentures(7)
OREO(8)
Appraised value
security
12.71%
Insurance liquidating trust preferred security
11.50%
5.65% - 11.00%
6.86%
Commercial - SBA
5.57%-6.25%
6.17%
Non-SBA commercial real estate - fixed
28,695
Discounted cash flow and appraisal
8.36%-11.65%
10.31%
Non-SBA commercial real estate - floating
413,731
7.07%-17.20%
7.90%
The valuations for each of the instruments above, as of the balance sheet date, are subject to judgments, assumptions and uncertainties, changes in which could have a significant impact on such valuations. Weighted averages were calculated by using the discount rate for each individual security or loan weighted by its market value, except for SBA loans. For SBA loans, the yields derived from market pricing indications for pools determined by date of loan origination were weighted. For commercial loans recorded at fair value, changes in fair value are reflected in the income statement. Changes in the fair value of securities which are unrelated to credit are recorded through equity. Changes in the fair value of loans recorded at amortized cost which are unrelated to credit are a disclosure item, without impact on the financial statements. The notes below refer to the March 31, 2023 table.
(1)Commercial mortgage-backed investment security, consisting of a single Bank-issued CRE security, is valued using discounted cash flow analysis. The discount rate and prepayment rate applied are based upon market observations and actual experience for comparable securities and implicitly assume market averages for defaults and loss severities. The CRE-2 security has significant credit enhancement, or protection from other tranches in the issue, which limits the valuation exposure to credit losses. Nonetheless, increases in expected default rates or loss severities on the loans underlying the issue could reduce its value. In market environments in which investors demand greater yield compensation for credit risk, the discount rate applied would ordinarily be higher and the valuation lower. Changes in prepayments and loss experience could also change the interest earned on this holding in future periods and impact its fair value. As a single security, the weighted average rate shown is the actual rate applied to the CRE-2 security.
(2)Insurance liquidating trust preferred security is a single debenture which is valued using discounted cash flow analysis. The discount rate used is based on the market rate on comparable relatively illiquid instruments and credit analysis. A change in the liquidating trust’s ability to repay the note, or an increase in interest rates, particularly for privately placed debentures, would affect the discount rate and thus the valuation. As a single security, the weighted average rate shown is the actual rate applied to the security.
(3)Loans, net of deferred loan fees and costs are valued using discounted cash flow analysis. Discount rates are based upon available information for estimated current origination rates for each loan type. Origination rates may fluctuate based upon changes in the risk free (Treasury) rate and credit experience for each loan type.
(4)Commercial – SBA Loans are comprised of the government guaranteed portion of SBA-insured loans. Their valuation is based upon the yield derived from dealer pricing indications for guaranteed pools, adjusted for seasoning and prepayments. A limited number of broker/dealers originate the pooled securities for which the loans are purchased and as a result, prices can fluctuate based on such limited market demand, although the government guarantee has resulted in consistent historical demand. Valuations are impacted by prepayment assumptions resulting from both voluntary payoffs and defaults. Such assumptions for both poolable and seasoned loans are based on a seasoning vector for constant prepayment rates from 3% to 30% over life.
(5)Non-SBA commercial real estate – fixed are fixed rate non-SBA commercial real estate mortgages. These loans are fair valued by a third party, based upon discounting at market rates for similar loans. Discount rates used in applying discounted cash flow analysis utilize input based upon loan terms, the general level of interest rates and the quality of the credit. Deterioration in loan performance or other credit weaknesses could result in fair value ranges which would be dependent upon potential buyers’ tolerance for such weaknesses and are difficult to estimate.
(6)Non-SBA commercial real estate – floating are floating rate non-SBA loans, the vast majority of which are secured by multi-family properties (apartments). These are bridge loans designed to provide owners time and funding for property improvements and are generally valued using discounted cash flow analysis. The discount rate for the vast majority of these loans was based upon current origination rates for similar loans. Deterioration in loan performance or other credit weaknesses could result in fair value ranges which would be dependent upon potential buyers’ tolerance for such weaknesses and are difficult to estimate. At March 31, 2023, these loans were fair valued by a third party, based upon discounting at market rates for similar loans.
(7)Subordinated debentures are comprised of two subordinated notes issued by the Company, maturing in 2038 with a floating rate of three-month London Inter-Bank Offered Rate (“LIBOR”) plus 3.25%. These notes are valued using discounted cash flow analysis. The discount rate is based on the market rate for comparable relatively illiquid instruments. Changes in those market rates, or the credit of the Company could result in changes in valuation.
(8)For OREO, fair value is based upon appraisals of the underlying collateral by third party appraisers, reduced by 7% to 10% for estimated selling costs. Such appraisals reflect estimates of amounts realizable upon property sales based on the sale of comparable properties and other factors. Actual sales prices may vary based upon the identification of potential purchasers, changing conditions in local real estate markets and the level of interest rates required to finance purchases.
Assets measured at fair value on a nonrecurring basis, segregated by fair value hierarchy, during the periods shown are summarized below (in thousands):
Quoted prices in active
markets for identical
assets
inputs (1)
Description
Collateral dependent loans(1)
11,578
Intangible assets
34,645
12,205
35,464
(1)The method of valuation approach for the loans evaluated for an allowance for credit losses on an individual loan basis and also for OREO was the market approach based upon appraisals of the underlying collateral by external appraisers, reduced by 7% to 10% for estimated selling costs. Intangible assets are valued based upon internal analyses.
At March 31, 2023, principal on collateral dependent loans and troubled debt restructurings, which is accounted for on the basis of the value of underlying collateral, is shown at estimated fair value of $11.6 million. To arrive at that fair value, related loan principal of $13.3 million was reduced by specific reserves of $1.7 million within the ACL as of that date, representing the deficiency between principal and estimated collateral values, which were reduced by estimated costs to sell. When the deficiency is deemed uncollectible, it is charged off by reducing the specific reserve and decreasing principal. Included in the collateral dependent loans at March 31, 2023 were 10 troubled debt restructured loans with a balance of $5.2 million, which had specific reserves of $587,000. Included in the collateral dependent loans at December 31, 2022, were 11 troubled debt restructured loans with a balance of $5.3 million which had specific allowances of $637,000. Valuation techniques consistent with the market and/or cost approach were used to measure fair value and primarily included observable inputs for the individual collateral dependent loans being evaluated such as recent sales of similar assets or observable market data for operational or carrying costs. In cases where such inputs were unobservable, the loan balance is reflected within the Level 3 hierarchy.
Note 9. Derivatives
The Company utilizes derivative instruments to assist in the management of interest rate sensitivity by modifying the repricing, maturity and option characteristics on certain non-SBA commercial estate loans held at fair value. These instruments are not accounted for as effective hedges. As of March 31, 2023, the Company had entered into one interest rate swap agreement with an aggregate notional amount of $6.8 million. Under that swap agreement the Company receives an adjustable rate of interest based upon LIBOR. The
Company recorded a net loss of $79,000 for the three months ended March 31, 2023 to recognize the fair value of the derivative instrument which is reported in net realized and unrealized gains (losses) on commercial loans, at fair value, in the consolidated statements of operations. The amount receivable by the Company under this swap agreement was $329,000 at March 31, 2023, which is reported in other assets. The Company had minimum collateral posting thresholds with certain of its derivative counterparties and had posted cash collateral of $527,000 as of March 31, 2023.
The maturity date, notional amount, interest rate paid and received and fair value of the Company’s remaining interest rate swap agreement as of March 31, 2023 is summarized below (dollars in thousands):
Maturity date
Notional amount
Interest rate paid
Interest rate received
December 23, 2025
6,800
2.16%
5.02%
Note 10. Other Identifiable Intangible Assets
In May 2016, the Company purchased approximately $60.0 million of lease receivables which resulted in a customer list intangible of $3.4 million that is being amortized over a ten year period. Amortization expense is $340,000 per year ($1.0 million over the next five years). The gross carrying amount of the customer list intangible is $3.4 million, and as of March 31, 2023 and December 31, 2022, respectively, the accumulated amortization expense was $2.4 million and $2.3 million.
In January 2020, the Company purchased McMahon Leasing and subsidiaries for approximately $8.7 million which resulted in $1.1 million of intangibles. The gross carrying value of $1.1 million of intangibles was comprised of a customer list intangible of $689,000, goodwill of $263,000 and a trade name valuation of $135,000. The customer list intangible is being amortized over a twelve year period and accumulated amortization expense was $187,000 at March 31, 2023 and $172,000 at December 31, 2022. Amortization expense is $57,000 per year ($287,000 over the next five years). The gross carrying value and accumulated amortization related to the Company’s intangibles at March 31, 2023 and December 31, 2022 are presented below.
Amount
Amortization
Customer list intangibles
4,093
2,541
2,442
Goodwill
Trade Name
4,491
Note 11. Recent Accounting Pronouncements
In March 2020, the FASB issued Accounting Standards Update (“ASU”) 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform in Financial Reporting, which addressed optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, resulting from the phase-out of the LIBOR reference rate. The Company discontinued LIBOR-based originations in 2021; however, certain financial instruments outstanding are indexed to LIBOR, including non-SBA commercial loans, at fair value, which amounted to $159.6 million at March 31, 2023. However, these loans are short-term and are generally expected to be repaid by the June 2023 LIBOR end date. At March 31, 2023, the Company owned $12.3 million of LIBOR-based securities purchased from previous securitizations, which are also expected to mature before June 2023. When the Company resumed originating non-SBA commercial loans in the third quarter of 2021, which are identified separately under real estate bridge loans, it utilized the secured overnight financing rate (“SOFR”) as the index. In addition, the Company owns collateralized loan obligations (“CLOs”) and U.S. government agency adjustable-rate mortgages which utilize LIBOR-based pricing. CLOs, which amounted to $325.6 million at March 31, 2023, generally have language regarding an index alternative should LIBOR no longer be available. U.S. government agencies generally have the ability to adjust interest rate indices as necessary on impacted LIBOR based securities, which amounted to $65.4 million at March 31, 2023. There is less clarity for the Company’s student loan securities of $7.6 million and its subordinated debentures payable of $13.4 million at March 31, 2023, and for which industry standards continue to be considered by trustees and other governing bodies. The Company’s derivative, the notional amount of which totaled $6.8 million at March 31, 2023, is an interest rate swap that is documented under a bilateral agreement which contains LIBOR fallback provisions by virtue of counterparty adherence to the 2020 International Swaps and Derivatives Association, Inc.’s LIBOR Fallbacks Protocol. The Bank also owns $10.0 million of a Floating Rate Junior Subordinated Deferrable Interest Debenture, with a market value of $7.8 million at March 31, 2023, issued by an insurance holding company in liquidation for which the rate index is three-month LIBOR. The indenture
contains terms for a substitution of the index when LIBOR quotes become unavailable. The Company continues to assess the potential impact of the phase-out of LIBOR on all affected accounts and any other potential impacts, and related accounting guidance. In December 2022, the FASB issued ASU No. 2022-06, which extended the original transition period end date referenced in ASU No. 2020-04 to December 31, 2024.
In March 2022, the FASB issued ASU 2022-02, Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures. ASU 2022-02 addresses areas identified by the FASB as part of its post-implementation review of the credit losses standard (ASU 2016-13) that introduced the CECL model. The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancings and modifications. The Company adopted ASU 2022-02 on January 1, 2023. Effective January 1, 2023 loan modifications to borrowers experiencing financial difficulty are required to be disclosed by type of modification and by type of loan. Prior accounting guidance classified loans which were modified as troubled debt restructurings only if the modification reflected a concession from the lender in the form of a below market interest rate or other concession in addition to borrower financial difficulty. Under the new guidance, loans with modifications will be reported whether a concession is made or not. In the first quarter of 2023, there were no loan modifications which were subject to the new reporting.
