Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2024
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-38290
Sterling Bancorp, Inc.
(Exact name of registrant as specified in its charter)
Michigan
38-3163775
(State or other jurisdiction ofincorporation or organization)
(I.R.S. Employer Identification Number)
One Towne Square, Suite 1900
Southfield, Michigan 48076
(248) 355-2400
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
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
SBT
Nasdaq Capital Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐
Accelerated filer ☒
Non-accelerated filer ☐
Smaller reporting company ☒
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of April 30, 2024, 52,025,988 shares of the registrant’s Common Stock were outstanding.
STERLING BANCORP, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
Page
PART I — FINANCIAL INFORMATION
Item 1.
Financial Statements (Unaudited)
2
Condensed Consolidated Balance Sheets at March 31, 2024 and December 31, 2023
Condensed Consolidated Statements of Operations for the three months ended March 31, 2024 and 2023
3
Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2024 and 2023
4
Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2024 and 2023
5
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2024 and 2023
6
Notes to the Condensed Consolidated Financial Statements
7
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
28
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
47
Item 4.
Controls and Procedures
49
PART II — OTHER INFORMATION
Legal Proceedings
50
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
51
Item 5.
Other Information
Item 6.
Exhibits
52
Exhibit Index
SIGNATURES
53
1
Condensed Consolidated Balance Sheets (Unaudited)
(dollars in thousands)
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
March 31,
December 31,
2024
2023
Assets
Cash and due from banks
$
646,168
577,967
Interest-bearing time deposits with other banks
5,229
5,226
Debt securities available for sale, at fair value (amortized cost $416,917 and $440,211 at March 31, 2024 and December 31, 2023, respectively)
394,852
419,213
Equity securities
4,656
4,703
Loans, net of allowance for credit losses of $29,257 and $29,404 at March 31, 2024 and December 31, 2023, respectively
1,274,022
1,319,568
Accrued interest receivable
9,195
8,509
Mortgage servicing rights, net
1,485
1,542
Leasehold improvements and equipment, net
5,206
5,430
Operating lease right-of-use assets
12,358
11,454
Federal Home Loan Bank stock, at cost
18,923
Federal Reserve Bank stock, at cost
9,096
9,048
Company-owned life insurance
8,764
8,711
Deferred tax asset, net
18,240
16,959
Other assets
6,361
8,750
Total assets
2,414,555
2,416,003
Liabilities and Shareholders’ Equity
Liabilities
Noninterest-bearing deposits
32,680
35,245
Interest-bearing deposits
1,973,175
1,968,741
Total deposits
2,005,855
2,003,986
Federal Home Loan Bank borrowings
50,000
Operating lease liabilities
13,407
12,537
Other liabilities
18,027
21,757
Total liabilities
2,087,289
2,088,280
Shareholders’ equity
Preferred stock, authorized 10,000,000 shares; no shares issued and outstanding
—
Common stock, no par value, authorized 500,000,000 shares; issued and outstanding 52,046,683 shares and 52,070,361 shares at March 31, 2024 and December 31, 2023, respectively
84,323
Additional paid-in capital
17,173
16,660
Retained earnings
241,767
241,964
Accumulated other comprehensive loss
(15,997)
(15,224)
Total shareholders’ equity
327,266
327,723
Total liabilities and shareholders’ equity
See accompanying notes to condensed consolidated financial statements.
Condensed Consolidated Statements of Operations (Unaudited)
(dollars in thousands, except per share amounts)
Three Months Ended
Interest income
Interest and fees on loans
20,969
22,160
Interest and dividends on investment securities and restricted stock
4,018
2,456
Other interest
8,295
4,807
Total interest income
33,282
29,423
Interest expense
Interest on deposits
18,100
9,809
Interest on Federal Home Loan Bank borrowings
248
245
Interest on Subordinated Notes
1,693
Total interest expense
18,348
11,747
Net interest income
14,934
17,676
Provision for credit losses
41
674
Net interest income after provision for credit losses
14,893
17,002
Non-interest income
Service charges and fees
87
94
Loss on the sale of investment securities
(2)
Loss on sale of loans held for sale
(25)
Unrealized gain (loss) on equity securities
(47)
71
Net servicing income
75
59
Income earned on company-owned life insurance
83
80
Other
Total non-interest income
199
278
Non-interest expense
Salaries and employee benefits
8,460
9,410
Occupancy and equipment
2,084
2,112
Professional fees
2,182
3,221
FDIC assessments
262
257
Data processing
733
738
1,671
2,099
Total non-interest expense
15,392
17,837
Loss before income taxes
(300)
(557)
Income tax benefit
(103)
(54)
Net loss
(197)
(503)
Loss per share, basic and diluted
(0.00)
(0.01)
Weighted average common shares outstanding:
Basic
50,843,106
50,444,463
Diluted
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
Other comprehensive income (loss), net of tax:
Unrealized gain (loss) on investment securities, arising during the period, net of tax effect of $(293) and $1,054, respectively
(773)
2,785
Reclassification adjustment for loss included in net loss of $— and $2, respectively, included in loss on sale of investment securities, net of tax effect of $— and $1, respectively
Total other comprehensive income (loss)
2,786
Comprehensive income (loss)
(970)
2,283
Condensed Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
Accumulated
Additional
Total
Paid-in
Retained
Comprehensive
Shareholders’
Shares
Amount
Capital
Earnings
Loss
Equity
Balance at January 1, 2023
50,795,871
83,295
14,808
234,049
(19,525)
312,627
Cumulative-effect adjustment of a change in accounting principle, net of tax, on adoption of ASU 2016-13
778
Cumulative-effect adjustment of a change in accounting principle, net of tax, on adoption of ASU 2022-02
(276)
Repurchase of restricted shares to pay employee tax liability
(12,166)
(75)
Stock-based compensation
24,411
173
Other comprehensive income
Balance at March 31, 2023
50,808,116
14,906
234,048
(16,739)
315,510
Balance at January 1, 2024
52,070,361
(38,033)
(216)
14,355
729
Other comprehensive loss
Balance at March 31, 2024
52,046,683
Condensed Consolidated Statements of Cash Flows (Unaudited)
Cash Flows From Operating Activities
Adjustments to reconcile net loss to net cash used in operating activities:
Deferred income taxes
(988)
2,394
Loss on sale of investment securities
Unrealized (gain) loss on equity securities
(71)
Net amortization (accretion) on debt securities
(1,128)
(491)
Depreciation and amortization on leasehold improvements and equipment
276
352
Originations, net of principal payments, of loans held for sale
(2,667)
Proceeds from sale of mortgage loans held for sale
2,979
25
Increase in cash surrender value of company-owned life insurance, net of premiums
(53)
(52)
Valuation allowance adjustments and amortization of mortgage servicing rights
57
91
9
175
Change in operating assets and liabilities:
(686)
212
1,967
(2,340)
(3,951)
(4,426)
Net cash used in operating activities
(3,877)
(3,473)
Cash Flows From Investing Activities
Maturities and principal receipts of debt securities
106,585
5,358
Proceeds from sale of debt securities
2,977
Purchases of debt securities
(82,162)
(2,979)
Purchase of shares of Federal Reserve Bank stock
(48)
Net decrease in loans
46,113
70,008
Principal payments received on commercial real estate loans held for sale
10
Purchases of leasehold improvements and equipment
(63)
(190)
Net cash provided by investing activities
70,425
75,184
Cash Flows From Financing Activities
Net increase (decrease) in deposits
1,869
(32,215)
Cash paid for surrender of vested shares to satisfy employee tax liability
Net cash provided (used in) financing activities
1,653
(32,290)
Net change in cash and due from banks
68,201
39,421
Cash and due from banks at beginning of period
379,798
Cash and due from banks at end of period
419,219
Supplemental cash flows information
Cash paid for:
Interest
18,129
11,424
Income taxes
Noncash investing and financing activities:
Transfer of residential real estate loans to loans held for sale
34,581
Transfer of residential real estate loans from loans held for sale
3,906
Right-of-use assets obtained in exchange for new operating lease liabilities
1,780
Notes to Condensed Consolidated Financial Statements – (Unaudited)
(dollars in thousands, except share and per share amounts)
Note 1—Nature of Operations and Basis of Presentation
Nature of Operations
Sterling Bancorp, Inc. (unless stated otherwise or the context otherwise requires, together with its subsidiaries, the “Company”) is a unitary thrift holding company that was incorporated in 1989 and the parent company of its wholly owned subsidiary, Sterling Bank and Trust, F.S.B. (the “Bank”), which was formed in 1984. The Company’s business is conducted through the Bank. The Bank originates commercial real estate loans and commercial and industrial loans, and provides deposit products, consisting primarily of checking, savings and term certificate accounts. The Bank also engages in mortgage banking activities and, as such, acquires, sells and services residential mortgage loans. The Bank operates through a network of 27 branches of which 25 branches are located in the San Francisco and Los Angeles, California metropolitan areas with the remaining branches located in New York, New York and Southfield, Michigan. In February 2024, the Company closed one of its branches in San Francisco and consolidated the operations into a nearby branch office. The Company is headquartered in Southfield, Michigan.
Historically, the Company’s largest asset class has been residential mortgage loans. In 2023, the Bank discontinued originating residential loans. The Company is currently exploring and evaluating potential strategic alternatives which may include incorporating new banking products and services.
The Company is subject to regulation, examination and supervision by the Board of Governors of the Federal Reserve System (the “FRB” or “Federal Reserve”). The Bank is a federally chartered stock savings bank that has elected to operate as a covered savings association, effective August 9, 2023. As a covered savings association, the Bank will generally function as a commercial bank without the constraints applicable to a thrift institution. Prior to the election becoming effective, the Bank was subject to the Qualified Thrift Lender (“QTL”) test. Under the QTL test, a savings institution is required to maintain at least 65% of its portfolio assets in certain qualified thrift investments (primarily residential mortgages and related investments, including certain mortgage-backed and related securities) in at least nine months out of each 12-month period. The Bank is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (“OCC”) of the U.S. Department of Treasury and the Federal Deposit Insurance Corporation (“FDIC”) and is a member of the FRB system and Federal Home Loan Bank (“FHLB”) system.
Basis of Presentation
The condensed consolidated balance sheet as of March 31, 2024, and the condensed consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity and cash flows for the three months ended March 31, 2024 and 2023 are unaudited. The unaudited condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and reflect all adjustments, in the opinion of management, of a normal recurring nature that are necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented. The financial data and other financial information disclosed in these notes to the condensed consolidated financial statements related to these periods are also unaudited. The results of operations for the three months ended March 31, 2024 are not necessarily indicative of the results that may be expected for the year ended December 31, 2024 or for any future annual or interim period. The condensed consolidated balance sheet at December 31, 2023 included herein was derived from the audited financial statements as of that date. The accompanying unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023, as filed with the U.S. Securities and Exchange Commission on March 14, 2024.
Note 2—Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The condensed consolidated financial statements include the results of Sterling Bancorp, Inc. and its wholly-owned subsidiaries.
All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Due to the inherent uncertainty involved in making estimates, actual results reported in the future periods may be based upon amounts that could differ from those estimates.
Concentration of Credit Risk
The loan portfolio consists primarily of residential real estate loans, which are collateralized by real estate. At March 31, 2024 and December 31, 2023, residential real estate loans accounted for 80% of total gross loans. In addition, most of these residential loans and other commercial loans have been made to individuals and businesses in the state of California, which are dependent on the area economy for their livelihoods and servicing of their loan obligation. At March 31, 2024 and December 31, 2023, approximately 79% and 80%, respectively, of gross loans were originated with respect to properties or businesses located in the state of California.
Also, the loan portfolio consists of a loan product of one-, three-, five- or seven-year adjustable-rate mortgages that required a down payment of at least 35% (also referred to herein as “Advantage Loan Program loans”) which was terminated at the end of 2019 and continues to be the largest portion of gross residential loans. An internal review of the Advantage Loan Program and investigations conducted by the U.S. Department of Justice and the OCC indicated that certain employees engaged in misconduct in connection with the origination of a significant number of such loans, including the falsification of information with respect to verification of income, the amount of income reported for borrowers, reliance on third parties and related documentation. This former loan product totaled $593,144, or 57% of gross residential loans, and $628,245, or 58% of gross residential loans, at March 31, 2024 and December 31, 2023, respectively.
