Year-over-year tone shift - average net-tone change across Risk Factors and MD&A vs the prior 10-K. This filing is -0.16pp more bearish than last year's.
Why YoY instead of absolute: the LM lexicon has ~6.6× more negative words than positive (legal/risk-disclosure language is heavy on hedging), so every 10-K reads bearish on raw tone. Year-over-year change strips that bias and surfaces the actual shift in management's framing.
Tone shift by section
The two components the gauge averages: how Risk Factors and MD&A each shifted in net tone versus last year's 10-K. The headline above is their average, so a green needle over a soft section just means the other section carried it.
Risk Factors
-0.21pp
Flat
Net-tone change vs last year's 10-K.
MD&A
-0.11pp
Flat
Net-tone change vs last year's 10-K.
Per-snippet highlights
Sentence-level sentiment highlighting with category and subcategory filters is coming once the snippet-scoring pipeline lands. For now, dig into the actual section text on the Sections tab.
Language change vs prior 10-K
Risk Factors (Item 1A) - words with the biggest YoY frequency increase
Negative rising
adversely+7
defaults+4
negative+3
disruptions+3
scrutiny+3
Positive rising
leading+2
effective+1
opportunities+1
success+1
encouraging+1
Risk Factors (Item 1A)
10,689 words
ITEM 1A. RISK FACTORS
An investment in the Company is subject to risks inherent in our business. The material risks and uncertainties that management believes affect the Company are described below. Before making an investment decision with respect to any of the Company's securities, you should carefully consider the risks and uncertainties described below, together with all of the information included herein. The risks and uncertainties described below are not the only risks and uncertainties the Company faces. Additional risks and uncertainties not presently known or currently deemed immaterial also may have a material adverse effect on the Company's results of operations and financial condition. If any of the following risks actually occur, the Company's business, financial condition, and results of operations could be adversely affected, possibly materially. In that event, the trading price of the Company's common stock or other securities could decline. The risks discussed below also include forward-looking statements, and actual results or outcomes may differ substantially from those discussed or implied in these forward-looking statements.
Risks Related to the Company's Business
Interest Rate and Credit Risks
The Company is subject to interest rate risk.
The Company's earnings and cash flows largely depend on its net interest income. Net interest income equals the difference between interest income and fees earned on interest-earning assets (such as loans and securities) and interest expense incurred on interest-bearing liabilities (such as deposits and borrowed funds). Interest rates are highly sensitive to many factors that are beyond the Company's control, including general economic conditions and policies of various governmental and regulatory agencies, particularly the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence the amount of interest the Company earns on loans and securities and the amount of interest it pays on deposits and borrowings. These changes could also affect (i) the Company's ability to originate loans and obtain deposits, (ii) the fair value of the Company's financial assets and liabilities, and (iii) the average duration of the Company's securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Company's net interest income and, therefore, earnings could be affected. Earnings could also be affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
Language change vs prior 10-K
MD&A (Item 7) - words with the biggest YoY frequency increase
Negative rising
substandard+14
termination+8
foreclosed+7
uncollectible+4
terminated+4
Positive rising
gains+9
enhanced+3
positively+3
advances+1
efficiency+1
MD&A (Item 7)
23,561 words
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
First Midwest Bancorp, Inc. is a bank holding company headquartered in Chicago, Illinois with operations in metropolitan Chicago, southeast Wisconsin, northwest Indiana, central and western Illinois, eastern Iowa, and other markets in the Midwest. Our principal subsidiary, First Midwest Bank, and other affiliates provide a full range of commercial, treasury management, equipment leasing, consumer, wealth management, trust, and private banking products and services through 115 banking locations. We are committed to meeting the financial needs of the people and businesses in the communities where we live and work by providing banking and wealth management solutions, quality products, and innovative services that fulfill those financial needs.
The following discussion and analysis is intended to address the significant factors affecting our Consolidated Statements of Income for the three years ended December 31, 2020 and Consolidated Statements of Financial Condition as of December 31, 2020 and 2019. Certain reclassifications were made to prior year amounts to conform to the current year presentation. When we use the terms "First Midwest," the "Company," "we," "us," and "our," we mean First Midwest Bancorp, Inc. and its consolidated subsidiaries. When we use the term "Bank," we are referring to our wholly-owned banking subsidiary, First Midwest Bank. Management's discussion and analysis should be read in conjunction with the consolidated financial statements, accompanying notes thereto, and other financial information presented in Item 8 of this Form 10-K.
Although management believes it implements effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the Company's results of operations, any substantial, unexpected, or prolonged change in market interest rates could have a material adverse effect on the Company's business, financial condition, and results of operations. See "Net Interest Income" in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of this Form 10-K for further discussion related to the Company's management of interest rate risk.
Changes in the method pursuant to which the LIBOR and other benchmark rates are determined could adversely impact our business and results of operations.
Our floating-rate funding, certain hedging transactions and certain of the products that we offer, such as floating-rate loans and mortgages, determine the applicable interest rate or payment amount by reference to a benchmark rate, such as the London Interbank Offered Rate ("LIBOR"), or to an index, currency, basket or other financial metric. LIBOR and certain other benchmark rates are the subject of recent national, international, and other regulatory guidance and proposals for reform. In July 2017, the Chief Executive of the Financial Conduct Authority ("FCA") announced that the FCA intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR after 2021. However, the administrator of LIBOR has proposed to extend publication of the most commonly used U.S. Dollar LIBOR settings until June 30, 2023 and will cease publishing other LIBOR settings on December 31, 2021. The U.S. federal banking agencies have issued guidance strongly encouraging banking organizations to cease using the U.S. Dollar LIBOR as a reference rate in "new" contracts as soon as practicable and in any event by December 31, 2021. It is not possible to predict whether LIBOR will continue to be viewed as an acceptable market benchmark, which rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes in views or alternatives may be on the markets for LIBOR-linked financial instruments.
Regulators, industry groups and certain committees (e.g., the Alternative Reference Rates Committee) have, among other things, published recommended fallback language for LIBOR-linked financial instruments, identified recommended alternatives for certain LIBOR rates (e.g., the Secured Overnight Financing Rate as the recommended alternative to U.S. Dollar LIBOR), and proposed implementations of the recommended alternatives in floating rate instruments. At this time, it is not possible to predict whether these recommendations and proposals will be broadly accepted, whether they will continue to evolve, and what the effect of their implementation may be on the markets for floating-rate financial instruments.
The discontinuation of LIBOR, changes in LIBOR or changes in market perceptions of the acceptability of LIBOR as a benchmark could result in changes to our risk exposures (for example, if the anticipated discontinuation of LIBOR adversely
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affects the availability or cost of floating-rate funding and, therefore, our exposure to fluctuations in interest rates) or otherwise result in losses on a product or having to pay more or receive less on securities that we own or have issued. In addition, such uncertainty could result in pricing volatility and increased capital requirements, loss of market share in certain products, adverse tax or accounting impacts, and compliance, legal and operational costs and risks associated with client disclosures, discretionary actions taken or negotiation of fallback provisions, systems disruption, business continuity, and model disruption.
The Company is subject to lending risk and lending concentration risk.
There are inherent risks associated with the Company's lending activities. Underwriting and documentation controls cannot mitigate all credit risks, especially those outside the Company's control. These risks include the impact of changes in interest rates, changes in the economic conditions in the markets in which the Company operates and across the U.S., and the ability of borrowers to repay loans based on their respective circumstances. Increases in interest rates or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing those loans.
In particular, economic weakness in real estate and related markets could increase the Company's lending risk as it relates to its commercial real estate loan portfolio and the value of the underlying collateral. In addition, the pandemic and the resulting restrictions on individual and economic activity adversely affected the Company's borrowers, including consumer unsecured installment loans, and certain industries more than others, including recreation and entertainment, hotels, and restaurants.
As of December 31, 2020, the Company's loan portfolio consisted of 33.5% of commercial and industrial and agricultural loans, 32.7% of commercial real estate loans, and 28.5% of consumer loans. The deterioration of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for loan losses, and an increase in loan charge-offs, all of which could have a material adverse effect on the Company's business, financial condition, and results of operations. See "Loan Portfolio and Credit Quality" in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of this Form 10-K for further discussion related to corporate and consumer loans.
Real estate market volatility and future changes in disposition strategies could result in net proceeds that differ significantly from fair value appraisals of loan collateral and OREO and could negatively impact the Company's business, financial condition, and results of operations.
Many of the Company's non-performing real estate loans are collateral-dependent, and the repayment of these loans largely depends on the value of the collateral securing the loans and the successful operation of the property. For collateral-dependent loans, the Company estimates the value of the loan based on the appraised value of the underlying collateral less costs to sell. The Company's OREO portfolio consists of properties acquired through foreclosure in partial or total satisfaction of certain loans as a result of borrower defaults.
In determining the value of OREO properties and other loan collateral, an orderly disposition of the property is generally assumed, except where a different disposition strategy is expected. The disposition strategy (e.g., "as-is", "orderly liquidation", or "forcedliquidation") the Company has in place for a non-performing loan will determine the appraised value it uses. Significant judgment is required in estimating the fair value of property, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility.
In response to market conditions and other economic factors, the Company may utilize sale strategies other than orderly dispositions as part of its disposition strategy, such as immediate liquidation sales. In this event, the net proceeds realized could differ significantly from estimates used to determine the fair value of the properties as a result of the significant judgments required in estimating fair value and the variables involved in different methods of disposition. This could have a material adverse effect on the Company's business, financial condition, and results of operations.
The Company's allowance for credit losses may be insufficient.
The Company maintains an allowance for credit losses at a level believed adequate to absorb estimated losses expected in its existing loan portfolio. The level of the allowance for credit losses reflects management's continuing evaluation of industry concentrations, specific credit risks, credit loss experience, current loan portfolio quality, current national, regional, and local economic trends and conditions, reasonable and supportable forecasts about the future, changes in competitive, legal, and regulatory conditions, and unidentified losses inherent in the current loan portfolio. Determination of the allowance for credit losses is inherently subjective since it requires significant estimates and management judgment of credit risks and future trends, which are subject to material changes. Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, changes in accounting principles, and other factors, both within and outside of the Company's control, may require an increase in the allowance for credit losses, as occurred as a result of the pandemic. In addition, bank regulatory agencies periodically review the Company's allowance for credit losses and may require an increase in the provision for loan losses or the recognition of additional loan charge-offs based on judgments different from
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those of management. Furthermore, if charge-offs in future periods exceed the allowance for credit losses, the Company will need additional provisions to increase the allowance. Any increases in the allowance for credit losses will result in a decrease in net income and capital and may have a material adverse effect on the Company's financial condition and results of operations. See Note 1 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K for further discussion related to the Company's process for determining the appropriate level of the allowance for credit losses.
Financial services companies depend on the accuracy and completeness of information about customers and counterparties.
The Company may rely on information furnished by or on behalf of customers and counterparties in deciding whether to extend credit or enter into other transactions. This information could include financial statements, credit reports, business plans, and other information. The Company may also rely on representations of those customers, counterparties, or other third-parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other information could have a material adverse impact on the Company's business, financial condition, and results of operations.
Funding Risks
The Company is a bank holding company and its sources of funds are limited.
The Company is a bank holding company, and its operations are primarily conducted by the Bank, which is subject to significant federal and state regulation. Cash available to pay dividends to stockholders of the Company is derived primarily from dividends received from the Bank. The Company's ability to receive dividends or loans from its subsidiaries is restricted by law. Dividend payments by the Bank to the Company in the future will require generation of future earnings by the Bank and could require regulatory approval if the proposed dividend is in excess of prescribed guidelines. Further, the Company's right to participate in the assets of the Bank upon its liquidation, reorganization, or otherwise will be subject to the claims of the Bank's creditors, including depositors, which will take priority except to the extent the Company may be a creditor with a recognized claim. As of December 31, 2020, the Company's subsidiaries had deposits and other liabilities of $18.3 billion.
The Company could experience an unexpectedinability to obtain needed liquidity.
Liquidity measures the ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits, and to take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets, and its access to alternative sources of funds. A substantial majority of our liabilities are demand deposits, savings deposits, NOW accounts and money market accounts, which are payable on demand or upon several days' notice, while by comparison, a substantial portion of our assets are loans, which cannot be called or sold in the same time frame. We may not be able to replace maturing deposits and advances as necessary in the future, especially if a large number of our depositors sought to withdraw their accounts, regardless of the reason. The Company seeks to ensure its funding needs are met by maintaining an adequate level of liquidity through asset and liability management. If the Company becomes unable to obtain funds when needed, or if there are unforeseen outflows of cash or collateral, it could have a material adverse effect on the Company's business, financial condition, and results of operations.
Loss of customer deposits could increase the Company's funding costs.
The Company relies on bank deposits to be a low cost and stable source of funding to make loans and purchase investment securities. The Company competes with banks and other financial services companies for deposits. If the Company's competitors raise the rates they pay on deposits, the Company's funding costs may increase, either because the Company raises its rates to avoid losing deposits or because the Company loses deposits and must rely on more expensive sources of funding. Higher funding costs could reduce the Company's net interest margin and net interest income and could have a material adverse effect on the Company's business, financial condition, and results of operations.
Any reduction in the Company's credit ratings could increase its financing costs.
Various rating agencies publish credit ratings for the Company's debt obligations, based on their evaluations of a number of factors, some of which relate to Company performance and some of which relate to general industry conditions. Management routinely communicates with each rating agency and anticipates the rating agencies will closely monitor the Company's performance and update their ratings from time to time during the year.
The Company cannot give any assurance that its current credit ratings will remain in effect for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances in the future so warrant. Downgrades in the Company's credit ratings may adversely affect its borrowing costs and its ability to borrow or raise capital, and may adversely affect the Company's reputation.
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The Company's current credit ratings are as follows:
Rating Agency
Rating
Standard & Poor's Rating Group, a division of the McGraw-Hill Companies, Inc.
BBB-
Moody's Investor Services, Inc.
Baa2
Regulatory requirements, future growth, or operating results may require the Company to raise additional capital, but that capital may not be available or be available on favorable terms, or it may be dilutive.