Note 12. Shareholders’ Equity
On October 20, 2021, the Board approved a common stock repurchase program for the 2022 fiscal year (the “2022 Repurchase Program”). Under the 2022 Repurchase Program, the Company repurchased $15.0 million in value of the Company’s common stock in each quarter of 2022.
On October 26, 2022, the Board approved a common stock repurchase program for the 2023 fiscal year (the “2023 Repurchase Program”), which authorizes the Company to repurchase $25.0 million in value of the Company’s common stock per fiscal quarter in 2023, for a maximum amount of $100.0 million. Under the 2023 Repurchase Program, the Company intends to repurchase shares through open market purchases, privately-negotiated transactions, block purchases or otherwise in accordance with applicable federal securities laws, including Rule 10b-18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The 2023 Repurchase Program may be modified or terminated at any time. During the three months ended March 31, 2023, the Company repurchased 778,442 shares of its common stock in the open market under the 2023 Repurchase Program at an average price of $32.12 per share.
Note 13. Regulatory Matters
Various federal and state statutory provisions limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval. Without the prior approval of the OCC, a dividend may not be paid if the total of all dividends declared by a bank in any calendar year is in excess of the current year’s net income combined with the retained net income of the two preceding years. Additionally, a dividend may not be paid in excess of a bank’s retained earnings. Moreover, an insured depository institution may not pay a dividend if the payment would cause it to be less than “adequately capitalized” under the prompt corrective action framework as defined in the Federal Deposit Insurance Act or if the institution is in default in the payment of an assessment due to the FDIC. Similarly, a banking organization that fails to satisfy regulatory minimum capital conservation buffer requirements will be subject to certain limitations, which include restrictions on capital distributions.
In addition to these explicit limitations, federal and state regulatory agencies are authorized to prohibit a banking subsidiary or financial holding company from engaging in an unsafe or unsound practice. Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Bank are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Moreover, capital requirements may be modified based upon regulatory rules or by regulatory discretion at any time reflecting a variety of factors including deterioration in asset quality.
The following table sets forth our regulatory capital amounts and ratios for the periods indicated:
Tier 1 capital
Total capital
Common equity
to average
to risk-weighted
tier 1 to risk
assets ratio
weighted assets
The Bancorp, Inc.
9.88%
14.34%
14.84%
The Bancorp Bank, National Association
15.94%
16.44%
"Well capitalized" institution (under federal regulations-Basel III)
5.00%
8.00%
10.00%
6.50%
9.63%
13.40%
13.87%
10.73%
14.95%
15.42%
Note 14. Legal
On June 12, 2019, the Bank was served with a qui tam lawsuit filed in the Superior Court of the State of Delaware, New Castle County. The Delaware Department of Justice intervened in the litigation. The case is titled The State of Delaware, Plaintiff, Ex rel. Russell S. Rogers, Plaintiff-Relator, v. The Bancorp Bank, Interactive Communications International, Inc., and InComm Financial Services, Inc., Defendants. The lawsuit alleges that the defendants violated the Delaware False Claims Act by not paying balances on certain open-loop “Vanilla” prepaid cards to the State of Delaware as unclaimed property. The complaint seeks actual and treble damages, statutory penalties, and attorneys’ fees. The Bank has filed an answer denying the allegations and continues to vigorously defend against the claims. The Bank and other defendants previously filed a motion to dismiss the action, but the motion was denied and the case is in preliminary stages of discovery. At this time, the Company is unable to determine whether the ultimate resolution of the matter will have a material adverse effect on the Company’s financial condition or operations.
As previously disclosed, the Company received and responded to a non-public fact-finding inquiry from the SEC, which seeks to determine if violations of the federal securities laws have occurred. On October 9, 2019, the Company received a subpoena seeking records related generally to the Bank’s debit card issuance activity and gross dollar volume data, among other things. The Company responded to the subpoena and subsequent subpoenas issued to the Company. By letter dated May 9, 2023, the SEC staff notified the Company that the SEC staff does not intend to recommend an enforcement action by the SEC against the Company. The Company now considers the matter closed. As a result, certain costs to the Company related to this inquiry will cease, including the legal costs of the investigation, compliance with the SEC’s subpoena, and cooperation with the SEC.
On January 12, 2021, three former employees of the Bank filed separate complaints against the Company in the Supreme Court of the State of New York, New York County. The Company subsequently removed all three lawsuits to the United States District Court for the Southern District of New York. The cases are captioned: John Edward Barker, Plaintiff v. The Bancorp, Inc., Defendant; Alexander John Kamai, Plaintiff v. The Bancorp, Inc., Defendant; and John Patrick McGlynn III, Plaintiff v. The Bancorp, Inc., Defendant. The lawsuits arise from the Bank’s termination of the plaintiffs’ employment in connection with the restructuring of its CMBS business. The plaintiffs sought damages in the following amounts: $4,135,142 (Barker), $901,088 (Kamai) and $2,909,627 (McGlynn). On June 11, 2021, the Company filed a consolidated motion to dismiss in each case. On February 25, 2022, the court granted the Company’s motion in part, dismissing McGlynn’s claims in entirety and most of Barker and Kamai’s claims. The sole claims remaining are Barker and Kamai’s breach of implied contract claims related to an unpaid bonus, for which they seek $2,000,000 and $300,000, respectively. The Company is vigorously defending against these claims. On September 29, 2022, the Company filed a motion for summary judgment in both matters, which is still pending before the court. The Company is not yet able to determine whether the ultimate resolution of this matter will have a material adverse effect on the Company’s financial conditions or operations.
On September 14, 2021, Cachet Financial Services (“Cachet”) filed an adversary proceeding against the Bank in the United States Bankruptcy Court for the Central District of California, titled Cachet Financial Services, Plaintiff v. The Bancorp Bank, et al., Defendants. The case was filed within the context of Cachet’s pending Chapter 11 bankruptcy case. The Bank previously served as the Originating Depository Financial Institution (“ODFI”) for automated clearing house (“ACH”) transactions in connection with Cachet’s payroll services business. The matter arises from the Bank’s termination of its Payroll Processing ODFI Agreement with Cachet on October 23, 2019, for safety and soundness reasons. The initial complaint alleges eight causes of action: (i) breach of contract; (ii) negligence; (iii) intentional interference with contract; (iv) conversion; (v) express indemnity; (vi) implied indemnity; (vii) accounting; and (viii) objection to the Bank’s proof of claim in the bankruptcy case. On November 4, 2021, the Bank filed a motion in the United States District Court for the Central District of California to withdraw the reference of the adversary proceeding to the bankruptcy court, which was denied in February 2023. On August 3, 2022, Cachet served the Bank with a First Amended Complaint wherein Cachet, among other things, withdraws its implied indemnity claim against the Bank and adds several defendants unaffiliated with the Bank and causes of action related to those parties. As to the Bank, Cachet seeks approximately $150 million in damages, and an accounting and
disallowance of the Bank’s proof of claim. The Bank is vigorously defending against these claims. On September 28, 2022, the Bank filed a partial motion to dismiss, seeking to dispose of the majority of Cachet’s claims against the Bank. The motion is still pending before the bankruptcy court. The Company is not yet able to determine whether the ultimate resolution of this matter will have a material adverse effect on the Company’s financial conditions or operations.
On March 27, 2023, the Bank received a Civil Investigative Demand (“CID”) from the Consumer Financial Protection Bureau (“CFPB”) seeking documents and information related to the Bank’s escheatment practices in connection with certain accounts offered through one of the Bank’s program partners. The Bank is cooperating with the CFPB in connection with the CID. The costs related to responding to and cooperating with CFPB staff may be material and could continue to be material at least through the completion of the investigation.
In addition, we are a party to various routine legal proceedings arising out of the ordinary course of our business. Management believes that none of these actions, individually or in the aggregate, will have a material adverse effect on our financial condition or operations.
Note 15. Segment Financials
The Company operates under three segments: specialty finance, payments and corporate. The chief operating decision maker for these segments is the Chief Executive Officer. Specialty finance includes the origination of non-SBA commercial real estate loans, SBA loans, direct lease financing, security-backed lines of credit, cash value insurance policy-backed lines of credit and deposits generated by those business lines. Payments include prepaid card accounts, card payments, ACH processing and deposits generated by those business lines. Corporate includes the Company’s investment portfolio, corporate overhead and non-allocated expenses. In the third quarter of 2022, the Company began allocating interest expense between segments and has adjusted prior period presentation to reflect such allocation. These operating segments reflect the way the Company views its current operations.
The following tables provide segment information for the periods indicated:
Specialty finance
Payments
Corporate
105,392
18
16,766
Interest allocation
(32,935)
34,851
(1,916)
1,486
30,504
4,370
70,971
4,365
10,480
3,417
25,528
21,479
19,217
7,334
Income before taxes
51,006
10,676
3,190
Net income (loss)
(12,560)
49,939
5,915
(3,528)
3,987
(459)
1,124
1,616
46,150
2,863
3,840
4,260
20,673
179
17,496
17,160
3,696
31,407
6,376
(8,817)
5,820,871
48,598
1,737,490
281,523
6,158,133
442,155
6,042,765
57,894
1,802,341
321,335
6,101,539
786,095
Note 16. Subsequent Events
The Company evaluated its March 31, 2023 consolidated financial statements for subsequent events through the date the consolidated financial statements were issued. Pursuant to the 2023 Repurchase Program, described in “Note 12. Shareholders’ Equity,” between April 1, 2023 and May 3, 2023, the Company repurchased 364,393 shares of its common stock, at a total cost of $10.2 million and an average price of $27.87 per share.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) provides information about the Company’s results of operations, financial condition, liquidity and asset quality. This information is intended to facilitate your understanding and assessment of significant changes and trends related to our financial condition and results of operations. This MD&A should be read in conjunction with our financial information in our 2022 Form 10-K and the unaudited interim consolidated financial statements and notes thereto contained in this Quarterly Report on Form 10-Q.
Important Note Regarding Forward-Looking Statements
When used in this Quarterly Report on Form 10-Q, the words “believes,” “anticipates,” “expects,” “intends,” “should,” “will,” “could,” “estimates,” “plans” or the negative versions of those words or other comparable words and similar expressions are intended to identify forward-looking statements, as such term is defined in the Private Securities Litigation Reform Act of 1995. Factors that could cause results to differ from those expressed in these forward-looking statements include, but are not limited to, the risks and uncertainties described or referenced in Part I, Item 1A. “Risk Factors,” in the 2022 Form 10-K and in other of our public filings with the SEC, as well as the following:
continued movement in interest rates and the resulting impact on net interest income;
changes in the monetary and fiscal policies of the federal government and its agencies;
the impacts of recent volatility in the banking sector and actual or perceived concerns regarding the liquidity and soundness of other financial institutions;
adverse changes in general economic and business conditions, including the impact of such conditions on the market value of real estate securing certain of our loans;
impacts of the phase-out of LIBOR or other changes involving LIBOR;
levels of net charge-offs and the adequacy of the ACL in covering expected losses;
any significant increase in the level of the Bank’s deposits that are uninsured by the FDIC;
any failure to maintain or enhance our competitive position with respect to new products, services and technology and achieve our strategic priorities, such as growing payments-related deposit accounts;
weather events, natural disasters, geopolitical events, public health crises and other catastrophic events beyond our control;
the outcome of regulatory matters or investigations, litigation, and other legal actions; and
our ability to identify and prevent cyber-security incidents, such as data security breaches, ransomware, malware intrusion, or other attacks.
We caution readers not to place undue reliance on forward-looking statements, which speak only as of the date hereof and are based on information presently available to the management of the Company. We undertake no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q except as required by applicable law.
