Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion provides additional information regarding our operations for the twelve-month periods ending December 31, 2020, 2019 and 2018, and financial condition at December 31, 2020 and 2019, and should be read in conjunction with our Consolidated Financial Statements and related notes that appear elsewhere in this report. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods.
We have made, and will continue to make, various forward-looking statements with respect to financial, business and economic matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see the “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report.
Overview
Howard Bancorp, Inc. is the holding company for Howard Bank. Howard Bank was formed in 2004. Howard Bank’s business has consisted primarily of originating both commercial and real estate loans secured by property in our market area. We are headquartered in Baltimore, Maryland. We consider our primary market area to be the Greater Baltimore Metropolitan Area. We engage in a general commercial banking business, making various types of loans and accepting deposits. We market our financial services primarily to small- and medium-sized businesses and their owners, professionals and executives, and high-net-worth individuals. Our loans are primarily funded by core deposits of customers in our market.
Recent Business Developments
We completed the exit of our mortgage banking activities in early 2020. On December 18, 2019, we entered into an agreement to release certain management members of our mortgage division from their employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring our remaining mortgage employees. We also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly created LLC. In consideration of the release of the employment agreements, the transfer of our mortgage employees, and the sale of the domain name, the LLC paid us $750 thousand. Under the agreement, we agreed to cease originating residential first lien mortgage loans and exit all our mortgage banking activities in 2020. Accordingly, all of our residential first lien mortgage pipeline loans were processed by the end of the first quarter of 2020 and our remaining mortgage loans held for sale were sold in the second quarter of 2020. In order to manage future loan run-off within our residential mortgage loan portfolio, we began (and plan to continue) buying first lien residential mortgage loans, on a servicing released basis, from third-party originators. The exit of our mortgage banking activities is discussed in Note 2 to the Consolidated Financial Statements.
COVID-19 Pandemic
Our business, financial condition and results of operations generally rely upon the ability of our borrowers to repay their loans, the value of collateral underlying our secured loans, and demand for loans and other products and services we offer, which are highly dependent on the business environment in our primary market and in the United States as a whole. The COVID-19 pandemic continues to create extensive disruptions to the global economy and financial markets and to businesses and the lives of individuals throughout the world. Federal and state governments have taken, and may continue to take, unprecedented actions to contain the spread of the disease, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief to businesses and individuals impacted by the pandemic. Although in various locations certain activity restrictions have been relaxed and businesses and schools have reopened with some level of success, in many states and localities the number of individuals diagnosed with COVID-19 has increased significantly, which may cause a freezing or, in certain cases, a reversal of previously announced relaxation of activity restrictions and may prompt the need for additional aid and other forms of relief.
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The impact of the COVID-19 pandemic is fluid and continues to evolve. The unprecedented and rapid spread of COVID-19 and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets. In addition, due to the COVID-19 pandemic, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time, then declining further to a low of 0.52% in early August. Since that time, intermediate and long-term bond yields have risen, with a sharper rise in 2021; the yield on the 10-year Treasury bond is now nearing where it was before the start of the pandemic in February 2020. On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00% to 1.25%. This range was further reduced to 0% to 0.25% percent on March 16, 2020 and remained at that level throughout the remainder of 2020. These reductions in interest rates and the other effects of the COVID-19 pandemic have had, and are expected to continue to have, possibly materially, an adverse effect on our business, financial condition, and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including the effect of governmental, regulatory and private sector initiatives, the effect of the recent rollout of vaccinations for the virus, whether such vaccinations will be effective against any resurgence of the virus, including any new strain, and the ability for customers and businesses to return to their pre-pandemic routine.
Our COVID-19 Operational Response
In response to the pandemic, we have taken a number of steps to protect our employees, customers and communities. Our response has continued to evolve since the first confirmed case of COVID-19 was reported in Maryland on March 5, 2020. We have implemented the following measures in an effort to ensure the safety of both our customers and employees while continuing to serve our customers during this challenging period:
● Twelve of the Bank’s fifteen branches remain accessible to customers – nine through drive thru capabilities and all twelve through pre-scheduled meetings.
● Encouraged utilization of our mobile, online, ATM, and other banking channels to limit personal contact.
● Implemented a work-from-home policy for substantially all employees other than branch personnel.
● Added one week of paid time off to all full-time employees to be used in either 2020 or 2021, to acknowledge long hours devoted to providing extraordinary customer service.
● Implemented deep cleaning procedures at all branch locations and other bank facilities.
● Instituted mandatory social distancing policies and wearing of masks for employees working in bank facilities.
Lending Operations and Accommodations to Borrowers
We actively participated in the Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”) established under the Coronavirus Aid, Relief and Economic Security Act (“CARES” Act), as amended and extended. Lending under the PPP commenced on April 3, 2020 and the SBA notified lenders that PPP funds were exhausted on or around April 16, 2020. On April 24, 2020, additional funds were allocated to the PPP and were available through August 8, 2020. An additional stimulus package, approved on December 27, 2020, authorized additional PPP funds. We are continuing to monitor the potential development of additional legislation and further actions taken by the U.S. government with respect to the PPP.
The Paycheck Protection Program Flexibility Act of 2020 (the “PPPF Act”) was enacted in June 2020 and modified the PPP as follows: (i) established a minimum maturity of five years for all loans made after the enactment of the PPPF Act and permits an extension of the maturity of existing loans to five years if the borrower and lender agree; (ii) extended the “covered period” of the CARES Act from June 30, 2020, to December 31, 2020; (iii) extended the eight-week “covered period” for expenditures that qualify for forgiveness to the earlier of 24 weeks following loan origination or December 31, 2020; (iv) extended the deferral period for payment of principal, interest and fees to the date on which the forgiveness amount is remitted to the lender by the SBA; (v) requires the borrower to use at least 60% (down from 75%) of the proceeds of the loan for payroll costs, and up to 40% (up from 25%), for other permitted purposes, as a condition to obtaining forgiveness of the loan; (vi) delayed from June 30, 2020 to December 31, 2020 the date by which employees must be rehired to avoid a reduction in the amount of forgiveness of a loan, and created a “rehiring safe harbor” that allows
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businesses to remain eligible for loan forgiveness if they make a good-faith attempt to rehire employees or hire similarly qualified employees, but are unable to do so, or are able to document an inability to return to pre-COVID-19 levels of business activity due to compliance with social distancing measures; and (vii) allows borrowers to receive both loan forgiveness under the PPP and the payroll tax deferral permitted under the CARES Act, rather than having to choose which of the two would be more advantageous.
In July 2020, the CARES Act was amended to extend, through August 8, 2020, the SBA’s authority to make commitments under the PPP. The SBA’s existing authority had previously expired on June 30, 2020. We are continuing to monitor the potential development of additional legislation and further actions taken by the U.S. government.
At December 31, 2020, we had originated $201.0 million of loans under the PPP. During the first phase of the program, which commenced on April 3, we funded 777 loans totaling $178.7 million. During the second phase, which commenced on April 24 and ended with applications submitted to the SBA by August 8, 2020, we funded an additional 285 loans totaling $22.5 million. The average loan size under the first and second phase of the PPP program was $230 thousand and $78 thousand, respectively. We will continue to support our customers throughout the forgiveness process. We received processing fees from the SBA for the originated PPP loans totaling $6.7 million, which were deferred. In addition, we deferred $782 thousand of origination costs. The net deferred fees are being accreted as a yield adjustment over the contractual term of the underlying PPP loans. PPP lending generated pretax income of $3.8 million, or $0.16 after tax per share in 2020. PPP loans, net of unearned income, totaled $167.6 million at December 31, 2020. A total of $30.1 million of PPP loans were forgiven during 2020.
During this unprecedented situation, we have also established client assistance programs, including offering loan modifications, on a case by case basis, in the form of payment deferrals for periods up to six months, to both commercial and retail customers as discussed in the “Nonperforming and Problem Assets” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”). We have also temporarily ceased making collection calls, are temporarily waiving a higher proportion of late fees assessed for consumer loans, and have paused new foreclosure and repossession actions. We will continue to re-evaluate these temporary actions based on the ongoing COVID-19 pandemic. These programs may negatively impact our revenue and other results of operations in the near term and, if not effective in mitigating the effect of COVID-19 on our customers, may adversely affect our business and results of operations more substantially over a longer period of time. Current and future governmental actions may require these and other types of customer-related responses.
The CARES Act also permits financial institutions to suspend requirements under GAAP for certain loan modifications to borrowers affected by COVID-19 that would otherwise be characterized as TDRs, as discussed in the “Nonperforming and Problem Assets” section of this MD&A.
Impact on Our Results of Operation and Financial Condition
We continue to monitor the impact of the COVID-19 pandemic on our results of operation and financial condition. While the pandemic did not have a significant impact on our financial condition as of December 31, 2020, in the form of significant incurred losses or any communications from our borrowers that significant losses were imminent, we nevertheless determined it prudent to increase our allowance for loan and lease losses (the “allowance”) by $8.8 million in 2020, related to changes in qualitative factors, primarily as a result of the abrupt slowdown in commercial economic activity related to COVID-19, as well as the dramatic rise in the unemployment rate in our market area. Our allowance may also be materially impacted in future periods by the COVID-19 pandemic.
In addition, due to the pandemic and the related economic fallout, including most specifically, declining stock prices at both the Company and peer banks, the Federal Reserve’s significant reduction in interest rates, and other business and market considerations, we performed an interim goodwill impairment analysis as of June 30, 2020. Based on this analysis, the estimated fair value of the Company was less than book value, resulting in a $34.5 million impairment charge, recorded in noninterest expense, in the second quarter of 2020. This was a non-cash charge to earnings and had no impact on our regulatory capital ratios, cash flows, or liquidity position.
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Capital and Liquidity
As of December 31, 2020, all of our capital ratios were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by the COVID-19 pandemic, our reported and regulatory capital ratios could be adversely impacted by loan and lease losses.
We anticipated potential stresses on liquidity management as a result of the COVID-19 pandemic and our participation in the PPP. We built on-balance sheet liquidity during the first quarter of 2020 in anticipation of a possible increase in the utilization of existing lines of credit or decreases in customer deposits. Since these events didn’t materialize, in part due to the various actions initiated by the Federal Reserve to provide market liquidity, we reduced this on-balance sheet liquidity to pre-COVID-19 levels during the second quarter of 2020 while continuing to build our contingent funding availability during 2020.
The Federal Reserve created the Paycheck Protection Program Lending Facility (“PPPLF”), a lending facility that allows us to obtain funding specifically for loans that we make under the PPP, and allows us to retain existing sources of liquidity for our traditional operations. While we had originally planned to use the PPPLF as the funding source for all PPP loans, strong customer deposit growth and the availability of alternative short-term funding sources at a lower cost resulted in our limited usage of the PPPLF and no borrowings outstanding at December 31, 2020.
Use of Non-GAAP Financial Measures and Related Reconciliations
This report contains references to financial measures that are not defined in GAAP. Such non-GAAP financial measures include the presentation of our tangible book value per share, portfolio loans, and portfolio loan-related asset quality ratios.
Management believes that the presentation of these non-GAAP financial measures (a) provides important supplemental information that contributes to a proper understanding of our operating performance and provides a meaningful comparison to our peers, (b) enables a more complete understanding of factors and trends affecting our business, and (c) allows investors to evaluate our performance in a manner similar to management, the financial services industry, bank stock analysts, and bank regulators. Management uses non-GAAP measures as follows: in the preparation of our operating budgets, monthly financial performance reporting, and in our presentation to investors of our performance. However, non-GAAP financial measures have a number of limitations. Limitations associated with non-GAAP financial measures include the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently. These disclosures should not be considered in isolation or as an alternative to our GAAP results. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is presented below.