The Company is required by federal and state regulatory authorities to maintain adequate levels of capital to support its operations. The Company may be required to raise capital if regulatory requirements change, the Company's future operating results erode capital, or the Company elects to expand through loan growth or acquisition.
The Company's ability to raise capital will depend on conditions in the capital markets, which are outside of its control, and on the Company's financial performance. Accordingly, the Company cannot be assured of its ability to raise capital when needed or on favorable terms. If the Company cannot raise additional capital when needed, it will be subject to increased regulatory supervision and the imposition of restrictions on its growth and business. These could negatively impact the Company's ability to operate or further expand its operations through acquisitions or the establishment of additional branches and may result in increases in operating expenses and reductions in revenues that could have a material adverse effect on its business, financial condition, and results of operations.
Operational Risks
The Company's reported financial results may be impacted by management's selection of accounting methods and certain assumptions and estimates.
The Company's financial performance is impacted by accounting principles, policies, and guidelines. Some of these policies require the use of estimates and assumptions that may affect the value of the Company's assets or liabilities and financial results. Some of the Company's accounting policies are critical because they require management to make subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. If such estimates or assumptions are incorrect, the Company may experience material losses. See "Critical Accounting Estimates" in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of this Form 10-K for further discussion.
The Company and its subsidiaries are subject to changes in accounting principles, policies, or guidelines.
From time to time, the Financial Accounting Standards Board ("FASB") and the SEC change the financial accounting and reporting standards, or the interpretation of those standards, that govern the preparation of the Company's external financial statements. These changes are beyond the Company's control, can be difficult to predict, and could materially impact how the Company reports its results of operations and financial condition. For example, on January 1, 2020, the Company adopted Accounting Standards Update ("ASU") 2016-13, Measurement of Credit Losses on Financial Instruments, which substantially changed the accounting for credit losses on loans and other financial assets held by banks, financial institutions and other organizations. The standard, commonly referred to as "CECL," changed the existing incurred loss model in GAAP for recognizing credit losses and instead required companies to reflect their estimate of current expected credit losses over the life of the financial assets. As a result of the adoption of CECL, the Company recognized $76.0 million of allowance for credit losses and a reduction to retained earnings of $26.8 million after-tax for which the Company elected to phase in the day-one effects on capital in accordance with regulatory guidance. It is also possible that the Company's ongoing reported earnings and lending activity could be negatively impacted in future periods as a result of CECL.
The Company's controls and procedures may fail or be circumvented.
Management regularly reviews and updates the Company's loan underwriting and monitoring process, internal controls, disclosure controls and procedures, compliance controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company's controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company's business, financial condition, and results of operations.
The Company's accounting estimates and risk management processes rely on analytical and forecasting models, which reflect assumptions that may not be accurate.
The processes the Company uses to estimate its loan losses and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on the Company's financial
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condition and results of operations, depend on the use of analytical and forecasting models. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If the models the Company uses for interest rate risk and asset-liability management are inadequate, the Company may incur increased or unexpectedlosses resulting from changes in market interest rates or other market measures. If the models the Company uses for estimating its loan losses are inadequate, the allowance for credit losses may not be sufficient to support future charge-offs. If the models the Company uses to measure the fair value of financial instruments are inadequate, the fair value of these financial instruments may fluctuate unexpectedly or may not accurately reflect what the Company could realize on the sale or settlement. Any failure in the Company's analytical or forecasting models could have a material adverse effect on the Company's business, financial condition, and results of operations.
The Company may not be able to attract and retain skilled people.
The Company's success depends on its ability to attract and retain skilled people. Competition for the best people in most activities in which the Company engages can be intense, and the Company may not be able to hire people or retain them.
The unexpectedloss of services of certain of the Company's skilled personnel could have a material adverse effect on the Company's business because of their skills, knowledge of the Company's market, years of industry experience, or customer relationships, and the difficulty of promptly finding qualified replacement personnel. In addition, the scope and content of the federal banking agencies' policies on incentive compensation, as well as changes to those policies, could adversely affect the ability of the Company to hire, retain, and motivate its key personnel.
The Company's information systems may experience an interruption or breach in security, including due to cyber-attacks.
The Company relies heavily on internal and outsourced digital technologies, communications, and information systems to conduct its business operations and store sensitive data. As the Company's reliance on technology systems increases, including as a result of work-from-home arrangements such as those implemented in response to the pandemic, the potential risks of technology-related operation interruptions in the Company's customer relationship management, general ledger, deposit, loan, or other systems or the occurrence of cyber incidents also increases. In addition, information security risks, have generally increased in recent years, and continue to increase, in part because of the proliferation of new technologies, the implementation of work-from-home arrangements, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties, some of which may be linked to terrorist organizations or hostile foreign governments. Cyber incidents can result from unintentional events or from deliberate attacks including, among other things, (i) gainingunauthorized access to digital systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing potentially debilitating operational disruptions, (ii) causing denial-of-service attacks on websites, or (iii) intelligence gathering and social engineering aimed at obtaining information. Cyber-attacks can originate from a variety of sources and the techniques used are increasingly sophisticated.
The occurrence of any failures, interruptions, or security breaches of the Company's technology systems could damage the Company's reputation, result in a loss of customer business, result in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of proprietary information, subject the Company to additional regulatory scrutiny, or expose the Company to civil litigation and possible financial liability, any of which could have a material adverse effect on the Company's business, financial condition, and results of operations, as well as its reputation or stock price. A successful cyber-attack could persist for an extended period of time before being detected, and, following detection, it could take considerable time and expense for us to obtain full and reliable information about the cybersecurity incident and the extent, amount and type of information compromised. During the course of an investigation, we may not necessarily know the effects of the incident or how to remediate it, and actions, decisions and mistakes that are taken or made may further increase the costs and other negative consequences of the incident. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of internet and mobile banking and other technology-based products and services, by the Company and its customers. As cyber threats continue to evolve, the Company expects it will be required to spend additional resources on an ongoing basis to continue to modify and enhance its protective measures and to investigate and remediate any information security vulnerabilities.
The confidential information of the Company's customers (including user names, passwords, and other personally identifiable information) may also be jeopardized from the compromise of customers' personal electronic devices or as a result of a data security breach at an unrelated company. Losses due to unauthorized account activity could harm the Company's reputation and may have a material adverse effect on the Company's business, financial condition and results of operations.
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Disruptions or breaches of third-party systems that the Company depends on for processing and handling Company records and data could have a material adverse effect on the Company.
The Company relies on software developed by third-party vendors to process various Company transactions. In some cases, the Company has contracted with third-parties to run their proprietary software on our behalf. These systems include, but are not limited to, general ledger, payroll, employee benefits, wealth management record keeping, loan and deposit processing, merchant processing, and securities portfolio management. While the Company performs a review of controls instituted by the vendors over these programs in accordance with industry and regulatory standards and performs its own testing of user controls, the Company must rely on the continued maintenance of these controls by the outside party, including safeguards over the security of customer data. In addition, the Company maintains backups of key processing output daily in the event of a failure on the part of any of these systems. Nonetheless, the Company may incur a temporary disruption in its ability to conduct its business or process its transactions or incur damage to its reputation if the third-party vendor, or the third-party vendor's vendor, fails to adequately maintain internal controls or institute necessary changes to systems. Such disruption or breach of security may have a material adverse effect on the Company's business, financial condition, and results of operations.
Failure to keep pace with technological change could have a material adverse effect on the Company.
The banking and financial services industry continually undergoes technological changes, with frequent introductions of new technology-driven products and services. In addition to better meeting customer needs, the effective use of technology increases efficiency and enables financial institutions to reduce costs. The Company's future success will depend, in part, on its ability to address the needs of its customers by using technology to provide products and services that enhance customer convenience and that create additional efficiencies in the Company's operations. Many of the Company's competitors, as well as larger financial institutions, have greater resources to invest in technological improvements, and the Company may not effectively implement new technology-driven products and services, or do so as quickly as its competitors or other larger financial institutions, which could reduce its ability to effectively compete. In addition, the necessary process of updating technology can itself lead to disruptions in availability or functioning of systems. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse effect on the Company's business, financial condition, and results of operations.
New lines of business or new products and services may subject the Company to additional risks.
From time to time, the Company may implement new lines of business or offer new products or services within existing lines of business. There can be substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products or services, the Company may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and new products or services may not be achieved, and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and new product or service could have a significant impact on the effectiveness of the Company's system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on the Company's business, financial condition, and results of operations.
External Risks
The Company operates in a highly competitive industry and market area.
The Company faces substantial competition in all areas of its operations from a variety of different competitors, including traditional competitors that may be larger and have more financial resources and non-traditional competitors that may be subject to fewer regulatory constraints and may have lower cost structures. Traditional competitors primarily include national, regional, and community banks within the markets in which the Company operates. The Company also faces competition from many other types of financial institutions, including savings and loan associations, credit unions, personal loan and finance companies, retail and discount stockbrokers, investment advisers, mutual funds, insurance companies, and other financial intermediaries. In addition, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as loans, automatic fund transfer and automatic payment systems. In particular, the activity and prominence of so-called marketplace lenders, FinTech companies, and other technology-driven financial services companies have grown significantly over recent years and are expected to continue growing.
The financial services industry could become even more competitive as a result of legislative, regulatory, and technological changes, illiquidity in the credit markets, and continued consolidation. Banks, securities firms, and insurance companies can merge under the umbrella of a FHC, which can offer virtually any type of financial service, including banking, securities underwriting, insurance, and merchant banking. Due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services, as well as better pricing for those products and services,
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than the Company can offer. In addition, legislative or regulatory changes could lead to increased competition in the financial services sector. For example, recent regulation has reduced the regulatory burden of large bank holding companies, and raised the asset thresholds at which more onerous requirements apply, which could cause certain large bank holding companies with less than $250 billion in total consolidated assets, which were previously subject to more stringentenhanced prudential standards, to become more competitive or to pursue expansion more aggressively.
The Company's ability to compete successfully depends on a number of factors, including:
• Developing, maintaining, and building long-term customer relationships.
• Expanding the Company's market position.
• Offering products and services at prices and with the features that meet customers' needs and demands.
• Introducing new products and services.
• Maintaining a satisfactory level of customer service.
• Anticipating and adjusting to changes in industry and general economic trends.
• Continued development and support of internet-based services.
• Continuing to hire and retain skilled employees.
Failure to perform in any of these areas could significantly weaken the Company's competitive position, which could adversely affect the Company's growth and profitability. This, in turn, could have a material adverse effect on the Company's business, financial condition, and results of operations.
The Company's business has been, and in the future may be, adversely affected by conditions in the financial markets, the geographic areas in which the Company operates, and economic conditions generally.
The Company's financial performance depends to a large extent on the business environment in the Chicago market, the states of Illinois, Wisconsin, Indiana, and Iowa, and the U.S. as a whole. In particular, the business environment impacts the ability of borrowers to pay interest on and repay principal of outstanding loans, and the value of collateral securing those loans. A favorable business environment is generally characterized by economic growth, low unemployment, efficient capital markets, low inflation, high business and investor confidence, strong business earnings, and other factors. Unfavorable or uncertain economic and market conditions are generally characterized by declines in economic growth, business activity, or investor or business confidence, limitations on the availability of or increases in the cost of credit and capital, increases in inflation or interest rates, high unemployment, natural disasters, or a combination of these or other factors.
Unfavorable or uncertain economic and market conditions can result from a wide array of economic and non-economic factors. For example, during and after the so-called "GreatRecession," the suburban metropolitan Chicago market, the states of Illinois, Wisconsin, Indiana, and Iowa, and the U.S. as a whole experienced a downward economic cycle, including a significant recession. Since the recession, economic growth has been slow and uneven and there are significant concerns regarding the fiscal affairs and status of the State of Illinois and the City of Chicago. More recently, the pandemic and governmental responses to it have resulted in decreased economic growth and business activity and investor confidence, increased unemployment and market and economic volatility, including due to stay-at-home orders, restrictions on the operations of businesses and general public sentiment around health and safety. While there are signs of economic recovery, both before and since the pandemic, there can be no assurance that economic conditions will continue to improve and conditions may instead worsen. The economic conditions in the State of Illinois and City of Chicago could also encourage businesses operating in or residents living in these areas to leave the state or discourage employers from starting or growing their businesses in or moving their businesses to the state, which could have a material adverse effect on the Company's business, financial condition, and results of operations.
Periods of increased volatility in financial and other markets, such as those experienced recently with regard to the pandemic, oil and other commodity prices and current rates, concerns over European sovereign debt risk, trade policies and tariffs affecting other countries, including China, the European Union, Canada, and Mexico and retaliatory tariffs by such countries, and those that may arise from global and political tensions can have a direct or indirect negative impact on the Company and our customers and introduce greater uncertainty into credit evaluation decisions and prospects for growth. Economic pressure on consumers and uncertainty regarding continuing economic improvement may also result in changes in consumer and business spending, borrowing and saving habits.
Such conditions could have a material adverse effect on the credit quality of the Company's loans or its business, financial condition, or results of operations, as well as other potential adverse impacts, including:
• There could be an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility, and widespread reduction of business activity generally.
• There could be an increase in write-downs of asset values by financial institutions, such as the Company.
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• The Company's ability to assess the creditworthiness of customers could be impaired if the models and approaches it uses to select, manage, and underwrite credits become less predictive of future performance.
• The process the Company uses to estimate losses inherent in the Company's loan portfolio requires difficult, subjective, and complex judgments. This process includes analysis of economic conditions and the impact of these economic conditions on borrowers' ability to repay their loans. The process could no longer be capable of accurate estimation and may, in turn, impact its reliability.
• The Bank could be required to pay significantly higher FDIC premiums in the future if losses further deplete the DIF.
• The Company could face increased competition due to intensified consolidation of the financial services industry and from non-traditional financial services providers.
• The Company may be adversely affected by the soundness of other financial institutions, which are interrelated as a result of trading, clearing, counterparty, or other relationships.
In addition, deterioration in market or economic conditions could have an adverse effect, which may be material, on the Company's ability to access capital and on its business, financial condition, and results of operations.
The Company's business, financial condition, liquidity, capital and results of operations have been, and may continue to be, adversely affected by the pandemic.