Overview
Nature of Operations
We are a Delaware financial holding company and our primary, wholly-owned subsidiary is The Bancorp Bank, National Association, or the Bank. The vast majority of our revenue and income is currently generated through the Bank. In our continuing operations, we have four primary lines of specialty lending:
SBLOC, IBLOC, and investment advisor financing;
leasing (direct lease financing);
SBLs, primarily SBA loans, and
non-SBA commercial real estate bridge loans.
SBLOCs and IBLOCs are loans which are generated through affinity groups and are respectively collateralized by marketable securities and the cash value of insurance policies. SBLOCs are typically offered in conjunction with brokerage accounts and are offered nationally. IBLOC loans are typically viewed as an alternative to standard policy loans from insurance companies and are utilized by our existing advisor base as well as insurance agents throughout the country. Investment advisor financing are loans made to investment advisors for purposes of debt refinance, acquisition of another investment firm or internal succession. Vehicle fleet and, to a lesser extent, other equipment leases are generated in a number of Atlantic Coast and other states and are collateralized primarily by vehicles. SBA loans are generated nationally and are collateralized by commercial properties and other types of collateral. Our non-SBA commercial real estate bridge loans, at fair value, are primarily collateralized by multi-family properties (apartment buildings), and to a lesser extent, by hotel and retail properties. These loans were originally generated for sale through securitizations. In 2020, we decided to retain these loans on our balance sheet as interest-earning assets and resumed originating such loans in the third quarter of 2021. These new originations are identified as real estate bridge loans and are held for investment in the loan portfolio. Prior originations originally intended for securitizations continue to be accounted for at fair value, and are included on the balance sheet in “Commercial loans, at fair value.”
The majority of our deposit accounts and non-interest income are generated in our payments business line, or the Fintech Solutions Group, which consists of consumer deposit accounts accessed by prepaid or debit cards, issuing deposit accounts, ACH accounts, other payments such as rapid funds transfer and the collection of payments through credit card companies on behalf of merchants. The issuing deposit accounts are comprised of debit and prepaid card accounts that are generated by independent companies that market directly to end users. Our issuing deposit account types are diverse and include: consumer and business debit, general purpose reloadable prepaid, pre-tax medical spending benefit, payroll, gift, government, corporate incentive, reward, business payment accounts and others. Our ACH accounts facilitate bill payments, and our collection services for payments made to merchants consist of those which must be settled through associations such as Visa or MasterCard. We also provide banking services to organizations with a pre-existing customer base tailored to support or complement the services provided by these organizations to their customers, known as “affinity banking.” These services include loan and deposit accounts for investment advisory companies through our institutional banking department. We typically provide these services under the name and through the facilities of each organization with whom we develop a relationship.
Performance Summary
Our net income increased to $49.1 million for the first quarter of 2023, from $29.0 million for the first quarter of 2022, primarily reflecting a $33.0 million increase in net interest income and a $3.9 million increase in non-interest income, partially offset by a $9.7 million increase in non-interest expense. Higher rates, and to a lesser extent loan growth, resulted in increases in net interest income, with higher rates also offsetting the impact of lower securities balances on securities interest. Our cost of funds rose to 2.15% in the first quarter of 2023, driven primarily by the timing of the adjustment of prepaid and debit card account deposits to Federal Reserve rate increases. See “Asset and Liability Management” in this MD&A for further discussion of how our funding sources and loans adjust to Federal Reserve rate adjustments.
Prepaid, debit card and other payment fees, including ACH, are the largest drivers of non-interest income. Such fees for the first quarter of 2023 increased $4.9 million over the comparable 2022 period. The first quarter of 2023 included approximately $600,000 of non-interest income related to the fourth quarter of 2022, and a $1.4 million termination fee from a client which formed its own bank.
First quarter 2023 non-interest expense increased $9.7 million which reflected an increase of $5.9 million in salaries and employee benefits. There was a $1.9 million provision for credit losses in the first quarter of 2023, compared to a provision for credit losses of $1.5 million in the first quarter of 2022.
Recent Developments
On February 1, 2023, the Bank relocated its main office from Wilmington, Delaware to Sioux Falls, South Dakota. The new headquarters houses many of the Bank’s payments operations and other core business and internal control functions, and is more geographically proximate to many fintech-related entities and their regulators than the prior main office location.
Key Performance Indicators
We use a number of key performance indicators (“KPIs”) to measure our overall financial performance and believe they are useful to investors because they provide additional information about our underlying operational performance and trends. We describe how we calculate and use a number of these KPIs and analyze their results below.
Return on assets and return on equity. Two KPIs commonly used within the banking industry to measure overall financial performance are return on assets and return on equity. Return on assets measures the amount of earnings compared to the level of assets utilized to generate those earnings and is derived by dividing net income by average assets. Return on equity measures the amount of earnings compared to the equity utilized to generate those earnings and is derived by dividing net income by average shareholders’ equity.
Ratio of equity to assets. Ratio of equity to assets is another KPI frequently utilized within the banking industry and is derived by dividing period-end shareholders’ equity by period-end total assets.
Net interest margin and credit losses. Net interest margin is a KPI associated with net interest income, which is the largest component of our earnings and is the difference between the interest earned on our interest-earning assets consisting of loans and investments, less the interest on our funding, consisting primarily of deposits. Net interest margin is derived by dividing net interest income by average interest-earning assets. Higher levels of earnings and net interest income on lower levels of assets, equity and interest-earning assets are generally desirable. However, these indicators must be considered in light of regulatory capital requirements, which impact equity, and credit risk inherent in loans. Accordingly, the magnitude of credit losses is an additional KPI.
Other KPIs. Other KPIs we use from time to time include growth in average loans and leases, non-interest income growth, the level of non-interest expense and various capital measures.
Results of KPIs
In the first quarter 2023, return on assets and return on equity amounted to 2.63% and 28.07% (annualized), respectively, compared to 1.68% and 18.01% (annualized) in the first quarter of 2022.
At March 31, 2023, ratio of equity to assets was 9.53%, compared to 9.21% at March 31, 2022, reflecting an increase in equity capital from retained earnings, partially offset by fair value adjustments to investment securities and share repurchases.
Net interest margin was 4.67% in the first quarter of 2023 versus 3.12% in the first quarter of 2022, reflecting a $33.0 million increase in net interest income in the first quarter of 2023 compared to the first quarter of 2022. Average loans and leases grew to $5.99 billion in first quarter 2023 compared to $5.14 billion in first quarter 2022. Increases in these KPIs in 2023 reflected the impact of higher rates as a result of Federal Reserve rate increases, and to a lesser extent, loan growth. The provision for credit losses was $1.9 million in the first quarter of 2023 compared to $1.5 million in the first quarter of 2022. Non-interest expense increased more than in prior periods, driven mostly by salary expense.
Critical Accounting Estimates
Our accounting and reporting policies conform with GAAP and general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. We view critical accounting estimates as those estimates made in accordance with GAAP that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. Our critical accounting policies and estimates as of March 31, 2023 remain unchanged from those presented in the 2022 Form 10-K under Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
LIBOR Transition
We discontinued LIBOR-based originations in 2021; however, certain financial instruments outstanding are indexed to LIBOR, including non-SBA commercial loans, at fair value, which amounted to $159.6 million at March 31, 2023. However, these loans are
short-term and are generally expected to be repaid by the June 2023 LIBOR end date. At March 31, 2023, we owned $12.3 million of LIBOR based securities purchased from previous securitizations, which are also expected to mature before June 2023. When we resumed originating non-SBA commercial loans in the third quarter of 2021, which are identified separately under real estate bridge loans, it utilized the secured overnight financing rate (“SOFR”) as the index. In addition, we own collateralized loan obligations (“CLOs”) and U.S. government agency adjustable-rate mortgages which utilize LIBOR based pricing. CLOs, which amounted to $325.6 million at March 31, 2023, generally have language regarding an index alternative should LIBOR no longer be available. U.S. government agencies generally have the ability to adjust interest rate indices as necessary on impacted LIBOR based securities, which amounted to $65.4 million at March 31, 2023. There is less clarity for our student loan securities of $7.6 million and its subordinated debentures payable of $13.4 million at that date, and for which industry standards continue to be considered by trustees and other governing bodies. Our derivative, the notional amount for which totaled $6.8 million at March 31, 2023, is an interest rate swap that is documented under a bilateral agreement which contains LIBOR fallback provisions by virtue of counterparty adherence to the 2020 International Swaps and Derivatives Association, Inc.’s LIBOR Fallbacks Protocol. We also own $10.0 million of a Floating Rate Junior Subordinated Deferrable Interest Debenture, with a market value of $7.8 million at March 31, 2023, issued by an insurance holding company in liquidation for which the rate index is three month LIBOR. The indenture contains terms for a substitution of the index when LIBOR quotes become unavailable. We continue to assess the potential impact of the phase-out of LIBOR on all affected accounts and any other potential impacts, and related accounting guidance.
Results of Operations
Comparison of first quarter 2023 to first quarter 2022
Net Income
Net income for the first quarter of 2023 was $49.1 million, or $0.88 per diluted share, compared to $29.0 million, or $0.50 per diluted share, for the first quarter of 2022. Income before income taxes was $64.9 million in the first quarter of 2023 compared to $38.1 million in the first quarter of 2022. Income increased between those respective periods primarily as a result of higher net interest income, which was primarily driven by the impact of Federal Reserve rate increases on the loan and securities portfolios. Variable rate loans and securities comprise the majority of the Company’s earning assets, and while they reprice on a lagged basis, they adjust more fully than deposits to Federal Reserve rate increases.
Diluted income per share was $0.88 in the first quarter of 2023 compared to $0.50 diluted income per share in the first quarter of 2022, The increase resulted primarily from higher net interest income, reflecting the aforementioned impact of Federal Reserve rate increases on variable rate loans and securities. The increase also reflected the impact of loan growth.
Net Interest Income
Our net interest income for the first quarter of 2023 increased $33.0 million, or 62.4%, to $85.8 million, from $52.9 million in the first quarter of 2022. Our interest income for the first quarter of 2023 increased to $122.2 million, an increase of $66.3 million, or 118.7%, from $55.9 million for the first quarter of 2022. The increase in interest income resulted primarily from the impact an increase in loan yields as a result of Federal Reserve rate increases, and to a lesser extent, loan growth.
Our average loans and leases increased to $5.99 billion for the first quarter of 2023 from $5.14 billion for the first quarter of 2022, an increase of $850.1 million, or 16.5%. Related interest income increased $55.7 million on a tax equivalent basis. The increase in average loans reflected growth in investment advisor loans, small business, direct lease financing, and real estate bridge loans. In the first quarter of 2023, net paydowns of IBLOC were experienced, which partially offset the impact of higher rates and loan growth in other categories. At March 31, 2023, the balance of IBLOC loans was $921.3 million compared to $1.12 billion at December 31, 2022. Continuing decreases in these balances will result in lower interest income, to the extent net decreases in IBLOC balances are not replaced by loan growth in other categories. Additionally, overall net interest income may be reduced from current levels should the Federal Reserve begin lowering interest rates. The balance of our commercial loans, at fair value also decreased, as a result of non-SBA commercial real estate bridge loan repayments. In the third quarter of 2021, we resumed originating such loans, referred to as real estate bridge loans.
Of the total $55.7 million increase in loan interest income on a tax equivalent basis, the largest increases were $22.6 million for SBLOC, IBLOC and investment advisor financing, $24.8 million for all real estate bridge loans, $2.9 million for leasing, and $3.6 million for SBA loans. Our average investment securities of $777.4 million for the first quarter of 2023 decreased $165.7 million from $943.1 million for the first quarter of 2022. Related tax equivalent interest income increased $4.4 million, primarily reflecting an increase in yields. Higher yields on loans and securities reflected the continuing impact of Federal Reserve rate increases as variable rate loans and securities repriced to higher rates. Federal Reserve rate had an immediate impact on cost of funds, while their impact on variable rate loans lags. Generally, interest expense is contractually adjusted daily. The majority of our loans and securities are variable rate and generally reprice monthly or quarterly, although some reprice over several years.