Certain information in this report is presented with respect to “portfolio loans,” a non-GAAP financial measure defined as total loans and leases, but excluding PPP loans. Portfolio loans is calculated by subtracting PPP loans (net of unamortized deferred fees and origination costs) from total loans and leases. We also provide certain asset quality ratios such as nonperforming loans and the allowance for loan and lease losses as a percentage of portfolio loans. We believe that the presentation of portfolio loans and the related asset quality measures provide additional useful information for purposes of evaluating our results of operations and financial condition with respect to the year 2020 when comparing to other periods, since the PPP loans are 100% guaranteed, were not subject to traditional loan underwriting standards, and a substantial portion of these loans are expected to be forgiven and repaid by the SBA within the next 12-18 months.
We also present “tangible book value per common share.” We believe that this measure is consistent with the treatment by bank regulatory agencies, which exclude intangible assets from the calculation of risk-based capital ratios. Accordingly, we believe that this non-GAAP financial measure provides information that is important to investors and that is useful in understanding our capital position and ratios. In addition, tangible book value per share is the key metric used by bank analysts in evaluating bank stock price performance. Tangible book value per common share is calculated by dividing tangible common stockholders' equity by total common shares outstanding. Tangible common stockholders' equity is calculated by subtracting goodwill and our net core deposit intangible from total stockholders' equity.
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The tables below provide a reconciliation of these non-GAAP financial measures with financial measures defined under GAAP.
Tangible Book Value per Common Share
December 31,
($ in thousands except per share data)
$Change
% Change
Total stockholders' equity (GAAP)
Subtract:
Goodwill
Core deposit intangible, net of deferred tax liability
Total subtractions
Tangible common stockholders' equity (non-GAAP)
Total common shares outstanding at end of period
Book value per common share (GAAP)
Tangible book value per common share (non-GAAP)
Portfolio Loans and Related Asset Quality Ratios
December 31,
($in thousands)
$Change
% Change
Total loans and leases (GAAP)
Subtract PPP loans, net
Total portfolio loans (non-GAAP)
Nonperformng loans
Total loans and leases (GAAP)
Portfolio loans (non-GAAP)
Allowance for loan and lease losses
Total loans and leases (GAAP)
Portfolio loans (non-GAAP)
Financial Highlights
Financial highlights for 2020 are as follows:
● We reported a net loss of $17.0 million, or a loss of $0.91 per diluted common share for the year ended December 31, 2020 compared to net income of $16.9 million, or $0.89 per diluted common share for the year ended December 31, 2019.
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● We recorded a goodwill impairment charge of $34.5 million (or a loss of $1.84 per share) in the second quarter of 2020, which was a non-cash charge that did not affect regulatory capital ratios, liquidity, or our overall financial strength.
● We recorded a provision for credit losses of $9.8 million in 2020, a $5.7 million increase from the $4.2 million we recorded in 2019.
● The allowance for loan and lease losses (the “allowance”) was $19.2 million at December 31, 2020, an increase of $8.8 million from $10.4 million at December 31 2019.
● The allowance was 1.03% of total loans and leases and 1.13% of portfolio loans (a non-GAAP financial measure – refer to the section “Use of Non-GAAP Financial Measures and Related Reconciliations” for additional detail) at December 31, 2020, compared to 0.60% of total loans and leases at December 31, 2019.
● Our net interest margin was 3.27% in 2020, a decrease of 23 basis points (“bp”) from 2019; due primarily to a 78 bp decrease in the average yield on our earning assets, partially offset by a 66 bp decrease in the average rate paid on interest-bearing liabilities.
● Total assets were $2.54 billion at December 31, 2020, up $163.4 million from year end 2019 with this asset growth primarily attributable to securities available for sale, up $159.9 million, and loans and leases, net of unearned income, up $120.4 million. Offsetting this growth were decreases in interest bearing deposits with banks, down $31.8 million, loans held for sale, down $30.7 million, and goodwill, down $34.5 million.
● Total loans and leases, net of unearned income, were $1.87 billion at December 31, 2020, up $120.4 million from December 31, 2019. Portfolio loans were $1.70 billion at December 31, 2020, a decrease of $47.0 million from December 31, 2019.
● Total deposits were $1.98 billion at December 31, 2020, up $261.0 million from year end 2019, with customer deposits up $221.9 million from year end 2019.
● Our borrowings of $242.1 million at December 31, 2020 decreased by $77.3 million since year end 2019 as strong customer and institutional deposit growth reduced our utilization of this source of funds.
● We completed our $7.0 million stock repurchase program on February 24, 2020; a total of 372,801 shares were repurchased during the first quarter for $6.7 million.
● We remained “well capitalized” by all regulatory measures in 2020.
● Our book value per common share was $15.72 at December 31, 2020, down $0.73 per share from December 31, 2019. The decrease in book value per share was driven by the goodwill impairment charge in 2020 of $1.84 per common share.
● Our tangible book value per common share (a non-GAAP financial measure – refer to the “Use of Non-GAAP Financial Measures” for additional detail) was $13.81 per share at December 31, 2020, an increase of 8.8%, or $1.13 per share since at December 31, 2019. The goodwill impairment charge did not impact tangible book value per share.
Critical Accounting Policies
Our accounting and financial reporting policies conform to the accounting principles generally accepted in the United States of America (“GAAP”) and general practice within the banking industry. Application of these principles requires management to make estimates, assumptions and complex judgements that affect the amounts reported in our Consolidated Financial Statements and accompanying notes. These estimates, assumptions and judgments are based on historical experience and various assumptions that we believe to be reasonable as of the date of the financial statements; accordingly, as this information changes, our Consolidated Financial Statements could reflect different estimates, assumptions and judgments. Actual results could differ significantly from those estimates.
Certain accounting measurements inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. The accounting policies we view as critical accounting policies are those relating to the allowance for loan and lease losses, the valuation of goodwill and other intangible assets, and income taxes.
In reviewing and understanding our financial information, we also encourage you to review our significant accounting policies used in preparing our financial statements. See Note 1 to our Consolidated Financial Statements for further discussion of our significant accounting policies.
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Allowance for Loan and Lease Losses
Our allowance for loan and lease losses (the “allowance”) is established through a provision for credit losses charged against income. Loans are charged against the allowance when we believe that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that represents the amount of probable and reasonably estimable known and inherent incurred losses in the loan portfolio, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the types and amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, estimated losses relating to specifically identified loans, and current economic conditions. Based on our estimate of the level of allowance required, we record a provision for loan losses to maintain the allowance at an appropriate level.
Our evaluation of the allowance is inherently subjective as it requires material estimates including, among others, exposure at default, the amount and timing of expected future cash flows on impaired loans, value of collateral, and estimated losses on our loan portfolios as well as consideration of general loss experience. The allowance is also influenced by factors outside of our control such as such as industry and business trends, geopolitical events and the effects of laws and regulations as well as economic conditions such as trends in housing prices, interest rates, GDP, inflation, energy prices and unemployment.
We cannot predict with certainty the amount of loan charge-offs that we will incur. We do not currently determine a range of loss with respect to the allowance. In addition, our regulatory agencies, as an integral part of their examination processes, periodically review our allowance. Such agencies may require that we recognize additions to the allowance based on their judgments about information available to them at the time of their examination. To the extent that actual outcomes differ from management’s estimates, additional provisions to the allowance may be required that would adversely impact earnings in future periods. Note 7 to our Consolidated Financial Statements describes the methodology used to determine the allowance.
Goodwill, Other Intangible Assets and Long-Lived Assets
Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in a business combination. The core deposit intangible is amortized over the estimated useful lives of the long-term deposits acquired, and the remaining amounts of the core deposit intangible are periodically reviewed for impairment. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. Long-lived assets are those that provide the Company with a future economic benefit beyond the current year or operating period. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset is greater than the fair value of the asset. Assets to be disposed of are reported at the lower of the cost or the fair value, less costs to sell.
Effective April 1, 2020, the Company adopted ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment , which simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value, to the extent that the loss recognized does not exceed the amount of goodwill allocated to that reporting unit.
Management has determined that we have one reporting unit. The sudden and continuing decline in economic conditions triggered by the pandemic included a significant decline in stock market valuations and the stock price of both the Company and our peer banks. These events indicated that goodwill may be impaired and resulted in us performing a goodwill impairment assessment. Based on this assessment, the Company's estimated fair value was less than its book value, resulting in a goodwill impairment charge of $34.5 million recorded in the second quarter of 2020.
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Based on the results of our annual impairment analysis, performed in the fourth quarter of 2020, we determined that there was no additional impairment of the carrying value of either the goodwill or core deposit intangible at December 31, 2020.
Income Taxes
We account for income taxes under the asset/liability method. We recognize deferred tax assets and liabilities for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carry-forwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on deferred tax assets and liabilities of a change in tax rates in income in the period indicated by the enactment date. We establish a valuation allowance for deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. The judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond our control. It is at least reasonably possible that management’s judgment about the need for a valuation allowance for deferred tax assets could change in the near term.
Balance Sheet Analysis and Comparison of Financial Condition
A comparison between December 31, 2020 and December 31, 2019 balance sheets is presented below.
General
Total assets increased $163.4 million, or 6.9%, to $2.54 billion at December 31, 2020 compared to $2.37 billion at December 31, 2019. Our asset growth consisted primarily of increases in our total loans of $120.4 million, which included $167.6 million of PPP loans, and investment securities available for sale of $159.9 million. The growth in these assets was partially offset by decreases in interest-bearing deposits with banks of $31.8 million, goodwill of $34.5 million, and loans held for sale of $30.7 million as we exited our mortgage banking activities. The primary source of funding our net asset growth was deposits. Total deposits increased by $261.0 million, including an increase in customer deposits of $221.9 million. Borrowings decreased by $77.3 million, primarily as a result of a decrease of $85.0 million in Federal Home Loan Bank of Atlanta (“FHLB”) borrowings. Total stockholders’ equity decreased by $19.5 million due primarily to the goodwill impairment charge to earnings.
Investment Securities
The following table sets forth the composition of our investment securities portfolio at the dates indicated.
December 31,
(in thousands)
Amortized
Estimated
Amortized
Estimated
Amortized
Estimated
$ Change in
Cost
Fair Value
Cost
Fair Value
Cost
Fair Value
Fair Value
% Change
Available for sale
U.S. Government
Agencies
Mortgage-backed
Other investments
Held to maturity
Corporate debentures
Available for sale
Our available for sale securities are reported at fair value. At December 31, 2020 and 2019, we held U.S. agency debentures, mortgage backed securities, and corporate debentures. This portfolio is used primarily to provide sufficient liquidity to fund our loans and provide funds for withdrawals of deposits. In addition, this portfolio is used as collateral
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for borrowings such as commercial customer overnight securities sold under agreements to repurchase (“repurchase agreements”) and as a source of earnings. At December 31, 2020 and 2019, $226.2 million and $11.6 million in fair value of available for sale securities, respectively, were pledged as collateral. These securities were pledged at the FRB Discount Window as well as for repurchase agreements and deposits of local government entities that require pledged collateral as a condition of maintaining these deposit accounts.