The pandemic has created economic and financial disruptions that have adversely affected, and are likely to continue to adversely affect, the Company's business, financial condition, liquidity, loans, asset quality, capital and results of operations. The extent to which the pandemic will continue to negatively affect the Company will depend on future developments that are highly uncertain and cannot be predicted and many of which are outside of the Company's control. These future developments may include the scope and duration of the pandemic, the possibility of future resurgences of the pandemic, the continued effectiveness of the Company's business continuity plan including work-from-home arrangements and staffing at branches and certain other facilities, the direct and indirect impact of the pandemic on the Company's employees, clients, counterparties and service providers, as well as on other market participants, actions taken, or that may yet be taken, by governmental authorities and other third parties in response to the pandemic, and the effectiveness and public acceptance of any vaccines for COVID-19.
Although financial markets have largely rebounded from the significant declines that occurred earlier in the pandemic and global economic conditions showed signs of improvement during the second half of 2020, many of the circumstances that arose or became more pronounced after the onset of the pandemic persist, including:
• Increased unemployment and decreased consumer and business confidence and economic activity, leading to certain lower loan demand and an increased risk of loan delinquencies, defaults and foreclosures.
• Ratings downgrades, credit deterioration and defaults in many industries, including, but not limited to, recreation and entertainment, hotels, and restaurants, as well as across consumer unsecured installment loans.
• A decrease in the rates and yields on U.S. Treasury securities, which may lead to further decreased net interest income.
• Volatility in financial and capital markets, interest rates and exchange rates.
• Declines in collateral values.
• Increased demands on capital and liquidity, leading the Company temporarily to suspend purchases of its common stock in order to more fully allocate towards client needs.
• A reduction in the value of the assets that the Company manages or otherwise administers or services for others, affecting related fee income and demand for the Company's services.
• Heightened cybersecurity, information security and operational risks as cybercriminals attempt to profit from the disruption resulting from the pandemic given increased online and remote activity, including as a result of work-from-home arrangements.
• Disruptions to business operations experienced by counterparties and service providers.
• Increased risk of business disruption if our employees are unable to work effectively because of illness, quarantines, government actions, failures in systems or technology that disrupt work-from-home arrangements or other effects of the pandemic.
• Decreased demands for our products and services.
As a result, our credit, operational and certain other risks are generally expected to remain elevated until the pandemic subsides. Depending on the duration and severity of the pandemic going forward, the conditions noted above could continue for an extended period and these or other adverse developments may occur or reoccur.
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Governmental authorities have taken unprecedented measures both to contain the spread of the pandemic and to provide economic assistance to individuals and businesses, stabilize the markets and support economic growth. The success of these measures is unknown and they may not be sufficient to fully mitigate the negative impact of the pandemic. Additionally, some measures, such as payment deferrals on loans, suspension of certain foreclosures, repossessions and other loan collection activity, continuation of certain fee assistance programs and other client accommodations may have a negative impact on the Company's business, financial condition, liquidity, capital and results of operations. If such measures are not effective in mitigating the effects of the pandemic on our borrowers, or if such measures exacerbate the effects of the pandemic on our borrowers, we may also experience higher rates of default and increased credit losses in future periods. The Company also faces an increased risk of litigation and governmental and regulatory scrutiny as a result of the effects of the pandemic and actions governmental authorities take in response to the pandemic. Furthermore, various government programs such as the U.S. Small Business Administration's Paycheck Protection Program ("PPP") are complex and our participation may lead to litigation and governmental, regulatory and third party scrutiny, negative publicity and damage to our reputation.
The length of the pandemic and the efficacy of the extraordinary measures being put in place to address it are unknown. There are no comparable recent events that provide guidance as to the economic recovery from the effects of the pandemic or the effect the spread of COVID-19 as a global pandemic may have. As a result of the pandemic, the Company has experienced and may continue to experience draws on lines of credit, reduced net interest income and net interest margin, reduced revenues in its fee-based businesses, and increased client defaults, including defaults on unsecured loans, resulting in overall declines in credit quality and higher credit loss expense. Even after the pandemic subsides, the U.S. economy may continue to experience a recession, and the Company anticipates that its businesses could be materially and adversely affected by a prolongedrecession. To the extent the pandemic adversely affects the Company's business, financial condition, liquidity, capital, loans, asset quality or results of operations, it may also have the effect of heightening many of the other risks described in this "Risk Factors" section of the Form 10-K.
Turmoil in the financial markets could result in lower fair values for the Company's investment securities.
Major disruptions in the capital markets experienced over the past decade have adversely affected investor demand for all classes of securities, excluding U.S. Treasury securities, and resulted in volatility in the fair values of the Company's investment securities. Significant prolonged reduced investor demand could manifest itself in lower fair values for these securities and may result in the recognition of impairment, which could have a material adverse effect on the Company's business, financial condition, and results of operations.
Municipal securities can also be impacted by the business environment of their geographic location. Although this type of security historically experienced extremely low default rates, municipal securities are subject to systemic risk since cash flows generally depend on (i) the ability of the issuing authority to levy and collect taxes or (ii) the ability of the issuer to charge for and collect payment for essential services rendered. If the issuer defaults on its payments, it may result in the recognition of impairment or total loss, which could have a material adverse effect on the Company's business, financial condition, and results of operations.
Damage to the Company's reputation could adversely affect the Company's ability to attract and maintain customers, investors, and employees.
Threats to the Company's reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable or fraudulent activities of the Company's customers. The Company has policies and procedures in place that seek to protect its reputation and promote ethical conduct. Nonetheless, negative publicity may arise regarding the Company's business, employees, or customers, with or without merit, and could result in the loss of customers, investors, and employees, costlylitigation, a decline in revenues, and increased governmental oversight. Negative publicity could have a material adverse impact on the Company's reputation, business, financial condition, results of operations, and liquidity.
The Company is subject to environmental liability risk associated with lending activities.
A significant portion of the Company's loan portfolio is secured by real property. During the ordinary course of business, the Company may foreclose on and take title to properties securing certain loans. There is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Company may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Company to incur substantial expenses and could materially reduce the affected property's value or limit the Company's ability to sell the affected property or to repay the indebtedness secured by the property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase the Company's exposure to environmental liability. Although the Company has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial
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liabilities associated with an environmental hazard could have a material adverse effect on the Company's business, financial condition, results of operations, and liquidity.
Changes in the federal, state or local tax laws may negatively impact the Company's financial performance.
We are subject to changes in tax law, which could increase our effective tax rates. These law changes may be retroactive to previous periods and as a result could negatively affect our current and future financial performance. Furthermore, the benefits of changes to tax laws that have decreased our effective tax rate, such as the Tax Cuts and Jobs Act ("federal income tax reform") may be reversed by future changes to tax law. In addition, to the extent that any change in tax law decreases our effective tax rate, some or all of this benefit could be lost if the banks and financial services companies we compete with elect to lower interest rates and fees and we are forced to respond in order to remain competitive. Such changes may have a long-term negative effect on borrowing as customers fund their activities with additional cash flow from lower taxes or if borrowing becomes less attractive due to, for example, changes in the ability to deduct interest expense, which could increase the cost of borrowing.
Legal/Compliance Risks
The Company and the Bank are subject to extensive government regulation and supervision and possible enforcement and other legal action.
The Company and the Bank are subject to extensive federal and state regulations and supervision. Banking regulations are primarily intended to protect depositors' funds, FDIC funds, and the banking system as a whole, not holders of our common stock. These regulations affect many aspects of the Company's business operations, lending practices, capital structure, investment practices, dividend policy, and growth. Congress and federal regulatory agencies continually review banking laws, regulations, policies, and other supervisory guidance for possible changes. Changes to statutes, regulations, regulatory policies, or other supervisory guidance, including changes in the interpretation or implementation of those regulations or policies, could affect the Company in substantial and unpredictable ways and could have a material adverse effect on the Company's business, financial condition, and results of operations. These changes could subject the Company to additional costs, limit the types of financial products and services the Company may offer, limit the activities it is permitted to engage in, and increase the ability of non-banks to offer competing financial products and services. Failure to comply with laws, regulations, policies, or other regulatory guidance could result in civil or criminal sanctions, enforcement actions by regulatory agencies, fines and civil money penalties, and damage to the Company's reputation. Government authorities, including bank regulatory agencies, are pursuing aggressive enforcement actions with respect to compliance and other legal matters involving financial activities. Any of these actions could have a material adverse effect on the Company's business, financial condition, and results of operations. While the Company has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See "Supervision and Regulation" in Item 1, "Business," and Note 19 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
The Company's business may be adversely affected in the future by the passage and implementation of legal and regulatory changes regarding banks and financial institutions.
There have been significant revisions to the laws and regulations applicable to financial institutions that recently have been enacted or proposed. In some cases, these and other rules to implement the changes have yet to be finalized, and the final timing, scope and impact of these changes to the regulatory framework applicable to financial institutions remain uncertain. See "Supervision and Regulation" in Item 1, "Business" of this Form 10-K for a discussion of several significant elements of the regulatory framework applicable to us, including recent regulatory developments.
The Company has incurred, and may in the future incur, significant expenses in connection with any change to applicable legal and regulatory requirements, including the hiring of additional compliance, legal, or other personnel, and design and implementation of additional internal controls. Changes in law or regulation could also result in increased competition. In addition, the Company expects that it will remain subject to extensive regulation and supervision, and that the level of regulatory scrutiny may fluctuate over time, based on numerous factors, including changes in the U.S. presidential administration or control of one or both houses of Congress and public sentiment regarding financial institutions. The Company is unable to predict the form or nature of any future changes to statutes or regulation, including the interpretation or implementation thereof. Changes to the Company's supervision or regulation could significantly affect the Company's ability to conduct certain of its businesses in a cost-effective manner, restrict the type of activities in which the Company is permitted to engage, affect the Company's business strategy (including the ability to return capital) or subject the Company to stricter and more conservative capital, leverage, liquidity, and risk management standards. Any such action could significantly increase our costs, limit our growth opportunities, or affect our strategies and business operations, any of which could have a material adverse effect on the Company's business, financial condition, or results of operations.
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To ensure compliance with new requirements when effective, the Company's regulators may require the Company to fully comply with these requirements or take actions to prepare for compliance even before it might otherwise be required, which may cause the Company to incur compliance-related costs before it might otherwise be required. The Company's regulators may also consider its preparation for compliance with these regulatory requirements when examining its operations generally or considering any request for regulatory approval the Company may make, even requests for approvals on unrelated matters.
The level of the commercial real estate loan portfolio may subject the Company to additional regulatory scrutiny.
The FDIC, the Federal Reserve, and the OCC have issued joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under the guidance, a financial institution that is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if (i) total reported loans for construction, land development, and other land represent 100% or more of total capital or (ii) total reported loans secured by multi-family and non-farm residential properties, loans for construction, land development, and other land loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total capital. The joint guidance provides that financial institutions should follow heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment, and monitoring through market analysis and stress testing. The Company is currently in compliance with the joint guidance. If regulators determine the Company does not hold adequate capital in relation to its commercial real estate portfolio, or has not adequately implemented risk management practices, they could impose additional regulatory restrictions against the Company, which could have a material adverse impact on the Company's business, financial condition, and results of operations.
The Company is subject to a variety of claims, litigation, and other actions.
From time to time we are subject to claims, litigation, and other legal or regulatory proceedings relating to our business. These claims, litigation and proceedings may pertain to, among other things, fiduciary responsibilities, contract claims, employment matters, compliance with law or regulations, or the general operation of the Company's business. Currently, there are certain proceedings pending against the Company and its subsidiaries in the ordinary course of business. While the outcome of any claim, litigation or other proceeding is inherently uncertain, the Company's management believes that any liabilities arising from these pending matters would be immaterial based on information currently available. However, if actual results differ from management's expectations, it could have a material adverse effect on the Company's financial condition or results of operations. For a detailed discussion on current legal proceedings, see Item 3, "Legal Proceedings," and Note 21 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Risks Related to Acquisition Activity
Future acquisitions may disrupt the Company's business and dilute stockholder value.
The Company strategically looks to acquire whole banks, branches of other banks, and non-banking organizations. The Company has recently been active in the merger and acquisition market and may consider future acquisitions to supplement internal growth opportunities, as permitted by regulators. Acquiring other banks, branches, or non-banks involves potential risks that could have a material adverse impact on the Company's business, financial condition, and results of operations, including:
• Exposure to unknown or contingent liabilities of acquired institutions.
• Disruption of the Company's business.
• Loss of key employees and customers of acquired institutions.
• Short-term decreases in profitability.
• Diversion of management's time and attention.
• Issues arising during transition and integration.
• Dilution in the ownership percentage of holders of the Company's common stock.
• Difficulty in estimating the value of the target company.
• Payment of a premium over book and market values that may dilute the Company's tangible book value and earnings per share in the short and long-term.
• Volatility in reported income as goodwill impairmentlosses could occur irregularly and in varying amounts.
• Inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits.
• Changes in banking or tax laws or regulations that could impair or eliminate the expected benefits of merger and acquisition activities.
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From time to time, the Company may evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, merger or acquisition discussions and negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. Acquisitions may involve the payment of a premium over book and market values and, therefore, some dilution of the Company's tangible book value and net income per common share may occur in connection with any future transaction. Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, or other projected benefits from an acquisition could have a material adverse effect on the Company's financial condition and results of operations. In addition, from time to time, bank regulators may restrict the Company from making acquisitions. See "Growth and Acquisitions" and "Supervision and Regulation" in Item 1, "Business," of this Form 10-K for additional detail and further discussion of these matters.
Competition for acquisition candidates is intense.
Numerous potential acquirers compete with the Company for acquisition candidates. The Company may not be able to successfully identify and acquire suitable targets, which could slow the Company's growth and have a material adverse effect on its ability to compete in its markets.
Acquisitions may be delayed, impeded, or prohibited due to regulatory issues.