Our net interest margin (calculated by dividing net interest income by average interest-earning assets) for the first quarter of 2023 was 4.67% compared to 3.12% for the first quarter of 2022, an increase of 155 basis points. While the yield on interest-earning assets increased 335 basis points, the cost of deposits and interest bearing liabilities increased 196 basis points, or a net change of 139 basis points. The more pronounced increase in the net interest margin compared to the net change reflected the impact of higher rates on assets funded by equity. Balances at the Federal Reserve earn lower rates of interest than loans and securities. Average interest-earning deposits at the Federal Reserve Bank decreased $106.6 million, or 15.5%, to $580.1 million in the first quarter of 2023 from $686.6 million in the first quarter of 2022. In the first quarter of 2023, the average yield on our loans increased to 7.10% from 3.93% for the first quarter of 2022, an increase of 317 basis points.
Yields on taxable investment securities in the first quarter of 2023 increased to 4.81% compared to 2.08% for the first quarter of 2022, an increase of 273 basis points. The cost of total deposits and interest bearing liabilities increased 196 basis points to 2.15% for the first quarter of 2023 compared to 0.19% in the first quarter of 2022.
Average Daily Balances
The following table presents the average daily balances of assets, liabilities and shareholders’ equity and the respective interest earned or paid on interest-earning assets and interest-bearing liabilities, as well as average annualized rates, for the periods indicated:
Three months ended March 31,
2023 vs 2022
Average
Balance
Interest(1)
Rate
Due to Volume
Due to Rate
Assets:
Interest-earning assets:
Loans, net of deferred loan fees and costs(2)
5,987,179
106,204
7.10%
5,136,377
50,508
3.93%
9,515
46,181
55,696
Leases-bank qualified(3)
3,361
8.21%
4,015
10.46%
(16)
(20)
Investment securities-taxable
774,055
4.81%
939,511
2.08%
(1,988)
6,397
4,409
Investment securities-nontaxable(3)
3,343
4.91%
3,559
3.60%
580,058
4.54%
686,614
0.20%
(45)
6,283
6,238
Net interest-earning assets
7,347,996
122,199
6.65%
6,770,076
55,883
3.30%
(22,533)
(17,810)
237,721
224,312
7,563,184
6,976,578
7,464
58,852
66,316
Liabilities and shareholders' equity:
Deposits:
6,406,834
32,383
2.02%
5,575,228
1,406
0.10%
30,736
30,977
132,279
3.69%
532,047
200
0.15%
1,053
Time
84,333
858
4.07%
6,623,446
6,107,275
0.11%
20,500
4.57%
555
Repurchase agreements
9,998
5.04%
Subordinated debt
7.79%
3.46%
99,092
5.16%
98,724
5.18%
Total deposits and liabilities
6,766,479
2.15%
6,219,996
0.19%
87,116
104,207
6,853,595
6,324,203
1,425
31,934
33,359
Shareholders' equity
709,589
652,375
Net interest income on tax equivalent basis(3)
85,839
52,882
6,039
26,918
32,957
Tax equivalent adjustment
Net interest margin(3)
4.67%
3.12%
(1)Interest on loans for 2023 and 2022 includes $10,000 and $440,000, respectively, of interest and fees on PPP loans.
(2)Includes commercial loans, at fair value. All periods include non-accrual loans.
(3)Full taxable equivalent basis, using 21% respective statutory federal tax rates in 2023 and 2022.
For the first quarter of 2023, average interest-earning assets increased to $7.35 billion, an increase of $577.9 million, or 8.5%, from $6.77 billion in the first quarter of 2022. The increase reflected increased average balances of loans and leases of $850.1 million, or 16.5%, partially offset by decreased average investment securities of $165.7 million, or 17.6%. For those respective periods, average demand and interest checking deposits increased $831.6 million, or 14.9%. A $399.8 million decrease in average savings and money market balances reflected the sweeping of deposits off our balance sheet to other institutions. Such sweeps are utilized to optimize diversity within our funding structure by managing the percentage of individual client deposits to total deposits. The interest expense
shown for demand and interest checking is primarily comprised of interest paid to our affinity groups. Additionally in the first quarter of 2023, average short-term borrowings increased $20.5 million and time deposits increased $84.3 million. The time deposits were short term and matured in the first quarter of 2023 and the borrowings mature on a daily basis.
Provision for Credit Losses
Our provision for credit losses was $1.9 million for the first quarter of 2023 compared to $1.5 million for the first quarter of 2022. Of the $1.9 million for the first quarter of 2023, $1.3 million resulted from the impact of historical net charge-offs applied to the estimated remaining lives of outstanding loans. The balance of the $1.9 million resulted primarily from charge-offs during the first quarter of 2023.
The ACL was $23.8 million, or 0.44% of total loans, at March 31, 2023, compared to $22.4 million, or 0.41% of total loans, at December 31, 2022. The higher ratio at March 31, 2023 reflected an increase in the ACL resulting from the impact of charge-offs as noted above, while total loans outstanding decreased. We believe that our ACL is adequate to cover expected losses. For more information about our provision and ACL and our loss experience, see “Financial Condition – Allowance for Credit Losses,” “– Net Charge-offs,” and “– Non-performing Loans, Loans 90 days Delinquent and Still Accruing, OREO and Troubled Debt Restructurings,” below and “Note 6. Loans” to the unaudited consolidated financial statements herein.
Non-Interest Income
Non-interest income was $29.0 million in the first quarter of 2023 compared to $25.1 million in the first quarter of 2022. The $3.9 million, or 15.4%, increase between those respective periods reflected a decrease in net realized and unrealized gains on commercial loans, at fair value to $1.7 million from $3.4 million. The $1.7 million change reflected a decrease in income recognized when such loans are repaid, as a result of fewer repayments as that portfolio continues to run off. The $1.7 million was comprised of $2.4 million of non-SBA commercial real estate loan repayment related income, $603,000 of fair value losses and $79,000 of hedge fair value adjustments.
Prepaid, debit card and related fees increased $4.7 million, or 25.0%, to $23.3 million for the first quarter of 2023 compared to $18.7 million in the first quarter of 2022. The first quarter of 2023 included approximately $600,000 of non-interest income related to the fourth quarter of 2022, and a $1.4 million termination fee from a client which formed its own bank. The increase also reflected higher transaction volume reflecting the impact of new clients and organic growth from existing clients. Related fees in this category include income related to the use of cash in ATMs for payroll cardholders. ACH, card and other payment processing fees, increased $187,000, or 9.4%, to $2.2 million for the first quarter of 2023 compared to $2.0 million in the first quarter of 2022, reflecting an increased volume of real time payments (“RTP”) and related fees. RTPs reflect transfers for payments between deposit accounts.
Leasing related income increased $517,000, or 53.1%, to $1.5 million for the first quarter of 2023 from $973,000 for the first quarter of 2022. The increase reflected higher volumes of vehicle sales. Both periods reflected vehicle sales at relatively higher market prices due to vehicle shortages.
Other non-interest income increased $160,000, or 133.3%, to $280,000 for the first quarter of 2023 from $120,000 in the first quarter of 2022 primarily reflecting increased prepayment fees on SBL.
Non-Interest Expense
Total non-interest expense was $48.0 million for the first quarter of 2023, an increase of $9.7 million, or 25.2%, compared to $38.4 million for the first quarter of 2022. The majority of the increase resulted from higher salaries and employee benefits expense, which reflected higher numbers of staff in financial crimes, compliance and information technology (“IT”) due to increases in deposit transaction volume and the development of new products. The increase also reflected higher stock compensation expense.
The following table presents the principal categories of non-interest expense for the periods indicated:
Increase (Decrease)
Percent Change
5,937
24.9%
(74)
(9.3)
8.1
132
11.1
59
68.6
30
8.3
164
20.7
(2.0)
373
9.7
22.7
0.5
Writedown on OREO
100.0
1,689
51.0
9,678
25.2%
Changes in categories of non-interest expense were as follows:
Salaries and employee benefits expense increased to $29.8 million for the first quarter of 2023, an increase of $5.9 million, or 24.9%, from $23.8 million for the first quarter of 2022.
Depreciation and amortization expense decreased $74,000, or 9.3%, to $721,000 in the first quarter of 2023 from $795,000 in the first quarter of 2022.
Rent and related occupancy cost increased $105,000, or 8.1%, to $1.4 million in the first quarter of 2023 from $1.3 million in the first quarter of 2022, reflecting increased IT-related equipment expense.
Data processing expense increased $132,000, or 11.1%, to $1.3 million in the first quarter of 2023 from $1.2 million in the first quarter of 2022, reflecting higher transaction volume.
Printing and supplies expense increased $59,000, or 68.6%, to $145,000 in the first quarter of 2023 from $86,000 in the first quarter of 2022.
Audit expense increased $30,000, or 8.3%, to $392,000 in the first quarter of 2023 from $362,000 in the first quarter of 2022.
Legal expense increased $164,000, or 20.7%, to $958,000 in the first quarter of 2023 from $794,000 in the first quarter of 2022 reflecting increased legal costs related to the matters discussed in “Note 14. Legal” to the unaudited consolidated financial statements herein.
FDIC insurance expense decreased $19,000, or 2.0%, to $955,000 for the first quarter of 2023 from $974,000 in the first quarter of 2022. The cost of resolving several recent bank failures may result in future increased premiums, or special assessments, which would serve to increase expense in the period assessed.
Software expense increased $373,000, or 9.7%, to $4.2 million in the first quarter of 2023 from $3.9 million in the first quarter of 2022. The largest component of the increase were expenditures related to compliance with anti-money laundering and other financial crimes regulations from deposit account activity.
Insurance expense increased $242,000, or 22.7%, to $1.3 million in the first quarter of 2023 compared to $1.1 million in the first quarter of 2022, reflecting higher rates, especially on cyber insurance.
Telecom and IT network communications expense increased $2,000, or 0.5%, to $376,000 in the first quarter of 2023 from $374,000 in the first quarter of 2022.
Consulting expense increased $19,000, or 6.3%, to $322,000 in the first quarter of 2023 from $303,000 in the first quarter of 2022.
The $1.0 million writedown on OREO resulted from a pending sale of a movie theater property as described in Note E to the December 31, 2022 consolidated financial statements. The property had previously been recorded at appraised value, which was adjusted to the proposed sales price in the first quarter of 2023.
Other non-interest expense increased $1.7 million, or 51.0%, to $5.0 million in the first quarter of 2023 from $3.3 million in the first quarter of 2022. The $1.7 million increase primarily reflected the following increases: a. exam assessment fees of $476,000, b. OREO expense of $308,000 and c. an increase of $153,000 in travel expenses, as travel increased post-pandemic.
Income Taxes
Income tax expense was $15.8 million for the first quarter of 2023 compared to $9.1 million in the first quarter of 2022. The increase resulted primarily from an increase in income, substantially all of which is subject to income tax. A 24.3% effective tax rate in 2023 and a 24.0% effective tax rate in 2022 primarily reflected a 21% federal tax rate and the impact of various state income taxes.
Liquidity
Liquidity defines our ability to generate funds to support asset growth, meet deposit withdrawals, satisfy borrowing needs and otherwise operate on an ongoing basis. We invest the funds we do not need for daily operations primarily in overnight federal funds or in our interest-bearing account at the Federal Reserve.