During 2020, we embarked on a strategy to monetize certain unrealized gains in our mortgage-backed securities (“MBS”) portfolio by selling $105 million of MBS with high prepayment speeds, resulting in net gains of $3.0 million. We then purchased $125 million of lower coupon MBS in order to replace both the MBS sold as well as other available for sale securities runoff. We also executed a leveraging strategy that increased the MBS portfolio by $102.4 million from the prior-year level. The leveraging strategy was designed to replace the decrease in the MBS portfolio’s net interest income that resulted from the completion of the strategy to monetize certain unrealized gains in the MBS portfolio. Our portfolio growth, consisting primarily of MBS, was part of our overall earnings and interest rate risk management strategies.
Our available for sale securities portfolio contained eight securities with unrealized losses of $58 thousand at December 31, 2020, and 16 securities with unrealized losses of $166 thousand at December 31, 2019. Changes in the fair value of these securities resulted primarily from interest rate fluctuations. We neither intend to sell these securities nor is it more likely than not that we would be required to sell these securities before their anticipated recovery. Furthermore, we believe the collection of the investment and related interest is probable. Based on this analysis, we do not consider any of the unrealized losses to be other-than-temporary impairment.
Average investment securities available for sale were $309.5 million for the year 2020, an increase of $127.1 million, or 69.7%, from the year 2019 average balance.
Held to maturity
Held to maturity securities are reported at amortized cost. The only investments that we have classified as held to maturity are certain corporate debentures. These investments are intended to be held until maturity. Our held to maturity securities balances were $7.3 million at December 31, 2020 and $7.8 million at December 31, 2019.
There were three held to maturity securities in an unrealized loss position totaling $32 thousand at December 31, 2020, and none at December 31, 2019. Based on our analysis of these securities, we do not consider the unrealized losses to be other-than-temporary impairment. Note 4 to our Consolidated Financial Statements provides more detail concerning the composition of our portfolio and our process for evaluating the portfolio for other-than-temporary impairment.
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Portfolio Maturities and Yields
The composition and maturities of the investment securities portfolio (with respect to those securities that have a fixed maturity date) at December 31, 2020 is summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur.
As of December 31, 2020
After one
After five
(in thousands)
One year or less
through five years
through ten years
After ten years
Total
Weighted
Weighted
Weighted
Weighted
Weighted
Amortized
Average
Amortized
Average
Amortized
Average
Amortized
Average
Amortized
Average
Cost
Yield
Cost
Yield
Cost
Yield
Cost
Yield
Cost
Yield
U.S. Government
Agencies
Mortgage-backed
Other investments
Held to maturity
Corporate debentures
Nonmarketable Equity Securities
At December 31, 2020 and 2019, we held an investment in stock of the Federal Home Loan Bank of Atlanta (“FHLB”) of $10.6 million and $14.2 million, respectively. This investment is required for continued FHLB membership and is based partially upon the amount of borrowings outstanding from the FHLB. This FHLB stock is carried at cost which approximates fair value.
Loan and Lease Portfolio
Total loans and leases (hereinafter referred to as “loans”) increased $120.4 million, or 6.9%, to $1.87 billion at December 31, 2020 from $1.75 billion at December 31, 2019. We originated $196.4 million of PPP loans, net of unamortized deferred fees and origination costs, during the second and third quarters of 2020. At December 31, 2020, PPP loans totaled $167.6 million. Our portfolio loans, which exclude PPP loans (a non-GAAP financial measure – refer to the “Use of Non-GAAP Financial Measures” section for additional detail), decreased by $47.0 million, or 2.7%, to $1.70 billion at December 31, 2020 from $1.75 billion at December 31, 2019.
The $47.0 million decrease in portfolio loans was primarily driven by residential real estate loans, which decreased by $70.7 million, or 13.8%. Despite $42.1 million of loan originations and purchases in 2020 ($11.4 million of portfolio originations prior to our exit of mortgage banking activities and $30.7 million of secondary market loan purchases), the net decrease in residential real estate loans was the result of a continued substantially higher level of prepayments due to lower interest rates that led to strong mortgage refinancing. The commercial lending portfolio modestly increased with commercial real estate loans up $56.8 million, or 8.3%, commercial and industrial (“C&I”) loans down $38.8 million, or 10.4%, primarily due to lower line utilization, and construction and land loans down $11.6 million, or 9.1% due primarily to transfers to other loan portfolios. Consumer loans were up $17.1 million, or 36.4%, primarily driven by growth in our marine lending portfolio.
Average loans were $1.85 billion for the year 2020, an increase of $166.8 million, or 9.9%, over average loans for the year 2019. Average portfolio loans were $1.72 billion for the year 2020, an increase of $35.3 million, or 2.1%, from average loans for the year 2019. The year over year growth was primarily in commercial real estate loans, partially offset by decreased residential real estate loans.
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The following table sets forth the composition of our loan portfolio at the dates indicated.
December 31,
(dollars in thousands)
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Real Estate
Construction and land
Residential – first lien
Residential – junior lien
Total residential real estate
Commercial – owner occupied
Commercial – non-owner occupied
Total commercial real estate
Total real estate loans
Commercial loans and leases 1
Consumer
Total portfolio loans and leases
Paycheck protection program (PPP)
Total loans and leases
Includes equipment financing leases of $3,597, $6,382, $7,607, $8,759, and $2,847 at December 31, 2020, 2019, 2018, 2017, and 2016, respectively.
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Loan Portfolio Maturities
The following table summarizes the scheduled repayments of our loan portfolio and sets forth the scheduled repayments of fixed and adjustable rate loans in our portfolio at December 31, 2020.
At December 31, 2020
After one
(dollars in thousands)
One year or less
through five years
After five years
Total
Real Estate
Construction and land
Residential - first lien
Residential - junior lien
Total residential real estate
Commercial - owner occupied
Commercial - non-owner occupied
Total commercial real estate
Total real estate loans
Commercial loans and leases 1
Consumer
Total portfolio loans and leases
Paycheck protection program (PPP)
Total loans and leases
Rate terms:
Fixed rate
Adjustable rate
Total
Includes equipment financing leases of $3,597 at December 31, 2020
Loans Held for Sale
In connection with exiting of our mortgage banking activities, we completed the processing of our remaining residential first lien mortgage loan pipeline during the first quarter of 2020 and sold the remaining loans held for sale during the second quarter of 2020. As a result, we did not have any loans held for sale at December 31, 2020 compared to $30.7 million at December 31, 2019.
Interest-Bearing Deposits with Banks
Interest-bearing deposits with banks, primarily with the Federal Reserve Bank of Richmond, were $65.2 million at December 31, 2020, a decrease of $31.8 million from the December 31, 2019 balance of $97.0 million. On March 15, 2020, the Board of Governors of the Federal Reserve System reduced the reserve requirement to zero percent due to the COVID-19 pandemic; this action and our active management of cash levels were the primary drivers of the lower balance.
Goodwill, Other Intangible Assets and Long-Lived Assets
Goodwill represents the excess of the purchase price over the sum of the estimated fair value of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired.
Due to the pandemic and the related economic fallout, including most specifically, declining stock prices at both the Company and peer banks, the Federal Reserve’s significant reduction in interest rates, and other business and market considerations, we performed an interim goodwill impairment analysis as of June 30, 2020. Based on this analysis, the estimated fair value of the Company was less than book value, resulting in a $34.5 million goodwill impairment charge,
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recorded in noninterest expense, in the second quarter of 2020. This was a non-cash charge to earnings and had no impact on our regulatory capital ratios, cash flows, or liquidity position. As a result, goodwill decreased to $31.4 million at December 31, 2020 compared to $65.9 million at December 31, 2019.
Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in a business combination. The core deposit intangible is amortized over the estimated useful lives of the long-term deposits acquired, and the remaining amounts of the core deposit intangible are periodically reviewed for impairment. The unamortized balance of our core deposit intangible was $5.8 million at December 31, 2020, compared to $8.5 million at December 31, 2019. Amortization expense reflected in noninterest expense totaled $2.7 million, $3.0 million and $2.9 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Deposits
We accept deposits primarily from the areas in which our branches and offices are located. We have consistently focused on building broader customer relationships and targeting small business customers to increase our core deposits. We also rely on our customer service to attract and retain deposits. We offer a variety of deposit accounts with a range of interest rates and terms. Our deposit accounts consist of commercial and retail checking accounts, savings accounts, certificates of deposit, money market accounts, and individual retirement accounts. In addition, we utilize brokered deposits, primarily through IntraFi Network’s certificate of deposit account registry service (“CDARS”) program. Customer deposits, which exclude brokered deposits and other non-customer deposits, have historically provided us with a sizeable source of relatively stable and low-cost funds to support asset growth.
We review and update interest rates paid, maturity terms, service fees and withdrawal penalties on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market interest rates, liquidity requirements, anticipated short term loan demand and our deposit growth goals.
Total deposits were $1.98 billion at December 31, 2020, an increase of $261.0 million, or 15.2%, from $1.71 billion at December 31, 2019. Customer deposits were $1.70 billion at December 31, 2020, an increase of $221.9 million, or 15.0%, from $1.47 billion at December 31, 2019. The increase in customer deposits was primarily the result of strong growth in low-cost, non-maturity deposits, which increased by $317.7 million, or 27.8%. $239.1 million of this non-maturity deposit growth was in transaction accounts, with $207.8 million of the transaction account growth in noninterest-bearing deposits. Offsetting this growth was a decline of $86.6 million, or 15.2%, in customer certificates of deposit. Brokered and other non-customer deposits were $279.2 million at December 31, 2020, compared to $240.0 million at December 31, 2019. Non-customer deposits are currently our lowest-cost incremental funding source.
Average customer deposits for the year 2020 were $1.60 billion, an increase of $124.2 million, or 8.4%, from the year 2019 average balance. Customer non-maturity deposit balances increased by $193.6 million, or 17.2%, with transaction accounts up $161.5 million; $170.4 million of the transaction account growth was in noninterest-bearing deposits.
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The following table sets forth the distribution of total deposits, by account type, at the dates indicated:
December 31, 2020
December 31, 2019
(dollars in thousands)
Amount
Total
Amount
Total
$ Change
% Change
Noninterest-bearing demand
Interest-bearing checking
Money market accounts
Savings
Certificates of deposit $250 and over
Certificates of deposit under $250
Total deposits
By deposit source:
Customer deposits
Brokered and other non-customer deposits
Total deposits
The following table sets forth the maturity of certificates of deposit of $100,000 or more at December 31, 2020.
(in thousands)
Three months or less
Over three to six months
Over six to twelve months
Over twelve months
FHLB Advances
Our primary source of non-deposit funding is FHLB advances. We use a variety of term structures in order to manage liquidity and interest rate risk. FHLB advances were $200.0 million at December 31, 2020, a decrease of $85.0 million from December 31, 2019. As of December 31, 2020, all FHLB advances have maturities beyond one year. In the second quarter of 2020, we repaid $5.0 million of long-term FHLB borrowings, recording a prepayment penalty of $224 thousand in other operating expenses. The early repayment of these advances were primarily for asset/liability management purposes and a result of the current rate environment.