Recently Issued Accounting Standards Not Yet Adopted
In December 2023, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures (“ASU 2023-09”), which requires greater disaggregation of information in a reporting entity’s effective tax rate reconciliation as well as disaggregation of income taxes paid by jurisdiction. This ASU 2023-09 is effective for annual periods beginning after December 15, 2024. The guidance should be applied on a prospective basis with the option to apply the standard retrospectively. Early adoption is permitted. The Company is currently evaluating the impact of ASU 2023-09 on its income tax disclosures.
8
In November 2023, the FASB issued ASU 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures (“ASU 2023-07”), which requires more disaggregated expense information about a public entity’s reportable segments if the significant segment expenses are regularly provided to the chief operating decision maker and included in each reported measure of segment profit or loss. Additionally, ASU 2023-07 allows public entities to disclose more than one measure of segment profit or loss used by the chief operating decision maker. For public entities that have one reportable segment, ASU 2023-07 confirmed that all of the disclosures required in the segment guidance, including disclosing a measure of segment profit or loss and reporting significant segment expense and other items apply to these entities. This ASU 2023-07 does not change the definition of a segment, the method of determining segments, or the criteria for aggregating operating segments into reportable segments. The ASU 2023-07 is effective for fiscal years beginning after December 15, 2023, and interim periods in fiscal years beginning after December 15, 2024. The ASU 2023-07 should be adopted retrospectively as of the beginning of the earliest period presented. Early adoption is permitted. The Company is currently evaluating the impact of ASU 2023-07 on its segment reporting disclosures.
Note 3—Debt Securities
The following tables summarize the amortized cost and fair value of available for sale debt securities at March 31, 2024 and December 31, 2023 and the corresponding amounts of gross unrealized gains and losses:
March 31, 2024
Amortized
Gross Unrealized
Fair
Cost
Gain
Value
Available for sale:
U.S. Treasury and Agency securities
154,007
(4,141)
149,869
Mortgage-backed securities
34,629
(4,020)
30,609
Collateralized mortgage obligations
228,131
(13,910)
214,231
Collateralized debt obligations
150
(7)
143
416,917
13
(22,078)
December 31, 2023
253,107
(4,176)
248,988
35,757
(3,830)
31,927
151,196
27
(13,066)
138,157
151
(10)
141
440,211
84
(21,082)
Investment securities with a fair value of $75,400 were pledged as collateral on the FHLB borrowings at March 31, 2024.
Accrued interest receivable on available for sale debt securities totaled $1,403 and $1,535 at March 31, 2024 and December 31, 2023, respectively.
The mortgage-backed securities, and a majority of the collateralized mortgage obligations are issued and/or guaranteed by a U.S. government agency (Government National Mortgage Association) or a U.S. government-sponsored enterprise (Federal Home Loan Mortgage Corporation (“Freddie Mac”) or Federal National Mortgage Association (“Fannie Mae”)). The fair value of the private-label collateralized mortgage obligations was $285 and $308 at March 31, 2024 and December 31, 2023, respectively.
No securities of any single issuer, other than debt securities issued by the U.S. government, government agency and government-sponsored enterprises, were in excess of 10% of total shareholders’ equity as of March 31, 2024 and December 31, 2023.
Information pertaining to sales of available for sale debt securities for the three months ended March 31, 2024 and 2023 is as follows:
Proceeds from the sale of debt securities
Gross realized gains
Gross realized losses
(3)
Total net realized losses
The income tax benefit related to the net realized losses was $(1) for the three months ended March 31, 2023.
The amortized cost and fair value of U.S. Treasury and Agency securities at March 31, 2024 are shown by contractual maturity in the table below. Mortgage-backed securities, collateralized mortgage obligations and collateralized debt obligations are disclosed separately as the expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
U.S. Treasury and Agency securities:
Due less than one year
74,470
74,469
Due after one year through five years
79,537
75,400
The following table summarizes available for sale debt securities, at fair value, in an unrealized loss position for which an allowance for credit losses has not been recorded at March 31, 2024 and December 31, 2023, aggregated by major security type and length of time the individual securities have been in a continuous unrealized loss position:
Less than 12 Months
12 Months or More
Unrealized
Losses
49,820
(4)
(4,137)
125,220
103,507
(277)
107,065
(13,633)
210,572
153,327
(281)
213,217
(21,797)
366,544
49,836
(1)
125,183
(4,175)
175,019
10,297
(221)
111,554
(12,845)
121,851
60,133
(222)
268,805
(20,860)
328,938
As of March 31, 2024, the debt securities portfolio consisted of 35 debt securities, with 32 debt securities in an unrealized loss position. For debt securities in an unrealized loss position, the Company has both the intent and ability to hold these investments and, based on the current conditions, the Company does not believe it is likely that it will be required to sell these debt securities prior to recovery of the amortized cost. As the Company had the intent and the ability to hold the debt securities in an unrealized loss position at March 31, 2024, each security with an unrealized loss position was further assessed to determine if a credit loss exists.
The Company’s debt, mortgage-backed securities and the majority of the collateralized mortgage obligations are issued and guaranteed by the U.S. government, its agencies and government-sponsored enterprises. The Company has a long history with no credit losses from issuers of U.S. government, its agencies and government-sponsored enterprises. As a result, management does not expect any credit losses on its available for sale debt securities. Accordingly, the Company has not recorded an allowance for credit losses for its available for sale debt securities at March 31, 2024 and December 31, 2023.
Note 4—Equity Securities
Equity securities consist of an investment in a qualified community reinvestment act investment fund, which is a publicly-traded mutual fund and an investment in the common equity of Pacific Coast Banker’s Bank, a thinly traded restricted stock. At March 31, 2024 and December 31, 2023, equity securities totaled $4,656 and $4,703, respectively.
Equity securities with readily determinable fair values are stated at fair value with realized and unrealized gains and losses reported in non-interest income in the condensed consolidated statements of operations. At March 31, 2024 and December 31, 2023, equity securities with readily determinable fair values were $4,410 and $4,457, respectively. The following is a summary of unrealized and realized gains and losses recognized in the condensed consolidated statements of operations:
Net gain (loss) recorded during the period on equity securities
Less: net gain (loss) recorded during the period on equity securities sold during the period
Unrealized gain (loss) recorded during the period on equity securities held at the reporting date
The Company has elected to account for its investment in a thinly traded, restricted stock using the measurement alternative for equity securities without readily determinable fair values, resulting in the investment carried at cost based on no evidence of impairment or observable trading activity during the three months ended March 31, 2024 and 2023. The investment was reported at $246 at March 31, 2024 and December 31, 2023.
Note 5—Loans
Loans Held for Investment
The major categories of loans held for investment and the allowance for credit losses were as follows:
Residential real estate
1,040,464
1,085,776
Commercial real estate
244,546
236,982
Construction
4,915
10,381
Commercial and industrial
13,348
15,832
Other consumer
Total loans
1,303,279
1,348,972
Less: allowance for credit losses
(29,257)
(29,404)
Loans, net
Accrued interest receivable related to total gross loans was $6,701 and $6,617 as of March 31, 2024 and December 31, 2023, respectively.
11
Loans totaling $533,650 and $428,358 were pledged as collateral on the FHLB borrowings at March 31, 2024 and December 31, 2023, respectively. Residential real estate loans collateralized by properties that were in the process of foreclosure totaled $2,027 and $4,004 at March 31, 2024 and December 31, 2023, respectively.
In March 2023, residential real estate loans held for investment with an amortized cost of $41,059 were transferred to loans held for sale due to management’s change in intent and decision to sell the loans. On the transfer, the Company recorded a $6,478 charge off applied against the allowance for credit losses to reflect these loans at their estimated fair value. These residential real estate loans were sold in May 2023.
Allowance for Credit Losses
The allowance for credit losses was estimated using the current expected credit loss model. The Company’s estimate of the allowance for credit losses reflects losses expected over the remaining contractual life of the loans. The contractual term does not consider extensions, renewals or modifications unless the Company has identified a loan where the individual borrower is experiencing financial difficulty. The following tables present the activity in the allowance for credit losses related to loans held for investment by portfolio segment for the three months ended March 31, 2024 and 2023:
Residential
Commercial
Three Months Ended March 31, 2024
Real Estate
and Industrial
Allowance for credit losses:
Balance at the beginning of the period
14,322
13,550
1,386
146
29,404
Provision for (recovery of) credit losses
912
(395)
(616)
(147)
Charge offs
Recoveries
Total ending balance
15,234
13,155
770
98
29,257
Three Months Ended March 31, 2023
27,951
11,694
5,781
38
45,464
Adoption of ASU 2016-13
865
1,151
(3,633)
(34)
(1,651)
Adoption of ASU 2022-02
(11)
391
380
(1,889)
3,217
(546)
784
(6,478)
60
66
20,498
16,067
1,994
38,565
Nonaccrual Loans and Past Due Loans
Past due loans held for investment are loans contractually past due 30 days or more as to principal or interest payments. A loan held for investment is classified as nonaccrual, and the accrual of interest on such loan is discontinued, when the contractual payment of principal or interest becomes 90 days past due. In addition, a loan may be placed on nonaccrual at any other time management has serious doubts about further collectability of principal or interest according to the contractual terms, even though the loan is currently performing. A loan held for investment may remain in accrual status if it is in the process of collection and well secured. When a loan held for investment is placed in nonaccrual status, interest accrued but not received is reversed against interest income. Interest received on such loans is applied to the principal balance of the loan until qualifying for return to accrual status. Loans are returned to accrual status after all principal and interest amounts contractually due are made and future payments are reasonably assured.
12
The following table presents the total amortized cost basis of loans on nonaccrual status, the amortized cost basis of loans on nonaccrual status with no related allowance for credit losses and loans past due 90 days or more and still accruing at March 31, 2024 and December 31, 2023:
Nonaccrual
Past Due 90
With No
Days or More
Allowance for
and Still
Loans
Credit Losses
Accruing
Residential real estate:
Residential first mortgage
9,318
2,064
30
8,942
4,079
31
At March 31, 2024, the Company had nonaccrual loans of $9,318 in its held for investment loan portfolio. The increase in nonaccrual loans from December 31, 2023 was due to the addition of $1,480 of residential loans to nonaccrual status which was partially offset by loans totaling $877 that were returned to accrual status and payments of the loan principal of $227.
The total interest income that would have been recorded if the nonaccrual loans had been current in accordance with their original terms was $215 and $538 for the three months ended March 31, 2024 and 2023, respectively. The Company does not record interest income on nonaccrual loans.
Aging Analysis of Past Due Loans
The following table presents an aging of the amortized cost basis of contractually past due loans as of March 31, 2024 and December 31, 2023:
30 - 59
60 - 89
90 Days
Days
or More
Current
Past Due
10,316
2,708
9,348
22,372
1,018,092
1,280,907
16,634
2,305
8,973
27,912
1,057,864
1,321,060
Collateral-Dependent Loans
Collateral-dependent loans are those for which repayment (on the basis of the Company’s assessment as of the reporting date) is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty. The amortized cost basis of collateral-dependent loans was $2,027 and $4,004 at March 31, 2024 and December 31, 2023, respectively. These loans were collateralized by residential real estate property and the fair value of collateral on substantially all collateral-dependent loans were significantly in excess of their amortized cost basis.
Modifications to borrowers experiencing financial difficulty may include interest rate reductions, principal or interest forgiveness, forbearances, term extensions, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Historically, the Company has provided loan forbearances to residential borrowers when mandated and modified construction loans by providing term extensions. The Company did not have any loans held for investment to borrowers experiencing financial difficulty that were modified during the three months ended March 31, 2024. The Company did not have any loans held for investment to borrowers experiencing financial difficulty that were previously modified that subsequently defaulted during the three months ended March 31, 2024.
Credit Quality Indicators
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes homogeneous loans, such as residential real estate and other consumer loans, and non-homogeneous loans, such as commercial and industrial, construction and commercial real estate loans. This analysis is performed at least quarterly. The Company uses the following definitions for risk ratings:
Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.
Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the loan. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, based on currently existing facts, conditions and values, highly questionable and improbable.
Loans not meeting the criteria above that are analyzed individually as part of the above-described process are considered pass-rated loans.