Our primary source of funding has been deposits. Average total deposits increased by $516.2 million, or 8.5%, to $6.62 billion for the first quarter of 2023 compared to the first quarter of 2022. Federal Reserve average balances decreased to $580.1 million in the first quarter 2023 from $686.6 million in the first quarter of 2022. In the first quarter of 2023, we averaged $84.3 million of time deposits with terms of 90 days and less. Overnight borrowings are also periodically utilized as a funding source to facilitate cash management, but average balances have generally not been significant.
One source of contingent liquidity is available-for-sale securities, which amounted to $787.4 million at March 31, 2023, compared to $766.0 million at December 31, 2022. The majority of these securities can be pledged to facilitate extensions of credit in addition to loans already pledged against lines of credit, as discussed later in this section. Loan repayments, another source of funds, have historically been exceeded by disbursements associated with new loan originations, a use of funds. However, loan repayments during the first quarter of 2023 exceeded originations, and the excess of repayments over originations provided additional liquidity. As a result of such higher loan repayments, at March 31, 2023, outstanding loans amounted to $5.35 billion, compared to $5.49 billion at the prior year end, a decrease of $132.5 million. Commercial loans, at fair value, decreased to $493.3 million from $589.1 million between those respective dates, a decrease of $95.8 million, which also provided funding. In 2019 and previous years, these loans were generally originated for securitization and sale, but in 2020 we decided to retain such loans on the balance sheet. While we suspended originating such loans after the first quarter of 2020, we resumed originations, which consist primarily of non-SBA commercial real estate bridge loans, in the third quarter of 2021. Such originations are held for investment and are included in “Loans, net of deferred loan fees and costs” on the balance sheet. Accordingly, commercial loans, at fair value will continue to run off. Our liquidity planning has not previously placed undue reliance on securitizations, and while our future planning excludes the impact of securitizations, other liquidity sources, primarily deposits, are determined to be adequate.
While we do not have a traditional branch system, we believe that our core deposits, which include our demand, interest checking, savings and money market accounts, have similar characteristics to those of a bank with a branch system. The majority of our deposit accounts are obtained with the assistance of third-parties and as a result have historically been classified as brokered by the FDIC. Prior to December 2020, FDIC guidance for classification of deposit accounts as brokered was relatively broad, and generally included accounts which were referred to or “placed” with the institution by other companies. If the Bank ceases to be categorized as “well capitalized” under banking regulations, it will be prohibited from accepting, renewing or rolling over any of its deposits classified as brokered without the consent of the FDIC. In such a case, the FDIC’s refusal to grant consent to our accepting, renewing or rolling over brokered deposits could effectively restrict or eliminate the ability of the Bank to operate its business lines as presently conducted. In December 2020, the FDIC issued a new regulation which, in the third quarter of 2021, resulted in the majority of our deposits being reclassified from brokered to non-brokered. As of March 31, 2023, an estimated $643.9 million of our total deposit accounts of $6.70 billion were not insured by FDIC insurance, which requires identification of the depositor and is limited to $250,000 per identified depositor. Uninsured accounts may represent a greater liquidity risk than FDIC-insured accounts should large depositors withdraw funds as a result of negative financial developments either at the Bank or in the economy. Significant amounts of our uninsured deposits are comprised of small balances, such as anonymous gift cards and corporate incentive cards for which there is no identified depositor. We do not believe that such uninsured accounts present a significant liquidity risk.
Certain components of our deposits experience seasonality, creating greater excess liquidity at certain times. The largest deposit inflows occur in the first quarter of the year when certain of our accounts are credited with tax refund payments from the U.S. Treasury.
While consumer deposit accounts, including prepaid and debit card accounts, comprise the vast majority of our funding needs, we maintain secured borrowing lines with the FHLB and the Federal Reserve. As of March 31, 2023, we had a line of credit with the Federal Reserve which exceeded $1 billion and may be collateralized by various types of loans, but which we generally did not use prior to the COVID-19 pandemic. In response to the COVID-19 pandemic, the Federal Reserve has encouraged banks to utilize their lines to maximize the amount of funding available for credit markets. Accordingly, the Bank has borrowed on its line on an overnight basis and may do so in the future. The amount of loans pledged varies and the collateral may be unpledged at any time to the extent the collateral exceeds advances. We have pledged in excess of $1.25 billion of multi-family loans to the FHLB. As a result, we have approximately $1.1 billion of availability on our line of credit which we can access at any time. Our collateralized line of credit with the Federal Reserve
Bank was $2.1 billion as of March 31, 2023. As of March 31, 2023, there were no amounts outstanding on either of these lines of credit. We expect to continue to maintain our facilities with the FHLB and Federal Reserve.
Another source of contingent liquidity is available-for-sale securities, which amounted to $787.4 million at March 31, 2023, compared to $766.0 million at December 31, 2022. Approximately $375 million of our available-for-sale securities are U.S. government agency securities which are highly liquid and may be immediately pledged as additional collateral. We actively monitor our positions and contingent funding sources daily.
As a holding company conducting substantially all our business through our subsidiaries, the Company’s near-term need for liquidity consists principally of cash for required interest payments on our subordinated debentures, consisting of $13.4 million of debentures bearing interest at three-month LIBOR plus 3.25% and maturing in March 2038 (the “2038 Debentures”), and senior debt, consisting of $100.0 million senior notes with an interest rate of 4.75% and maturing in August 2025 (the “2025 Senior Notes”). Semi-annual interest payments on the 2025 Senior Notes are approximately $2.4 million, and quarterly interest payments on the 2038 Debentures are approximately $300,000. As of March 31, 2023, we had cash reserves of approximately $16.0 million at the holding company. During the first quarter of 2023, $25.0 million of common stock repurchases were funded by a dividend from the Bank, as are interest payments on the above debt instruments. Stock repurchases may be terminated at any time. The holding company’s sources of liquidity are primarily comprised of dividends paid by the Bank to the Company, and the issuance of debt.
Included in our cash and cash-equivalents at March 31, 2023 were $773.4 million of interest-earning deposits which primarily consisted of deposits with the Federal Reserve.
In the first quarter of 2023, purchases of $39.8 million of securities were partially offset by $23.4 million of redemptions. We had outstanding commitments to fund loans, including unused lines of credit, of $1.94 billion and $1.98 billion as of March 31, 2023 and December 31, 2022, respectively. The majority of our commitments are variable rate and originate with SBLOC. The recorded amount of such commitments has, for many accounts, been based on the full amount of collateral in a customer’s investment account. The funding requirements for such commitments occur on a measured basis over time and would be funded by normal deposit growth. Additionally, these loans are “demand” loans and as such, represent a contingent source of funding.
Capital Resources and Requirements
We must comply with capital adequacy guidelines issued by our regulators. A bank must, in general, have a Tier 1 leverage ratio of 5.00%, a ratio of Tier I capital to risk-weighted assets of 8.0%, a ratio of total capital to risk-weighted assets of 10.0% and a ratio of common equity tier 1 to risk weighted assets of 6.5% to be considered “well capitalized.” The Tier I leverage ratio is the ratio of Tier 1 capital to average assets for the quarter. “Tier I capital” includes common shareholders’ equity, certain qualifying perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less intangibles. At March 31, 2023, both the Company and the Bank were “well capitalized” under banking regulations.
Asset and Liability Management
The management of rate sensitive assets and liabilities is essential to controlling interest rate risk and optimizing interest margins. An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line with general market rates. Interest rate sensitivity measures the relative volatility of an institution’s interest margin resulting from changes in market interest rates. While it is difficult to predict the impact of inflation and responsive Federal Reserve rate changes on our net interest income, the Federal Reserve has historically utilized increases in the overnight federal funds rate as one tool in fighting inflation. As a result of high rates of inflation, the Federal Reserve raised rates in each quarter of 2022 and in the first quarter of 2023. Our largest funding source, prepaid and debit card deposit accounts, contractually adjusts to only a portion of increases or decreases in
rates which are largely determined by such Federal Reserve actions. That pricing has generally supported the maintenance of a balance sheet for which net interest income tends to increase with increases in rates. While deposits reprice to only a portion of Federal Reserve rate changes, such changes are immediate. Interest-earning assets, comprised primarily of loans and securities, tend to adjust more fully to rate increases at lagged contractual pricing intervals. The majority of our loans and securities are variable rate and generally reprice monthly or quarterly, although some reprice over several years. Additionally, the impact of loan interest rate floors which must be exceeded before rates on certain loans increase, may result in decreases in net interest income with lesser increases in rates. Cumulative 2022 Federal Reserve interest rate increases resulted in contractual rates on loans generally exceeding rate floors in the second quarter of 2022.
We have adopted policies designed to manage net interest income and preserve capital over a broad range of interest rate movements. To effectively administer the policies and to monitor our exposure to fluctuations in interest rates, we maintain an asset/liability committee, consisting of the Bank’s Chief Executive Officer, Chief Accounting Officer, Chief Financial Officer, Chief Credit Officer and others. This committee meets quarterly to review our financial results, develop strategies to optimize margins and to respond to market conditions. The primary goal of our policies is to optimize margins and manage interest rate risk, subject to overall policy constraints for prudent management of interest rate risk.
We monitor, manage and control interest rate risk through a variety of techniques, including the use of traditional interest rate sensitivity analysis (also known as “gap analysis”) and an interest rate risk management model. With the interest rate risk management model, we project future net interest income and then estimate the effect of various changes in interest rates on that projected net interest income. We also use the interest rate risk management model to calculate the change in net portfolio value over a range of interest rate change scenarios. Traditional gap analysis involves arranging our interest-earning assets and interest bearing liabilities by repricing periods and then computing the difference (or “interest rate sensitivity gap”) between the assets and liabilities that we estimate will reprice during each time period and cumulatively through the end of each time period.
Both interest rate sensitivity modeling and gap analysis are done at a specific point in time and involve a variety of significant estimates and assumptions. Interest rate sensitivity modeling requires, among other things, estimates of how much and when yields and costs on individual categories of interest-earning assets and interest bearing liabilities will respond to general changes in market rates, future cash flows and discount rates. Gap analysis requires estimates as to when individual categories of interest-sensitive assets and liabilities will reprice, and assumes that assets and liabilities assigned to the same repricing period will reprice at the same time and in the same amount. Gap analysis does not account for the fact that repricing of assets and liabilities is discretionary and subject to competitive and other pressures. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. During a period of falling interest rates, a positive gap would tend to adversely affect net interest income, while a negative gap would tend to result in an increase in net interest income. During a period of rising interest rates, a positive gap would tend to result in an increase in net interest income while a negative gap would tend to affect net interest income adversely.
The following table sets forth the estimated maturity or repricing structure of our interest-earning assets and interest bearing liabilities at March 31, 2023. Except as stated below, the amounts of assets or liabilities shown which reprice or mature during a particular period were determined in accordance with the contractual terms of each asset or liability. The majority of transaction and savings balances are assumed to be “core” deposits, or deposits that will generally remain with us regardless of market interest rates. We estimate the repricing characteristics of these deposits based on historical performance, past experience, judgmental predictions and other deposit behavior assumptions. However, we may choose not to reprice liabilities proportionally to changes in market interest rates for competitive or other reasons. Additionally, although non-interest bearing transaction accounts are not paid interest, we estimate certain of the balances will reprice as a result of the contractual fees that are paid to the affinity groups which are based upon a rate index, and therefore are included in interest expense. We have adjusted the transaction account balances in the table downward, to better reflect the impact of their partial adjustment to changes in rates. Loans and security balances, which adjust more fully to market rate changes, are based upon actual balances. The rates on the majority of commercial loans, at fair value, and IBLOC loans totaling $352.4 million and $921.3 million at March 31, 2023, respectively, generally exceeded their floors at that date. The table does not assume any prepayment of fixed-rate loans and mortgage-backed securities are scheduled based on their anticipated cash flow, including prepayments based on historical data and current market trends. The table does not necessarily indicate the impact of general interest rate movements on our net interest income because the repricing and related behavior of certain categories of assets and liabilities (for example, prepayments of loans and withdrawal of deposits) is beyond our control. As a result, certain assets and liabilities indicated as repricing within a stated period may in fact reprice at different times and at different rate levels.