Additional information regarding FHLB borrowings with final maturities of less than one year are presented in the following table:
Maximum
Maximum
Maximum
Month-End
Month-End
Month-End
(dollars in thousands)
Amount
Rate
Balance
Amount
Rate
Balance
Amount
Rate
Balance
Balance at December 31
Averages for the year
Stockholders’ Equity
Total stockholders’ equity was $294.6 million at December 31, 2020, a $19.5 million decrease from $314.1 million at December 31, 2019. Our decrease in stockholders’ equity was primarily the result of our $17.0 million net loss in 2020, which included the $34.5 million goodwill impairment charge. On February 24, 2020, we completed our stock repurchase program authorized by the Board of Directors on April 24, 2019. A cumulative total of 392,565 shares, at an average price
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paid per share of $17.83, for an aggregate amount of $7.0 million, were repurchased under the program. A total of 372,801 shares were repurchased during the first quarter of 2020 for an aggregate amount of $6.7 million.
Our book value per common share was $15.72 at December 31, 2020, down $0.73 per share from December 31, 2019. The decrease in book value per share was driven by the goodwill impairment charge in 2020 of $1.84 per common share.
Our tangible book value per common share (a non-GAAP financial measure – refer to the “Use of Non-GAAP Financial Measures” section for additional detail) was $13.81 per share at December 31, 2020, an increase of 8.8%, or $1.13 per share since December 31, 2019. The goodwill impairment charge had no impact on our tangible book value per common share.
Comparison of Results of Operations
General
Our results of operations depend mainly on our net interest income, which is the difference between the interest income we earn on our loan and investment portfolios, as well as accretion income on acquired loans, and the interest expense we pay on deposits and borrowings. Our net interest income can be significantly influenced by a variety of factors, including overall loan demand, economic conditions, credit risk, the amount of nonearning assets including nonperforming loans and acquired credit impaired loans, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities, early withdrawal of deposits, exercise of call options on borrowings or securities, a general rise or decline in interest rates, changes in the slope of the yield-curve, and balance sheet growth or contraction.
Our results of operations are also affected by provisions for credit losses, noninterest income and noninterest expense. Our noninterest expense consists primarily of compensation and employee benefits, as well as office occupancy, data processing, deposit insurance, and general administrative expenses.
A discussion of our results of operations for the years ended December 31, 2020, 2019 and 2018 follows.
Average Balance and Yields
The following tables set forth average balances, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, and have been
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reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
December 31,
Average
Income
Yield
Average
Income
Yield
Average
Income
Yield
(dollars in thousands)
Balance
/ Expense
/ Rate
Balance
/ Expense
/ Rate
Balance
/ Expense
/ Rate
Earning assets
Loans and leases: (1)
Commercial loans and leases
Commercial real estate
Construction and land
Residential real estate
Consumer
Paycheck Protection Program (PPP)
Total loans and leases
Securities available for sale: (2)
U.S. Treasury
U.S Gov agencies
Mortgage-backed
Corporate debentures
Total available for sale securities
Securities held to maturity: (2)
FHLB Atlanta stock, at cost
Interest bearing deposit in banks
Loans held for sale
Total earning assets
Cash and due from banks
Bank premises and equipment, net
Goodwill
Core deposit intangible
Other assets
Less: allowance for credit losses
Total assets
Interest-bearing liabilities
Deposits:
Interest-bearing demand accounts
Money market
Savings
Time deposits
Total interest-bearing deposits
Borrowings:
FHLB advances
Fed funds and other borrowings
Subordinated debt
Total borrowings
Total interest-bearing funds
Noninterest-bearing deposits
Other liabilities
Total liabilities
Stockholders’ equity
Total liabilities & equity
Net interest rate spread (3)
Effect of noninterest-bearing funds
Net interest margin on earning assets (4)
Loan fee income is included in the interest income calculation, and non-accrual loans are included in the average loan balance; they have been reflected as loans carrying a zero yield.
Available for sale securities are presented at fair value; held to maturity securities are presented at amortized cost.
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Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
Net interest margin represents net interest income divided by average total interest-earning assets.
Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate) as well as any impact of number of days and mix.
The total of the changes set forth in the rate and volume columns are presented in the total column.
For the year ended December 31,
Due to variances in
Due to variances in
(in thousands)
Total
Rates
Volumes
Total
Rates
Volumes
Effect on interest income on earning assets:
Loans and leases:
Commercial loans and leases
Commercial real estate
Construction and land
Residential real estate
Consumer
Paycheck Protection Program (PPP)
Total interest on loans and leases
Securities available for sale:
U.S. Treasury
U.S. Gov agencies
Mortgage-backed
Corporate debentures
Total interest on available for sale securities
Securities held to maturity
FHLB Atlanta stock, at cost
Interest bearing deposit in banks
Loans held for sale
Total interest income
Effect on interest expense on interest-bearing liabilities: Deposits:
Interest-bearing demand accounts
Money market
Savings
Time deposits
Total deposit on deposits
Borrowings:
FHLB advances
Fed funds and other borrowings
Subordinated debt
Total interest on borrowings
Total interest expense
Effect on net interest earned
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The Federal Reserve’s Federal Open Market Committee’s target for federal funds increased 125 bp in 2017 and 100 bp in 2018 to a range of 2.25% to 2.50% for the year ended December 31, 2018. During 2019, the federal funds target rate remained at the 2.25% to 2.50% range until July 2019 when the Federal Reserve began to drop the federal funds target rate. In the last half of 2019, the Federal Reserve dropped the federal funds target rate 75 bp to the range of 1.50% to 1.75% at December 31, 2019. In March 2020, in response to the COVID19 pandemic, the Federal Reserve then dropped the federal funds target rate 150 bp to a range of 0.00% to 0.25% where it remained at December 31, 2020.
Comparison of the years ended December 31, 2020 and December 31, 2019
General
We reported a net loss of $17.0 million, or a loss of $0.91 per both basic and diluted common share for the year ended December 31, 2020, compared to net income of $16.9 million, or $0.89 per both basic and diluted common share for the year ended December 31, 2019. The $33.9 million, or $1.80 per diluted common share, decrease in net income for 2020 compared to 2019, was driven primarily by the $34.5 million goodwill impairment charge ($1.84 per diluted common share) in 2020, which was not tax deductible. Outside of the goodwill impairment, net income increased by $628 thousand, or $0.03 per diluted common share, in 2020 compared to 2019, primarily as a result of the following:
Increase in securities gains of $2.4 million ($0.10 after tax per diluted common share) in 2020;
Income tax benefit of $1.3 million ($0.07 per diluted common share) in 2020 resulting from a net operating loss carryback provision in the CARES Act;
Decrease in prepayment penalties on FHLB advances of $427 thousand ($0.02 after tax per diluted common share) in 2020;
Decrease in branch optimization charges of $2.7 million ($0.11 after tax per diluted common share) in 2020;
PPP loan pretax income of $3.8 million ($0.16 after tax per diluted common share) in 2020; and
Litigation settlement charge of $700 thousand ($0.03 after tax per diluted common share) in 2019 stemming from certain mortgages originated by First Mariner Bank before its merger with Howard Bank.
These items were partially offset by:
Higher provision for credit losses in 2020 when compared to 2019 of $5.7 million (or $0.23 after tax per diluted common share) as we increased our allowance for loan and lease losses due to the current economic environment;
Decrease in pretax income from our now exited mortgage banking activities of $2.1 million (or $0.08 after tax per diluted common share) in 2020;
Litigation settlement charge of $2.0 million (or $0.08 after tax per diluted common share) in 2020 stemming from certain mortgages originated by First Mariner Bank before its merger with Howard Bank. This settlement was not related to the litigation accrual recorded in 2019; and
Expenses attributable to the departure of our former CFO of $788 thousand (or $0.03 after tax per diluted common share) in 2020.
Net Interest Income
Net interest income is our largest source of operating revenue. Net interest income is affected by various factors including changes in interest rates and the composition of interest-earning assets and interest-bearing liabilities and maturities. Net interest income is determined by the interest rate spread (i.e., the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities.
Net interest income for 2020 was $73.6 million, an increase of $4.3 million, or 6.2%, from 2019. Our net interest margin was 3.27% in 2020, a decrease of 23 bp from the net interest margin of 3.50% in 2019. We continue to experience compression in our net interest margin as market interest rates, after falling to historically low levels as a result of the COVID-19 pandemic through the second quarter of 2020, have generally stabilized. Average earning assets for 2020 of $2.25 billion increased by $267.3 million, or 13.5%, while total interest income decreased by $5.1 million when compared to 2019, as the impact of the 78 bp decrease in the average yield on our earning assets more than offset the interest income
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benefit attributable to the growth in earning assets. Our average interest-bearing liabilities for 2020 increased by $62.6 million while interest expense decreased by $9.4 million compared 2019, as the impact of the 66 bp decrease in the average rate paid on our interest-bearing liabilities more than offset the increase in interest expense attributable to the growth in interest-bearing liabilities.
The net accretion of fair value adjustments on acquired loans added ten bp to our net interest margin in 2020, unchanged from 2019. We expect the impact of this net accretion to continue declining in future periods. PPP loans, with an average yield of 3.06% and an interest spread (net of an assumed funding cost at 0.35%) of 2.71%, reduced our net interest margin by four bp in 2020. The PPP program commenced in the second quarter of 2020; therefore, we had no PPP loans in 2019.
Interest Income
Interest income decreased by $5.1 million, or 5.6%, to $86.4 million in 2020, compared to $91.4 million in 2019. Interest income on loans and leases decreased by $3.7 million, or 4.5%, in 2020 compared to 2019, while average loans and leases increased by 9.9% to $1.85 billion in 2020 when compared to 2019. The average yield on loans and leases of 4.25% for 2020 was down 64 bp from 2019, primarily driven by the lower interest rate environment and, to a lesser extent, the impact of the lower-yielding PPP loans. PPP loans reduced the average loan yield by nine bp in 2020. The net accretion of fair value adjustments on acquired loans added 13 bp to our average yield on loans in 2020, unchanged from 2019.
The average yield on available for sale securities decreased by 104 bp to 1.99%, in 2020 compared to 2019, with the yield on the MBS portfolio, which represents 74.5% and 51.3% of the average available for sale securities portfolio in 2020 and 2019, respectively, down 143 bp to 1.66% in 2020 compared to 2019. Average MBS were up $137.3 million in 2020 (refer to the “Balance Sheet Analysis and Comparison of Financial Condition, Investment Securities” section for additional detail), with net purchases in 2020 at lower yields. In addition, higher prepayment speeds within this portfolio adversely impacted the portfolio yield in 2020. Reflective of the significant decline in the federal funds target rate, the average yield on our interest-bearing deposits in banks fell 128 bp to 0.43% in 2020 compared to 2019.
Interest Expense
Interest expense decreased $9.4 million, or 42.3%, to $12.8 million, in 2020, compared to $22.1 million in 2019. The average rate on interest-bearing liabilities decreased by 66 bp to 0.82% in 2020 compared to 2019. Driving this decrease was a $5.0 million decrease in average interest-bearing deposits which included a 56 bp reduction in the average rate paid on total interest-bearing deposits. We lowered the interest rates paid on interest-bearing deposits in response to the lower prevailing competitive market rates starting in late February 2020, with the full impact of those rate reductions expected as maturing time deposits reprice at lower market interest rates. In addition, our interest expense on FHLB advances decreased $2.3 million in 2020 compared to 2019, while the average balance increased by $54.4 million. The average rate paid on FHLB advances of 0.94% for 2020 decreased by 135 bp when compared to 2019.