Acquisitions by financial institutions, including by the Company, are subject to approval by a variety of federal and state regulatory agencies. The process for obtaining these required regulatory approvals is complex and can be difficult. Regulatory approvals could be delayed, impeded, restrictively conditioned or denied due to existing or new regulatory issues the Company may have with regulatory agencies, including, without limitation, issues related to BSA compliance, CRA issues, fair lending laws, fair housing laws, consumer protection laws, unfair, deceptive, or abusive acts or practices regulations and other laws and regulations. The Company may fail to pursue, evaluate, or complete strategic and competitively significant acquisition opportunities as a result of its inability, or perceived or anticipated inability, to obtain regulatory approvals in a timely manner, under reasonable conditions, or at all. Difficulties associated with potential acquisitions that may result from these factors could have a material adverse effect on our business, financial condition and results of operations.
The valuations of acquired loans and OREO rely on estimates that may be inaccurate.
The Company performs a valuation of acquired loans and OREO. Although management makes various assumptions and judgments about the collectability of the acquired loans, including the creditworthiness of borrowers and the value of the real estate and other assets serving as collateral for the repayment of secured loans associated with these transactions, its estimates of the fair value of assets acquired could be inaccurate. Valuing these assets using inaccurate assumptions could materially and adversely affect the Company's business, financial condition, and results of operations.
Risks Associated with the Company's Common Stock
The Company's stock price can be volatile.
Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. The Company's common stock price can fluctuate significantly in response to a variety of factors including:
• Actual or anticipated variations in quarterly results of operations.
• Recommendations by securities analysts.
• Operating and stock price performance of other companies that investors deem comparable to the Company.
• News reports relating to trends, concerns, and other issues in the financial services industry.
• Perceptions in the marketplace regarding the Company and/or its competitors.
• New technology used or services offered by competitors.
• Significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving the Company or its competitors.
• Failure to integrate acquisitions or realize anticipated benefits from acquisitions.
• Changes in government regulations.
• Geopolitical conditions, such as acts or threats of terrorism or military conflicts.
• Lack of an adequate market for the shares of our stock.
General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, credit loss trends, or the pandemic could also cause the Company's common stock price to decrease regardless of operating results.
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The Company's Restated Certificate of Incorporation and Amended and Restated By-laws, as well as certain banking laws, may have an anti-takeover effect.
Provisions of the Company's Restated Certificate of Incorporation and Amended and Restated By-laws and federal banking laws, including regulatory approval requirements, could make it more difficult for a third-party to acquire the Company, even if doing so would be perceived to be beneficial by the Company's stockholders. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of the Company's common stock.
The Company may issue additional securities, which could dilute the ownership percentage of holders of the Company's common stock.
The Company may issue additional securities to raise additional capital, finance acquisitions, or for other corporate purposes, or in connection with its share-based compensation plans or retirement plans, and, if it does, the ownership percentage of holders of the Company's common stock could be diluted, potentially materially.
The Company has not established a minimum dividend payment level, and it cannot ensure its ability to pay dividends in the future.
The Company's fourth quarter 2020 cash dividend was $0.14 per share. The Company has not established a minimum dividend payment level, and the amount of its dividend, if any, may fluctuate. All dividends will be made at the discretion of the Company's Board of Directors (the "Board") and will depend on the Company's earnings, financial condition, and such other factors as the Board may deem relevant from time to time. The Board may, at its discretion, further reduce or eliminate dividends or change its dividend policy in the future.
In addition, the Federal Reserve issued Federal Reserve Supervision and Regulation Letter SR 09-4, which reiterates and heightens expectations that bank holding companies inform and consult with Federal Reserve supervisory staff prior to declaring and paying a dividend that exceeds earnings for the period for which the dividend is being paid. If the Company experiences losses in a series of consecutive quarters, it may be required to inform and consult with the Federal Reserve supervisory staff prior to declaring or paying any dividends. In this event, there can be no assurance that the Company's regulators will approve the payment of such dividends.
Offerings of debt, which would be senior to the Company's common stock upon liquidation, and/or preferred equity securities, which may be senior to the Company's common stock for purposes of dividend distributions or upon liquidation, may adversely affect the market price of the Company's common stock.
The Company may attempt to increase capital or raise additional capital by making additional offerings of debt or preferred equity securities, including trust-preferred securities, senior or subordinated notes, and preferred stock. In the event of liquidation, holders of the Company's debt securities and shares of preferred stock and lenders with respect to other borrowings will receive distributions of the Company's available assets prior to the holders of the Company's common stock. Additional equity offerings may dilute the holdings of the Company's existing stockholders or reduce the market price of the Company's common stock, or both. Holders of the Company's common stock are not entitled to preemptive rights or other protections against dilution.
The Board is authorized to issue one or more series of preferred stock from time to time without any action on the part of the Company's stockholders. The Board also has the power, without stockholder approval, to set the terms of any such classes or series of preferred stock that may be issued, including voting rights, dividend rights, and preferences over the Company's common stock with respect to dividends or upon the Company's dissolution, winding-up, liquidation, and other terms. In 2020, the Company issued $230.5 million of 7.000% Fixed Rate Non-Cumulative Perpetual Preferred Stock. If the Company issues additional preferred stock in the future that has a preference over the Company's common stock with respect to the payment of dividends or upon liquidation, or if the Company issues preferred stock with voting rights that dilute the voting power of the Company's common stock, the rights of holders of the Company's common stock or the market price of the Company's common stock could be adversely affected.
Our results of operations are affected by various factors, many of which are beyond our control, including interest rates, local, regional, and national economic conditions, business spending, consumer confidence, legislative and regulatory changes, certain seasonal factors, and changes in real estate and securities markets. Our management evaluates performance using a variety of qualitative and quantitative metrics. The primary quantitative metrics used by management include:
• Net Interest Income – Net interest income, our primary source of revenue, equals the difference between interest income and fees earned on interest-earning assets and interest expense incurred on interest-bearing liabilities.
• Net Interest Margin – Net interest margin equals tax-equivalent net interest income divided by total average interest-earning assets.
• Noninterest Income – Noninterest income is the income we earn from fee-based revenues, investment in bank-owned life insurance ("BOLI"), other income, and non-operating revenues.
• Noninterest Expense – Noninterest expense is the expense we incur to operate the Company, which includes salaries and employee benefits, net occupancy and equipment, professional services, and other costs.
• Asset Quality – Asset quality represents an estimation of the quality of our loan portfolio, including an assessment of the credit risk related to existing and potential loss exposure, and can be evaluated using a number of quantitative measures, such as non-performing loans to total loans.
• Regulatory Capital – Our regulatory capital is classified in one of the following tiers: (i) CET1, which consists of common equity and retained earnings, less goodwill and other intangible assets and a portion of disallowed deferred tax assets ("DTAs"), (ii) Tier 1 capital, which consists of CET1 and the remaining portion of disallowed DTAs, and (iii) Tier 2 capital, which includes qualifying subordinated debt, qualifying trust-preferred securities, and the allowance for credit losses, subject to limitations.
Some of these metrics may be presented on a basis not in accordance with U.S. generally accepted accounting principles ("non-GAAP"). For detail on our non-GAAP measures, see the discussion in the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations." Unless otherwise stated, all earnings per common share data included in this section and throughout the remainder of this discussion are presented on a fully diluted basis.
A quarterly summary of operations for the years ended December 31, 2020 and 2019 is included in the section of this Item 7 titled "Quarterly Earnings."
This Form 10-K, as well as any oral statements made by or on behalf of First Midwest, may contain certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In some cases, forward-looking statements can be identified by the use of words such as "may," "might," "will," "would," "should," "could," "expect," "plan," "intend," "anticipate," "believe," "estimate," "outlook," "predict," "project," "probable," "potential," "possible," "target," "continue," "look forward," or "assume," and words of similar import. Forward-looking statements are not historical facts or guarantees of future performance but instead express only management's beliefs regarding future results or events, many of which, by their nature, are inherently uncertain and outside of management's control. It is possible that actual results and events
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may differ, possibly materially, from the anticipated results or events indicated in these forward-looking statements. We caution you not to place undue reliance on these statements. Forward-looking statements speak only as of the date of this report, and we undertake no obligation to update any forward-looking statements.
Forward-looking statements may be deemed to include, among other things, statements relating to our future financial performance, including the related outlook for 2021, the performance of our loan or securities portfolio, the expected amount of future credit allowances or charge-offs, corporate strategies or objectives, including the impact of certain actions and initiatives, anticipated trends in our business, regulatory developments, acquisition transactions, estimated synergies, cost savings and financial benefits of completed transactions, and growth strategies, including possible future acquisitions. These statements are subject to certain risks, uncertainties, and assumptions. These risks, uncertainties, and assumptions include, among other things, the following:
• Management's ability to reduce and effectively manage interest rate risk and the impact of interest rates in general on the volatility of our net interest income.
• Asset and liability matching risks and liquidity risks.
• Fluctuations in the value of our investment securities.
• The ability to attract and retain senior management experienced in banking and financial services.
• The sufficiency of the allowance for credit losses to absorb the amount of actual losses inherent in the existing loan portfolio.
• The models and assumptions underlying the establishment of the allowance for credit losses and estimation of values of collateral and various financial assets and liabilities may be inadequate.
• Credit risks and risks from concentrations (by geographic area and by industry) within our loan portfolio.
• Changes in the economic environment, competition, or other factors that may influence the anticipated growth rate of loans and deposits, the quality of the loan portfolio, and loan and deposit pricing.
• Changes in general economic or industry conditions, nationally or in the communities in which we conduct business.
• Volatility of rate sensitive deposits.
• Our ability to adapt successfully to technological changes to compete effectively in the marketplace.
• Operational risks, including data processing system failures, vendor failures, fraud, or breaches.
• Our ability to successfully pursue acquisition and expansion strategies and integrate any acquired companies.
• The impact of liabilities arising from legal or administrative proceedings, enforcement of bank regulations, and enactment or application of laws or regulations.
• Governmental monetary and fiscal policies and legislative and regulatory changes that may result in the imposition of costs and constraints through, for example, higher FDIC insurance premiums, significant fluctuations in market interest rates, increases in capital or liquidity requirements, operational limitations, or compliance costs.
• Changes in federal and state tax laws or interpretations, including changes affecting tax rates, income not subject to tax under existing law and interpretations, income sourcing, or consolidation/combination rules.
• Changes in accounting principles, policies, or guidelines affecting the business we conduct.
• Acts of war or terrorism, natural disasters, pandemics, and other external events.
• Other economic, competitive, governmental, regulatory, and technological factors affecting our operations, products, services, and prices.
Statements relating to the pandemic and its continued effects may also be forward-looking statements. The pandemic is adversely affecting us, our customers, counterparties, employees, and third-party service providers, and the ultimate extent of the impacts on our business, financial position, results of operations, capital, liquidity, and prospects is uncertain. Continued deterioration in general business and economic conditions or turbulence in domestic or global financial markets could adversely affect our revenues, the values of our assets and liabilities, reduce the availability of funding to certain financial institutions, lead to a tightening of credit, and increase stock price volatility.
For a further discussion of these risks, uncertainties and assumptions, you should refer to the section entitled "Risk Factors" in Item 1A in this report, this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our subsequent filings made with the SEC. However, these risks and uncertainties are not exhaustive. Other sections of this report describe additional factors that could adversely impact our business and financial performance.
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ADOPTION OF THE CURRENT EXPECTED CREDIT LOSSES STANDARD
On January 1, 2020, the Company adopted the current expected credit losses accounting standard ("CECL"), which requires the Company to present financial assets measured at amortized cost at the net amount expected to be collected considering our current estimate of all expected credit losses. Adoption of this standard on January 1, 2020 increased the allowance for credit losses by $76 million, which includes $32 million attributable to loans and unfunded commitments and $44 million attributable to PCD and non-PCD acquired loans. For additional discussion of adopted accounting pronouncements, see Note 2 of "Notes to the Consolidated Financial Statements" in Part II, Item 8 of this Form 10-K.
COVID-19 PANDEMIC
The pandemic and the resulting governmental responses continue to impact our business and operations, as well as the business and operations of our clients. A variety of restrictions have been placed on companies and individuals throughout our primary operating footprint of Illinois, Wisconsin, Indiana and Iowa. In Illinois, where we are headquartered and conduct the substantial majority of our operations, ongoing business restrictions continue to be in place. The pandemic and these governmental measures have created and are expected to continue to create significant economic disruption and decreased economic activity.
We have experienced, and may continue to experience in the future, a number of financial impacts as a result of the pandemic and governmental responses to it, including a higher provision for loan losses and lower net interest and noninterest income. Additionally, we are actively participating in the U.S. Small Business Administration's ("SBA's") Paycheck Protection Program ("PPP") and have funded approximately $1.2 billion of these loans through the end of 2020. PPP loans have been funded by a combination of deposits and borrowings, with the related processing fees earned being recognized as a yield adjustment over the terms of these loans. We are also committed to using our strong capital levels and ample liquidity to support our clients and communities as they navigate the pandemic. We are temporarily offering several programs and services to support our clients, including:
• Consumer, mortgage, and auto loan payment deferrals;
• Small business payment deferrals;
• Consumer and small business fee assistance programs;
• A suspension of foreclosure and repossession actions; and
• A wide range of financial accommodations for our commercial clients based on individual circumstances.
We have included additional disclosure throughout this Item 7 in this Form 10-K regarding the impact of the pandemic, including with respect to our loan portfolio, income, and funding and liquidity.
We have modified our operations to comply with governmental restrictions and public health authority guidelines. The majority of our non-client facing colleagues are working remotely. A majority of our branches remain open for business through drive-up services with certain branches open for walk-in lobby traffic. For those colleagues who work on-site, they are subject to enhanced health and safety protocols.
Additionally, we have implemented a variety of policies and programs to support our colleagues during the pandemic. We have expanded our paid time off programs and have added health and welfare benefits for all colleagues, including emergency medical and hardship loans, enhanced health insurance programs, and access to retirement benefits under certain pandemic-related circumstances.
Consistent with our long-standing emphasis on community engagement, we are actively supporting the communities we serve during the pandemic. We have committed $2.5 million from the First Midwest Charitable Foundation to support the immediate and long-term needs of our communities. This commitment does not impact the Company's current or future expense as the foundation is a separate entity that is not included in our consolidated financial statements. We also recently introduced enhanced matching gift programs to support colleague donations to eligible 501(c)(3) organizations.
For additional information regarding the risks associated with the pandemic and its expected impact on the Company, refer to the section entitled "Risk Factors" in Part I, Item 1A of this Form 10-K.