1-90
91-364
1-3
3-5
Over 5
Days
Years
Interest earning assets:
323,224
16,674
17,120
136,316
4,078,468
128,048
319,535
618,861
209,435
Investment securities
410,018
38,244
136,384
102,564
100,219
Interest earning deposits
Total interest earning assets
5,585,156
182,966
473,039
857,741
309,654
Interest bearing liabilities:
Transaction accounts as adjusted(1)
3,303,884
Senior debt and subordinated debentures
Total interest bearing liabilities
3,414,217
Gap
2,170,939
373,897
Cumulative gap
2,353,905
2,727,802
3,585,543
3,895,197
Gap to assets ratio
29%
2%
5%
11%
4%
Cumulative gap to assets ratio
31%
36%
47%
51%
(1)Transaction accounts are comprised primarily of demand deposits. While demand deposits are non-interest bearing, related fees paid to affinity groups may reprice according to specified indices.
The methods used to analyze interest rate sensitivity in this table have a number of limitations. Certain assets and liabilities may react differently to changes in interest rates even though they reprice or mature in the same or similar time periods. The interest rates on certain assets and liabilities may change at different times than market interest rates, with some changing in advance of changes in market rates and some lagging behind changes in market rates. Additionally, the actual prepayments and withdrawals we experience when interest rates change may deviate significantly from those assumed in calculating the data shown in the table. Accordingly, actual results can and often do differ from projections.
We believe that the assumptions utilized in evaluating our estimated net interest income are reasonable; however, the interest rate sensitivity of our assets, liabilities and off-balance sheet financial instruments, as well as the estimated effect of changes in interest rates on estimated net interest income, could vary substantially if different assumptions are used or actual experience differs from presumed behavior of various deposit and loan categories. The following table shows the effects of interest rate shocks on our net portfolio value described as Market Value of Portfolio Equity (“MVPE”) and net interest income. Rate shocks assume that current interest rates change immediately and sustain parallel shifts. For interest rate increases or decreases of 100 and 200 basis points, our policy includes a guideline that our MVPE ratio should not decrease more than 10% and 15%, respectively, and that net interest income should not decrease more than 10% and 15%, respectively. As illustrated in the following table, we complied with our asset/liability policy guidelines at March 31, 2023, except for a slight deviation in the 200 basis point decrease scenario. While our modeling suggests that rate increases of 100 and 200 basis points will have a positive impact on net interest income (as shown in the table below), the actual amount of such increase cannot be determined, and there can be no assurance any increase will be realized. Because the Company has emphasized variable rate instruments in its loan and investment portfolios, it tends to benefit from higher interest rate environments. As a result of the Federal Reserve rate increases in 2022 and 2023, net interest income has increased and exceeded prior period levels. Future Federal Reserve rate reductions may result in a return to lower net interest income levels.
Net portfolio value at
Percentage
Rate scenario
change
+200 basis points
1,364,190
8.04%
418,481
14.05%
+100 basis points
1,312,198
3.92%
392,728
7.04%
Flat rate
1,262,706
366,912
-100 basis points
1,209,016
(4.25)%
340,897
(7.09)%
-200 basis points
1,151,319
(8.82)%
314,872
(14.18)%
Financial Condition
General. Our total assets at March 31, 2023 were $7.61 billion, of which our total loans were $5.35 billion, and our commercial loans, at fair value, were $493.3 million. At December 31, 2022, our total assets were $7.90 billion, of which our total loans were $5.49 billion, and our commercial loans, at fair value were $589.1 million. The decrease in assets reflected decreases both in IBLOC loan balances and in commercial loans, at fair value as that portfolio continues to run off, partially offset by increases in securities.
Interest-earning Deposits
At March 31, 2023, we had a total of $773.4 million of interest-earning deposits compared to $864.1 million at December 31, 2022, a decrease of $90.7 million. These deposits were comprised primarily of balances at the Federal Reserve.
Investment Portfolio
For detailed information on the composition and maturity distribution of our investment portfolio, see “Note 5. Investment Securities” to the unaudited consolidated financial statements herein. Total investment securities increased to $787.4 million at March 31, 2023, an increase of $21.4 million, or 2.8%, from December 31, 2022.
Under the accounting guidance related to CECL, changes in fair value of securities unrelated to credit losses continue to be recognized through equity. However, credit-related losses are recognized through an allowance, rather than through a reduction in the amortized cost of the security. CECL accounting guidance also permits the reversal of allowances for credit deterioration in future periods based on improvements in credit, which was not included in previous guidance. Generally, a security’s credit-related loss is the difference between its amortized cost basis and the best estimate of its expected future cash flows discounted at the security’s effective yield. That difference is recognized through the income statement, as with prior guidance, but is renamed a provision for credit loss. For the three months ended March 31, 2023 and 2022, we recognized no credit-related losses on our portfolio.
Investments in FHLB, ACBB and Federal Reserve Bank stock are recorded at cost and amounted to $12.6 million at each of March 31, 2023 and December 31, 2022. Each of these institutions require their correspondent banking institutions to hold stock as a condition of membership. The Bank’s conversion to a national charter required the purchase of $11.0 million of Federal Reserve Bank stock in September 2022. While a fixed stock amount is required by each of these institutions, the FHLB stock requirement increases or decreases with the level of borrowing activity.
At March 31, 2023 and December 31, 2022 no investment securities were encumbered, as lines of credit established for borrowings were collateralized by loans.
The following table shows the contractual maturity distribution and the weighted average yield of our investment portfolio securities as of March 31, 2023 (dollars in thousands). The weighted average yield was calculated by dividing the amount of individual securities to total securities in each category, multiplying by the yield of the individual security and adding the results of those individual computations.
After
Zero
one to
five to
Over
to one
five
ten
year
yield
years
8,968
2.59%
17,416
4.85%
10,345
4,883
161,259
6.40%
166,916
6.58%
Tax-exempt obligations of states and political subdivisions(1)
340
2.60%
2,856
2.81%
577
3.80%
1,437
3.90%
6,934
3.48%
36,089
3.26%
1,164
4.33%
45,704
2.67%
35,293
3.94%
83,696
3.28%
6,155
2.71%
2.38%
33,323
3.74%
44,503
2.65%
32,995
3.45%
78,014
3.72%
7.75%
Weighted average yield
5.53%
4.96%
(1)If adjusted to their taxable equivalents, yields would approximate 3.29%, 3.56%, 4.81%, and 4.94% for zero to one year, one to five years, five to ten years, and over ten years, respectively, at a federal tax rate of 21%.
Commercial Loans, at Fair Value
Commercial loans, at fair value are comprised of non-SBA commercial real estate loans and SBA loans which had been originated for sale or securitization through first quarter 2020, and which are now being held on the balance sheet. Non-SBA commercial real estate loans and SBA loans are valued using a discounted cash flow analysis based upon pricing for similar loans, on a pooled basis. Commercial loans, at fair value decreased to $493.3 million at March 31, 2023 from $589.1 million at December 31, 2022, primarily reflecting the impact of loan repayments as this portfolio runs off. These loans continue to be accounted for at fair value. In the third quarter of 2021 we resumed originating non-SBA commercial real estate loans, after suspending such originations in the first quarter of 2020. These originations reflect lending criteria similar to the existing loan portfolio and are primarily comprised of multi-family
(apartment buildings) collateral. The new originations, which are intended to be held for investment, are accounted for at amortized cost.
Loan Portfolio. Total loans decreased to $5.35 billion at March 31, 2023 from $5.49 billion at December 31, 2022.
The following table summarizes our loan portfolio, excluding loans held at fair value, by loan category for the periods indicated (in
thousands):
(1)SBLOC are collateralized by marketable securities, while IBLOC, are collateralized by the cash surrender value of insurance policies. At March 31, 2023 and December 31, 2022, respectively, IBLOC loans amounted to $921.3 million and $1.12 billion.
(2)In 2020 the Company began originating loans to investment advisors for purposes of debt refinancing, acquisition of another firm or internal succession. Maximum loan amounts are subject to loan-to-value (“LTV”) ratios of 70%, based on third-party business appraisals, but may be increased depending upon the debt service coverage ratio. Personal guarantees and blanket business liens are obtained as appropriate.
(4)The SBLs held at fair value are comprised of the government guaranteed portion of 7(a) Program loans at the dates indicated.
The following table summarizes our SBL portfolio, including loans held at fair value, by loan category as of March 31, 2023 (in thousands):
Loan principal
U.S. government guaranteed portion of SBA loans(1)
380,147
PPP loans(1)
4,011
Commercial mortgage SBA(2)
256,942
Construction SBA(3)
10,714
Non-guaranteed portion of U.S. government guaranteed 7(a) Program loans(4)
104,319
Non-SBA SBLs
22,946
Total principal
779,079
Unamortized fees and costs
10,688
Total SBLs
(1)Includes the portion of SBA 7(a) Program loans and PPP loans which have been guaranteed by the U.S. government, and therefore are assumed to have no credit risk.
(2)Substantially all these loans are made under the 504 Program, which dictates origination date LTV percentages, generally 50-60%, to which the Bank adheres.
(3)Includes $9.0 million in 504 Program first mortgages with an origination date LTV of 50-60% and $1.7 million in SBA interim loans with an approved SBA post-construction full takeout/payoff.
(4)Includes the unguaranteed portion of 7(a) Program loans which are 70% or more guaranteed by the U.S. government. SBA 7(a) Program loans are not made on the basis of real estate LTV; however, they are subject to SBA's "All Available Collateral" rule which mandates that to the extent a borrower or its 20% or greater principals have available collateral (including personal residences), the collateral must be pledged to fully collateralize the loan, after applying SBA-determined liquidation rates. In addition, all 7(a) Program loans and 504 Program loans require the personal guaranty of all 20% or greater owners.
The following table summarizes our SBL portfolio, excluding the government guaranteed portion of SBA 7(a) Program loans and PPP loans, by loan type as of March 31, 2023 (dollars in thousands):
SBL commercial mortgage(1)
SBL construction(1)
% Total
Hotels and motels
74,299
71
74,390
19%
Full-service restaurants
15,698
3,359
1,742
20,799
Lessors of nonresidential buildings
19,247
Car washes
16,750
106
18,474
Child day care services
13,715
470
1,435
15,620
Homes for the elderly
15,531
15,606
Outpatient mental health and substance abuse centers
15,428
Funeral homes and funeral services
14,814
47
14,861
Gasoline stations with convenience stores
12,504
147
12,651
3%
Fitness and recreational sports centers
7,681
2,228
9,909
Offices of lawyers
9,202
Lessors of other real estate property
8,075
General warehousing and storage
6,767
Plumbing, heating, and air-conditioning companies
5,658
967
6,625
Limited-service restaurants
1,061
2,086
2,575
5,722
1%
Lessors of residential buildings and dwellings
4,865
Miscellaneous durable goods merchants
4,834
4,836
Technical and trade schools
4,781
Packaged frozen food merchant wholesalers
4,772
Other amusement and recreation industry
285
4,556
Offices of dentists
2,469
3,188
Other warehousing and storage
3,122
Vocational rehabilitation services
3,090
Miscellaneous wood product manufacturing
2,922
Other(2)
76,395
1,567
27,451
105,413
26%
343,126
14,646
37,149
394,921
100%
(1)Of the SBL commercial mortgage and SBL construction loans, $90.1 million represents the total of the non-guaranteed portion of SBA 7(a) Program loans and non-SBA loans. The balance of those categories represents SBA 504 Program loans with 50%-60% origination date LTVs.