Provision for Credit Losses
We recorded a provision for credit losses of $9.8 million in 2020, compared to $4.2 million in 2019, an increase of $5.7 million. The higher provision for credit losses reflects the changing economic environment driven by COVID-19. The provision for credit losses included $320 thousand attributable to our reserve for unfunded commitments, with the remaining $9.5 million attributable to loan and lease losses. For 2020, the portion of the provision for credit losses attributable to loan and lease losses, less net charge-offs of $764 thousand, resulted in an increase in the allowance for loan and lease losses of $8.8 million. For 2019, the provision for credit losses, less net charge-offs of $3.7 million, resulted in an increase in the allowance of $528 thousand. The increase in our allowance is more fully discussed below under the sections of this MD&A entitled “Nonperforming and Problem Assets; COVID-Related Loan Deferrals” and “Allowance for Loan and Lease Losses.”
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Noninterest Income
The following table presents the major categories of noninterest income for the years ended December 31, 2020 and 2019:
(in thousands)
$ Change
% Change
Service charges on deposit accounts
Realized and unrealized gains on mortgage banking activity
Gain on the sale of securities
Gain (loss) on the disposal of bank premises & equipment
Income from bank owned life insurance
Loan related fees and service charges
Other operating income
Total noninterest income
Noninterest income for the year 2020 was $12.4 million, a decrease of $8.7 million, or 41.2%, compared to $21.0 million for 2019. The primary drivers of this decrease were the $9.2 million decrease in noninterest income attributable to exiting our mortgage banking activities, which was partially offset by a $3.0 million increase in gains on the sale of investment securities. Noninterest income other than from mortgage banking activities and securities gains, decreased by $1.9 million, or 19.1%, in 2020 compared to 2019.
Noninterest income from our mortgage banking activities consisted of realized and unrealized gains on mortgage banking activity as well as a portion of the line item “loan related fees and service charges.” Noninterest income attributable to our mortgage banking activities was $1.4 million in 2020, compared to $10.6 million in 2019. We completed the exit of our mortgage banking activities during the second quarter of 2020.
During the second quarter of 2020, we embarked on a strategy to monetize certain unrealized gains in our MBS portfolio. We identified and sold $105 million of MBS with high prepayment speeds, resulting in net gains on the sale of securities of $3.0 million in 2020.
Service charges on deposit accounts, which consisted of account activity fees such as nonsufficient funds (”NSF”) and overdraft fees in addition to other traditional banking fees, decreased by $631 thousand in 2020 when compared to 2019. While the traditional banking fee component was up $150 thousand, NSF and overdraft fees were down $781 thousand in 2020 from 2019 levels, with a portion of this reduction representing accommodations to COVID-19 impacted customers.
Loan related fees and service charges decreased by $2.6 million in 2020 when compared to 2019, which included $389 thousand and $2.8 million attributable to our now exited mortgage banking activities in 2020 and 2019, respectively. Outside of our mortgage banking activities, loan related fees and service charges were down $126 thousand in 2020. 2019 included an early payoff fee of $308 thousand while 2020 included an interest rate swap arrangement fee of $217 thousand.
Other operating income, which consisted mainly of non-depository account fees such as wire, merchant card and ATM services, decreased by $1.1 million in 2020 when compared to 2019. Interchange income declined by $238 thousand in 2020, with a portion of the decline in transaction volumes attributable to the COVID-19 related drop in economic activity. Additionally, 2019 included $750 thousand in revenue associated with the exit of our mortgage banking activities.
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Noninterest Expenses
The following table presents the major categories of noninterest expense for the years ended December 31, 2020 and 2019:
(in thousands)
$ Change
% Change
Compensation and benefits
Occupancy and equipment
Marketing and business development
Professional fees
Data processing fees
FDIC assessment
Other real estate owned
Loan production expense
Amortization of core deposit intangible
Other operating expense
Total noninterest expense before goodwill impairment
Goodwill impairment
Total noninterest expense
N/M - not meaningful
Noninterest expenses increased by $25.4 million to $89.5 million in 2020, compared to $64.1 million in 2019. The increase in noninterest expenses was primarily driven by a $34.5 million goodwill impairment charge in 2020. Partially offsetting this increase was a reduction in noninterest expenses attributable to our now exited mortgage banking activities, which were $1.4 million in 2020, down $7.6 million from 2019. Noninterest expenses other than from our goodwill impairment charge and mortgage banking activities, were down $1.5 million, or 2.8%, in 2020 compared to 2019.
Compensation and benefits expense is the largest component of our noninterest expenses, and decreased by $3.5 million in 2020, compared to 2019. Compensation and benefits expense attributable to our now exited mortgage banking activities was $928 thousand in 2020, compared to $6.4 million 2019, a $5.5 million decrease. Compensation and benefits expense other than from our mortgage banking activities increased $2.0 million, or 7.7%, in 2020 compared to 2019. Included within this increase was $698 thousand of compensation expense attributable to the departure of our former CFO in the first quarter of 2020, $214 thousand related to higher claims experience in our self-insured healthcare plan, an increase of $171 thousand resulting from a lower level of loan origination cost deferrals driven by a decline in lending activities, $360 thousand attributable to an accrual for compensated absences related to additional PTO with a carryover provision granted in light of COVID-19, and $527 thousand attributable to increased staff costs.
Occupancy and equipment expense decreased by $3.6 million in 2020 compared to 2019. In 2020, we continued to evaluate our branch delivery system and further optimized our branch locations, resulting in a $1.1 million branch optimization charge in the fourth quarter of 2020 associated with our decision to close two branches in early 2021. Both of these branches have been temporarily closed since March 2020 due to the pandemic. This $1.1 million charge was partially offset by the partial reversal of a $538 thousand branch closing liability, initially recorded in 2019, as a result of securing a sublease on the former branch location. In 2019, we reported a branch optimization charge of $3.6 million, as we closed three branch locations in 2019 and consolidated two other existing branch locations into a new smaller branch location in 2020. The projected cost savings from our 2019 branch optimization initiative have been realized. Occupancy and equipment expense also decreased by $334 thousand in 2020 due to the exit of our mortgage banking activities.
Marketing and business development expenses decreased by $940 thousand, to $1.4 million in 2020. Lower marketing and business development expenses were driven primarily by the impact of COVID-19 and non-customer direct contact, although our corporate sponsorships were up $195 thousand in 2020 as we increased our level of community support in response to the pandemic.
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Data processing fees consist of core system processors and banking network costs. These expenses decreased by $935 thousand to $4.0 million in 2020, from $4.9 million in 2019, as we realize the benefits from our renegotiated core processing contract.
Loan production expenses decreased by $1.6 million in 2020 compared to 2019, with $1.2 million attributable to our now exited mortgage banking activities.
Our FDIC insurance expense increased by $657 thousand in 2020 compared to 2019. Our second and third quarter 2020 FDIC assessment rate increased due to the impact of the goodwill impairment charge on the assessment calculation. We received small bank assessment credits from the FDIC of $522 thousand in 2019 that did not reoccur in 2020.
Other operating expenses increased by $1.2 million in 2020 compared to 2019. Other operating expenses consisted mainly of a variety of general expenses such as telephone and data lines, supplies and postage, courier services, general insurance, director fees, and miscellaneous losses. Also included in other operating expenses in 2020 was a $2.0 million litigation settlement charge associated with potential litigation claims stemming from certain mortgages originated by First Mariner Bank before its merger with Howard Bank. The settlement agreement was executed in January 2021. Prepayment penalties on FHLB advances were $224 thousand in 2020, a decrease of $427 thousand from 2019. Included in other operating expenses in 2019 was a $700 thousand litigation settlement charge stemming from certain mortgages originated by First Mariner Bank before its merger with Howard Bank. That settlement was not related to the $2.0 million litigation settlement charge recorded in 2020.
Income Tax Expense
Income tax expense for 2020 was $3.6 million compared to $5.2 million in 2019. Our effective tax rate (income tax expense as a percentage of pretax income) was -27.3% in 2020 and 23.5% in 2019. The effective tax rate is influenced by sources of non-taxable income, such as the income from Bank Owned Life Insurance (“BOLI”) as well as certain non-deductible expense items. The $34.5 million goodwill impairment charge in 2020 was not tax deductible. Income tax expense for 2020 was favorably impacted by certain provisions of the CARES Act. The CARES Act permits corporate taxpayers to recover prior period taxes paid by carrying back net operating losses incurred in tax years ending after December 31, 2017 to tax years ending up to five years earlier. As a result, we will be able to carryback the 2018 tax net operating loss of $9.8 million to tax years 2013-2017. The $1.3 million tax benefit represents the difference between the current federal statutory tax rate of 21% and the 34% statutory federal tax rate applicable during the carryback years. Excluding the impact of the goodwill impairment charge and the $1.3 million benefit from the CARES Act, the effective tax rate for 2020 would have been 23.2%.
Income tax expense for 2019 was favorably impacted by a 2019 U.S. Treasury Department change in tax regulations that provided for retroactive application to the taxability of income from BOLI contracts that were acquired in certain tax-free merger transactions. As a result of the change in tax regulations, we recognized a $232 thousand net reduction of tax expense in 2019 pertaining to BOLI income that was earned, and initially treated as subject to income tax, in 2018. Excluding the impact of the $232 thousand of BOLI income, the effective tax rate for 2019 would have been 24.5%.
Comparison of the years ended December 31, 2019 and December 31, 2018
General
Our net income increased $20.7 million to $16.9 million in 2019, compared to a net loss of $3.8 million in 2018. The net loss in 2018 was primarily driven by $15.5 million of merger and restructuring expenses related to our March 1, 2018 merger with First Mariner, which were not repeated in 2019. The increase in net income in 2019 was also driven by an $11.0 million increase in interest income, compared to 2018, primarily from an increase in interest and fees earned on loans and leases as a result of organic growth and a full-year impact of our merger with First Mariner, partially offset by an $8.4 million increase in interest expense. In 2019, net income was also partially offset by $3.6 million of expense, included within occupancy and equipment expense, related to our branch optimization initiative that resulted in three branch closures in 2019, and the expected consolidation of two additional branches in the first quarter of 2020. Our results
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for 2019 also included the proceeds from our agreement to exit our mortgage banking activities (net of expenses recorded) of $462 thousand.
Both our basic and diluted earnings per common share were $0.89 in 2019, compared to both a basic and diluted loss per common share of $0.22 in 2018.
Net Interest Income
Net interest income increased $2.7 million in 2019, compared to 2018. The increase in net interest income, while up $7.3 million due to favorable volume variances, was offset by unfavorable rate variances of $4.6 million. Our net interest margin was 3.50% in 2019, a decline of 28 bp, compared to 3.78% in 2018. This decrease was primarily driven by a 44 bp increase in the average rate paid on interest bearing liabilities, which more than offset the six bp increase in the average yield on interest earning assets. The net accretion of fair value adjustments added eight bp to our net interest margin in 2019, compared to 18 bp in 2018.
Interest Income
Interest income increased $11.0 million, or 13.7%, to $91.4 million in 2019, compared to $80.4 million in 2018. $8.9 million of this increase was attributable to interest and fees on loans and leases (excluding loans held for sale) and was primarily attributable to organic loan growth with the average balance of our loans and leases up $170.6 million, or 11.3%, in 2019. Interest income was further aided by a four bp increase in the average yield on our loans and leases, with increases in yields in all categories of loans other than consumer loans. The accretion of fair value adjustments in our loan portfolio added ten bp to the average yield on loans in 2019, compared to 15 bp in 2018. Interest and dividends on investment securities increased $2.5 million in 2019 as a result of both an increase in average balances of $59.1 million and a 36 bp increase in the average yield.