OPTIMIZATION STRATEGIES
During the third quarter of 2020, the Company initiated certain actions that include optimizing its retail branch network and delivery model through the consolidation of 17 branches, or approximately 15% of its branch network, which will be completed in early 2021. These actions reflect First Midwest's commitment to best meet the evolving needs and preferences of its clients and resulted in pre-tax costs of $19.9 million in 2020 associated with valuation adjustments related to locations identified for consolidation due to their close proximity to another branch, modernization of our ATM network, advisory fees, employee
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severance, and other expenses associated with locations identified for consolidation. These costs are recorded in optimization costs within noninterest expense and are expected to be earned back in approximately 2 years.
During the second half of 2020, the Company terminated longer term interest rate swaps with a notional amount of $1.6 billion, as well as reduced a portion of the borrowed funds related to the terminated swaps. In addition during the third quarter of 2020, the Company liquidated $159.8 million of securities. As a result of these transactions, $31.9 million of pre-tax losses on swap terminations were partly offset by $14.3 million of pre-tax securities gains, with both items recorded within noninterest income. These actions are expected to positively impact future net interest income along with reducing high levels of excess liquidity.
ACQUISITIONS
Park Bank
On March 9, 2020, the Company completed its acquisition of Bankmanagers, the holding company for Park Bank, based in Milwaukee Wisconsin. At closing, the Company acquired $1.2 billion of assets, $1.0 billion of deposits, and $687.9 million of loans, net of fair value adjustments. Under the terms of the merger agreement, on March 9, 2020, each outstanding share of Bankmanagers common stock was exchanged for 29.9675 shares of Company common stock, plus $623.02 of cash (of which $346.00 per share was paid by Bankmanagers to its shareholders by a special cash dividend immediately prior to closing). This resulted in merger consideration of $174.4 million, which consisted of 4.9 million shares of Company common stock and $102.5 million of cash. Goodwill of $60.6 million associated with the acquisition was recorded by the Company. Park Bank merged into First Midwest Bank and all operating systems were converted to our operating platform in the second quarter of 2020.
Bridgeview Bancorp, Inc.
On May 9, 2019, the Company completed its acquisition of Bridgeview, the holding company for Bridgeview Bank Group. At closing, the Company acquired $1.2 billion of assets, $1.0 billion of deposits, and $709.4 million of loans, net of fair value adjustments. The merger consideration totaled $135.4 million and consisted of 4.7 million shares of Company common stock and $37.1 million of cash. All Bridgeview operating systems were converted to our operating platform during the second quarter of 2019.
Northern Oak Wealth Management, Inc.
On January 16, 2019, the Company completed its acquisition of Northern Oak, a registered investment adviser based in Milwaukee, Wisconsin with approximately $800 million of assets under management at closing.
ISSUANCE OF PREFERRED STOCK
During the second quarter of 2020, the Company issued 4.3 million depositary shares, each representing a 1/40th interest in a share of the Company's 7.000% Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series A, and 4.9 million depositary shares, each representing a 1/40th interest in a share of the Company's 7.000% Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series C, for an aggregate of $230.5 million. The Company received proceeds of $221.2 million, net of underwriting discounts and commissions and issuance costs and expects to use the proceeds for general corporate purposes.
STOCK REPURCHASES
On February 26, 2020, the Company announced a stock repurchase program, under which the Company is authorized to repurchase up to $200 million of its outstanding common stock through December 31, 2021. This stock repurchase program replaced the prior $180 million program, which was scheduled to expire in March 2020. Stock repurchases under the program may be made from time to time on the open market, in privately negotiated transactions or through accelerated share repurchase programs. The timing, pricing and amount of any repurchases under the program will be determined by the Company’s management in its discretion. The stock repurchase program does not obligate the Company to repurchase a specific dollar amount or number of shares, and the program may be extended, modified, or discontinued at any time.
The Company suspended stock repurchases in March 2020 as it shifted its capital deployment strategy in response to the pandemic. Prior to this action, the Company repurchased 1.2 million shares of its common stock at a total cost of $22.6 million during 2020 under both the current and prior stock repurchase programs.
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PERFORMANCE OVERVIEW
Table 1
Selected Financial Data
(Dollar amounts in thousands, except per share data)
Years Ended December 31,
Operating Results
Interest income
Interest expense
Net interest income
Provision for loan losses
Noninterest income
Noninterest expense
Income before income tax expense
Income tax expense
Net income
Preferred dividends
Net income applicable to non-vested restricted shares
Net income applicable to common shares
Weighted-average diluted common shares outstanding
Diluted earnings per common share
Diluted earnings per common share, adjusted (1)
Performance Ratios
Return on average common equity
Return on average common equity, adjusted (1)
Return on average tangible common equity
Return on average tangible common equity, adjusted (1)
Return on average assets
Return on average assets, adjusted (1)
Tax-equivalent net interest margin (1)(2)
Tax-equivalent net interest margin, adjusted (1)(2)
Efficiency ratio (1)
(1) This item is a non-GAAP financial measure. For a discussion of non-GAAP financial measures, see the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations."
(2) See the section of this Item 7 titled "Earnings Performance" below for additional discussion and calculation of this metric.
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As of December 31,
$ Change
% Change
Balance Sheet Highlights
Total assets
Total loans
Total deposits
Core deposits
Loans to deposits
Core deposits to total deposits
Asset Quality Highlights
Non-accrual loans, excluding PCD loans (1)(2)
Non-accrual PCD loans (1)
Total non-accrual loans
90 days or more past due loans, still accruing interest (1)
Total NPLs
Accruing troubled debt restructurings ("TDRs")
Foreclosed assets (3)
Total NPAs
30-89 days past due loans (1)
NPAs to loans plus foreclosed assets
NPAs to total loans plus foreclosed assets, excluding PCD
and PPP loans (1)(2)(5)
Allowance for Credit Losses
Allowance for credit losses
Allowance for credit losses to total loans (4)
Allowance for credit losses to total loans, excluding
PPP loans (4)(5)
Allowance for credit losses to non-accrual loans
N/M – Not meaningful.
(1) Prior to the adoption of CECL on January 1, 2020, purchased credit impaired ("PCI") loans with accretable yield were considered current and were not included in past due loan totals. In addition, PCI loans with an accretable yield were excluded from non-accrual loans. Subsequent to adoption, PCD loans, including those previously classified as PCI, are included in past due and non-accrual loans totals. In addition, an allowance for credit losses is established as of the acquisition date or upon the adoption of CECL for loans previously classified as PCI, as PCD loans are no longer recorded net of credit-related acquisition adjustment.
(2) This item is a non-GAAP financial measure. For a discussion of non-GAAP financial measures, see the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations."
(3) Foreclosed assets consists of OREO and other foreclosed assets acquired in partial or total satisfaction of defaulted loans. Other foreclosed assets are included in other assets in the Consolidated Statement of Financial Condition.
(4) Prior to the adoption of CECL on January 1, 2020, this ratio included acquired loans that were recorded at fair value through an acquisition adjustment netted in loans. Subsequent to adoption, an allowance for credit losses on acquired loans is established as of the acquisition date and the acquired loans are no longer recorded net of credit-related acquisition adjustment.
(5) This ratio excludes PPP loans that are expected to be forgiven. As a result, no allowance for credit losses associated with these loans. See the "Non-GAAP Financial Information" section presented later in this release for a discussion of this non-GAAP financial measure.
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EARNINGS PERFORMANCE
Net Interest Income
Net interest income is our primary source of revenue and is impacted by interest rates and the volume and mix of interest-earning assets and interest-bearing liabilities. The accounting policies for the recognition of interest income on loans, securities, and other interest-earning assets are presented in Note 1 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Our accounting and reporting policies conform to GAAP and general practices within the banking industry. For purposes of this discussion, both net interest income and net interest margin have been adjusted to a fully tax-equivalent basis to more appropriately compare the returns on certain tax-exempt loans and securities to those on taxable interest-earning assets. The effect of this adjustment is shown at the bottom of Table 2. Although we believe that these non-GAAP financial measures enhance investors' understanding of our business and performance, they should not be considered an alternative to GAAP. For a discussion of non-GAAP financial measures, see the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations."
Table 2 summarizes our average interest-earning assets and interest-bearing liabilities for the years ended December 31, 2020, 2019, and 2018, the related interest income and interest expense for each earning asset category and funding source, and the average interest rates earned and paid. Table 3 details differences in interest income and expense from prior years and the extent to which any changes are attributable to volume and rate fluctuations.
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Table 2
Net Interest Income and Margin Analysis
(Dollar amounts in thousands)
Years Ended December 31,
Average
Balance
Interest
Yield/
Rate (%)
Average
Balance
Interest
Yield/
Rate (%)
Average
Balance
Interest
Yield/
Rate (%)
Assets
Other interest-earning assets
Securities:
Equity - taxable
Investment securities - taxable
Investment securities -
nontaxable (1)
Total securities
Federal Home Loan Bank
("FHLB") and Federal Reserve
Bank ("FRB") stock
Loans, excluding PPP loans (1)(2)
PPP loans (1)
Total loans (1)(2)
Total interest-earning
assets (1)(2)
Cash and due from banks
Allowance for loan losses
Other assets
Total assets
Liabilities and Stockholders' Equity
Savings deposits
NOW accounts
Money market deposits
Total interest-bearing
core deposits
Time deposits
Total interest-bearing
deposits
Borrowed funds
Subordinated debt
Total interest-bearing
liabilities
Demand deposits
Total funding sources
Other liabilities
Stockholders' equity
Total liabilities and
stockholders' equity
Tax-equivalent net interest
income/margin (1)
Tax-equivalent adjustment
Net interest income (GAAP)
Impact of acquired loan
accretion (1)
Tax-equivalent net interest
income/margin, adjusted (1)
(1) Interest income and yields on tax-exempt securities and loans are presented on a tax-equivalent basis, assuming a federal income tax rate of 21%. The corresponding income tax impact related to tax-exempt items is recorded in income tax expense. These adjustments have no impact on net income. For a discussion of tax-equivalent net interest income/margin, net interest income (GAAP), and tax-equivalent net interest income/margin, adjusted, see the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations."
(2) Non-accrual loans, which totaled $142.5 million as of December 31, 2020, $82.3 million as of December 31, 2019, and $56.9 million as of December 31, 2018, are included in loans for purposes of this analysis. Additional detail regarding non-accrual loans is presented in the section of this Item 7 titled "Non-Performing Assets and Performing Potential Problem Loans."
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2020 Compared to 2019
Net interest income was $579.6 million for 2020 compared to $588.5 million for 2019, a decrease of 1.5%. The decrease in net interest income resulted primarily from lower market rates on loans and securities primarily as a result of the pandemic and lower acquired loan accretion, partially offset by growth in loans and securities, the acquisition of interest-earning assets from the Park Bank transaction in March 2020, interest income and fees on PPP loans, and lower cost of funds.
Acquired loan accretion contributed $29.5 million and $35.6 million to net interest income for 2020 and 2019, respectively.
Tax-equivalent net interest margin was 3.18% for 2020, down 72 basis points from 2019. Excluding the impact of acquired loan accretion, tax-equivalent net interest margin was 3.02%, down 65 basis points from 2019. The decrease was driven primarily by lower interest rates on loans and securities primarily as a result of the pandemic, lower yields on PPP loans, as well as a higher balance of other interest-earning assets due to higher demand deposits as a result of PPP loan funds and other government stimuli, partially offset by lower cost of funds.
Total average interest-earning assets were $18.4 billion for 2020, an increase of $3.2 billion, or 21.0%, from 2019. The increase resulted from the Park Bank transaction, loan growth, PPP loans, securities purchases, and a higher balance of other interest-earning assets. In addition, the full year impact of the Bridgeview transaction in May 2019 contributed to the increase.
Total average interest-bearing liabilities were $12.3 billion for 2020, an increase of $1.7 billion, or 15.8%, from 2019. The increase resulted from deposits assumed in the Park Bank and Bridgeview transactions, FHLB advances, and higher customer balances resulting from PPP funds and other government stimulus.
2019 Compared to 2018
Net interest income was $588.5 million for 2019 compared to $516.6 million for 2018, an increase of 13.9%. The rise in net interest income resulted primarily from growth in loans and securities, the impact of higher market rates on loan and security yields, higher acquired loan accretion, and the acquisition of interest-earning assets from the Bridgeview transaction and the Northern States transaction in October of 2018, partially offset by higher cost of funds.
Acquired loan accretion contributed $35.6 million and $19.5 million to net interest income for 2019 and 2018, respectively.
Tax-equivalent net interest margin was 3.90% for 2019 consistent with 2018. Excluding the impact of acquired loan accretion, tax-equivalent net interest margin was 3.67%, down 8 basis points from 2018. The decrease was driven primarily by actions taken to reduce rate sensitivity and higher cost of funds, partially offset by the impact of higher yields on loans and securities.
Total average interest-earning assets were $15.2 billion for 2019, an increase of $1.8 billion, or 13.8%, from 2018. The increase resulted from growth in loans and securities purchases as well as the acquisition of interest-earning assets from the Bridgeview and Northern States transactions.
Total average interest-bearing liabilities were $10.7 billion for 2019, an increase of $1.6 billion, or 17.9%, from 2018. The increase resulted from deposits assumed in the Bridgeview and Northern States transactions, FHLB advances, and organic growth in deposits.
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Table 3
Changes in Net Interest Income Applicable to Volumes and Interest Rates (1)
(Dollar amounts in thousands)
2020 compared to 2019
2019 compared to 2018
Volume
Rate
Total
Volume
Rate
Total
Other interest-earning assets
Securities:
Equity – taxable
Investment securities – taxable
Investment securities – nontaxable (2)
Total securities
FHLB and FRB stock
Loans, excluding PPP loans (2)
PPP loans (2)
Loans (2)
Total tax-equivalent interest income (2)
Savings deposits
NOW accounts
Money market deposits
Total interest-bearing core deposits
Time deposits
Total interest-bearing deposits
Borrowed funds
Subordinated debt
Total interest expense
Tax-equivalent net interest income (2)
(1) For purposes of this table, changes that are not due solely to volume changes or rate changes are allocated to each category on the basis of the percentage relationship of each to the sum of the two.