(2)Loan types of less than $3.0 million are spread over approximately one hundred different classifications such as commercial printing, pet and pet supplies stores, securities brokerage, etc.
The following table summarizes our SBL portfolio, excluding the government guaranteed portion of SBA 7(a) Program loans and PPP loans, by state as of March 31, 2023 (dollars in thousands):
California
70,741
3,227
77,327
20%
Florida
66,408
531
3,540
70,479
18%
North Carolina
33,722
7,086
2,006
42,814
New York
25,839
5,052
30,962
8%
Pennsylvania
20,921
708
21,629
Georgia
14,810
1,510
16,320
New Jersey
11,922
3,583
15,772
Illinois
14,486
15,765
Texas
11,719
15,490
Other States <$10 million
72,558
3,332
12,473
88,363
22%
The following table summarizes the ten largest loans in our SBL portfolio, including loans held at fair value, as of March 31, 2023 (in thousands):
Type(1)
State
Mental health and substance abuse center
Hotel
8,571
Lawyer's office
8,339
6,769
5,809
5,787
5,687
Connecticut
5,150
Lessor of residential building
4,912
67,819
(1)All ten largest loans in our SBL portfolio are SBA 504 Program loans with 50%-60% origination date LTVs. The table above does not include loans to the extent that they are U.S. government guaranteed.
Commercial real estate loans, primarily real estate bridge loans and excluding SBA loans, were as follows as of March 31, 2023 (dollars in thousands):
# Loans
Weighted average origination date LTV
Weighted average interest rate
Real estate bridge loans (multi-family apartment loans recorded at book value)(1)
72%
8.40%
Non-SBA commercial real estate loans, at fair value:
Multi-family (apartment bridge loans)(1)
302,615
76%
8.20%
Hospitality (hotels and lodging)
30,255
65%
8.50%
Retail
12,295
7.30%
9,601
73%
5.20%
354,766
75%
8.11%
Fair value adjustment
(2,341)
Total non-SBA commercial real estate loans, at fair value
352,425
Total commercial real estate loans
2,104,747
8.36%
(1)In the third quarter of 2021, we resumed the origination of multi-family apartment loans. These are similar to the multi-family apartment loans carried at fair value, but at origination are intended to be held on the balance sheet, so are not accounted for at fair value.
The following table summarizes our commercial real estate loans, primarily real estate bridge loans and excluding SBA loans, by state as of March 31, 2023 (dollars in thousands):
Origination date LTV
782,591
241,699
71%
239,363
70%
Tennessee
98,612
Ohio
90,083
69%
Michigan
67,964
Alabama
66,427
Other States each <$55 million
518,008
74%
The following table summarizes our fifteen largest commercial real estate loans, primarily real estate bridge loans and excluding SBA loans, as of March 31, 2023 (dollars in thousands). All of these loans are multi-family loans.
41,544
40,271
39,400
39,344
79%
37,380
37,258
80%
36,443
62%
32,550
32,237
67%
31,520
30,576
30,361
Indiana
29,410
29,150
28,651
77%
15 largest commercial real estate loans
516,095
The following table summarizes our institutional banking portfolio by type as of March 31, 2023 (dollars in thousands):
Type
Principal
% of total
50%
41%
9%
2,242,875
For SBLOC, we generally lend up to 50% of the value of equities and 80% for investment grade securities. While equities have fallen in excess of 30% in recent years, the reduction in collateral value of brokerage accounts collateralizing SBLOCs generally has been less. This is because many collateral accounts are “balanced” and accordingly, have a component of debt securities, which have either not decreased in value as much as equities, or in some cases may have increased in value. Further, many of these accounts have the benefit of professional investment advisors who provided some protection against market downturns, through diversification and other means. Additionally, borrowers often utilize only a portion of collateral value, which lowers the percentage of principal to the market value of collateral.
The following table summarizes our ten largest SBLOC loans as of March 31, 2023 (dollars in thousands):
Principal amount
% Principal to collateral
20,268
54%
18,000
40%
12,466
28%
9,465
35%
9,376
9,034
43%
8,577
61%
7,905
68%
6,936
6,096
38%
Total and weighted average
108,123
49%
IBLOC loans are backed by the cash value of life insurance policies which have been assigned to us. We generally lend up to 95% of such cash value. Our underwriting standards require approval of the insurance companies which carry the policies backing these loans. Currently, nine insurance companies have been approved and, as of March 31, 2023, all were rated A- or better by AM Best.
The following table summarizes our direct lease financing portfolio by type as of March 31, 2023 (dollars in thousands):
Principal balance(1)
Construction
112,115
17%
Waste management and remediation services
85,461
13%
Government agencies and public institutions(2)
81,267
12%
Real estate and rental and leasing
66,559
10%
Retail trade
46,658
7%
Finance and insurance
40,281
6%
Health care and social assistance
31,110
Manufacturing
22,364
Professional, scientific, and technical services
21,673
Wholesale trade
17,688
Transportation and warehousing
11,525
Educational services
9,244
Mining, quarrying, and oil and gas extraction
8,446
98,150
(1)Of the total $652.5 million of direct lease financing, $574.9 million consisted of vehicle leases with the remaining balance consisting of equipment leases.
(2)Includes public universities and school districts.
The following table summarizes our direct lease financing portfolio by state as of March 31, 2023 (dollars in thousands):
Principal balance
91,182
14%
68,107
Utah
64,053
40,637
39,991
32,857
31,277
29,453
Maryland
27,806
26,431
Washington
16,130
15,600
Idaho
15,481
12,590
11,781
Other States
129,165
21%
The following table presents loan categories by maturity for the period indicated. Actual repayments historically have, and will likely in the future, differ significantly from contractual maturities because individual borrowers generally have the right to prepay loans, with or without prepayment penalties. See “Asset and Liability Management” in this MD&A for a discussion of interest rate risk.
Within
One to five
After five but
one year
within 15 years
After 15 years
7,705
35,089
122,535
1,364
166,693
20,395
15,158
145,220
408,814
589,587
2,080
33,487
Leasing
122,984
503,448
26,109
SBLOC/IBLOC
35,474
153,951
Real estate bridge lending
28,025
4,486
7,521
17,719
57,751
Loans at fair value excluding SBL
334,994
17,431
2,569,633
2,363,408
455,336
459,304
5,847,681
Loan maturities after one year with:
Fixed rates
529,557
3,703
21,814
Total loans at fixed rates
564,067
180,452
762,238
Variable rates
31,078
154,977
569,192
783
7,129
7,912
Total at variable rates
1,799,341
274,884
441,585
2,515,810
3,278,048
Allowance for Credit Losses
We review the adequacy of our ACL on at least a quarterly basis to determine a provision for credit losses to maintain our ACL at a level we believe is appropriate to recognize current expected credit losses. Our Chief Credit Officer oversees the loan review department, which measures the adequacy of the ACL independently of loan production officers. For detailed information on the ACL methodology, see “Note 6. Loans” to the unaudited consolidated financial statements herein.
At March 31, 2023, the ACL amounted to $23.8 million, which represented a $1.4 million increase compared to the $22.4 million ACL at December 31, 2022. The increase reflected the impact of historical net charge-offs applied to the estimated remaining lives of outstanding loans.
A description of loan review coverage targets is set forth below.
The following loan review percentages are performed over periods of eighteen to twenty-four months. At March 31, 2023, in excess of 50% of the total continuing loan portfolio was reviewed by the loan review department or, for SBLs, rated internally by that department. In addition to the review of all classified loans, the targeted coverages and scope of the reviews are risk-based and vary according to each portfolio as follows:
SBLOC – The targeted review threshold is 40%, including a sample focusing on the largest 25% of SBLOCs by commitment. A random sample of at least twenty loans will be reviewed each quarter. At March 31, 2023, approximately 46% of the SBLOC portfolio had been reviewed.
IBLOC – The targeted review threshold is 40%, including a sample focusing on the largest 25% of IBLOCs by commitment. A random sample of at least twenty loans will be reviewed each quarter. At March 31, 2023, approximately 48% of the IBLOC portfolio had been reviewed.
Advisor Financing – The targeted review threshold is 50%. At March 31, 2023, approximately 92% of the advisor financing portfolio had been reviewed. The loan balance review threshold is $1.0 million.
SBLs – The targeted review threshold is 60%, to be rated and/or reviewed within 90 days of funding, excluding fully guaranteed loans purchased for CRA purposes, and fully guaranteed PPP loans. The loan balance review threshold is $1.5 million and additionally includes any classified loans. At March 31, 2023, approximately 72% of the non-government guaranteed SBL loan portfolio had been reviewed.
Direct Lease Financing – The targeted review threshold is 35%. At March 31, 2023, approximately 42% of the leasing portfolio had been reviewed. The loan balance review threshold is $1.5 million.
Commercial Real Estate Bridge Loans, at fair value and Commercial Real Estate Bridge Loans, at amortized cost (floating rate, excluding SBA, which are included in SBLs above) – The targeted review threshold is 60%. Floating rate loans will be reviewed initially within 90 days of funding and will be monitored on an ongoing basis as to payment status. Subsequent reviews will be performed for relationships over $10.0 million. At March 31, 2023, approximately 100% of the floating rate, non-SBA commercial real estate bridge loans outstanding for more than 90 days had been reviewed.
Commercial Real Estate Loans, at fair value (fixed rate, excluding SBA, which are included in SBLs above) – The targeted review threshold is 100%. At March 31, 2023, approximately 100% of the fixed rate, non-SBA commercial real estate loan portfolio had been reviewed.
Specialty Lending – Specialty lending, defined as commercial loans unique in nature that do not fit into other established categories, has a targeted review coverage threshold of 100% for non-CRA loans. At March 31, 2023, approximately 100% of the non-CRA loans had been reviewed.
Home Equity Lines of Credit (“HELOC”) – Due to the small number and outstanding balances of HELOCs, only the largest loans will be subject to review. The remaining loans are monitored and, if necessary, adversely classified under the Uniform Retail Credit Classification and Account Management Policy. At March 31, 2023, approximately 72% of the HELOC portfolio had been reviewed.
Other minor loan categories are reviewed at the discretion of the loan review department.
The following tables present delinquencies by type of loan as of the dates specified (in thousands):
Although we consider our ACL to be adequate based on information currently available, future additions to the ACL may be necessary due to changes in economic conditions, our ongoing loss experience and that of our peers, changes in management’s assumptions as to future delinquencies, recoveries and losses, deterioration of specific credits and management’s intent with regard to the disposition of loans and leases.
The following table summarizes select asset quality ratios for each of the periods indicated:
For the year ended
or as of March 31,
or as of December 31,
Ratio of:
ACL to total loans
0.44%
0.46%
0.41%
ACL to non-performing loans(1)
172.28%
231.82%
123.40%
Non-performing loans to total loans(1)
0.26%
0.33%
Non-performing assets to total assets(1)
0.38%
0.50%
Net charge-offs to average loans
0.01%
0.03%
(1)Includes loans 90 days past due still accruing interest.
The ratio of the ACL to total loans decreased to 0.44% as of March 31, 2023 from 0.46% at March 31, 2022. The reduction resulted from an increase in loans which was proportionately greater than the increase in the ACL. SBLOC, IBLOC and real estate bridge loans have allowance allocations lower than the overall percentage of ACL to total loans, due to the nature of the collateral, which serves to reduce that percentage.
The ratio of the ACL to non-performing loans decreased to 172.28% at March 31, 2023, from 231.82% at March 31, 2022, primarily as a result of the increase in non-performing loans which proportionately exceeded the increase in the ACL. As a result of the increase in non-performing loans, the ratio of non-performing loans to total loans also increased to 0.26% at March 31, 2023 from 0.20% at March 31, 2022.