Interest Expense
Interest expense increased $8.4 million, or 60.7%, to $22.1 million, in 2019, compared to $13.8 million in 2018. Interest expense on deposits increased by $6.9 million in 2019, compared to 2018, with $3.9 million of the increase resulting from increases in average volumes and $3.0 million resulting from increases in rates paid on interest-bearing deposits. These increases were influenced by a $129.4 million increase in the average balance of time deposits and a corresponding 75 bp increase in the rate paid on such deposits. Average non-maturity interest bearing deposits increased $43.7 million with a 12 bp increase in the average rate paid on such deposits. We increased the interest rates on our interest-bearing deposits in response to the prevailing competitive rates in our market. The amortization of fair value adjustments in our interest-bearing liabilities, primarily in time deposits, reduced the rate on interest bearing liabilities by one bp in 2019, compared to six bp in 2018. Overall, the average interest rate paid on interest bearing deposits increased 45 bp in 2019. In addition, interest expense on short- and long-term borrowings increased an aggregate of $1.4 million in 2019, compared to 2018, resulting from a 148 bp increase in the average rate paid on such borrowings. The increase in average rates paid on borrowings more than offset the $4.9 million decrease in our average balance of short- and long-term borrowings in 2019, compared to 2018.
Provision for Credit Losses
We recorded a provision for credit losses of $4.2 million for 2019, compared to $6.1 million for 2018, a decrease of $1.9 million. The decrease included the impact of a decrease in specific reserves from $2.4 million at December 31, 2018 to $500 thousand at December 31, 2019. The trend in our asset quality metrics indicate year over year improvement. Our nonperforming loans, as a percentage of gross loans, declined to 1.10% at 2019, from 1.50% at 2018, and nonperforming assets, as a percentage of total assets, declined to 0.94% at 2019 from 1.28% at 2018.
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Noninterest Income
The following table presents the major categories of noninterest income for the years ended December 31, 2019 and 2018:
(in thousands)
$ Change
% Change
Service charges on deposit accounts
Realized and unrealized gains on mortgage banking activity
Gain (loss) on the sale of securities
Loss on the disposal of bank premises & equipment
Income from bank owned life insurance
Loan related fees and service charges
Other operating income
Total noninterest income
Noninterest income was $21.0 million for 2019, compared to $17.9 million for 2018. This increase was primarily driven by a $2.6 million increase in realized and unrealized gains on mortgage banking activity and the net $1.0 million increase in gain (loss) on the sale of securities. While our mortgage loans originated for sale were down 2.2% in 2019, compared to 2018, our increase in realized and unrealized gains was up 48.7%. This represents an average gain on loans originated for sale of 1.36% in 2019, compared to 0.89% in 2018. The improvement in our average gain on loans originated for sale was the result of a stronger management focus on originating a more profitable product mix. The gain/(loss) on the sale of securities in 2019 and 2018, respectively, were both due to our interest rate positioning strategies at the time of the respective sales.
Service charges on deposit accounts, which consisted of account activity fees such as overdraft fees and other traditional banking fees, increased $531 thousand in 2019, compared to 2018, primarily as a result of increased overdraft activities resulting from deposit growth during 2019.
Other operating income, which consisted mainly of non-depository account fees such as wire, merchant card and ATM services increased $252 thousand in 2019, compared to 2018. Reflected in 2019 other operating income was $750 thousand in revenue associated with the previously disclosed exit of our mortgage banking activities. In 2018, other operating income included a $750 thousand insurance refund.
Partially offsetting the above increases was a $1.7 million decrease in loan related fees and service charges. This decrease was primarily due to a $2.0 million reduction in underwriting and processing fees in 2019. Underwriting and processing fees from our mortgage banking activities decreased $2.3 million in 2019, compared to 2018. This reduction resulted from our decision to discontinue our national consumer direct origination channel in mid-2018. The loans originated from this channel generated substantially higher underwriting and processing fees per loan than comparable fees on loans originated from our retail origination channel.
Our mortgage banking activities generated total noninterest income of $10.6 million in 2019 and $10.2 million in 2018.
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Noninterest Expenses
The following table presents the major categories of noninterest expense for the years ended December 31, 2019 and 2018:
(in thousands)
$ Change
% Change
Compensation and benefits
Occupancy and equipment
Marketing and business development
Professional fees
Data processing fees
Merger and restructuring expense
FDIC assessment
Other real estate owned
Loan production expense
Amortization of core deposit intangible
Other operating expense
Total noninterest expense
Noninterest expenses decreased $19.0 million, or 22.9%, to $64.1 million for 2019, compared to $83.1 million for 2018. This decrease was primarily driven by $15.5 million of merger and restructuring expenses related to our merger with First Mariner in 2018, which were not repeated in 2019.
Compensation and benefits expense decreased $1.6 million in 2019, compared to 2018. The primary driver of this decrease was decreases in staff related to our branch optimization initiative in 2019.
Occupancy and equipment expense decreased $1.6 million in 2019, compared to 2018. Following our merger with First Mariner in 2018, we evaluated our retail branch network, which resulted in the closing of several acquired and existing locations that we deemed to be redundant. In 2019, we continued to evaluate our branch delivery system and further optimized our branch locations. Because of our branch optimization efforts, we incurred $3.6 million and $2.7 million in lease termination and location closing costs in 2019 and 2018, respectively, partially offset by a reduction in lease liability expense on one branch location closed in 2019. These efficiencies also reduced general operating expenses (rent, janitorial, utilities, and depreciation) by $2.0 million in 2019, and equipment expenses (hardware and maintenance contracts and real estate taxes) by $281 thousand in 2019.
Marketing and business development expenses decreased by $1.0 million, or 29.9%, to $2.3 million in 2019. The 2018 expense level included $1.1 million of costs associated with mortgage lead generation from our former national leads-based consumer direct residential first lien mortgage origination channel that we discontinued in mid-2018. Data processing costs increased by $877 thousand to $4.9 million in 2019, from $4.0 million in 2018, resulting from the large growth in loan and deposit accounts primarily resulting from our merger with First Mariner, which increased our core processing cost, as well as improved technology to enhance product deliveries. Our FDIC insurance expense was down $601 thousand in 2019. We received small bank assessment credits from the FDIC of $522 thousand in 2019, resulting from the Deposit Insurance Fund ratio exceeding 1.38%.
Other operating expenses increased $268 thousand in 2019, compared to 2018, primarily as a result of a $700 thousand charge related to the settlement of a litigation claim related to mortgages originated by First Mariner before our acquisition of the bank and $692 thousand of prepayment penalties resulting from our early redemption of FHLB advances. Partially offsetting these increases was a $1.4 million reduction in various categories of other expense, due primarily to merger integration and branch optimization efficiencies.
Income Tax Expense
Income tax expense for 2019 was $5.2 million, compared to an income tax benefit in 2018 of $897 thousand. Our effective tax rate (income tax expense as a percentage of pretax income) was 23.5% in 2019 and 19.0% in 2018. The effective tax rate is influenced by sources of non-taxable income, such as the income from Bank Owned Life Insurance (“BOLI”) as
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well as certain non-deductible expense items. Certain merger and acquisition costs are deemed not deductible for income tax purposes, which impacted the effective tax rate for 2018. Income tax expense for 2019 was favorably impacted by a 2019 U.S. Treasury Department change in tax regulations that provided for retroactive application to the taxability of income from BOLI contracts that were acquired in certain tax-free merger transactions. As a result of the change in tax regulations, we recognized a $232 thousand net reduction of tax expense in 2019 pertained to BOLI income that was earned, and initially treated as subject to income tax, in 2018. Excluding the impact of the $232 thousand of BOLI income, the effective tax rate for 2019 would have been 24.5%.
Nonperforming and Problem Assets; COVID–Related Loan Deferrals
We perform reviews of all delinquent loans and our loan officers contact customers to attempt to resolve potential credit issues in a timely manner. Loans are placed on non-accrual status when payment of principal or interest is 90 days or more past due and the value of the collateral securing the loan, if any, is less than the outstanding balance of the loan. Loans are also placed on non-accrual status if we have serious doubt about further collectability of principal or interest on the loan, even though the loan is currently performing. When loans are placed on non-accrual status, unpaid accrued interest is fully reversed, and subsequent income, if any, is recognized only to the extent received. The loan may be returned to accrual status if the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time and ultimate collectability of the total contractual principal and interest is no longer in doubt.
Under GAAP we are required to account for certain loan modifications or restructurings as troubled debt restructurings (“TDRs”). In general, the modification or restructuring of a debt constitutes a TDR if we, for economic or legal reasons related to the borrower’s financial difficulties, grant a concession, such as a reduction in the effective interest rate, to the borrower that we would not otherwise consider. However, all debt restructurings or loan modifications for a borrower do not necessarily constitute TDRs. We believe loan modifications will potentially result in a lower level of loan losses and loan collection costs than if we proceeded immediately through the foreclosure process with these borrowers.
The CARES Act, as extended by certain provisions of the Consolidated Appropriations Act, 2021, permits banks to suspend requirements under GAAP for loan modifications to borrowers affected by COVID-19 that may otherwise be characterized as TDRs and suspend any determination related thereto if (i) the borrower was not more than 30 days past due as of December 31, 2019, (ii) the modifications are related to COVID-19, and (iii) the modification occurs between March 1, 2020 and the earlier of 60 days after the date of termination of the national emergency or January 1, 2022. Federal bank regulatory authorities also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19 and confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.
Our level of COVID-19-related loan deferrals has generally continued to trend favorably. As of December 31, 2020, a total of $56.1 million of loans, representing 3.0% of total loans and 3.3% of portfolio loans, were performing under some form of deferral or other payment relief. By comparison, $291.4 million of loans, representing 15.3% of total loans and 17.1% of portfolio loans, were performing under some form of deferral or other payment relief as of June 30, 2020; June 30, 2020 represented our highest level of loan deferrals at any quarter-end in 2020. As of March 12, 2021, loan deferrals were $55.8 million, representing 3.0% of total loans and 3.3% of portfolio loans. We expect that some requests for payment deferral extensions will continue while other borrowers currently on payment deferral will resume payments.
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The table below sets forth the amounts and categories of our nonperforming assets, which consist of non-accrual loans, TDRs and OREO (which includes real estate acquired through, or in lieu of, foreclosure), at the dates indicated.
December 31,
(in thousands)
Non-accrual loans:
Real estate loans:
Construction and land
Residential - first lien
Residential - junior lien
Commercial owner occupied
Commercial non-owner occupied
Commercial and leases
Consumer
Total non-accrual loans
Accruing troubled debt restructured loans:
Real estate loans:
Construction and land
Residential - first lien
Commercial non-owner occupied
Commercial and leases
Total accruing troubled debt restructured loans
Total nonperforming loans
Other real estate owned:
Land
Residential - first lien
Commercial non-owner occupied
Total other real estate owned
Total nonperforming assets
Ratios:
Nonperforming loans to total loans and leases
Nonperforming loans to portfolio loans (1)
Nonperforming assets to total assets
Loans past due 90 days still accruing:
Real estate loans:
Construction and land
Residential - first lien
Residential - junior lien
Commercial owner occupied
Commercial non-owner occupied
Commercial and leases
Consumer
Denotes a non-GAAP measure; refer to the section “Use of Non-GAAP Financial Measures and Related Reconciliations” for additional detail.
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Nonperforming Loans
The government fiscal stimulus and relief programs appear to have delayed any materially adverse financial impact to our loan portfolio. Once these stimulus programs have been exhausted, however, we believe our credit metrics could worsen and loan losses could ultimately materialize. Any potential loan losses will be contingent upon a number of factors beyond our control, such as the resurgence of the virus, including any new strains, offset by the potency of the vaccine along with its extensive distribution, and the ability for customers and businesses to return to their pre-pandemic routines.