(2) Interest income and yields on tax-exempt securities and loans are presented on a tax-equivalent basis, assuming the applicable federal income tax rate of 21%. For a discussion of non-GAAP financial measures, see the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations."
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Noninterest Income
A summary of noninterest income for the three years ended December 31, 2020 is presented in the following table.
Table 4
Noninterest Income Analysis
(Dollar amounts in thousands)
Years Ended December 31,
% Change
Wealth management fees
Service charges on deposit accounts
Mortgage banking income
Card-based fees, net (1)
Capital market products income
Other service charges, commissions, and fees
Total fee-based revenues
Other income (3)
Swap termination costs
Net securities gains (2)
Total noninterest income
N/M – Not meaningful.
(1) Card-based fees, net consists of debit and credit card interchange fees for processing transactions as well as various fees on both customer and non-customer ATM and point-of-sale transactions processed through the ATM and point-of-sale networks, as well as the related cardholder expense.
(2) For a discussion of this item, see the section of this Item 7 titled "Investment Portfolio Management."
(3) Other income consists primarily of BOLI income, safe deposit box rentals, miscellaneous recoveries, and gains on the sales of various assets.
2020 Compared to 2019
Total noninterest income was $140.7 million, decreasing by 13.6% compared to 2019. Excluding the impact of swap termination costs and net securities gains, total noninterest income of $159.2 million decreased 2.3% compared to 2019. Record wealth management fees resulted from a higher market environment and continued sales of fiduciary and investment advisory services to new and existing clients. The decrease in services charges on deposit accounts, net card-based fees, and other service charges, commissions and fees compared to 2019 was due primarily to the impact of lower transaction volumes and the fee assistance programs offered to our clients as a result of the pandemic. Capital market products income decreased compared to 2019 as a result of lower levels of sales to corporate clients in light of market conditions. Record mortgage banking income for 2020 resulted from sales of $812.7 million of 1-4 family mortgage loans in the secondary market compared to $464.9 million during 2019. In addition, mortgage banking income for 2020 was positively impacted by market pricing on sales 1-4 family mortgage loans.
During 2020, the Company terminated longer term interest rate swaps with notional amounts of $1.6 billion due to excess liquidity and in response to market conditions. As a result of these transactions, $31.9 million of pre-tax losses on swap terminations were recorded. In addition, the Company liquidated securities during 2020, which resulted in $13.3 million of pre-tax net securities gains to partially offset the loss on swap terminations.
2019 Compared to 2018
Total noninterest income was $162.9 million, increasing by 12.6% compared to 2018. The increase in wealth management fees compared to 2019 was driven primarily by customers acquired in the Northern Oak transaction, continued sales of fiduciary and investment advisory services to new and existing clients, and a higher market environment. Net card-based fees increased due to higher transaction volumes and customers acquired in the Bridgeview and Northern States transactions. The increase in capital market products income compared to 2019 was a result of higher sales to corporate clients reflecting the lower long-term rate environment. Mortgage banking income for 2019 resulted from sales of $464.9 million of 1-4 family mortgage loans in the secondary market compared to sales of $240.8 million during 2018. In addition, mortgage banking income for 2019 was negatively impacted by changes in the fair value of mortgage servicing rights, reflective of lower mortgage rates. Other income was elevated compared to 2018 due primarily to benefit settlements on BOLI.
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Noninterest Expense
A summary of noninterest expense for the three years ended December 31, 2020 is presented in the following table.
Table 5
Noninterest Expense Analysis
(Dollar amounts in thousands)
Years Ended December 31,
% Change
Salaries and employee benefits:
Salaries and wages
Retirement and other employee benefits
Total salaries and employee benefits
Net occupancy and equipment expense
Technology and related costs
Professional services
Amortization of other intangible assets
FDIC premiums
Advertising and promotions
Net OREO expense
Other expenses
Optimization costs
Acquisition and integration related expenses
Delivering Excellence implementation costs
Total noninterest expense
Optimization costs
Acquisition and integration related expenses
Delivering Excellence implementation costs
Total noninterest expense, adjusted (1)
N/M – Not meaningful.
(1) This item is a non-GAAP financial measure. For a discussion of non-GAAP financial measures, see the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations."
2020 Compared to 2019
Total noninterest expense for 2020 increased 10.3% compared to 2019. Noninterest expense for 2020 was impacted by optimizations costs and acquisition and integration related expenses; 2019 was impacted by acquisition and integration related expenses and costs related to the Delivering Excellence initiative. Excluding these items, noninterest expense for 2020 was up 8.4%, from 2019, which resulted in an efficiency ratio of 61% for 2020 compared to 55% for 2019. Overall, noninterest expense, adjusted, to average assets, excluding PPP loans, decreased 15 basis points to 2.31% for 2020.
Operating costs associated with the Park Bank and Bridgeview transactions completed in the first quarter of 2020 contributed to the increase in noninterest expense compared to 2019. These costs primarily occurred in salaries and employee benefits, net occupancy and equipment expense, technology and related costs, professional services, and other expenses.
The increase in salaries and employee benefits compared to 2019 was driven primarily by merit increases, higher commissions resulting from sales of 1-4 family mortgage loans in the secondary market, and expanded health and welfare benefits related to the pandemic, partially offset by lower incentive compensation. Expenses from the pandemic contributed to the increase in occupancy and equipment costs compared to 2019. The increase in technology and related costs was impacted by investments in technology, including certain costs associated with the origination of PPP loans. Professional services was positively impacted by lower loan remediation expenses compared to 2019, while 2019 was elevated due to process enhancements and services associated with organizational growth. Compared to 2019, advertising and promotions expense decreased due to the timing of certain costs related to marketing campaigns. The increase in FDIC premiums compared to 2019 was driven primarily by organizational growth. In addition, FDIC premiums for 2019 were lower due to small bank assessment credits received. The decrease in net OREO expense for 2020 was due mainly to sales of properties at gains. Other expenses were impacted by a negative valuation adjustment on a foreclosed asset.
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Optimization costs of $19.9 million for 2020 primarily include valuation adjustments and other expenses related to locations identified for consolidation, modernization of our ATM network, advisory fees, and employee severance.
Acquisition and integration related expenses for 2020 resulted primarily from the acquisition of Park Bank. Acquisition and integration related expenses for 2019 resulted from the acquisition of Northern States, Northern Oak, and Bridgeview, as well as the pending acquisition of Park Bank
2019 Compared to 2018
Total noninterest expense for 2019 increased by 6.0% compared to 2018. Noninterest expense for 2019 and 2018 was impacted by acquisition and integration related expenses and costs related to the implementation of the Delivering Excellence initiative. Excluding these items, noninterest expense for 2019 was up by 8.3%, from 2018, which resulted in an efficiency ratio of 55% for 2019, improved from 58% for 2018.
Operating costs associated with the Bridgeview and Northern Oak transactions completed during the first half of 2019, as well as the full year impact of the Northern States transaction completed during the fourth quarter of 2018, contributed to the increase in noninterest expense compared to 2018. These costs primarily occurred within salaries and employee benefits, net occupancy and equipment expense, professional services, advertising and promotions, and other expenses.
The increase in salaries and employee benefits compared to 2018 was driven primarily by merit increases, and higher commissions resulting from sales of 1-4 family mortgage loans in the secondary market, partially offset by the ongoing benefits of the Delivering Excellence initiative. Compared to 2018, net occupancy and equipment expense increased due to a deferred gain no longer being included as a reduction to expense upon adoption of lease accounting guidance at the beginning of 2019, partially offset by the ongoing benefits of the Delivering Excellence initiative. Professional services increased compared to 2018 as a result of technology and process enhancements due to organizational growth. Compared to 2018, the increase in advertising and promotions expense was impacted by higher costs related to marketing campaigns. FDIC premiums decreased compared to 2018 due to small bank assessment credits received. Net OREO expense for 2019 was impacted by sales of properties at a loss, partially offset by positive valuation adjustments.
Acquisition and integration related expenses for 2018 resulted from the acquisition of Northern States.
The Company initiated certain actions in connection with its Delivering Excellence initiative in 2018, demonstrating the Company's ongoing commitment to provide service excellence to its clients and maximizing both the efficiency and scalability of its operating platform. Costs for 2019 and 2018 include property valuation adjustments on locations identified for closure, employee severance, and general restructuring and advisory services.
Income Taxes
Our provision for income taxes includes both federal and state income tax expense. An analysis of the provision for income taxes is detailed in the following table.
Table 6
Income Tax Expense Analysis
(Dollar amounts in thousands)
Years Ended December 31,
Income before income tax expense
Income tax expense:
Federal income tax expense
State income tax expense
Total income tax expense
Effective income tax rate
Effective income tax rate, adjusted (1)
(1) For a discussion of non-GAAP financial measures, see the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations."
Federal income tax expense and the related effective income tax rate are influenced by the amount of tax-exempt income derived from investment securities and BOLI in relation to pre-tax income as well as state income taxes. State income tax expense and the related effective income tax rate are driven by the amount of state tax-exempt income in relation to pre-tax income and state tax rules related to consolidated/combined reporting and sourcing of income and expense.
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The decrease in the effective tax rate and income tax expense for 2020 compared to 2019 was due primarily to $3.6 million of income tax benefits resulting from deferred tax asset adjustments, as well as the finalization of prior year returns and the expiration of the statute of limitations on uncertain tax positions. In addition, the decrease in tax expense for 2020 was impacted by a decrease in income subject to tax at statutory rates. The increase in the effective tax rate and income tax expense for 2019 compared to 2018 was due primarily to a rise in income subject to tax at statutory rates. The effective tax rate and total income tax expense for 2018 was impacted by $7.8 million of income tax benefits resulting from federal income tax reform that was enacted on December 22, 2017.
Our accounting policies regarding the recognition of income taxes in the Consolidated Statements of Financial Condition and Income are described in Notes 1 and 16 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
FINANCIAL CONDITION
Investment Portfolio Management
Securities that we have the intent and ability to hold until maturity are classified as securities held-to-maturity and are accounted for using historical cost, adjusted for amortization of premiums and accretion of discounts. Equity securities are carried at fair value and consist primarily of community development investments, certain diversified investment securities held in a grantor trust for participants in the Company's nonqualified deferred compensation plan that are invested in money market and mutual funds, and various preferred equity investments. All other securities are classified as securities available-for-sale and are carried at fair value with unrealized gains and losses, net of related deferred income taxes, recorded in stockholders' equity as a separate component of AOCI.
We manage our investment portfolio to maximize the return on invested funds within acceptable risk guidelines, to meet pledging and liquidity requirements, and to adjust balance sheet interest rate sensitivity to mitigate the impact of changes in interest rates on net interest income.
From time to time, we adjust the size and composition of our securities portfolio based on a number of factors, including expected loan growth, anticipated changes in collateralized public funds on account, the interest rate environment, and the related value of various segments of the securities markets. The following table provides a valuation summary of our investment portfolio.
Table 7
Investment Portfolio
(Dollar amounts in thousands)
As of December 31,
Amortized Cost
Fair Value
% of Total
Amortized Cost
Fair Value
% of Total
Amortized Cost
Fair Value
% of Total
Securities Available-for-Sale
U.S. treasury securities
U.S. agency securities
Collateralized mortgage
obligations ("CMOs")
Other mortgage-backed
securities ("MBSs")
Municipal securities
Corporate debt
securities
Total securities
available-for-sale
Securities Held-to-Maturity
Municipal securities (1)
Equity Securities
(1) Net of $220 of allowance for securities held-to-maturity as of December 31, 2020 which was established upon adoption of CECL on January 1, 2020.
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Portfolio Composition
As of December 31, 2020, our securities available-for-sale portfolio totaled $3.1 billion, increasing by $223.0 million, or 7.8%, from December 31, 2019, following a 26.5% increase from December 31, 2018. The increase from December 31, 2019 was driven primarily by purchases, consisting primarily of U.S. agency securities and CMOs, as well as $136.9 million of securities acquired in the Park Bank transaction and an increase in unrealized gains due to lower market interest rates, which were partially offset by maturities, calls, and prepayments.
Investments in municipal securities consist of general obligations of local municipalities in various states. Our municipal securities portfolio has historically experienced very low default rates and provides a predictable cash flow.
The following table presents the effective duration, average life, and yield to maturity for the Company's securities portfolio by category as of December 31, 2020 and 2019.
Table 8
Securities Effective Duration Analysis
(Dollar amounts in thousands)
As of December 31,
Effective
Average
Yield to
Effective
Average
Yield to
Duration (1)
Life (2)
Maturity (3)
Duration (1)
Life (2)
Maturity (3)
Securities Available-for-Sale
U.S. treasury securities
U.S. agency securities
CMOs
MBSs
Municipal securities
Corporate debt securities
Total securities available-for-sale
Securities Held-to-Maturity
Municipal securities
(1) The effective duration represents the estimated percentage change in the fair value of the securities portfolio given a 100 basis point increase or decrease in interest rates. This measure is used to evaluate the portfolio's price volatility at a single point in time and is not intended to be a precise predictor of future fair values since those values will be influenced by a number of factors.
(2) Average life is presented in years and represents the weighted-average time to receive half of all expected future cash flows using the dollar amount of principal paydowns, including estimated principal prepayments, as the weighting factor.
(3) Yields on municipal securities are reflected on a tax-equivalent basis, assuming the applicable federal income tax rate for each period presented.
Effective Duration
The average life and effective duration of our securities available-for-sale portfolio was 4.64 years and 3.54%, respectively, as of December 31, 2020, down from 4.75 years and 3.26% as of December 31, 2019. The decrease resulted primarily from higher expected future prepayments of CMOs and MBSs due to lower market interest rates.
Realized Losses and Gains
There were $13.3 million net securities gains recognized for the year ended December 31, 2020, as a result of repositioning of the securities portfolio due to market conditions in the first quarter of 2020 and optimization strategies in the third quarter of 2020. There were no net securities gains recognized for the years ended December 31, 2019 and 2018.