14
For residential and consumer loan classes, the Company evaluates credit quality based on the accrual status of the loan. The following table presents the amortized cost in residential loans based on accrual status:
Revolving
Term Loans Amortized Cost Basis by Origination Year
Converted
As of March 31, 2024
2022
2021
2020
Prior
Costs Basis
to Term
Residential lending
Residential mortgage loans:
Payment performance:
Accrual
762
71,885
130,283
97,241
722,935
7,767
273
1,031,146
Total residential mortgage loans
732,253
Current period gross write offs
As of December 31, 2023
2019
764
72,840
132,567
99,676
202,793
560,185
7,729
280
1,076,834
1,739
7,203
204,532
567,388
1,858
4,601
19
6,478
The amortized cost basis by year of origination and credit quality indicator of the Company’s commercial loans based on the most recent analysis performed was as follows:
Commercial lending
Real estate - commercial real estate:
Risk rating
Pass
14,929
22,176
78,672
34,970
34,958
24,352
210,057
Special mention
944
3,550
2,718
8,632
15,844
Substandard or lower
11,785
6,860
18,645
Total real estate – commercial real estate
23,120
82,222
46,755
37,676
39,844
Real estate – commercial real estate:
Current period gross charge offs
Real estate – construction:
4,903
Total real estate - construction
Commercial and industrial:
9,467
1,064
2,672
Total commercial and industrial
15
28,975
79,013
33,694
35,148
6,938
13,020
196,788
948
3,574
1,407
2,724
8,610
4,253
21,516
11,778
2,805
4,095
18,678
Total real estate - commercial real estate
29,923
82,587
46,879
37,872
18,353
21,368
Real estate - construction:
1,591
1,605
8,776
14,461
1,071
97
130
73
Note 6—Mortgage Servicing Rights, net
The Company records servicing assets from the sale of residential real estate mortgage loans to the secondary market for which servicing has been retained. Residential real estate mortgage loans serviced for others are not included in the condensed consolidated balance sheets. The principal balance of these loans at March 31, 2024 and December 31, 2023 are as follows:
Residential real estate mortgage loan portfolios serviced for:
FNMA
103,969
105,689
FHLB
30,464
31,016
Private investors
29,937
33,044
164,370
169,749
Custodial escrow balances maintained with these serviced loans were $352 and $620 at March 31, 2024 and December 31, 2023, respectively. These balances are included in noninterest-bearing deposits in the condensed consolidated balance sheets.
16
Activity for mortgage servicing rights and the related valuation allowance are as follows:
Mortgage servicing rights:
Beginning of period
1,590
1,840
Additions
Amortization
(64)
(74)
End of period
1,526
1,766
Valuation allowance:
48
46
Additions (recoveries)
17
63
1,703
Servicing income, net of amortization of servicing rights and changes in the valuation allowance, was $75 and $59 for the three months ended March 31, 2024 and 2023, respectively.
The fair value of mortgage servicing rights was $1,807 and $1,857 at March 31, 2024 and December 31, 2023, respectively. The fair value of mortgage servicing rights is highly sensitive to changes in underlying assumptions. Changes in prepayment speed assumptions have the most significant impact on the estimate of the fair value of mortgage servicing rights. The fair value at March 31, 2024 was determined using discount rates ranging from 10.0% to 12.5%, prepayment speeds with a weighted average of 9.6% (depending on the stratification of the specific right), a weighted average life of the mortgage servicing right of 77 months and a weighted average default rate of 0.2%. The fair value at December 31, 2023 was determined using discount rates ranging from 10.0% to 12.5%, prepayment speeds with a weighted average of 9.8% (depending on the stratification of the specific right), a weighted average life of the mortgage servicing right of 77 months and a weighted average default rate of 0.2%.
Impairment is determined by stratifying the mortgage servicing rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type. At March 31, 2024 and December 31, 2023, the carrying amount of certain individual groupings exceeded their fair value, resulting in write-downs to fair value. Refer to Note 12—Fair Value.
Note 7—Deposits
Time deposits, included in interest-bearing deposits in the condensed consolidated balance sheets, were $900,996 and $873,220 at March 31, 2024 and December 31, 2023, respectively. The Company did not have any brokered deposits at March 31, 2024 and December 31, 2023.
Time deposits that meet or exceed the FDIC insurance limit of $250 were $267,934 and $255,222 at March 31, 2024 and December 31, 2023, respectively.
Note 8—FHLB Borrowings
FHLB Advances
At March 31, 2024 and December 31, 2023, the Company has a long-term fixed-rate FHLB advance of $50,000 with a maturity date of May 2029. The FHLB advance requires monthly interest-only payments at 1.96% per annum with the principal amount due on the maturity date and may contain a prepayment penalty if paid before maturity. The advance is callable by the FHLB on May 15, 2024.
FHLB Overdraft Line of Credit and Letters of Credit
The Company has established a short-term overdraft line of credit agreement with the FHLB, which provides for maximum borrowings of $20,000. The overdraft line of credit was not used during the three months ended March 31, 2024 and 2023. Borrowings accrue interest at a variable-rate based on the FHLB’s overnight cost of funds rate, which was 5.71% and 5.76% at March 31, 2024 and December 31, 2023, respectively. At March 31, 2024 and December 31, 2023, there were no outstanding borrowings under this agreement. The overdraft line of credit was renewed in October 2023. The overdraft line of credit is issued for a one-year term and automatically extends for an additional one-year term unless terminated in advance of the renewal by the Company.
The Company entered into irrevocable standby letters of credit arrangements with the FHLB to provide credit support for certain of its obligations related to its commitment to repurchase certain pools of Advantage Loan Program loans. The irrevocable standby letter of credit of $2,000 has a 36-month term and expires in July 2024. There were no borrowings outstanding on these standby letters of credit during the three months ended March 31, 2024 and 2023.
The long-term fixed-rate advance and the overdraft line of credit are collateralized by certain investment securities and loans. Based on this collateral and holdings of FHLB stock, the Company had additional borrowing capacity with the FHLB of $370,471 at March 31, 2024. Refer to Note 3—Debt Securities for further information on securities pledged and Note 5—Loans for further information on loans pledged.
Other Borrowings
The Company has available unsecured federal funds credit lines, which were held by two banks and reduced to $60,000 in March 2024. Previously, these unsecured federal funds credit lines were held by three banks totaling $80,000. There were no borrowings under these unsecured credit lines during the three months ended March 31, 2024 and 2023.
Note 9—Stock-based Compensation
The board of directors established the 2020 Omnibus Equity Incentive Plan (the “2020 Plan”), which was approved by the shareholders in December 2020. The 2020 Plan provides for the grant of up to 3,979,661 shares of common stock for stock options, stock appreciation rights, restricted stock, restricted stock units, performance units and performance shares for issuance to employees, consultants and the board of directors of the Company, of which 2,239,858 shares were available for future grants as of March 31, 2024. The stock-based awards are issued at no less than the market price on the date the awards are granted.
Previously, the board of directors had established a 2017 Omnibus Equity Incentive Plan (the “2017 Plan”) which was approved by the shareholders. The 2017 Plan initially provided for the grant of up to 4,237,100 shares of common stock for stock options, stock appreciation rights, restricted stock, restricted stock units and other stock-based awards for issuance to employees, consultants and the board of directors of the Company. The stock-based awards were issued at no less than the market price on the date the awards were granted. Due to the adoption of the 2020 Plan, no further grants will be issued under the 2017 Plan.
Stock Options
Stock option awards are granted with an exercise price equal to the market price of the Company’s common stock on the date of grant. Beginning with grants in 2020, stock option awards vest ratably over three years (one-third per year) after the date of grant, while stock option awards granted prior to 2020 generally vest in installments of 50% in each of the third and fourth year after the date of grant. All stock option awards have a maximum term of ten years.
18
A summary of the Company’s stock option activity as of and for the three months ended March 31, 2024 is as follows:
Weighted
Average
Remaining
Aggregate
Number
Exercise
Contractual
Intrinsic
of Shares
Price
Term
(Years)
Outstanding at January 1, 2024
340,395
4.96
6.23
531
Granted
Exercised
Forfeited/expired
Outstanding and exercisable at March 31, 2024
5.98
348
The Company recorded stock-based compensation expense associated with stock options of $1 for the three months ended March 31, 2023.
Restricted Stock Awards
Restricted stock awards are issued to independent directors and certain key employees. The restricted stock awards generally vest one-third per year over three years after the date of grant, unless the Executive Compensation Committee determines to establish a different vesting schedule for specific grants. The value of a restricted stock award is based on the market value of the Company’s common stock at the date of grant reduced by the present value of dividends per share expected to be paid during the period the shares are not vested. Upon a change in control, as defined in the 2017 Plan and 2020 Plan, the outstanding restricted stock awards will immediately vest.
During the three months ended March 31, 2024, the board of directors approved the issuance of 60,000 shares of restricted stock to independent directors with a weighted average grant-date fair value of $5.77. During the three months ended March 31, 2023, the board of directors approved the issuance of 60,000 shares of restricted stock to independent directors with a weighted average grant-date fair value of $6.09.
During the three months ended March 31, 2024 and 2023, the Company withheld 38,033 shares and 12,166 shares, respectively, of common stock representing a portion of the restricted stock awards that vested during the period in order to satisfy certain related employee tax withholding liabilities of $216 and $75, respectively, associated with vesting. These withheld shares are treated the same as repurchased shares for accounting purposes.
A summary of the restricted stock awards activity as of and for the three months ended March 31, 2024 is as follows:
Weighted Average
Grant Date
Fair Value
Nonvested at January 1, 2024
1,364,570
5.27
60,000
5.77
Vested
(176,644)
5.50
Forfeited
(45,645)
5.36
Nonvested at March 31, 2024
1,202,281
5.26
The fair value of the award is recorded as compensation expense on a straight-line basis over the vesting period. The Company recorded stock-based compensation expense associated with restricted stock awards of $729 and $172 for the three months ended March 31, 2024 and 2023, respectively. At March 31, 2024, there was $4,527 of total unrecognized compensation cost related to the nonvested stock granted which is expected to be recognized over a weighted-average period of 2.33 years. The total fair value of shares vested during the three months ended March 31, 2024 and 2023 was $1,007 and $399, respectively.
Note 10—Regulatory Capital Requirements
The Bank is subject to the capital adequacy requirements of the OCC. The Company, as a thrift holding company, generally is subject to the capital adequacy requirements of the Federal Reserve. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Prompt corrective action regulations provide five classifications for depository institutions like the Bank, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors, and the regulators, in their discretion, can require the Company to lower classifications in certain cases. Failure to meet minimum capital requirements can initiate regulatory action that could have a direct material effect on the Company’s business, financial condition and results of operations.
The federal banking agencies’ regulations provide for an optional simplified measure of capital adequacy for qualifying community banking organizations (that is, the “CBLR” framework), as implemented pursuant to the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018. The CBLR framework is designed to reduce the burden of the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework. In order to qualify for the CBLR framework, a community banking organization must have (i) a Tier 1 leverage ratio of greater than 9.0%, (ii) less than $10 billion in total consolidated assets, and (iii) limited amounts of off-balance-sheet exposure and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the capital ratio requirements for the well capitalized capital category under applicable prompt corrective action regulations and will not be required to report or calculate risk-based capital under generally applicable capital adequacy requirements. Failure to meet the qualifying criteria within the grace period of two reporting periods, or to maintain a leverage ratio of 8.0% or greater, would require the institution to comply with the generally applicable capital adequacy requirements. An eligible banking organization can opt out of the CBLR framework and revert to compliance with general capital adequacy requirements and capital measurements under prompt corrective action regulations without restriction.
The Company and the Bank have determined the organization is a qualifying community banking organization and has elected to measure capital adequacy under the CBLR framework, effective as of January 1, 2023. Management believes as of March 31, 2024, the Company and the Bank meet all capital adequacy requirements to which they are subject. The following tables present the consolidated Company’s and the Bank’s actual and minimum required capital amounts and ratios under the CBLR framework at March 31, 2024 and December 31, 2023:
To be Well
Capitalized Under
Prompt Corrective
Action Regulations
Actual
(CBLR Framework)
Ratio
Ratio(1)
Tier 1 (core) capital to average total assets (leverage ratio)
Consolidated
341,243
14.10
%
217,783
9.00
Bank
328,531
13.58
217,727
(1) Also represents the minimum leverage ratio threshold under the CBLR framework.
20
342,368
13.95
220,950
328,362
13.38
220,920
Dividend Restrictions
As noted above, federal banking regulations require the Bank to maintain certain capital levels and may limit the dividends paid by the Bank to the holding company or by the holding company to its shareholders. The holding company’s principal source of funds for dividend payments is dividends received from the Bank. Regulatory approval is required if (i) the total capital distributions for the applicable calendar year exceed the sum of the Bank’s net income for that year to date plus the Bank’s retained net income for the preceding two years or (ii) the Bank would not be at least adequately capitalized following the distribution. In addition, the Company currently is required to obtain the prior approval of the FRB in order to pay dividends to the Company’s shareholders.