Nonperforming loans were $19.4 million, or 1.04% of total loans and leases and 1.14% of portfolio loans, at December 31, 2020. Nonperforming loans were up $288 thousand from the December 31, 2019 level, which represented 1.10% of total loans. The $288 thousand increase in 2020 was due primarily to $6.9 million in new nonaccrual loans offset by $5.2 million in payoffs, $1.0 million of charge-offs and $369 thousand of returns to accruing status. $564 thousand of the 2020 nonperforming loan charge-offs were attributable to the full charge-off of loans to one borrower during the first quarter of 2020 where we had recorded a specific allocation of the allowance for loan and lease losses of $500 thousand at December 31, 2019.
Included in non-accrual loans at December 31, 2020 are three troubled debt restructured loans (“TDRs”) with a new carrying balance totaling $498 thousand that were not performing in accordance with their modified terms, and the accrual of interest has ceased. In addition, there were five TDRs totaling $1.5 million that were performing in accordance with their modified terms. There were no additional TDRs in 2020.
The composition of our nonperforming loans at December 31, 2020 is further described below:
Non-Accrual Loans
● Two construction and land loans
● 55 residential first lien loans, three with a combined fair value of $2.5 million in the process of foreclosure
● 22 residential junior lien loans, one with a fair value of $25 thousand in the process of foreclosure
● Two commercial real estate owner-occupied loans, one with a fair value of $294 thousand in the process of foreclosure
● Four commercial real estate non-owner-occupied loans
● Nine commercial loans representing five separate relationships, one with an SBA guarantee, and two loans to one relationship with specific reserves totaling $894 thousand
Accruing Troubled Debt Restructured Loans
● Three residential real estate loans
● Two commercial loans
Nonperforming Assets
Nonperforming assets consist of nonperforming loans and other real estate owned (“OREO”). Our nonperforming assets were $20.2 million, or 0.79% of total assets, at December 31, 2020 compared to $22.2 million, or 0.94% of total assets, at December 31, 2019. Nonperforming assets decreased by $2.1 million at December 31, 2020, compared to December 31, 2019, with OREO down $2.4 million, partially offset by a $288 thousand increase in nonperforming loans.
Other Real Estate Owned
Real estate we acquire as a result of foreclosure is classified as OREO. When a property is acquired as a result of foreclosure, it is recorded at fair value less the anticipated cost to sell at the date of foreclosure. If there is a subsequent change in the value of OREO, we record a valuation allowance to adjust the carrying value of the real estate to its current fair value less estimated disposal costs. Costs relating to holding such real estate are expensed in the current period while
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costs relating to improving such real estate are capitalized up to the property’s net realizable value until a saleable condition is reached. Costs in excess of the property’s net realizable value would be expensed in the current period.
Our OREO totaled $743 thousand at December 31, 2020, a $2.4 million decrease from $3.1 million at December 31, 2019. Included in noninterest expenses were $257 thousand, $473 thousand and $352 thousand for 2020, 2019 and 2018, respectively, attributable to net increases in valuation allowances as the current appraised value of OREO properties, less estimated cost to sell, was insufficient to cover the recorded OREO amount. In addition, we sold several parcels of land, one commercial real estate property, and three residential real estate properties with a combined net carrying balance of $2.1 million in 2020, which resulted in a $98 thousand net loss on the disposition of OREO in 2020. We added one new residential real estate property with a carrying balance of $51 thousand in 2020.
OREO at December 31, 2020 consisted of:
● Several parcels of unimproved land.
● Two residential 1-4 family properties.
Classification of Loans
Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality as Substandard, Doubtful, or Loss assets. An asset is considered Substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Substandard assets include those assets characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all of the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable or improbable. Assets (or portions of assets) classified as Loss are those considered uncollectible and of such little value that their continuance as assets is not warranted. Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve our close attention, are required to be designated as Special Mention.
We maintain an allowance for loan and lease losses at an amount estimated to equal all loan losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Our determination as to the classification of our assets is subject to review by the Commissioner and the FDIC. We regularly review our asset portfolio to determine whether any assets require classification in accordance with applicable regulations.
The $22.2 million increase in special mention loans at December 31, 2020, is primarily due to COVID-related downgrades. The following table sets forth our amounts of classified loans and criticized loans (classified loans plus loans designated as Special Mention) at the dates indicated.
December 31,
(in thousands)
Classified loans:
Substandard
Doubtful
Total classified loans
Special mention
Total criticized loans
Allowance for Loan and Lease Losses
Our allowance for loan and lease losses (the “allowance”) at December 31, 2020 was $19.2 million, up $8.8 million or 84.2% from $10.4 million at December 31, 2019. Net charge-offs in 2020 were $764 thousand and we recorded a $9.5 million provision for credit losses attributable to loan and lease losses. The allowance was 1.03% of total loans and leases and 1.13% of portfolio loans (a non-GAAP financial measure – refer to the “Use of Non-GAAP Financial Measures” section for additional detail) at December 31, 2020, compared to 0.60% of total loans and leases at December 31, 2019.
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The allowance was also 98.62% of nonperforming loans at December 31, 2020, an increase of 44.28% from 54.34% of nonperforming loans at December 31, 2019. The $8.8 million increase in our allowance was primarily the result of management’s response to the COVID-19 pandemic and changes in the qualitative factors discussed below.
COVID-19 and Our Evaluation of the Allowance
The December 31, 2020 allowance reflects our assessment of the impact of COVID-19 on the national and local economies and the impact on various categories of our loan portfolio. Management’s evaluation of COVID-19’s impact on the allowance identified the following qualitative factors for further review:
● Changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
● The existence and effect of any concentrations of credit, and changes in the level of such concentrations;
● Changes in the value of underlying collateral for collateral-dependent loans; and
● Changes in the volume and severity of past due, nonaccrual, and adversely classified loans.
Our evaluation of changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments, considered the abrupt slowdown in commercial economic activity and the dramatic rise in the unemployment rate in our market area. Initially, stay-at-home orders, travel restrictions and closure of non-essential businesses resulted in significant business and operational disruptions, including business closures, supply chain disruptions, mass layoffs, and furloughs. Although many of those restrictions have been lifted or eased, continuing capacity restrictions and health and safety recommendations that discourage travel and encourage continued physical distancing and teleworking have limited the ability of businesses to return to pre-pandemic levels of activity and employment. Therefore, this qualitative factor was increased during 2020 in response to this potential risk, and represents $6.0 million, or 0.35%, of the increase in the allowance.
We also evaluated the existence and effect of any concentrations of credit, and changes in the level of such concentrations, with a focus on the identification of our exposure to industry segments that may potentially be the most highly impacted by COVID-19. The following table identifies those industry segments within our loan portfolio that we believe may potentially be most highly impacted by COVID-19. All balances are as of December 31, 2020; note that the column “Initial SBA PPP Loan Relief” indicates the original balance of PPP loans received by our borrowers in each of the identified loan segments. The potentially highly impacted loan segments total $352.0 million, or 18.9% of total loans and leases, at December 31, 2020. However, the table presents each of these loan segments as a percentage of portfolio loans, which we believe is a more meaningful measure of our potentially highly impacted loan concentration. The definition of our potentially highly impacted (“PHI”) loan segments has remained unchanged through December 31, 2020.
Total Credit
Balance
Initial SBA
($in millions)
Loan
Portfolio
Exposure
Total Credit
with
Loan
PPP Loan
Loan Category
Balance
Loans (1)
Exposure
Deferrals
Category
Relief
Loan Category
CRE - retail
Hotels
CRE - residential rental
Nursing and residential care
Retail trade
Restaurants and caterers
Religious and similar organizations
Arts, entertainment, and recreation
Total - selected categories
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A non-GAAP financial measure – refer to the section “Use of Non-GAAP Financial Measures and Related Reconciliation” for additional detail
Includes unused lines of credit, unfunded commitments, and letters of credit
The PHI breakdown by loan portfolio segment is as follows:
($in millions)
Loan
Portfolio
Total
Loan Portfolio Segment
Balance
Total Loans
Loans (1)
"High Impacts"
Commercial real estate - non-owner occupied
Commercial real estate - owner occupied
Construction and land
Commercial loans and leases
Other
Total
A non-GAAP financial measure – refer to the section “Use of Non-GAAP Financial Measures and Related Reconciliation” for additional detail
PHI loan exposures at December 31, 2020 were concentrated in non-owner-occupied commercial real estate (62.1% of total PHI), owner-occupied commercial real estate (19.4% of total PHI), construction and land (9.6% of total PHI), and C&I loans (8.4% of total PHI). Therefore, this qualitative factor within these PHI loan portfolio segments was increased during 2020 in response to this potential risk, and represents $1.3 million, or 0.08%, of the increase in the allowance.
Our evaluation of potential changes in the value of underlying collateral for collateral-dependent loans considered the potential impact of the economic fallout from COVID-19 on commercial property values due to rent relief and possible business failures resulting in vacancies. In addition, the need for office space may diminish in the future as work from home policies have allowed much office-oriented business activity to continue. We concluded that 53% of our non-owner-occupied commercial real estate portfolio at December 31, 2020 was not included in a PHI loan segment. Therefore, this qualitative factor was increased during 2020 in response to this potential risk, and represents $1.0 million, or 0.06%, of the increase in the allowance.
Our evaluation of changes in the volume and severity of past due, nonaccrual, and adversely classified loans identified three loan portfolio segments where adverse risk rating migration warranted an upward revision to this qualitative factor during 2020; these portfolio segments were both non-owner-occupied and owner-occupied commercial real estate loans as well as C&I loans. The increase in this qualitative factor represents $1.3 million, or 0.08%, of the increase in the allowance.
Credit Risk Management and Allowance Methodology
We provide for loan and lease losses (hereinafter referred to as “loan losses”) based upon the consistent application of our documented allowance methodology. All loan losses are charged to the allowance and all recoveries are credited to it. Additions to the allowance are provided by charges to income based on various factors that, in our judgment, deserve current recognition in estimating probable losses. We regularly review the loan portfolio and make provisions for credit losses in order to maintain the allowance in accordance with GAAP.
In accordance with accounting guidance for business combinations, there was no allowance brought forward on any acquired loans in our acquisitions. For acquired performing loans, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and the discount is accreted to interest income over the life of the loan. Subsequent to the purchase date, the method used to evaluate the sufficiency of the credit discount is similar to originated loans, and if necessary, additional reserves are recognized in the allowance.
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We recorded acquired credit impaired loans in our acquisitions net of purchase accounting adjustments. Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each acquired credit impaired loan in comparison to management’s initial performance expectations. Subsequent decreases in the present value of expected cash flows will be recorded as an increase in the allowance through a provision for credit losses. Subsequent significant increases in cash flows result in a reversal of the provision for credit losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.
The allowance consists of two components – specific and general allowances:
Specific allowances are established for loans classified as Substandard or Doubtful. For loans classified as impaired, the allowance is established when the net realizable value (collateral value less costs to sell) of the impaired loan is lower than the carrying amount of the loan. The amount of impairment provided for as a specific allowance is represented by the deficiency, if any, between the underlying collateral value and the carrying value of the loan. Impaired loans for which the estimated fair value of the loan, or the loan’s observable market price or the fair value of the underlying collateral, if the loan is collateral dependent, exceeds the carrying value of the loan are not considered in establishing specific allowances; and
General allowances established for loan losses on a portfolio basis for loans that do not meet the definition of impaired loans. The portfolio is grouped into similar risk characteristics, primarily loan type and regulatory classification. We apply an estimated loss rate to each loan group. The loss rates applied are based upon our loss experience adjusted, as appropriate, for the qualitative factors discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions.