Unrealized Gains and Losses
Unrealized gains and losses on securities available-for-sale represent the difference between the aggregate cost and fair value of the portfolio. These amounts are presented in the Consolidated Statements of Comprehensive Income and reported as a separate component of stockholders' equity in AOCI, net of deferred income taxes. This balance sheet component will fluctuate as interest rates and conditions change and affect the aggregate fair value of the portfolio. Lower market interest rates drove the change to $52.9 million of unrealized gains as of December 31, 2020 compared to $21.9 million of unrealized gains as of December 31, 2019. For additional discussion of unrealized gains and losses on securities available-for-sale, see Note 4 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
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Table 9
Repricing Distribution and Portfolio Yields
(Dollar amounts in thousands)
As of December 31, 2020
One Year or Less
One Year to Five Years
Five Years to Ten Years
After 10 years
Amortized Cost
Yield to Maturity (1)
Amortized Cost
Yield to Maturity (1)
Amortized Cost
Yield to Maturity (1)
Amortized Cost
Yield to Maturity (1)
Securities Available-for-Sale
U.S. treasury securities
U.S. agency securities
CMOs (2)
MBSs (2)
Municipal securities (3)
Corporate debt securities (4)
Total available-for-sale
securities
Securities Held-to-Maturity
Municipal securities (3)
(1) Based on amortized cost.
(2) The repricing distributions and yields to maturity of CMOs and MBSs are based on estimated future cash flows and prepayment assumptions. Actual repricings and yields of the securities may differ from those reflected in the table depending on actual interest rates and prepayment speeds.
(3) Yields on municipal securities are reflected on a tax-equivalent basis, assuming the applicable federal income tax rate for the periods presented. The maturity date of bonds is based on contractual maturity, unless the bond, based on current market prices, is deemed to have a high probability that the call will be exercised, in which case the call date is used as the maturity date.
(4) Yields on equity securities are presented on a tax-equivalent basis, assuming the applicable federal income tax rate for the periods presented. Maturity dates are based on contractual maturity or repricing characteristics.
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LOAN PORTFOLIO AND CREDIT QUALITY
Our principal source of revenue is generated by our lending activities and is composed primarily of interest income as well as loan origination and commitment fees (net of related costs). The accounting policies for the recording of loans in the Consolidated Statements of Financial Condition and the recognition and/or deferral of interest income and fees in the Consolidated Statements of Income are included in Note 1 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Portfolio Composition
Our loan portfolio is comprised of both corporate and consumer loans with corporate loans representing 71.5% of total loans as of December 31, 2020. Consistent with our emphasis on relationship banking, the majority of our corporate loans are made to our core, multi-relationship customers. The customers usually maintain deposit relationships and utilize certain of our other banking services, such as treasury or wealth management services.
To maximize loan income with an acceptable level of risk, we have certain lending policies and procedures that management reviews on a regular basis. In addition, management receives periodic reporting related to loan production, loan quality, credit concentrations, loan delinquencies, and non-performing and corporate performing potential problem loans to monitor and mitigate potential and current risks in the portfolio.
Table 10
Loan Portfolio
(Dollar amounts in thousands)
As of December 31,
Total
Total
Total
Total
Total
Commercial and industrial
Agricultural
Commercial real estate:
Office, retail, and
industrial
Multi-family
Construction
Other commercial
real estate
Total commercial
real estate
Total corporate loans,
excluding PPP loans
PPP loans
Total corporate loans
Home equity
1-4 family mortgages
Installment
Total consumer loans
Total loans
2020 Compared to 2019
Total loans includes loans originated under the PPP loan program in 2020, which totaled $785.6 million as of December 31, 2020. Excluding PPP loans, total loans grew 8.8% from December 31, 2019. Excluding loans acquired in the Park Bank acquisition in March 2020, which totaled $809.9 million as of December 31, 2020, total loans grew by 2.5% from December 31, 2019. Compared to December 31, 2019, corporate loans, excluding PPP loans, were impacted by lower production and line usage, as well as excess borrower liquidity and higher paydowns due to current economic conditions as a result of the pandemic. Growth in consumer loans benefited from strong production and purchases of high-quality 1-4 family mortgages.
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2019 Compared to 2018
Total loans of $12.8 billion as of December 31, 2019 reflect growth of $1.4 billion, or 12.2%, from December 31, 2018. Excluding loans acquired in the Bridgeview transaction, total loans grew by 7.1%. Total corporate loans benefited from growth in commercial and industrial loans, primarily within our sector-based and middle market lending businesses, as well as growth in multi-family loans. In addition, strong production within commercial real estate loans was offset by the impact of certain customers selling their commercial business or investment real estate properties, as well as refinancing with other banks and non-banks offering loan terms outside of our credit parameters. Growth in consumer loans benefited from purchases of 1-4 family mortgages and home equity loans, as well as organic growth.
Comparisons of Prior Years (2018, 2017, and 2016)
Total loans of $11.4 billion as of December 31, 2018 reflect growth of $1.0 billion, or 9.7%, from December 31, 2017. Excluding loans acquired in the Northern States transaction, total loans grew by approximately 7.1%. Growth in commercial and industrial loans was driven primarily by strong production in our sector-based lending. The rise in construction loans was due largely to draws on existing lines of credit. The overall decline in office, retail, and industrial and other commercial real estate loans resulted primarily from the decision of certain customers to opportunistically sell their commercial business and investment real estate properties, as well as expected payoffs. Growth in consumer loans benefited from organic production as well as the impact of purchases of 1-4 family mortgages, shorter-duration, floating rate home equity loans, and installment loans.
Total loans of $10.4 billion as of December 31, 2017 reflects growth of $2.2 billion, or 26.5%, from December 31, 2016. Excluding loans acquired in the Standard transaction, total loans grew by 7.0%. Growth in commercial and industrial loans, primarily within our sector-based lending businesses and multi-family loans, contributed to the increase in total corporate loans. Total loans were also impacted by purchases of 1-4 family mortgages, installment loans, and shorter-duration, floating rate home equity loans.
Commercial, Industrial, and Agricultural Loans
Commercial, industrial, and agricultural loans represent 33.5% of total loans and totaled $4.9 billion as of December 31, 2020, an increase of $55.2 million, or 1.1%, from December 31, 2019. Our commercial and industrial loans are a diverse group of loans generally located in the Chicago metropolitan area with purposes that include supporting working capital needs, accounts receivable financing, inventory and equipment financing, and select sector-based lending, such as healthcare, asset-based lending, structured finance, and syndications. Most commercial and industrial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory. The underlying collateral securing commercial and industrial loans may fluctuate in value due to the success of the business or economic conditions. For loans secured by accounts receivable, the availability of funds for repayment and economic conditions may impact the cash flow of the borrower. Accordingly, the underwriting for these loans is based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower and may incorporate a personal guarantee.
Agricultural loans are generally provided to meet seasonal production, equipment, and farm real estate borrowing needs of individual and corporate crop and livestock producers. Seasonal crop production loans are repaid by the liquidation of the financed crop that is typically covered by crop insurance. Equipment and real estate term loans are repaid through cash flows of the farming operation. Risks uniquely inherent in agricultural loans relate to weather conditions, agricultural product pricing, and loss of crops or livestock due to disease or other factors. Therefore, as part of the underwriting process, the Company examines projected future cash flows, financial statement stability, and the value of the underlying collateral.
Commercial Real Estate Loans
Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans. The repayment of commercial real estate loans depends on the successful operation of the property securing the loan or the business conducted on the property securing the loan. This category of loans may be more adversely affected by conditions in real estate markets. In addition, many commercial real estate loans do not fully amortize over the term of the loan, but have balloon payments due at maturity. The borrower's ability to make a balloon payment may depend on the availability of long-term financing or their ability to complete a timely sale of the underlying property. Management monitors and evaluates commercial real estate loans based on cash flow, collateral, geography, and risk rating criteria.
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Construction loans are generally made based on estimates of costs and values associated with the completed projects and are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analyses of absorption and lease rates, and financial analyses of the developers and property owners. Sources of repayment may be permanent long-term financing, sales of developed property, or an interim loan commitment until permanent financing is obtained. Generally, construction loans have a higher risk profile than other real estate loans since repayment is impacted by real estate values, interest rate changes, governmental regulation of real property, demand and supply of alternative real estate, the availability of long-term financing, and changes in general economic conditions.
The following table presents commercial real estate loan detail as of December 31, 2020, 2019, and 2018.
Table 11
Commercial Real Estate Loans
(Dollar amounts in thousands)
As of December 31,
Total
Total
Total
Office, retail, and industrial:
Office
Retail
Industrial
Total office, retail, and industrial
Multi-family
Construction
Other commercial real estate:
Multi-use properties
Rental properties
Warehouses and storage
Hotels
Restaurants
Service stations and truck stops
Recreational
Other
Total other commercial real estate
Total commercial real estate
Commercial real estate loans represent 32.7% of total loans and totaled $4.8 billion as of December 31, 2020, consistent with December 31, 2019.
The mix of properties securing the loans in our commercial real estate portfolio is balanced between owner-occupied and investor categories and is diverse in terms of type and geographic location, generally within the Company's markets. Approximately 45% of the commercial real estate portfolio, excluding multi-family and construction loans, is owner-occupied as of December 31, 2020. Using outstanding loan balances, non-owner-occupied commercial real estate loans to total capital was 166% and construction loans to total capital was 27% as of December 31, 2020. Non-owner-occupied (investor) commercial real estate is calculated in accordance with federal banking agency guidelines and includes construction, multi-family, non-farm non-residential property, and commercial real estate loans that are not secured by real estate collateral.
As a result of the Company's review of its loan portfolio in connection with the pandemic, certain elevated risk segments were identified in the corporate loan portfolio including recreation and entertainment, hotels, and restaurants, which are included in commercial and industrial loans in addition to commercial real estate loans detailed above. As of December 31, 2020, these elevated risk segments totaled $480 million, 3.5% of our granular and diverse total loan portfolio, excluding PPP loans.
PPP Loans
The Company began originating PPP loans during the second quarter of 2020 as a part of the SBA's program established by the CARES Act. These loans are fully guaranteed by the SBA and are expected to be forgiven by the SBA if the applicable criteria are met.
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Consumer Loans
Consumer loans represent 28.5% of total loans, and totaled $4.2 billion as of December 31, 2020, an increase of $923.1 million, or 28.2%, from December 31, 2019. Consumer loans are centrally underwritten using a credit scoring model developed by the Fair Isaac Corporation ("FICO"), which employs a risk-based system to determine the probability that a borrower may default. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include loan-to-value and affordability ratios, risk-based pricing strategies, and documentation requirements. The home equity category consists mainly of revolving lines of credit secured by junior liens on owner-occupied real estate. Loan-to-value ratios on home equity loans and 1-4 family mortgages are based on the current appraised value of the collateral. Repayment for these loans is dependent on the borrower's continued financial stability, and is more likely to be impacted by adverse personal circumstances.
As a result of the Company's review of its loan portfolio in connection with the pandemic, unsecured installment loans, which totaled approximately $220 million and was less than 2% of our total loan portfolio, excluding PPP loans, as of December 31, 2020, were identified as an elevated risk segment in the consumer loan portfolio. These loans are high credit quality, geographically dispersed, high-yielding, have average loan sizes of less than $9,000, and do not include any sub-prime loans, which reduces our risk exposure.
Maturity and Interest Rate Sensitivity of Corporate Loans
The following table summarizes the maturity distribution and interest rate sensitivity of our corporate loan portfolio as of December 31, 2020, For additional discussion of interest rate sensitivity, see Item 7A, "Quantitative and Qualitative Disclosures about Market Risk," of this Form 10-K.
Table 12
Maturities and Sensitivities of Corporate Loans to Changes in Interest Rates
(Dollar amounts in thousands)
Maturity Due In
One Year or Less
Greater Than One to Five Years
Greater Than Five Years
Total
As of December 31, 2020
Commercial, industrial, and agricultural
Commercial real estate
Total corporate loans
Loans by interest rate type:
Fixed interest rates
Floating interest rates
Total corporate loans, excluding PPP loans
As of December 31, 2020, the composition of our corporate loans, excluding PPP loans, between fixed and floating interest rates was 38% and 62%, respectively. As of December 31, 2020, the Company hedged $430.0 million of certain corporate variable rate loans using interest rate swaps through which the Company receives fixed amounts and pays variable amounts. Including the impact of these interest rate swaps, 50% of the total loan portfolio consisted of fixed rate loans and 50% were floating rate loans as of December 31, 2020. See Note 20 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K for detail regarding interest rate swaps.
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Allowance for Credit Losses
Methodology for the Allowance for Credit Losses
On January 1, 2020, the Company adopted CECL, which requires the Company to present financial assets measured at amortized cost at the net amount expected to be collected considering an entity's current estimate of all expected credit losses. Prior to the adoption of CECL, the allowance for credit losses was estimated using an incurred loss model based on historical loss experience. The adoption of CECL impacted both the level of allowance for credit losses as well as other asset quality metrics due to the change in accounting for acquired PCD loans. As a result, certain metrics are presented excluding PCD loans to provide comparability to prior periods.
The allowance for credit losses is comprised of the allowance for loan losses and the allowance for unfunded commitments and is maintained by management at a level believed adequate to absorb current expected credit losses inherent in the existing loan portfolio. The determination of the allowance for credit losses is inherently subjective since it requires significant estimates and management judgment, including the amounts and timing of expected future cash flows on non-accrual loans, actual loss experience, consideration of current national, regional, and local economic trends and conditions, reasonable and supportable forecasts about the future, changes in interest rates and property values, various internal and external qualitative factors, and other factors.
While management utilizes its best judgment and information available, the ultimate adequacy of the allowance for credit losses depends on a variety of factors beyond the Company's control, including the performance of its loan portfolio, the economy, changes in interest rates and property values, and the interpretation of loan risk ratings by regulatory authorities. Management believes that the allowance for credit losses is an appropriate estimate of current expected credit losses inherent in the existing loan portfolio as of December 31, 2020.