The ratio of non-performing assets to total assets increased to 0.46% at March 31, 2023 from 0.38% at March 31, 2022, again reflecting the increase in non-performing loans. The higher non-performing assets total at March 31, 2023 included OREO of $3.9 million for a movie theater property as described in Note E to the consolidated financial statements in the 2022 Form 10-K.
The ratio of net charge-offs to average loans was 0.01% for the three months ended March 31, 2023 and 0.01% for the three months ended March 31, 2022. While net charge-offs increased between those periods, increases in average loans partially offset the impact of such increases.
Net Charge-offs
Net charge-offs were $778,000 for the three months ended March 31, 2023, an increase of $520,000 from net charge-offs of $258,000 during the three months ended March 31, 2022. Charge-offs in both periods resulted primarily from non-real estate SBL and leasing charge-offs. SBL charge-offs resulted primarily from the non-government guaranteed portion of SBA loans.
The following tables reflect the relationship of year-to-date average loans outstanding, based upon quarter end balances, and net charge-offs by loan category (dollars in thousands):
214
905
(202)
(67)
Net charge-offs
838
Average loan balance
111,644
483,647
31,990
642,351
2,192,960
180,947
1,710,677
60,945
Ratio of net charge-offs during the period to average loans during the period
0.13%
98
191
172
135,055
373,365
29,316
534,814
1,998,407
131,116
712,589
33,055
0.06%
We review charge-offs at least quarterly in loan surveillance meetings which include the chief credit officer, the loan review department and other senior credit officers in a process which includes identifying any trends or other factors impacting portfolio management. In recent periods charge-offs have been primarily comprised of the non-guaranteed portion of SBA 7a loans and leases. The charge-offs have resulted from individual borrower or business circumstances as opposed to overall trends or other factors.
Non-accrual Loans, Loans 90 Days Delinquent and Still Accruing, OREO and Troubled Debt Restructurings.
Loans are considered to be non-performing if they are on a non-accrual basis or they are past due 90 days or more and still accruing interest. A loan which is past due 90 days or more and still accruing interest remains on accrual status only when it is both adequately secured as to principal and interest, and is in the process of collection. Troubled debt restructurings are loans with terms that have been renegotiated to provide a reduction or deferral of interest or principal, because of a weakening in the financial positions of the borrowers. We had $21.1 million of OREO at March 31, 2023 and $21.2 million of OREO at December 31, 2022. The following tables summarize our non-performing loans, OREO, and loans past due 90 days or more still accruing interest.
We had no commitments to extend additional credit to loans classified as troubled debt restructurings as of March 31, 2023 or December 31, 2022.
The following table summarizes loans that were restructured within the twelve months ended March 31, 2023 that have subsequently defaulted (dollars in thousands)
The following table provides information about credit deteriorated loans at March 31, 2023 and December 31, 2022 (in thousands):
We had $12.9 million of non-accrual loans at March 31, 2023, compared to $10.4 million of non-accrual loans at December 31, 2022. The $2.5 million increase in non-accrual loans was primarily due to $6.8 million of loans placed on non-accrual status, partially offset by $2.9 million transferred to repossessed vehicle inventory, $1.0 million of charge-offs, and $342,000 of payments. Loans past due 90 days or more still accruing interest amounted to $873,000 at March 31, 2023 and $7.8 million at December 31, 2022. The $6.9 million decrease reflected $1.4 million of additions partially offset by $3.8 million of loan payments, $3.6 million transferred to non-accrual loans $737,000 transferred to OREO, and $207,000 of charge-offs.
We had $21.1 million of OREO at March 31, 2023 and $21.2 million of OREO at December 31, 2022. The change in balance reflected $737,000 transferred from loans past due 90 days or more still accruing interest, and $830,000 of charge-offs.
We evaluate loans under an internal loan risk rating system as a means of identifying problem loans. At March 31, 2023 and December 31, 2022, classified loans were segregated by year of origination and are shown in “Note 6. Loans” to the unaudited consolidated financial statements herein.
Premises and Equipment, Net
Premises and equipment amounted to $21.3 million at March 31, 2023, compared to $18.4 million at December 31, 2022. The increase reflected the acquisition of equipment for a new data center.
Our primary source of funding is deposit acquisition. We offer a variety of deposit accounts with a range of interest rates and terms, including demand, checking and money market accounts. The majority of our deposits are generated through prepaid and debit card and other payments related deposit accounts. One of our strategic focuses is growing these accounts through affinity groups. At March 31, 2023, we had total deposits of $6.70 billion compared to $7.03 billion at December 31, 2022, a decrease of $325.5 million, or 4.6%. The change reflected a $330.0 million decrease in short term time deposits. Those time deposits matured in the first quarter of 2023.
The following table presents the average balance and rates paid on deposits for the periods indicated (dollars in thousands):
balance
rate
Demand and interest checking(1)
5,670,818
0.70%
510,370
1.67%
86,907
3.15%
6,268,095
0.82%
(1)Non-interest bearing demand accounts are not paid interest. The amount shown as interest reflects the fees paid to affinity groups, which are based upon a rate index, and therefore classified as interest expense.
Short-term Borrowings
Short-term borrowings consist of amounts borrowed on our lines of credit with the Federal Reserve Bank or FHLB. There were no borrowings on either line at March 31, 2023 or December 31, 2022. We generally utilize overnight borrowings to manage our daily reserve requirements at the Federal Reserve. Period-end and year-to-date information for the dates shown is as follows.
Balance at period end
Average for the three months ended March 31, 2023
Average during the year
60,312
Maximum month-end balance
450,000
495,000
Weighted average rate during the period
2.55%
Rate at period end
Senior Debt
On August 13, 2020, we issued $100.0 million of the 2025 Senior Notes, with a maturity date of August 15, 2025, and a 4.75% interest rate, with interest paid semi-annually on March 15 and September 15. The 2025 Senior Notes are the Company’s direct, unsecured and unsubordinated obligations and rank equal in priority with all our existing and future unsecured and unsubordinated indebtedness and senior in right of payment to all our existing and future subordinated indebtedness. In lieu of repayment of debt from dividends paid by the Bank to the Company, industry practice includes the issuance of new debt to repay maturing debt.
Borrowings
At March 31, 2023, we had other long-term borrowings of $10.0 million, unchanged from $10.0 million at December 31, 2022. The borrowings consisted of sold loans which were accounted for as a secured borrowing because they did not qualify for true sale accounting. We do not have any policy prohibiting us from incurring debt.
The 2038 Debentures, which total $13.4 million, mature in March 2038 and bear interest at three-month LIBOR plus 3.25%, are grandfathered to qualify as tier 1 capital at the Bank.
Other Liabilities
Other liabilities amounted to $54.6 million at March 31, 2023, compared to $56.3 million at December 31, 2022.
Off-balance sheet arrangements
There were no off-balance sheet arrangements during the three months ended March 31, 2023 that have or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to our interests.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Information about market risk for the quarter ended March 31, 2023 is included under “Asset and Liability Management” in Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report on Form 10-Q. Except for such information, there has been no material change to our assessment of our sensitivity to market risk as discussed in the 2022 Form 10-K.
As noted under “Asset and Liability Management,” the Company’s exposure to interest rate risk is managed through the use of guidelines which limit interest rate exposure to higher interest rates. Because the Company has emphasized variable rate instruments in its loan and investment portfolios, it tends to benefit from higher interest rate environments. As a result of the Federal Reserve rate increases in 2022 and 2023, net interest income has increased and exceeded prior period levels. Future Federal Reserve rate reductions may result in a return to lower net interest income levels. In addition to the aforementioned guidelines which the Company uses to manage interest rate risk, the Company utilizes an asset liability committee to provide oversight by multiple departments and senior officers.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (our principal executive officer) and our Chief Financial Officer (our principal financial officer), as appropriate, to allow timely decisions regarding required disclosure. Because of inherent limitations, disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of disclosure controls and procedures are met.
Under the supervision of our Chief Executive Officer and Chief Financial Officer, our management carried out an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at a reasonable level of assurance as of March 31, 2023.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
For a discussion of our material pending legal proceedings, see “Note 14. Legal” to the unaudited consolidated financial statements in this Quarterly Report on Form 10-Q, which is incorporated herein by reference.
Item 1A. Risk Factors
Our business, financial condition, operating results and cash flows are subject to various risks and uncertainties, including those described in Part I, Item 1A. “Risk Factors” in the 2022 Form 10-K and additionally by the following risk factor.
Recent developments in the banking industry related to specific problem banks could have a negative impact on the industry as a whole and may negatively impact stock prices and result in additional regulations that could increase our expenses and otherwise affect our operations.
Recent high-profile bank failures have generated market volatility among publicly traded bank holding companies, unrelated to the Company, and industry commentary through social media and other outlets has negatively impacted confidence in depository institutions and created uncertainty with respect to the health of the U.S. banking system. If such levels of financial market volatility continue, or if rumored or actual events occur which further erode the actual or perceived stability of the banking system and financial markets, this could trigger additional regulatory scrutiny, increased FDIC insurance premiums or assessments, and new or amended regulations which may adversely affect the Company. While the underlying causes of these recent market events are not apparent within the Company or the Bank, these recent events and regulatory agency responses, including increased FDIC insurance premiums or assessments, could have a material impact on our business.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Stock Repurchases
The following table sets forth information regarding the Company’s repurchases of its common stock during the quarter ended March 31, 2023:
Period
Total number of shares purchased
Average price paid per share
Total number of shares purchased as part of publicly announced plans or programs(1)
Approximate dollar value of shares that may yet be purchased under the plans or programs(2)
January 1, 2023 - January 31, 2023
321,653
29.65
90,462
February 1, 2023 - February 28, 2023
275,552
35.14
80,778
March 1, 2023 - March 31, 2023
181,237
31.88
75,000
778,442
32.12
(1)During the first quarter of 2023, all shares of common stock were repurchased pursuant to the 2023 Repurchase Program, which was approved by the Board on October 26, 2022 and publicly announced on October 27, 2022. Under the 2023 Repurchase Program, the Company is authorized to repurchase shares of its common stock totaling up to $25.0 million per quarter, for a maximum amount of $100.0 million in 2023. The Company may repurchase shares through open market purchases, including through written trading plans under Rule 10b5-1 under the Exchange Act, privately-negotiated transactions, block purchases or otherwise in accordance with applicable federal securities laws, including Rule 10b-18 under the Exchange Act.
(2)The 2023 Repurchase Program may be suspended, amended or discontinued at any time and has an expiration date of December 31, 2023. With respect to further repurchases, the Company cannot predict if, or when, it will repurchase any shares of common stock, and the timing and amount of any shares repurchased will be determined by management based on its evaluation of market conditions and other factors.
Item 6. Exhibits
Exhibit No.
3.1.1
Certificate of Incorporation filed July 20, 1999, amended July 27, 1999, amended June 7, 2001, and amended October 8, 2002 (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-4 filed July 15, 2004)
3.1.2
Amendment to Certificate of Incorporation filed July 30, 2009 (incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q filed November 9, 2016)
3.1.3
Amendment to Certificate of Incorporation filed May 18, 2016 (incorporated by reference to Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q filed November 9, 2016)
3.2
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K filed March 16, 2017)
31.1
Rule 13a-14(a)/15d-14(a) Certifications *
31.2
32.1
Section 1350 Certifications *
32.2
101.INS
Inline XBRL Instance Document **
101.SCH
Inline XBRL Taxonomy Extension Schema Document *
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document *
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document *
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document *
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document *
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) *
*
Filed herewith
**
The Instance Document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
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.
THE BANCORP, INC.
(Registrant)
May 10, 2023
/S/ DAMIAN KOZLOWSKI
Date
Damian Kozlowski
Chief Executive Officer
/S/ PAUL FRENKIEL
Paul Frenkiel
Chief Financial Officer and Secretary