Note 11—Loss Per Share
Basic income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted income per common share further includes any common shares available to be issued upon the exercise of outstanding stock options and restricted stock awards if such inclusions would be dilutive. The Company determines the potentially dilutive common shares using the treasury stock method. In periods of a net loss, basic and diluted per share information are the same. The following table presents the computation of loss per share, basic and diluted:
Numerator:
Denominator:
Weighted average common shares outstanding, basic
Weighted average effect of potentially dilutive common shares:
Stock options
Restricted stock
Weighted average common shares outstanding, diluted
Loss per share:
21
The weighted average effect of certain stock options and nonvested restricted stock that were excluded from the computation of weighted average diluted shares outstanding, as inclusion would be anti-dilutive, are summarized as follows:
109,775
349,545
530,449
349,512
640,224
699,057
Note 12—Fair Value
Financial instruments include assets carried at fair value, as well as certain assets and liabilities carried at cost or amortized cost but disclosed at fair value in these condensed consolidated financial statements. Fair value is defined as the exit price, the price that would be received for an asset or paid to transfer a liability in the most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date under current market conditions. The inputs to valuation techniques used to measure fair value are prioritized into a three-level hierarchy. The hierarchy gives the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The following methods and significant assumptions are used to estimate fair value:
Investment Securities
The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar investment securities (Level 2). For investment securities where quoted prices or market prices of similar investment securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). The fair value of the collateralized debt obligations, which are categorized as Level 3, is obtained from third-party pricing information. It is determined by calculating discounted cash flows that include spreads that adjust for credit risk and illiquidity. The Company also performs an internal analysis that considers the structure and term of the collateralized debt obligations and the financial condition of the underlying issuers to corroborate the information used from the independent third party.
Mortgage Servicing Rights
Fair value of mortgage servicing rights is initially determined at the individual grouping level based on an internal valuation model that calculates the present value of estimated future net servicing income. On a quarterly basis, mortgage servicing rights are evaluated for impairment based upon third-party valuations obtained. As disclosed in Note 6—Mortgage Servicing Rights, net, the valuation model utilizes interest rate, prepayment speed and default rate assumptions that market participants would use in estimating future net servicing income (Level 3).
22
Assets Measured at Fair Value on a Recurring Basis
The table below presents the assets measured at fair value on a recurring basis categorized by the level of inputs used in the valuation of each asset at March 31, 2024 and December 31, 2023:
Fair Value Measurements
at March 31, 2024
Quoted Prices in
Significant Other
Significant
Active Markets for
Observable
Unobservable
Identical Assets
Inputs
(Level 1)
(Level 2)
(Level 3)
Financial Assets
Available for sale debt securities:
120,598
29,271
4,410
at December 31, 2023
219,582
29,406
4,457
The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2024 and 2023:
Measurements Using Significant
Unobservable Inputs (Level 3)
Collateralized Debt Obligations
Three Months Ended March 31,
Balance of recurring Level 3 assets at beginning of period
147
Total gains or losses (realized/unrealized):
Included in other comprehensive income (loss)
Principal maturities/settlements
Balance of recurring Level 3 assets at end of period
144
23
Assets Measured at Fair Value on a Nonrecurring Basis
From time to time, the Company may be required to measure certain other assets at fair value on a nonrecurring basis in accordance with U.S. GAAP. These adjustments to fair value usually result from the application of lower of cost or fair value accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis that were recorded in the condensed consolidated balance sheets at March 31, 2024 and December 31, 2023, the following table provides the level of valuation assumptions used to determine each adjustment and the related carrying value:
Mortgage servicing rights
382
576
The following tables present quantitative information about Level 3 fair value measurements for assets measured at fair value on a nonrecurring basis at March 31, 2024 and December 31, 2023:
Quantitative Information about Level 3 Fair Value Measurements at March 31, 2024
Range
Valuation Technique
Unobservable Inputs
(Weighted Average) (1)
Discounted cash flow
Discount rate
10.0% - 12.5%
(11.9%)
Prepayment speed
7.1% - 22.8%
(16.7%)
Default rate
0.1% - 0.2%
(0.1%)
Quantitative Information about Level 3 Fair Value Measurements at December 31, 2023
(12.2%)
6.9% - 22.7%
(18.5%)
24
Fair Value of Financial Instruments
The carrying amounts and estimated fair values of financial instruments not carried at fair value at March 31, 2024 and December 31, 2023, are as follows:
Carrying
Level 1
Level 2
Level 3
1,270,120
Financial Liabilities
Time deposits
900,996
902,983
49,780
1,313,282
873,220
874,274
49,370
Note 13—Commitments and Contingencies
Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit, such as loan commitments and unused credit lines, and standby letters of credit, which are not reflected in the condensed consolidated financial statements.
The Company is required to estimate the expected credit losses for off-balance sheet credit exposures. The Company maintains an estimated liability for unfunded commitments, primarily related to commitments to extend credit, which is included in other liabilities on the condensed consolidated balance sheets. The liability for unfunded commitments is reduced in the period in which the off-balance sheet financial instruments expire, loan funding occurs or is otherwise settled. The following presents the activity in the liability for unfunded commitments for the three months ended March 31, 2024 and 2023:
Liability for unfunded commitments:
124
763
896
Increase (decrease) in provision for (recovery of) credit losses
(9)
107
90
188
115
870
1,084
125
398
579
(110)
102
155
208
469
Unfunded Commitments to Extend Credit
A commitment to extend credit, such as a loan commitment, credit line and overdraft protection, is a legally binding agreement to lend funds to a customer, usually at a stated interest rate and for a specific purpose. Such commitments have fixed expiration dates and generally require a fee. The extension of a commitment gives rise to credit risk. The actual liquidity requirements or credit risk that the Company may experience is expected to be lower than the contractual amount of commitments to extend credit because a significant portion of those commitments are expected to expire without being used. Certain commitments are subject to loan agreements containing covenants regarding the financial performance of the customer that must be met before the Company is required to fund the commitment. The Company uses the same credit policies in making commitments to extend credit as it does in making loans.
Unused Lines of Credit
The Company also issues unused lines of credit to meet customer financing needs. At March 31, 2024, the unused lines of credit include residential second mortgages of $9,370, construction loans of $5,536, commercial real estate of $2,165 and commercial and industrial loans of $13,279, totaling $30,350. These unused lines of credit consisted of a fixed rate loan of $5,000 with an interest rate of 6.00% and a maturity of two years and variable-rate loans of $25,350 with interest rates ranging from 4.54% to 10.88% and maturities ranging from five months to 22 years.
Standby Letters of Credit
Standby letters of credit are issued on behalf of customers in connection with construction contracts between the customers and third parties. Under standby letters of credit, the Company assures that the third parties will receive specified funds if customers fail to meet their contractual obligations. The credit risk to the Company arises from its obligation to make payment in the event of a customer’s contractual default. The maximum amount of potential future payments guaranteed by the Company is limited to the contractual amount of these letters. Collateral may be obtained at exercise of the commitment. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
The following is a summary of the total amount of unfunded commitments to extend credit and standby letters of credit outstanding at March 31, 2024 and December 31, 2023:
Unused lines of credit
30,350
18,542
Standby letters of credit
The Company and its subsidiaries may be subject to legal actions and claims arising from contracts or other matters from time to time in the ordinary course of business. Management is not aware of any pending or threatened legal proceedings that are considered other than routine legal proceedings. The Company believes that the ultimate disposition or resolution of its routine legal proceedings, in the aggregate, are not material to its financial position, results of operations or liquidity.
26
The Bank has incurred and expects to continue to incur significant costs in connection with its ongoing cooperation with the government investigations of certain individuals and the advancement or reimbursement of third parties for the legal costs pursuant to requests for indemnification and advancement of expenses, which are reflected in the Company’s condensed consolidated statements of operations for the three months ended March 31, 2024 and 2023. In addition, the Company’s directors and officers insurance policies for matters related to the ongoing government investigations against selected individuals was exhausted in the fourth quarter of 2023. The Company understands that the government investigations into certain individuals are continuing, including calling individuals as witnessess. Therefore, the Company expects to continue to receive claims for advancement or reimbursement of legal fees and any future costs the Company incurs will not be reimbursed by its insurance carriers.
Mortgage Repurchase Liability
The Company has previously sold portfolio loans originated under the Advantage Loan Program to private investors in the secondary market. The Company also sold conventional residential real estate loans (which excludes Advantage Loan Program loans) in the secondary market primarily to Fannie Mae on an ongoing basis. In connection with these loans sold, the Company makes customary representations and warranties about various characteristics of each loan. The Company may be required pursuant to the terms of the applicable mortgage loan purchase and sale agreements to repurchase any previously sold loan or indemnify (make whole) the investor for which the representation or warranty of the Company proves to be inaccurate, incomplete or misleading. In the event of a repurchase, the Company is typically required to pay the unpaid principal balance, the proportionate premium received when selling the loan and certain expenses. As a result, the Company may incur a loss with respect to each repurchased loan.
Pursuant to the existing agreements with such investors, the Company also agreed to repurchase additional pools of Advantage Loan Program loans at the predetermined repurchase prices as stated in the agreements. At March 31, 2024, there is an outstanding agreement to repurchase an additional pool of Advantage Loan Program loans with an unpaid principal balance of $15,481 that extends to July 2025, with the final decision to effect any such repurchase, as determined by the applicable investor.
At March 31, 2024 and December 31, 2023, the mortgage repurchase liability was $749 and $750, respectively, which is included in other liabilities in the condensed consolidated balance sheets. The unpaid principal balance of residential real estate loans sold that were subject to potential repurchase obligations in the event of breach of representations and warranties totaled $40,033 and $49,667 at March 31, 2024 and December 31, 2023, respectively, including Advantage Loan Program loans totaling $29,936 and $33,044 at March 31, 2024 and December 31, 2023, respectively.
Activity in the mortgage repurchase liability was as follows:
Balance, beginning of period
750
809
Net provision (recovery)
120
Balance, end of the period
749
929
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 should be read in conjunction with the unaudited condensed consolidated financial statements, related notes, and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q and the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2023, as filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 14, 2024 (the “2023 Form 10-K”).
Unless we state otherwise or the context otherwise requires, references in this Quarterly Report on Form 10-Q to “Sterling,” “we,” “our,” “us” or “the Company” refer to Sterling Bancorp, Inc., a Michigan corporation, and its subsidiaries, including Sterling Bank and Trust, F.S.B., which we sometimes refer to as “Sterling Bank,” “the Bank” or “our Bank.”
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain statements that are, or may be deemed to be, “forward-looking statements” regarding the Company’s plans, expectations, thoughts, beliefs, estimates, goals and outlook for the future. These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance, including any statements that refer to projections, forecasts or other characterizations of future events or circumstances, including any underlying assumptions. These statements are often, but not always, made through the use of words or phrases such as “may,” “might,” “should,” “could,” “predict,” “potential,” “believe,” “expect,” “attribute,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “goal,” “target,” “outlook” and “would,” or the negative versions of those words or other comparable words or phrases of a future or forward-looking nature, though the absence of these words does not mean a statement is not forward-looking. All statements other than statements of historical facts, including but not limited to statements regarding the economy and financial markets, government investigations, credit quality, the regulatory scheme governing our industry, competition in our industry, interest rates, our liquidity, our business and our governance, are forward-looking statements. We have based the forward-looking statements in this Quarterly Report on Form 10-Q primarily on current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, prospects, business strategy and financial needs. These forward-looking statements are not historical facts, and they are based on our current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. There can be no assurance that future developments will be those that have been anticipated. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements. Our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions, estimates and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements. Accordingly, you should not place undue reliance on any such forward-looking statements.
The risks, uncertainties and other factors detailed from time to time in our public filings, including those included in the disclosures under the heading “Risk Factors” in our 2023 Form 10-K and subsequent periodic reports, could affect future results and events, causing those results and events to differ materially from those views expressed or implied in the Company’s forward-looking statements. A summary of these factors is below, under the heading “Risk Factors Summary.” For additional information on factors that could materially affect the forward-looking statements included in this Quarterly Report on Form 10-Q, see the risk factors set forth under “Item 1A. Risk Factors” in our 2023 Form 10-K. You should carefully consider these risk factors in evaluating these forward-looking statements. These risks are not exhaustive. Other sections of this Quarterly Report on Form 10-Q and our other filings with the SEC include additional factors that could adversely impact our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. Should one or more of the foregoing risks materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those projected in, or implied by, such forward-looking statements.
Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update, revise, correct or review any forward-looking statement, whether as a result of new information, future developments or otherwise except as required by law. New risks and uncertainties arise from time to time, and it is not possible for us to predict those events or how they may affect us. In addition, we cannot assess the impact of any particular risk, uncertainty or other factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
Risk Factors Summary
The following is a summary of the material risks we are exposed to in the course of our business activities. The below summary does not contain all of the information that may be important to you, and you should read the below summary together with the more detailed discussion of risks set forth under “Part II, Item 1A. Risk Factors” and in our 2023 Form 10-K, as well as under this “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Risks Related to Our Strategy
Risks Related to the Economy and Financial Markets
Risks Related to Credit
Risks Related to Interest Rates
Risks Related to Liquidity
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Risks Related to the Advantage Loan Program
Risks Related to Our Highly Regulated Industry
Risks Related to Competition
Other Risks Related to Our Business
Risks Related to Governance Matters
The foregoing risk factors should not be construed as an exhaustive list and should be read in conjunction with the cautionary statements that are included under “Cautionary Note Regarding Forward-Looking Statements” above under “Item 1A. Risk Factors” in our 2023 Form 10-K and elsewhere in this Quarterly Report on Form 10-Q, including the items set forth under “Part II, Item A. Risk Factors.”
Company Overview
We are a unitary thrift holding company incorporated in 1989 and headquartered in Southfield, Michigan, and our primary business is the operation of our wholly owned subsidiary, Sterling Bank, which was formed in 1984. Through Sterling Bank, we currently originate commercial real estate loans and commercial and industrial loans, and provide deposit products, consisting primarily of checking, savings and term certificate accounts. The Bank also engages in mortgage banking activities and, as such, acquires, sells and services residential mortgage loans. The Bank operates through a network of 27 branches of which 25 branches are located in the San Francisco and Los Angeles, California metropolitan areas with the remaining branches located in New York, New York and Southfield, Michigan.
Overview of Quarterly Performance
Financial results for the three months ended March 31, 2024 are essentially break-even and are consistent with our plan to protect both book value and liquidity during this period of financial uncertainty. We believe our credit quality, liquidity and capital levels are robust. However, market interest rate movements continue to exert pressure on our net interest margin, as deposit costs have increased faster than the yields of our interest-earning assets, further inhibiting meaningful profitability. Our net loss was $(0.2) million for the three months ended March 31, 2024 compared to $(0.5) million for the three months ended March 31, 2023. The net loss for the three months ended March 31, 2024 reflects a decline in net interest income from $17.7 million during the three months ended March 31, 2023 to $14.9 million during the three months ended March 31, 2024. The decline in our net interest income primarily reflects a significant increase in our deposit costs in the higher interest rate environment, which outpaced the increase in the yields we earned on our interest-earning assets.
The decrease in net interest income was partially offset by the decrease in total non-interest expense from $17.8 million for the three months ended March 31, 2023 to $15.4 million for the three months ended March 31, 2024. Such decrease was primarily driven by salaries and employee benefits expense and professional fees, each of which decreased $1.0 million compared to the three months ended March 31, 2023. While the governmental investigations into the Company and the Bank are now resolved, we continued to incur significant professional fees, primarily due to the exhaustion of our directors and officers insurance, in connection with the ongoing investigations into certain individuals involved with the former Advantage Loan Program.
In addition, our credit quality remained strong overall. Our nonperforming assets were $9.3 million, or 0.39% of total assets, at March 31, 2024 compared to $9.0 million, or 0.37% of total assets, at December 31, 2023. In addition, our provision for credit losses during the three months ended March 31, 2024 decreased $0.6 million from $0.7 million during the three months ended March 31, 2023.
At March 31, 2024, the Tier 1 leverage capital ratios of both the Company and the Bank remained above the capital ratio requirements to be considered well capitalized under applicable prompt corrective action requirements.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP and with general practices within the financial services industry. Application of these principles requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under current circumstances. These assumptions form the basis for our judgments about the carrying values of assets and liabilities that are not readily available from independent, objective sources. We evaluate our estimates on an ongoing basis. Use of alternative assumptions may have resulted in significantly different estimates. Actual results may differ from these estimates.
During the three months ended March 31, 2024, there were no significant changes to our accounting policies that we believe are critical to an understanding of our financial condition and results of operations, which critical accounting policies are disclosed in our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Company’s 2023 Form 10-K.
Balance Sheet and Capital Analysis
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated.
At March 31, 2024
At December 31, 2023
(Dollars in thousands)
Real estate:
Total real estate
1,289,925
99
1,333,139
100
Most of our residential loans and other commercial loans have been made to individuals and businesses in the state of California, specifically in the San Francisco and Los Angeles metropolitan areas. As of March 31, 2024, approximately 79% of our loan portfolio was based in California with 55% and 24% in the San Francisco and Los Angeles metropolitan areas, respectively.
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Residential Loans. Our loan portfolio consists primarily of residential real estate loans. At March 31, 2024, residential real estate loans accounted for 80% of total gross loans held for investment. Our residential loans totaled $1.0 billion at March 31, 2024, a decrease of $45.3 million, or 4%, from $1.1 billion at December 31, 2023. No new residential real estate loans were added during the three months ended March 31, 2024.
Commercial Loans. We offer a variety of commercial loan products, consisting of commercial real estate loans, construction loans and commercial and industrial loans. These categories of commercial loans totaled $262.8 million at March 31, 2024, a decrease of $0.4 million from December 31, 2023. During the three months ended March 31, 2024, we originated commercial loans with an aggregate principal balance of $30.0 million at the time of origination. Our construction loans decreased to $4.9 million from $10.4 million at December 31, 2023 due to maturing construction loans that were paid in full in the three months ended March 31, 2024. The majority of our commercial loans are secured by real estate or other business assets. Our commercial loans are almost exclusively recourse loans, as we generally obtain personal guarantees on each loan.
Commercial real estate loans totaled $244.5 million at March 31,2024, of which the largest portion of these loans, or 42%, are secured by multifamily properties. The repayment of commercial real estate loans is often more sensitive than other types of loans to adverse conditions in the real estate market or the general business climate and economy because it is dependent on the successful operation or development of the property or business involved. In addition, the collateral for commercial real estate loans is generally less readily marketable than for residential real estate loans, and its value may be more difficult to determine. A primary repayment risk for commercial real estate loans is the interruption or discontinuation of operating cash flows from the properties or businesses involved, which may be influenced by economic events, changes in governmental regulations, vacancies or other events not under the control of the borrower. Additionally, with the higher interest rate environment and slowed transaction market, the commercial real estate sector faces increased risk of economic distress. The table below summarizes the commercial real estate loan portfolio, by property type, as of March 31, 2024:
Percent of
Commercial real estate:
Retail
37,936
Multifamily
102,332
42
Office
39,113
Hotels/Single-room occupancy hotels
3,551
Industrial
29,586
Mixed-use
9,314
22,714
Commercial and Industrial loans. Our commercial and industrial loans totaled $13.3 million at March 31, 2024, a decrease of $2.5 million, or 16%, from December 31, 2023.
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Maturities and Sensitivities of Loans to Changes in Interest Rates. The Company’s loan portfolio includes adjustable-rate loans, primarily tied to Prime, U.S. Treasuries and the secured overnight financing rate ("SOFR"), and fixed-rate loans, for which the interest rate does not change through the life of the loan. The following table sets forth the recorded investment by interest rate type in our loan portfolio at March 31, 2024:
Adjustable Rate
Prime
Treasury
SOFR
Fixed Rate
( Dollars in thousands)
8,040
302,732
712,751
1,023,523
16,941
135,394
21,491
156,885
87,661
9,005
211
2,461
11,677
21,948
438,337
736,703
1,196,988
106,291
% by rate type at March 31, 2024
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56
92
Across our loan portfolio, our adjustable-rate loans are typically based on a 30-year amortization schedule and generally interest rates and payments adjust annually after a one-, three-, five- or seven-year initial fixed period. Our prime-based loans, which typically are commercial and industrial loans, construction loans and home equity loans, adjust to an interest rate equal to Prime or up to 238 basis points above Prime. Our commercial real estate loans predominately adjust based on the U.S. Treasury five-year constant maturity Treasury rate. Interest rates on our adjustable-rate SOFR-based loans adjust to an interest rate typically equal to 350 to 450 basis points above the one-year SOFR. Our Treasury-based residential loans adjust to an interest rate based on the U.S. Treasury one- and five-year constant maturity Treasury rates.
The following table sets forth the contractual maturities of our loan portfolio and sensitivities of those loans to changes in interest rates at March 31, 2024. Overdraft loans are reported as being due in one year or less. The table does not include any estimate of prepayments that could significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below.
Due in One
Due After One
Due After Five
Due After
Year or Less
To Five Years
To Fifteen Years
Fifteen Years
(In thousands)
438
11,966
1,028,056
37,129
64,625
142,792
1,326
12,022
43,368
77,097
154,758
Total loans with:
Adjustable interest rates
5,169
35,519
139,592
1,016,708
Fixed interest rates
38,199
41,578
15,166
11,348
The table set forth below contains the repricing dates of adjustable-rate loans included within our loan portfolio as of March 31, 2024:
Consumer
Amounts to adjust in:
6 months or less
349,759
22,562
388,901
After 6 months through 12 months
336,438
47,044
383,482
After 12 months through 24 months
102,922
4,354
107,276
After 24 months through 36 months
95,770
26,963
122,733
After 36 months through 60 months
76,938
55,962
132,900
After 60 months
61,696
Fixed to maturity
At March 31, 2024, $117.9 million, or 10%, of our adjustable interest rate loans were at their interest rate floor.
Asset Quality
Nonperforming Assets. Nonperforming assets include nonaccrual loans and loans that are past due 90 days or more and still accruing interest. Restructuring of loans to borrowers who are experiencing financial difficulty are accounted for as a modification and further evaluated as to classification of a performing or nonperforming asset.
In addition, a loan may be placed on nonaccrual at any other time management has serious doubts about further collectability of principal or interest according to the contractual terms, even though the loan is currently performing or when a loan becomes 90 days past due as to principal or interest. For nonaccrual loans, interest previously accrued but not collected is reversed and charged against income at the time a loan is placed on nonaccrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The following table sets forth information regarding our nonperforming assets at the dates indicated.
At March 31,
At December 31,
Nonaccrual loans(1):
Loans past due 90 days or more and still accruing interest
Total nonperforming assets
Total loans(1)
Total nonaccrual loans to total loans
0.71
0.66
Total nonperforming assets to total assets
0.39
0.37
As of March 31, 2024, nonperforming assets, comprised primarily of nonaccrual residential real estate loans, totaled $9.3 million, an increase of $0.4 million from December 31, 2023. This increase is primarily due to the addition of $1.5 million of residential loans to nonaccrual status which was partially offset by loans totaling $0.9 million that were returned to accrual status and payments of loan principal totaling $0.2 million that were received.
As a result of the increase in nonaccrual loans, the ratio of nonaccrual loans to total loans held for investment increased to 0.71% at March 31, 2024 from 0.66% at December 31, 2023. Also, our ratio of nonperforming assets to total assets increased to 0.39% at March 31, 2024 from 0.37% at December 31, 2023.
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The total amount of additional interest income on nonaccrual loans that would have been recorded if the interest on all such loans had been recorded based upon the original terms was $0.2 million and $0.5 million for the three months ended March 31, 2024 and 2023, respectively. The Company does not record interest income on nonaccrual loans.
Delinquent Loans. The following tables set forth our loan delinquencies, including nonaccrual loans, by type and amount at the dates indicated.
Total loans past due declined $5.5 million, or 20%, from $27.9 million at December 31, 2023 to $22.4 million at March 31, 2024. This decline is primarily due to a $6.3 million decrease, or 38%, of loans 30 – 59 days past due from $16.6 million at December 31, 2023. This decline is partially offset by an increase of loans 90 days or more past due, including nonaccrual loans, of $0.4 million, or 4%, from $9.0 million at December 31, 2023, which was primarily attributable to the change in nonaccrual loans discussed in “—Nonperforming Assets” above.