The allowance is maintained at a level to provide for loan losses that are probable and can be reasonably estimated. Our periodic evaluation of the adequacy of the allowance is based on past credit loss experience, known and inherent losses in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans.
A loan is considered past due or delinquent when a contractual payment is not paid on the day it is due. A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. The impairment of a loan may be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, our impairment on such loans is measured by reference to the fair value of the collateral. Interest income on impaired loans is recognized on the cash basis.
Our loan policies state that after all collection efforts have been exhausted, and the loan is deemed to be a loss, then the remaining loan balance will be charged off against the allowance. All loans are evaluated for loss potential once it has been determined by our Watch Committee that the likelihood of repayment is in doubt. When a loan is past due for at least 90 days or a deterioration in debt service coverage ratio, guarantor liquidity, or loan-to-value ratio has occurred that would cause concern regarding the likelihood of the full repayment of principal and interest, and the loan is deemed not to be well secured, the loan is moved to non-accrual status and a specific reserve is established if the net realizable value is less than the principal value of the loan balance(s). Once the actual loss value has been determined, this amount is charged off against the allowance. Each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss.
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The adjustments to historical loss experience are based on our evaluation of several qualitative factors, including:
● changes in lending policies, procedures, and practices;
● changes in international, national, state and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
● changes in the nature and volume of the loan portfolio;
● changes in the experience, ability and depth of the lending staff;
● changes in the volume and severity of past due, nonaccrual, and adversely classified loans;
● changes in the quality of our loan review system;
● changes in the value of underlying collateral for collateral-dependent loans;
● the existence of any concentrations of credit, and changes in the level of such concentrations;
● the effect of other external factors such as competition and legal and regulatory requirements; and
● any other factors that management considers relevant to the quality or performance of the loan portfolio.
We evaluate the allowance based upon the combined total of the specific and general components. Generally when the loan portfolio increases, absent other factors, the allowance methodology results in a higher dollar amount of estimated probable losses than would be the case without the increase. Generally when the loan portfolio decreases, absent other factors, the allowance methodology results in a lower dollar amount of estimated probable losses than would be the case without the decrease.
Commercial and commercial real estate loans generally have greater credit risks compared to the one- to four-family residential mortgage loans in our loan portfolio, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related business and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. Actual loan and lease losses may be significantly more than the allowance we have established, which could have a material negative effect on our financial results.
Generally, we underwrite commercial loans based on cash flow and business history and receive personal guarantees from the borrowers where appropriate. We generally underwrite commercial real estate loans and residential real estate loans at a loan-to-value ratio of 85% or less at origination. In the event that a loan becomes significantly past due, we will conduct visual inspections of collateral properties and/or review publicly available information, such as online databases, to ascertain property values. We will also obtain formal appraisals on a regular basis even if we are not considering liquidation of the property to repay a loan. It is our practice to obtain updated appraisals if there is a material change in market conditions or if we become aware of new or additional facts that indicate a potential material reduction in the value of any individual property collateral.
For impaired loans, we utilize the appraised value or present value of expected cash flows in determining the appropriate specific allowance attributable to the loan. In addition, changes in the appraised value of multiple properties securing our loans may result in an increase or decrease in our general allowance as an adjustment to our historical loss experience due to qualitative and environmental factors, as described above.
Nonperforming loans are evaluated and valued at the time the loan is identified as impaired on a case by case basis, at the lower of cost or market value. Market value is measured based on the value of the collateral securing the loan. The value of real estate collateral is determined based on an appraisal by qualified licensed appraisers hired by us. Appraised values may be discounted based on management’s historical experience, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. The difference between the appraised value and the principal balance of the loan will determine the specific allowance valuation required for the loan, if any. Nonperforming loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.
We evaluate the loan portfolio on at least a quarterly basis, more frequently if conditions warrant, and the allowance is adjusted accordingly. While we use the best information available to make evaluations, future adjustments to the
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allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Commissioner and the FDIC will periodically review the allowance. The Commissioner and the FDIC may require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination.
The following table sets forth activity in our allowance for loan and lease losses for the periods ended:
December 31,
(in thousands)
Balance at beginning of year
Charge-offs:
Real estate
Construction and land loans
Residential first lien loans
Residential junior lien loans
Commercial owner occupied loans
Commercial non-owner occupied loans
Commercial loans and leases
Consumer loans
Total charge-offs
Recoveries:
Real estate
Construction and land loans
Residential first lien loans
Residential junior lien loans
Commercial owner occupied loans
Commercial non-owner occupied loans
Commercial loans and leases
Consumer loans
Total recoveries
Net charge-offs
Provision for credit losses (1)
Balance at end of year
Allowance as a % of total loans and leases
Allowance as a % of portfolio loans (2)
Allowance as a % of nonperforming loans
Net charge-offs to average loans and leases
Provision for credit losses to average loans and leases
Portion attributable to loan and lease losses
Denotes a non-GAAP measure - refer to the section “Use of Non-GAAP Financial Measures and Related Reconciliations” for additional detail
Allocation of Allowance for Loan and Lease Losses
The following table sets forth the allocation of the allowance by loan category and the percent of loans in each category to total loans at the dates indicated. The allowance allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories. Loans funded through the PPP program are fully guaranteed by the U.S. government and we anticipate that the majority of these loans
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will ultimately be forgiven by the SBA in accordance with the terms of the program. Therefore, no allowance for loan and lease losses is attributable to this loan portfolio segment.
December 31,
(in thousands)
Amount
Percent (1)
Amount
Percent (1)
Amount
Percent (1)
Amount
Percent (1)
Amount
Percent (1)
Real estate loans:
Construction and land loans
Residential first lien loans
Residential junior lien loans
Commercial owner occupied loans
Commercial non-owner occupied loans
Total real estate loans
Commercial loans and leases
Consumer loans
Paycheck Protection Program (PPP)
Total
Represents the percent of loans in each category to total loans and leases.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, and the sale of securities available for sale. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Committee (“ALCO”) is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we had enough sources of liquidity to satisfy our short- and long-term liquidity needs as of December 31, 2020 and December 31, 2019.
We regularly monitor and adjust our investments in liquid assets based upon our assessment of:
● Expected loan demand;
● Expected deposit flows and borrowing maturities;
● Yields available on interest-earning deposits and securities; and
● The objectives of our asset/liability management program.
The most liquid of all assets are cash and cash equivalents. The level of these assets is dependent on our operating, financing, lending and investing activities during any given period. At December 31, 2020 and 2019, cash and cash equivalents totaled $74.6 million and $110.0 million, respectively. Our excess liquid assets were invested in interest-bearing deposits in banks (primarily the Federal Reserve Bank of Richmond). The level of these assets is dependent on our operating, financing, lending and investing activities during any given period.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in our statements of cash flows included in our financial statements.
Our total commitments to extend credit and available credit lines are discussed in the “Commitments and Off-Balance Sheet Arrangements” section of this MD&A, including a table presenting our comparative exposure at December 31, 2020 and 2019.
CDs due within one year totaled $416.1 million, or 21.1% of total deposits, and $458.9 million, or 26.8% of total deposits, at December 31, 2020 and 2019, respectively. If we do not retain these deposits, we may be required to seek other sources of funds, including loan and securities sales and FHLB advances. Based on current market conditions, a substantial portion of our customer CDs with maturities of one year or less are at significantly higher rates than current market rates for both customer CDs and other funding sources. As a result, we do not expect to retain some portion of our customer CDs with maturities of one year or less as of December 31, 2020.
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Our primary investing activity is originating loans. During the years ended December 31, 2020 and December 31, 2019, cash used to fund net loan growth was $119.5 million and $99.2 million, respectively. PPP loans accounted for $167.6 million of the net loan growth in 2020. During 2020, we purchased $340.4 million of securities which partially offset $80.1 million of securities maturities / calls / paydowns and $105.0 million of securities sales. In 2019, we purchased $102.7 million of securities which partially offset $80.4 million of securities maturities / calls / paydowns and $35.4 million of securities sales.
Financing activities consist primarily of activity in deposit accounts and FHLB advances. We experienced a net increase in cash provided from deposits of $261.0 million and $28.6 million, respectively, during the years ended December 31, 2020 and 2019. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors, including the pandemic which caused significant growth in deposit balances held by both households and businesses.
Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB, which provide an additional source of funds. FHLB advances decreased to $200.0 million at December 31, 2020 compared to $285.0 million at December 31, 2019. At December 31, 2020, we had an available line of credit for $639.7 million at the FHLB, with borrowings limited to a total of $475.0 million based on pledged collateral. At December 31, 2019, this available line of credit at the FHLB was $573.3 million, with borrowings limited to a total of $435.4 million based on pledged collateral. Additionally, we participated in and continue to have access to borrowing availability under the FRB’s PPPLF. At December 31, 2020 there were no outstanding PPPLF advances.
The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2020 and 2019, we exceeded all regulatory capital requirements and are considered “well capitalized” under regulatory guidelines. See “Item 1. Business—Supervision and Regulation—Howard Bank—Capital Requirements” and Note 20 of our Consolidated Financial Statements.
Commitments and Off-Balance Sheet Arrangements
We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our customers. These financial instruments are limited to commitments to originate loans and involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not represent unusual risks, and management does not anticipate any losses that would have a material effect on us.
Outstanding loan commitments and lines of credit at December 31, 2020 and December 31, 2019 are as follows:
December 31,
(in thousands)
Unfunded loan commitments
Unused lines of credit
Letters of credit
Total commitments to extend credit and available credit lines
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. We generally require collateral to support financial instruments with credit risk on the same basis as we do for balance sheet instruments. Management generally bases the collateral required on the credit evaluation of the counterparty. Commitments generally have interest rates at current market rates, expiration dates or other termination clauses and may require payment of a fee. Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no violation of any contractual condition. These lines generally have variable interest rates. Since we expect many of the commitments to expire without being drawn upon, and since it is unlikely that all customers will draw upon their lines of credit in full at any one time, the total commitment amount or line of credit amount does not necessarily represent future cash requirements. We evaluate each
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customer’s credit-worthiness on a case-by-case basis. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.
The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. At December 31, 2020 we had a $320 thousand reserve for potential credit losses related to these commitments, recorded in other liabilities on the consolidated balance sheet. We did not have a reserve for potential credit losses related to these commitments at December 31, 2019.
We have contractual obligations to make future payments on debt and lease agreements. In the normal course of business, we enter into contractual arrangements whereby we commit to future purchases of products or services from unaffiliated parties. These purchase obligations are legally binding agreements whereby we agree to purchase products or services with a specific minimum quantity at a fixed, minimum or variable price over a specified period of time. Purchase obligations may include vendor contracts, communication services, processing services and software contracts. We also have contractual obligations under real property leases for certain facilities we utilize.
Payments due by period for our contractual obligations at December 31, 2020 are as follows:
Within
One to
Three to
Over
(in thousands)
one year
three years
five years
five years
Total
Certificates of deposit
FHLB borrowings
Estimated interest due on certificates of deposit and long-term borrowings
Contractual service obligations
Future lease payments
Impact of Inflation and Changing Prices
Our financial statements and related notes have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