Classified Loans. We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes homogeneous loans, such as residential real estate and other consumer loans, and non-homogeneous loans, such as commercial and industrial, construction and commercial real estate loans. This analysis is performed at least quarterly. The four risk categories utilized are Pass, Special Mention, Substandard and Doubtful. Loans in the Pass category are considered of satisfactory quality, while the remaining three categories indicate varying levels of increasing credit risk. See Note 5—Loans—Credit Quality to our condensed consolidated financial statements for additional information about our risk categories.
Loans classified as Special Mention, Substandard and Doubtful were as follows at the dates indicated:
Special Mention:
Substandard:
Total Substandard
32,896
36,427
Total(1)
48,740
57,943
Classified assets to total loans
Total Special Mention and Substandard loans were $48.7 million, or 4% of total gross loans, at March 31, 2024, compared to $57.9 million, or 4% of total gross loans, at December 31, 2023.
The decrease of $5.7 million in Special Mention loans was primarily attributable to loans that were upgraded from Special Mention to Pass totaling $5.6 million, as a result of two commercial loans where the borrowers took actions to improve the debt service coverage ratios of their loans.
The decrease of $3.5 million in Substandard loans was primarily attributable to loans that were paid in full totaling $4.0 million, and loans that were upgraded from Substandard to Pass totaling $0.9 million. The decrease in Substandard loans was partially offset by loans downgraded to Substandard totaling $1.5 million.
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The allowance for credit losses is a valuation allowance estimated at each balance sheet date in accordance with U.S. GAAP that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. When the Company deems all or a portion of a loan to be uncollectible the appropriate amount is written off and the allowance for credit losses is reduced by the same amount. Subsequent recoveries, if any, are credited to the allowance for credit losses when received.
The Company estimates the allowance for credit losses on loans using a Probability of Default/Probability of Attrition model which incorporates probability of default, loss given default, exposure to default and probability of attrition attributes. The model considers relevant available information at both the portfolio and loan level from internal data that is supplemented by information sourced from a third party. The model also incorporates reasonable and supportable forecasts over an 8-quarter forecast period. We continued to consider the impact of inflation and the risk of a recession in our process for estimating expected credit losses along with the uncertainty related to the severity and duration of the economic consequences resulting from such events. Our methodology and framework include a 8-quarter forecast period and 2-quarter reversion period, which is the period where the macroeconomic variables are relaxed and revert to the average historical loss rates.
Also included in the allowance for credit losses on loans are qualitative amounts to cover risks that, in the Company’s assessment, may not be adequately reflected in the quantitative analysis. Factors that the Company considers include, among other things, adjustments for imprecision inherent in the forecasts of macroeconomic variables, levels of criticized and classified loans and collection strategies management may employ to reduce these levels, portfolio dispersion and the unique characteristics of our Advantage Loan Program loans which could result in behavior different than our historic losses in a downside economic cycle.
The following table presents the activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2024 and 2023:
Provision for (recovery of) for credit losses
Net (charge offs) recoveries
Total net (charge offs) recoveries
Average gross loans during period
1,064,153
246,423
7,246
15,087
1,332,956
Net (charge offs) recoveries to average gross loans during period
(6,418)
(6,412)
1,366,840
223,929
41,436
1,382
1,633,619
(0.47)
(0.39)
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Our allowance for credit losses at March 31, 2024 was $29.3 million, or 2.24% of total loans held for investment, compared to $29.4 million, or 2.18% of total loans held for investment, at December 31, 2023. Our allowance for credit losses as a percentage of total gross loans increased due in part to the changes in economic forecasts used in our quantitative model assumptions for our residential real estate portfolio. In addition, our allowance for credit losses as a percentage of nonaccrual loans was 314% and 329% as of March 31, 2024 and December 31, 2023, respectively.
No charge offs were recorded during the three months ended March 31, 2024 compared to $6.5 million for the comparable period in 2023. Net charge offs in the three months ended March 31, 2023 primarily reflected the $6.5 million in charge offs of our recorded investment on residential loans transferred to held for sale.
The following table sets forth the allowance for credit losses allocated by loan category at the dates indicated. The allowance for credit losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance for credit losses to absorb losses in other categories.
Loans in
Allowance
Each
for Credit
to Category
Category to
of Loans
Total Loans
1.46
1.32
5.38
5.72
15.67
13.35
0.73
0.92
2.24
2.18
Nonaccrual loans
Nonperforming loans (1)
Allowance for credit losses to nonaccrual loans
314
329
Allowance for credit losses to total loans
Although we believe that we use the best information available to establish the allowance for credit losses, future adjustments to the allowance for credit losses may be necessary and our results of operations could be adversely affected if circumstances differ substantially from the assumptions used in determining the allowance for credit losses. Furthermore, while we believe we have established our allowance for credit losses in conformity with U.S. GAAP, there can be no assurance that regulators, in reviewing our loan portfolio, will not require us to increase our allowance for credit losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for credit losses is adequate or that increases will not be necessary should the quality of any loans deteriorate. Any material increase in the allowance for credit losses may adversely affect our financial condition and results of operations.
Collateral-dependent loans are those for which repayment (on the basis of the Company’s assessment as of the reporting date) is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty. As of March 31, 2024, the amortized cost basis of collateral-dependent loans was $2.0 million. These loans were collateralized by residential real estate property and the fair value of collateral on substantially all collateral-dependent loans were significantly in excess of their amortized cost basis loans.
Modifications to Borrowers Experiencing Financial Difficulty
Modifications to borrowers experiencing financial difficulty may include interest rate reductions, principal or interest forgiveness, forbearances, term extensions, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Historically, the Company has provided loan forbearances to residential borrowers when mandated and modified construction loans by providing term extensions. The Company did not have any loans held for investment made to borrowers
experiencing financial difficulty that were modified during the three months ended March 31, 2024. The Company did not have any loans held for investment made to borrowers experiencing financial difficulty that were previously modified that subsequently defaulted during the three months ended March 31, 2024.
Investment Securities Portfolio
The following table sets forth the amortized cost and estimated fair value of our available for sale debt securities portfolio at the dates indicated.
The size of our available for sale debt securities portfolio (on an amortized-cost basis) decreased by $23.3 million, or 5%, to $416.9 million at March 31, 2024. We continually evaluate our investment securities portfolio in response to established asset/liability management objectives and changing market conditions that could affect profitability and the level of interest rate risk to which we are exposed. These evaluations may cause us to change the level of funds we deploy into investment securities and change the composition of our investment securities portfolio.
For available for sale debt securities in an unrealized loss position, we first assess whether we intend to sell, or it is more likely than not that we will be required to sell the security before recovery of its amortized cost. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For available for sale debt securities that do not meet the aforementioned criteria, we evaluate at the individual security level whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income (loss), net of income taxes.
We review the debt securities portfolio on a quarterly basis to determine the cause and magnitude of declines in the fair value of each security. At March 31, 2024, gross unrealized losses on debt securities totaled $22.1 million. Our U.S. Treasury and Agency securities, mortgage-backed securities and the majority of the collateralized mortgage obligations are issued or guaranteed by the U.S. government, its agencies and government-sponsored enterprises. The Company has a long history with no credit losses from issuers of U.S. government, its agencies and government-sponsored enterprises. As a result, management does not expect any credit losses on its available for sale debt securities. Accordingly, we have not recorded an allowance for credit losses for our available for sale debt securities at March 31, 2024.
Our equity securities consist of an investment in a qualified community reinvestment act investment fund, which is a publicly-traded mutual fund, and an investment in the common equity of Pacific Coast Banker’s Bank, a thinly traded restricted stock. At March 31, 2024 and December 31, 2023, equity securities totaled $4.7 million.
We are required to hold non-marketable equity securities, comprised of FHLB stock, as a condition of our membership in the FHLB system. Our FHLB stock is accounted for at cost, which equals its par value. At March 31, 2024 and December 31, 2023, we held $18.9 million in FHLB stock.
We are also required to hold FRB stock as a condition of our membership in the Federal Reserve, which is required of us as a covered savings association. Our FRB stock is considered a non-marketable equity security that is accounted for at cost, which equals its par value. At March 31, 2024 and December 31, 2023, we held $9.1 million and $9.0 million, respectively, in FRB stock.
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Deposits
Deposits are the primary source of funding for the Company. We regularly review the need to adjust our deposit offering rates on various deposit products in order to maintain a stable liquidity profile and a competitive cost of funds. We obtain funds from depositors by offering a range of deposit types, including demand, savings money market and time. The following table sets forth the composition of our deposits by account type at the dates indicated.
Money market, savings and NOW
1,072,179
1,095,521
Total deposits were $2.0 billion as of March 31, 2024, an increase of $1.9 million from December 31, 2023. Our time deposits increased by $27.8 million, or 3%. Our money market, savings and NOW deposits decreased by $23.3 million, or 2%, and our noninterest-bearing demand deposits decreased $2.6 million, or 7%, from December 31, 2023. We did not have any brokered deposits at March 31, 2024 and December 31, 2023. We have continued our current strategy of offering competitive interest rates on our deposit products to maintain our existing customer deposit base and help manage our liquidity.
Our estimated uninsured deposits were $430.1 million, or approximately 22% of total deposits, and $434.4 million, or 22% of total deposits, at March 31, 2024 and December 31, 2023, respectively. The uninsured amounts are estimated based on methodologies and assumptions used for the Bank’s regulatory reporting requirements.
The portion of U.S. time deposits, by account, that exceed the FDIC insurance limit of $250,000 was $94.9 million at March 31, 2024.
Borrowings
In addition to deposits, we use short-term borrowings, such as FHLB advances and drawdowns on an overdraft credit line with the FHLB, as sources of funds to meet the daily liquidity needs of our customers. Our short-term advances with the FHLB consist primarily of advances of funds for one- or two-week periods.
At March 31, 2024, our outstanding FHLB borrowings consisted of a long-term fixed rate advance of $50.0 million with an interest rate of 1.96% with a maturity date of May 2029, although the advance is callable by the FHLB on May 15, 2024. We expect to repay the FHLB advance with our existing cash funds and do not currently intend to replace it with another borrowing.
At March 31, 2024, we had the ability to borrow an additional $370.5 million from the FHLB, which included an available line of credit of $20.0 million. In addition, we have standby letters of credit, totaling $2.0 million, which provide credit support for certain of our obligations related to our commitments to repurchase certain pools of Advantage Loan Program loans. We also had available credit lines with other banks totaling $60.0 million. There were no borrowings outstanding on the lines of credit with other banks.
Shareholders’ Equity
Total shareholders’ equity was $327.3 million at March 31, 2024, compared to $327.7 million at December 31, 2023.
Analysis of Results of Operations
General. The Company had a net loss of $(0.2) million for the three months ended March 31, 2024 compared to a net loss of $(0.5) million for the three months ended March 31, 2023.
40
Average Balance Sheet and Related Yields and Rates. The following table sets forth the average balance sheet, interest income or interest expense, average yields earned and rates paid for each category of interest-earning assets and interest-bearing liabilities, net interest spread and net interest margin on average interest-earning assets. The average balances are daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of discount accretion and net deferred loan origination costs accounted for as yield adjustments.
Yield/
Balance
Rate
Interest-earning assets
Loans(1)
Residential real estate and other consumer
1,064,200
17,197
6.46
1,366,872
18,514
5.42
3,213
5.22
2,596
4.64
242
13.36
1,034
9.98
317
8.40
4.63
6.29
5.43
Securities, includes restricted stock(2)
437,712
3.67
366,346
2.68
Other interest-earning assets
601,791
5.51
411,766
4.67
Total interest-earning assets
2,372,459
5.61
2,411,731
4.88
Noninterest-earning assets
4,643
4,475
29,521
28,398
2,406,623
2,444,604
Interest-bearing liabilities
1,074,937
9,655
3.60
1,001,505
4,614
1.87
884,115
8,445
3.83
900,890
5,195
2.34
Total interest-bearing deposits
1,959,052
3.71
1,902,395
2.09
FHLB borrowings
1.96
Subordinated Notes, net
0.00
65,264
10.38
Total borrowings
115,264
1,938
6.73
Total interest-bearing liabilities
2,009,052
3.66
2,017,659
2.36
Noninterest-bearing liabilities
Demand deposits
35,348
50,284
34,924
63,308
327,299
313,353
Net interest income and spread(2)
1.95
2.52
Net interest margin(2)
2.93
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities for the periods indicated. The table distinguishes between: (1) changes attributable to volume (changes in volume multiplied by the prior period’s rate), (2) changes attributable to rate (change in rate multiplied by the prior period’s volume) and (3) total increase (decrease) (the sum of the previous columns). Changes attributable to both volume and rate are allocated ratably between the volume and rate categories.
March 31, 2024 vs. 2023
Increase (Decrease)
Net
due to
Increase
Volume
(Decrease)
Change in interest income:
(4,514)
3,197
(1,317)
275
342
617
(1,058)
266
(792)
301
(5,019)
3,828
(1,191)
Securities, includes restricted stock
539
1,023
1,562
2,510
978
3,488
Total change in interest income
(1,970)
5,829
3,859
Change in interest expense:
370
4,671
5,041
(98)
3,348
3,250
272
8,019
8,291
(1,693)
Total change in interest expense
(1,419)
8,020
6,601
Change in net interest income
(551)
(2,191)
(2,742)
Net Interest Income. Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends primarily upon the volume of interest-earning assets and interest-bearing liabilities and the corresponding interest rates earned or paid. Our net interest income is significantly impacted by changes in interest rates and market yield curves and their related impact on cash flows.
Net interest income was $14.9 million for the three months ended March 31, 2024, a decrease of $2.7 million, or 16%, from $17.7 million for the three months ended March 31, 2023. The decrease in net interest income primarily reflects the impact of interest expense, primarily on interest-bearing deposits, increasing more than interest income on interest-earning assets during the higher rate environment. The higher rate environment reflects the Federal Open Market Committee increasing the target range for the federal funds rate by a total of 525 basis points from the end of the first quarter of 2022 to July 2023. The prevailing market rate environment combined with significant competition for deposits resulted in significant disparity between the impact on interest expense compared to interest income. In addition, the decline in net interest income partially reflects the continued reduction of our residential mortgage loan portfolio.
Interest income was $33.3 million for the three months ended March 31, 2024, an increase of $3.9 million, or 13%, from the three months ended March 31, 2023. The increase in interest income was primarily due to the yield earned on the average balance of our interest-earning assets as these portfolios repriced higher in the higher interest rate environment. The yield on the average balance of our loans, securities and other interest-earning assets increased 86 basis points, 99 basis points and 84 basis points, respectively, for the three months ended March 31, 2024 as compared to the three months ended March 31, 2023. The increase in the yield on the average balance of our loans was primarily due to residential mortgage rates resetting in the higher interest rate environment. The increase in the yield on the average balance of our securities was primarily due to the yield on our recently purchased securities being higher than the yield on the average balance of our securities for the three months ended March 31, 2023. The yield on the average balance of our other interest-earning assets, which are comprised primarily of cash and due from banks, benefitted from the higher rate environment as correspondent banks and the Federal Reserve increased their deposit rates and overnight funding rates. Also contributing to the increase in interest income, the average balance of our other interest-earning assets of $601.8 million for the three months ended March 31, 2024 increased $190.0 million, or 46%, compared to the three months ended March 31, 2023, and the average balance of our securities portfolio of $437.7 million for the three months ended March 31, 2024 increased $71.4 million, or 19%, compared to the three months ended March 31, 2023. Partially offsetting the increase in interest income was the decline in interest income earned on our loans since the average balance of our loans decreased $300.7 million, or 18%.
Interest expense was $18.3 million for the three months ended March 31, 2024, an increase of $6.6 million, or 56%, from the three months ended March 31, 2023. Similar to our interest-earning assets, the increase in our interest expense was primarily driven by the change in interest rates. The rate paid on the average balance of interest-bearing deposits increased 162 basis points. We continued to competitively price our deposits as rates continued to rise in 2023 and as competition for deposits significantly increased. Interest expense for the three months ended March 31, 2024 also reflected the elimination of interest expense from our Subordinated Notes, which were redeemed in the third quarter of 2023, and totaled $1.7 million for the three months ended March 31, 2023.
Net Interest Margin and Interest Rate Spread. Net interest margin was 2.52% for the three months ended March 31, 2024, down 41 basis points from 2.93% for the three months ended March 31, 2023. The interest rate spread was 1.95% for the three months ended March 31, 2024, down 57 basis points from 2.52% for the three months ended March 31, 2023. Our net interest margin and interest rate spread were negatively impacted during the three months ended March 31, 2024, primarily due to higher interest rates paid on our interest-bearing deposits than in the comparable period in 2023, which outpaced the increase in the average yield on our interest-earning assets over the same period.
Provision for (Recovery of) Credit Losses. The following table presents the components of our provision for credit losses:
Provision for (recovery of) credit losses:
Off-balance sheet credit exposures
Our provision for credit losses was $41 thousand for the three months ended March 31, 2024 compared $0.7 million for the three months ended March 31, 2023. Included in the provision for (recovery of) credit losses related to loans, we have recorded a provision for credit losses on residential loans of $0.9 million for the three months ended March 31, 2024 and a recovery of credit losses on residential loans of $(1.9) million for the three months ended March 31, 2023. The provision for credit losses attributable to loans for the three months ended March 31, 2024 was primarily due to changing economic forecasts used in model assumptions, partially offset by the decline in the residential loan portfolio during the three months ended March 31, 2024. The recovery of credit losses attributable to loans for the three months ended March 31, 2023 was primarily as a result of the transfer of nonaccrual and delinquent loans to held for sale and loan payoffs.
Additionally, the recovery for credit losses related to loans includes a recovery of commercial real estate loans of $(0.4) million for the three months ended March 31, 2024 and was primarily a result of the decrease in special mention loans of $5.7 million. A provision for credit losses of $3.2 million was recorded for the three months ended March 31, 2023. The provision for credit losses on the commercial real estate loan portfolio for the three months ended March 31, 2023 was primarily due to changes in our economic forecasts to reflect the weakening commercial real estate market. For additional information on changes to the allowance for credit losses, see “—Allowance for Credit Losses.”
43
In addition, the provision for credit losses related to off-balance sheet credit exposures increased by $0.3 million to $0.2 million during the three months ended March 31, 2024 compared to the three months ended March 31, 2023. This increase is primarily attributable to the Bank’s origination of a commercial and industrial loan with an aggregate principal balance of $15.0 million that also increased our unfunded commitments by $11.8 million during the three months ended March 31, 2024 compared to a decrease of our unfunded commitments by $3.1 million during the three months ended March 31, 2023.
Non-interest Income. The components of non-interest income were as follows:
Change
Percent
(118)
N/M
Income earned on company‑owned life insurance
Total non‑interest income
(79)
(28)
N/M - not meaningful
Non-interest income was $0.2 million for the three months ended March 31, 2024, a decrease of $0.1 million from the three months ended March 31, 2023. Such decrease in non-interest income is primarily due to the decline in fair value of the equity securities during the three months ended March 31, 2024.
Non-interest Expense. The components of non-interest expense were as follows:
(950)
(1,039)
(32)
(5)
(428)
(20)
(2,445)
(14)
Non-interest expense of $15.4 million for the three months ended March 31, 2024, reflected a decrease of $2.4 million compared to the three months ended March 31, 2023, primarily due to decreases in salaries and employee benefits and professional fees. Salaries and employee benefits expense decreased $1.0 million for the three months ended March 31, 2024 compared to the same period in the prior year primarily due to continued staff reductions in various support functions and the reversal of a liability for deferred compensation that is no longer due to a former executive. Professional fees also decreased $1.0 million from the comparable prior period. Partially offsetting this decrease were reimbursements received in the three months ended March 31, 2023 from an insurance carrier of $2.2 million for previously incurred direct and third-party legal expenses related to the governmental investigations. The decrease in professional fees is due to lower legal fees incurred as the governmental investigations against the Company and Bank were resolved. As previously reported, our directors and officers insurance was exhausted in the fourth quarter of 2023. To the extent the governmental investigations with respect to individuals continue and involve the cooperation of individuals entitled to advancement and indemnification, we may continue to receive and pay such claims in accordance with our legal obligations but for which we no longer have insurance. Additionally, professional fees decreased due to replacing certain previously outsourced functions with internal resources.
44
Income Tax Benefit. We recorded an income tax benefit of $(103) thousand, or an effective tax rate of 34.3%, for the three months ended March 31, 2024 compared to an income tax benefit of $(54) thousand, or an effective tax rate of 9.7%, for the three months ended March 31, 2023. The effective rates vary from our statutory rate primarily due to the low level of pretax earnings, the effect of non-deductible compensation and interest on U.S. Treasury obligations which is exempt from state income taxes.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations when they come due. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans to ensure we have adequate liquidity to fund our operations.
Our primary sources of funds consist of cash flows from operations, deposits, principal repayments on loans and maturities and principal receipts on our available for sale debt securities. Additional liquidity is provided by our ability to borrow from the FHLB, our ability to sell portions of our loan portfolio and access to the discount window of the Federal Reserve and brokered deposits. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.
Our most liquid assets are cash and due from banks and interest-bearing time deposits with other banks. These funds offer substantial resources to meet either new loan demand or to help offset reductions in our deposit funding base. At March 31, 2024 and December 31, 2023, cash and due from banks totaled $646.2 million and $578.0 million, respectively. Interest-bearing time deposits with other banks totaled $5.2 million at March 31, 2024 and December 31, 2023.
Our liquidity is further enhanced by our ability to pledge loans and investment securities to access secured borrowings from the FHLB. Our available for sale debt securities totaled $394.9 million and $419.2 million at March 31, 2024 and December 31, 2023, respectively. We regularly review the need to adjust our investments in liquid assets based upon our assessment of: (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest earning deposits and securities and (4) the objectives of our asset/liability management program. The Company’s Asset Liability Management Committee monitors sources and uses of funds and modifies asset and liability positions as liquidity requirements change. Excess liquid assets are generally invested in interest-earning deposits and short-term securities.
At March 31, 2024, we have a long-term fixed rate FHLB advance outstanding of $50.0 million with a maturity date of May 2029. The FHLB advance accrues interest at 1.96%. The advance is callable by the FHLB on May 15, 2024. On May 7, 2024, we received notification from the FHLB that the FHLB will exercise their call right. We expect to repay the FHLB advance with existing cash funds and do not currently intend to replace it with another borrowing. Based on our collateral, consisting of certain loans and investment securities, and holdings of FHLB stock, the Company had additional borrowing capacity with the FHLB of $370.5 million at March 31, 2024. We also had available credit lines with other banks totaling $60.0 million.
Cash flows from investing activities are primarily impacted by our loan and investment securities activity, as discussed above. The Company’s goal is to obtain as much of its funding for loans held for investment and other earning assets as possible from customer deposits. During the three months ended March 31, 2024 and 2023, we originated $30.0 million and $6.2 million of loans, respectively. Cash flows provided by loan payoffs totaled $40.7 million and $53.2 million during the three months ended March 31, 2024 and 2023, respectively. From time to time, we also sell residential mortgage loans in the secondary market primarily to third party investors. Often, the agreements under which we sell residential mortgage loans may contain provisions that include various representations and warranties regarding origination and characteristics of the residential mortgage loans. The Company has outstanding commitments to repurchase pools of Advantage Loan Program loans sold with an unpaid principal balance of $15.5 million at March 31, 2024. These commitments expire in July 2025. We also have outstanding $14.5 million of Advantage Loan Program loans that could be subject to repurchase at the demand of the investors. In addition, the unpaid principal balance of residential real estate loans, other than Advantage Loan Program loans, sold in the secondary market that were subject to potential repurchase obligations in the event of breach of representations and warranties totaled $10.0 million at March 31, 2024. Should additional secondary market investors require us to repurchase a substantial portion of such outstanding loans subject to potential purchase, the cash required to fund these purchases will reduce our liquidity.
45
Cash flows from financing activities are primarily impacted by our deposits. Our total deposits were $2.0 billion at March 31, 2024, an increase of $1.9 million, from December 31, 2023. We generate deposits from local businesses and individuals through customer referrals and other relationships and through our retail presence. We obtain funds from depositors by offering a range of deposit types, including demand, savings, money market and time. We utilize borrowings and brokered deposits to supplement funding needs and manage our liquidity position though we have not used brokered deposits during the past two years. At March 31, 2024, time deposits due within one year were $796.0 million, or 40% of total deposits. At December 31, 2023, time deposits due within one year were $761.7 million, or 38% of total deposits. In addition, we estimated our total uninsured deposits were approximately 22% of total deposits at March 31, 2024.
We are a party to financial instruments in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to make loans and standby letters of credit that are not reflected in our condensed consolidated balance sheets, as well as commitments on unused lines of credit that involve elements of credit and interest rate risk in excess of the amount recorded in the condensed consolidated balance sheets. Our exposure to credit loss is represented by the contractual amount of these instruments. At March 31, 2024, we had unfunded commitments to extend credit totaling $30.4 million and standby letters of credit outstanding of $24 thousand.
The Company is a separate and distinct legal entity from the Bank, and, on a parent company-only basis, the Company’s primary source of funding is dividends received from the Bank. Federal banking regulations limit the dividends that may be paid by the Bank. Regulatory approval is required if the Bank’s total capital distributions for the applicable calendar year exceed the sum of the Bank’s net income for that year to date plus the Bank’s retained net income for the preceding two years, or the Bank would not be at least “adequately capitalized” under applicable regulations following the distribution. Federal banking regulations also limit the ability of the Bank to pay dividends under other circumstances. Even if an application is not otherwise required, every savings bank that is a subsidiary of a unitary thrift holding company, such as the Bank, must still file a notice with the FRB at least 30 days before its board of directors declares a dividend or approves a capital distribution. The Company has the legal ability to access the debt and equity capital markets for funding, although the Company currently is required to obtain the prior approval of the FRB in order to issue debt.
The Company’s ability to pay cash dividends is restricted by the terms of the applicable provisions of Michigan law and the rules and regulations of the OCC and the FRB. In addition, under Michigan law, the Company is prohibited from paying cash dividends if, after giving effect to the dividend, (i) it would not be able to pay its debts as they become due in the usual course of business or (ii) its total assets would be less than the sum of its total liabilities plus the preferential rights upon dissolution of shareholders with preferential rights on dissolution that are superior to those receiving the dividend, and we are currently required to obtain the prior approval of the FRB in order to pay any dividends to our shareholders.
The Company and the Bank are subject to minimum capital adequacy requirements administered by the Federal Reserve and the OCC, respectively. We manage our capital to comply with our internal planning targets and regulatory capital standards administered by the Federal Reserve and the OCC. We review capital levels on a quarterly basis. At March 31, 2024, the Company and the Bank met all regulatory capital requirements to which they were subject. The Company and Bank satisfied the requirements of the CBLR framework with leveraged capital ratios of 14.10% and 13.58%, respectively, compared to the requirement for these ratios to be greater than 9%, and therefore are considered to have met the minimum capital requirements to be “well capitalized” under applicable prompt corrective action requirements. For further information regarding our regulatory capital requirements, refer to Note 10—Regulatory Capital Requirements to our condensed consolidated financial statements included in “Item 1. Financial Statements.”
The compliance with regulatory minimum capital requirements is a tool used in assessing the Company’s capital adequacy, but is not necessarily determinative of how the Company would fare under extreme stress. Factors that may affect the adequacy of the Company’s capital include the inherent limitations of fair value estimates and the assumptions thereof, the inherent limitations of accounting classifications of certain investments and the effect on their measurement, external macroeconomic conditions and their effects on capital and the Company’s ability to raise capital or refinance capital commitments, and extent of steps taken by state or federal governmental authorities in periods of extreme stress.
As a result of the Company’s guilty plea and criminal conviction in July 2023 pursuant to our Plea Agreement with the U.S. Department of Justice, we fall within the “bad actor” disqualification provisions of Regulation A and Regulation D under the Securities Act. These provisions prohibit an issuer from offering or selling securities in a private placement in reliance on Regulation A for certain small offerings and Regulation D for certain private placement transactions for a period of up to five years under certain circumstances. The SEC may waive such disqualification upon a showing of good cause that disqualification is not necessary under the circumstances for which the safe harbor exemptions are being denied. Absent a waiver, we will be restricted in our ability to raise capital in a private placement in reliance on the safe harbors provided by Regulation A or Regulation D. We have submitted to the SEC a waiver request from the “bad actor” disqualifications. If the SEC were to deny our waiver request, we will be limited in our ability to raise capital through a private placement under Regulation A or Regulation D, although we would remain eligible as an SEC registrant to access the equity capital markets through an SEC-registered offering or through another exemption from the registration requirements.
Recently Issued Accounting Guidance
See Note 2 – Summary of Significant Accounting Policies to our condensed consolidated financial statements included in “Item 1. Financial Statements” for a discussion of recently issued accounting guidance and related impact on our financial condition and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
General. The principal objective of our asset and liability management function is to evaluate the interest rate risk within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing net income and preserving adequate levels of liquidity and capital. The Asset Liability Committee of our board of directors serves as oversight of our asset and liability management function, which is implemented and managed by our Management Asset Liability Committee. Our Management Asset Liability Committee meets regularly to review, among other things, the sensitivity of our assets and liabilities to product offering rate changes, local and national market conditions and market interest rates. That group also reviews our liquidity, capital, deposit mix, loan mix and investment positions.
We manage our exposure to interest rates primarily by structuring our balance sheet in the ordinary course of business based on a risk management infrastructure approved by our board of directors that outlines reporting and measurement requirements. In particular, this infrastructure sets limits, calculated quarterly, for various interest rate-related metrics, our economic value of equity (“EVE”) and net interest income simulations involving parallel shifts in interest rate curves. Steepening and flattening yield curves and various prepayment and deposit duration assumptions are prepared at least annually. Our interest rate management policies also require periodic review and documentation of all key assumptions used, such as identifying appropriate interest rate scenarios, setting loan prepayment rates and deposit durations based on historical analysis.
We do not typically enter into derivative contracts for the purpose of managing interest rate risk, but we may do so in the future. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.
Net Interest Income Simulation. We use an interest rate risk simulation model to test the interest rate sensitivity of net interest income and the balance sheet. Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest income. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates on a static balance sheet and use various assumptions, including, but not limited to, prepayments on loans and securities, deposit decay rates and pricing decisions on loans and deposits.
Because these scenarios simulate instantaneous changes in interest rates on a static balance sheet that are subject to various assumptions, the scenarios below may not fully reflect our exposure to interest rate risk. For example, in the event of a significant decrease of the target federal funds rate by the Federal Open Market Committee we may not be able to lower our deposit rates at a similar pace in order to avoid significant deposit withdrawals as customers seek the highest yield possible for their funds. A significant, rapid decrease in interest rates could affect (i) the demand of our deposit products; (ii) our liquidity position if our depositors were to withdraw and move their funds to competing financial institutions; (iii) the expected yield of our loan portfolio and debt securities; (iv) the average duration of our loan portfolio and debt securities; (v) the fair value of our financial assets and financial liabilities; and (vi) our balance sheet mix and composition. In addition, the lack of robust loan originations will inhibit our ability to reinvest loan prepayments that occur as interest rates decline in interest earning assets at the higher end of the yield curve, thus either narrowing our interest rate spread and net interest margin or resulting in further significant decline in the size of our condensed consolidated balance sheet.
The following table presents the estimated changes in net interest income of the Bank, calculated on a bank-only basis, which would result from changes in market interest rates over a 12-month period beginning March 31, 2024 and December 31, 2023. The table below demonstrates that we are asset sensitive at March 31, 2024 and December 31, 2023, with the asset sensitivity of our balance sheet increasing from December 31, 2023 primarily from higher cash balances and shifting balances from money market accounts into time deposits. Quarter-over-quarter, the base net interest income decreased primarily due to increased interest expense on our time deposits.
Estimated
12-Months
Net Interest
Change in Interest Rates (Basis Points)
Income
200
62,322
62,356
62,001
62,560
0
60,412
61,652
−100
57,556
60,057
−200
54,428
57,636
Economic Value of Equity Simulation. We also analyze our sensitivity to changes in interest rates through an EVE model. EVE represents the present value of the expected cash flows from our assets less the present value of the expected cash flows arising from our liabilities. EVE attempts to quantify our economic value using a discounted cash flow methodology. We estimate what our EVE would be as of a specific date. We then calculate what EVE would be as of the same date throughout a series of interest rate scenarios representing immediate and permanent parallel shifts in the yield curves.
As described above, due to the nature of the EVE model and its underlying assumptions, the scenarios below may not fully reflect our exposure to interest rate risk. See “—Net Interest Income Simulation” above for further discussion regarding how our exposure to interest rate risk may change, particularly upon a significant, rapid decrease in interest rates.
The following table presents, as of March 31, 2024 and December 31, 2023, respectively, the impacts of immediate and permanent parallel hypothetical changes in market interest rates on EVE of the Bank, calculated on a bank-only basis. The base EVE increased from December 31, 2023 partially from higher market interest rates combined with changes to our decay speed assumptions which improved our money market account values. The sensitivity of our balance sheet worsened slightly from December 31, 2023 in the rising rate scenarios primarily as a result of slower loan prepayments and faster decay speed assumptions in our key money market product. Since EVE is a long-term measurement of value, the change in EVE is not indicative of the short term (12-months) effects on earnings.
Economic
of Equity
270,543
(17)
261,202
304,806
293,190
(6)
327,428
313,220
335,266
322,399
339,241
326,171
As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing tables. Many assumptions are used to calculate the impact of interest rate fluctuations. Actual results may be significantly different than our projections due to several factors, including the timing and frequency of rate changes, market conditions and the shape of the yield curve. The computations of interest rate risk shown above do not include actions that our management may undertake to manage the risks in response to anticipated changes in interest rates, and actual results may also differ due to any actions taken in response to the changing rates. Accordingly, the data presented in the tables in this section should not be relied upon as indicative of actual results in the event of changes in interest rates and the resulting EVE and net interest income estimates are not intended to represent and should not be construed to represent our estimate of the underlying EVE or forecast of net interest income. Furthermore, the EVE presented in the foregoing table is not intended to present the fair market value of the Company, nor does it represent amounts that would be available for distribution to shareholders in the event of the liquidation of the Company.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in the Company’s reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the specified time periods in the rules and forms of the SEC, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
Our management, with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) promulgated under the Exchange Act) as of March 31, 2024. Based on these evaluations, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2024.
Changes in Internal Control Over Financial Reporting
Our management is required to evaluate, with the participation of our Chief Executive Officer and our Chief Financial Officer, any changes in internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during each quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. There were no changes in our internal control over financial reporting during the three months ended March 31, 2024 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
We are not aware of any material developments to our pending legal proceedings as disclosed in the Company’s 2023 Form 10-K, nor are we involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. We believe that such routine legal proceedings, in the aggregate, are not material to our financial condition and results of operations.
ITEM 1A. RISK FACTORS
There are no material changes from the risk factors as disclosed in the Company’s 2023 Form 10-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Purchases of Equity Securities by the Issuer
Withholding of Vested Restricted Stock Awards
During the three months ended March 31, 2024, the Company withheld shares of common stock representing a portion of the restricted stock awards that vested during the period under our employee stock benefit plans in order to pay employee tax liabilities associated with such vesting. These withheld shares are treated the same as repurchased shares for accounting purposes.
The following table provides certain information with respect to our purchases of shares of the Company’s common stock, as of the settlement date, during the three months ended March 31, 2024, all of which represent tax withholding of restricted stock awards:
Issuer Purchases of Equity Securities
Total Number of
Approximate Dollar
Shares Purchased as
Value of Shares that
Total Number
Part of Publicly
May Yet Be Purchased
Price Paid
Announced Plans or
Under the
Period
Purchased(1)
per Share
Programs
Plans or Programs(2)
January 1 - 31, 2024
38,033
5.67
19,568,117
February 1 - 29, 2024
March 1 - 31, 2024
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
A list of exhibits to this Form 10-Q is set forth in the Exhibit Index below.
Incorporated by Reference
ExhibitNumber
Exhibit Description
Filed /FurnishedHerewith
Form
PeriodEnding
Exhibit /AppendixNumber
Filing Date
31.1
Section 302 Certification — Chief Executive Officer
X
31.2
Section 302 Certification — Chief Financial Officer
32.1*
Section 906 Certification — Chief Executive Officer
32.2*
Section 906 Certification — Chief Financial Officer
101.INS**
Inline XBRL Instance Document
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
104
Cover Page Interactive Data File (formatted in Inline XBRL and contained in Exhibit 101)
* This document is being furnished with this Quarterly Report on Form 10-Q. This certification is deemed not filed for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act, or the Exchange Act.
** The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 9, 2024
(Registrant)
By:
/s/ THOMAS M. O’BRIEN
Thomas M. O’BrienChairman and Chief Executive Officer(Principal Executive Officer)
/s/ KAREN KNOTT
Karen KnottChief Financial Officer(Principal Financial and Accounting Officer)