The accounting policy for the allowance for credit losses can be found in Note 1 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
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Table 13
Allowance for Credit Losses and
Summary of Credit Loss Experience
(Dollar amounts in thousands)
Years Ended December 31,
Change in allowance for credit losses
Beginning balance
Adjustment to apply recent accounting
pronouncements (1)
Allowance established for acquired PCD loans
Loan charge-offs:
Commercial, industrial, and agricultural
Office, retail, and industrial
Multi-family
Construction
Other commercial real estate
Consumer
Total loan charge-offs
Recoveries of loan charge-offs:
Commercial, industrial, and agricultural
Office, retail, and industrial
Multi-family
Construction
Other commercial real estate
Consumer
Total recoveries of loan charge-offs
Net loan charge-offs
Provision for loan losses
Increase (decrease) in allowance for unfunded
commitments (2)
Total provision for loan losses and
other expense
Ending balance
Total net charge-offs, excluding PCD loans (3)
Allowance for credit losses
Allowance for loan losses
Allowance for unfunded commitments
Total allowance for credit losses
Allowance for credit losses to loans (2)
Allowance for credit losses to loans,
excluding PPP loans (3)
Allowance for credit losses to
non-accrual loans
Allowance for credit losses to
non-performing loans
Net loan charge-offs to average loans
Net loan charge-offs to average loans, excluding
PCD and PPP loans (2)(3)
(1) As a result of accounting guidance adopted in 2020, the increase in allowance for credit losses, net of tax, was recognized as a cumulative-effect adjustment to retained earnings as of January 1, 2020. For further discussion of this guidance, see Note 2, "Recent Accounting Pronouncements and Other Guidance."
(2) Prior to the adoption of CECL on January 1, 2020, the portion of PCI loans deemed to be uncollectible was recorded as a reduction of the credit-related acquisition adjustment, which was netted within loans. Subsequent to adoption, an allowance for credit losses on PCD loans, including those previously identified as PCI, is established as of the acquisition date and the PCD loans are no longer recorded net of a credit-related acquisition adjustment. PCD loans deemed to be uncollectible are recorded as a charge-off through the allowance for credit losses. This item is a non-GAAP financial measure. For a discussion of non-GAAP financial measures, see the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations."
(3) This ratio excludes PPP loans that are expected to be forgiven. As a result, no allowance for credit losses is associated with these loans. See the "Non-GAAP Financial Information" section presented later in this release for a discussion of this non-GAAP financial measure.
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Activity in the Allowance for Credit Losses
The allowance for credit losses was $247.0 million or 1.67% of total loans as of December 31, 2020, increasing $137.8 million compared to December 31, 2019. Excluding the impact of PPP loans, the allowance for credit losses to total loans was 1.77% as of December 31, 2020. Adoption of the CECL standard on January 1, 2020 increased the allowance for credit losses by $75.8 million, which includes $31.6 million attributable to loans and unfunded commitments, $35.7 million for PCD acquired loans, and $8.5 million for non-PCD acquired loans. As a result of the pandemic, a provision for loan losses of $63.0 million was recorded during 2020. In addition, $14.3 million in allowance for credit losses was established through acquisition accounting adjustments for PCD loans acquired in the Park Bank acquisition in the first quarter of 2020 along with an additional $1.7 million of provision for loan losses on non-PCD loans subsequent to acquisition.
The allowance for credit losses was $109.2 million as of December 31, 2019, up compared to $103.4 million as of December 31, 2018, driven primarily by loan growth. The decrease in the allowance for credit losses to total loans to 0.85% as of December 31, 2019 from 0.90% as of December 31, 2018 was due primarily to loans acquired in the Bridgeview transaction, for which no allowance for credit losses was established at the time of acquisition in accordance with accounting guidance applicable to business combinations.
The allowance for credit losses was $103.4 million as of December 31, 2018, up compared to $96.7 million as of December 31, 2017, driven primarily by loan growth. The decrease in the allowance for credit losses to total loans to 0.90% as of December 31, 2018 from 0.93% as of December 31, 2017 was due primarily to loans acquired in the Northern States transaction.
Net loan charge-offs to average loans was 0.36% for 2020 compared to 0.31% for 2019 and 0.38% for 2018. Excluding net charge-offs on PCD loans, net loan charge-offs to average loans was 0.24% for 2020, lower than both prior periods.
Allocation of the Allowance for Credit Losses
Table 14
Allocation of Allowance for Credit Losses
(Dollar amounts in thousands)
As of December 31,
% of Total Loans (1)
% of Total Loans (1)
% of Total Loans (1)
% of Total Loans (1)
% of Total Loans (1)
Commercial, industrial, and
agricultural
Commercial real estate:
Office, retail, and
industrial
Multi-family
Construction
Other commercial real
estate
Total commercial
real estate
PPP loans
Consumer
Total allowance for
credit losses
(1) Percentages represent total loans in each category to total loans.
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Non-performing Assets and Performing Loans Classified as Substandard and Special Mention
The following table presents our loan portfolio by performing and non-performing status. A discussion of our accounting policies for non-accrual loans, TDRs, and loans 90 days or more past due can be found in Note 1 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Table 15
Loan Portfolio by Performing/Non-performing Status (1)
(Dollar amounts in thousands)
Current
30-89 Days Past Due
90 Days Past Due
Non-accrual
Total
Loans
As of December 31, 2020
Commercial and industrial
Agricultural
Commercial real estate:
Office, retail, and industrial
Multi-family
Construction
Other commercial real estate
Total commercial real estate
Total corporate loans, excluding
PPP loans
PPP loans
Total corporate loans
Home equity
1-4 family mortgages
Installment
Total consumer loans
Total loans
As of December 31, 2019
Commercial and industrial
Agricultural
Commercial real estate:
Office, retail and industrial
Multi-family
Construction
Other commercial real estate
Total commercial real estate
Total corporate loans
Home equity
1-4 family mortgages
Installment
Total consumer loans
Total loans
(1) Prior to the adoption of CECL on January 1, 2020, PCI loans with an accretable yield were considered current and were not included in past due loan totals. In addition, PCI loans with an accretable yield were excluded from non-accrual loans. Subsequent to adoption, PCD loans, including those previously classified as PCI, are included in past due and non-accrual loan totals. In addition, an allowance for credit losses is established as of the acquisition date or upon the adoption of CECL for loans previously classified as PCI, as PCD loans are no longer recorded net of a credit-related acquisition adjustment.
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The following table provides a comparison of our non-performing assets and past due loans to prior periods.
Table 16
Non-performing Assets and Past Due Loans
(Dollar amounts in thousands)
As of December 31,
Non-accrual loans, excluding PCD
loans (1)(2)
Non-accrual PCD loans (1)
Non-accrual loans
90 days or more past due loans, still
accruing interest (1)
Total NPLs
Accruing TDRs
Foreclosed assets (3)
Total NPAs
30-89 days past due loans (1)
Non-accrual loans to total loans:
Non-accrual loans to total loans
Non-accrual loans to total loans, excluding
PPP loans (1)(2)(4)
Non-accrual loans to total loans, excluding
PCD and PPP loans (1)(2)(4)
Non-performing loans to total loans:
NPLs to total loans
NPLs to total loans, excluding PPP
loans (1)(2)(4)
NPLs to total loans, excluding PCD and
PPP loans (1)(2)(4)
Non-performing assets to total loans plus foreclosed assets:
NPAs to total loans plus foreclosed assets
NPAs to total loans plus foreclosed assets,
excluding PPP loans (1)(2)(4)
NPAs to total loans plus foreclosed assets,
excluding PCD and PPP loans (1)(2)(4)
Interest income not recognized in the financial statements related to non-accrual loans for 2020
(1) Prior to the adoption of CECL on January 1, 2020, PCI loans with an accretable yield were considered current and were not included in past due loan totals. In addition, PCI loans with an accretable yield were excluded from non-accrual loans. Subsequent to adoption, PCD loans, including those previously classified as PCI, are included in past due and non-accrual loan totals. In addition, an allowance for credit losses is established as of the acquisition date or upon the adoption of CECL for loans previously classified as PCI, as PCD loans are no longer recorded net of a credit-related acquisition adjustment.
(2) This item is a non-GAAP financial measure. For a discussion of non-GAAP financial measures, see the section of this Item 2 titled "Non-GAAP Financial Information and Reconciliations."
(3) Foreclosed assets consists of OREO and other foreclosed assets acquired in partial or total satisfaction of defaulted loans. Other foreclosed assets are included in other assets in the Consolidated Statements of Financial Condition.
(4) This ratio excludes PPP loans that are expected to be forgiven. As a result, no allowance for credit losses is associated with these loans.
Non-performing Assets
Total non-performing assets represented 1.11% of total loans and foreclosed assets at December 31, 2020. Excluding the impact of PCD and PPP loans, non-performing assets to total loans and foreclosed assets was 0.96% at December 31, 2020, compared to 0.85%, 0.70%, 0.89%, and 1.12% at December 31, 2019, 2018, 2017, and 2016, respectively, reflective of normal fluctuations.
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TDRs
Loan modifications may be performed at the request of an individual borrower and may include reductions in interest rates, changes in payments, and extensions of maturity dates. We occasionally restructure loans at other than market rates or terms to enable the borrower to work through financial difficulties for a period of time, and these restructured loans remain classified as TDRs for the remaining terms of the loans. A discussion of our accounting policies for TDRs can be found in Note 1 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Table 17
TDRs by Type
(Dollar amounts in thousands)
As of December 31,
Number of Loans
Amount
Number of Loans
Amount
Number of Loans
Amount
Commercial and industrial
Commercial real estate:
Office, retail, and industrial
Multi-family
Other commercial real estate
Total commercial real estate loans
Total corporate loans
Home equity
1-4 family mortgages
Installment
Total consumer loans
Total TDRs
Accruing TDRs
Non-accrual TDRs
Total TDRs
Year-to-date charge-offs on TDRs
Specific reserves related to TDRs
In March of 2020, the CARES Act was enacted by the U.S. government in response to the economic disruption caused by the pandemic. The Company's banking regulators issued a statement titled the "Interagency Statement on Loan Modifications by Financial Institutions Working with Customers Affected by the Coronavirus" that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the pandemic. Additionally, the CARES Act, as amended by the 2021 Consolidated Appropriations Act, which was signed into law in December 2020, provides that a qualified loan modification is exempt from classification as a TDR as defined by GAAP, from the period beginning March 1, 2020 until the earlier of January 1, 2022 or the date that is 60 days after the date on which the national emergency concerning the pandemic declared by the President of the United States terminates. Accordingly, we are offering short-term modifications made in response to the pandemic to borrowers who are current and otherwise not past due. These include short-term modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. As of December 31, 2020, the Company has eligible modifications with outstanding balances totaling $96.7 million.
As of December 31, 2020, TDRs totaled $12.5 million, decreasing by $9.2 million from December 31, 2019. The December 31, 2020 total includes $813,000 in loans that are accruing interest, with the majority restructured at market terms. After a sufficient period of performance under the modified terms, the loans restructured at market rates will be reclassified to performing status.
As of December 31, 2019, TDRs totaled $21.7 million, increasing by $13.3 million from December 31, 2018. The increase was driven primarily by the extension of one non-accrual credit during 2019.
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Performing Loans Classified as Substandard and Special Mention
Performing loans classified as substandard and special mention excludes accruing TDRs. These loans are performing in accordance with their contractual terms, but we have concerns about the ability of the borrower to continue to comply with loan terms due to the borrower's operating or financial difficulties.
Table 18
Performing Loans Classified as Substandard and Special Mention
(Dollar amounts in thousands)
December 31, 2020
December 31, 2019
Special
Mention (1)
Substandard (2)
Total (3)
Special
Mention (1)
Substandard (2)
Total (3)
Commercial and industrial
Agricultural
Commercial real estate
Total performing loans classified
as substandard and special
mention (4)
PCD and PCI performing loans
classified as substandard and
special mention (4)
Performing loans classified as
substandard and special mention to
corporate loans
Performing loans classified as
substandard and special mention to
corporate loans, excluding PPP
loans (5)(6)
(1) Loans categorized as special mention exhibit potential weaknesses that require the close attention of management since these potential weaknesses may result in the deterioration of repayment prospects in the future.
(2) Loans categorized as substandard exhibit well-defined weaknesses that may jeopardize the liquidation of the debt. These loans continue to accrue interest because they are well-secured, and collection of principal and interest is expected within a reasonable time.
(3) Total performing loans classified as substandard and special mention excludes accruing TDRs.
(4) Includes PCD performing loans classified as substandard and special mention subsequent to the adoption of CECL on January 1, 2020. Prior to the adoption of CECL, included PCI performing loans classified as substandard and special mention.
(5) This ratio excludes PPP loans that are expected to be forgiven. As a result, no allowance for credit losses is associated with these loans.
(6) This item is a non-GAAP financial measure. For a discussion of non-GAAP financial measures, see the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations."
Performing loans classified as substandard and special mention were 7.26% of corporate loans as of December 31, 2020. Excluding the impact of PPP loans on this metric, performing loans classified as substandard and special mention to corporate loans was 7.84% compared to 3.95% at December 31, 2019. The increase resulted primarily from the impact of the pandemic on certain borrowers primarily focused in elevated risk sectors that the Company has determined require additional monitoring. These loans exhibit potential or well-defined weaknesses but continue to accrue interest because they are well-secured and collection of principal and interest is expected.
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Foreclosed Assets
Foreclosed assets consists of OREO and other foreclosed assets acquired in partial or total satisfaction of defaulted loans. A discussion of our accounting policies for OREO is contained in Note 1 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Table 19
Foreclosed Assets by Type
(Dollar amounts in thousands)
As of December 31,
Single-family homes
Land parcels:
Raw land
Commercial lots
Single-family lots
Total land parcels
Multi-family units
Commercial properties
Total OREO
Other foreclosed assets (1)
Total
(1) Other foreclosed assets are included in other assets in the Consolidated Statements of Financial Condition.
Foreclosed Assets Activity
A rollforward of foreclosed assets balances for the years ended December 31, 2020 and 2019 is presented in the following table.
Table 20
Foreclosed Assets Rollforward
(Dollar amounts in thousands)
Years Ended December 31,
Beginning balance
Transfers from loans
Acquisitions
Proceeds from sales
Gains on sales of foreclosed assets
Valuation adjustments
Ending balance
INVESTMENT IN BANK-OWNED LIFE INSURANCE
We previously purchased life insurance policies on the lives of certain directors and officers and are the sole owner and beneficiary of the policies. We invested in these BOLI policies to provide an efficient form of funding for long-term retirement and other employee benefit costs. Therefore, our BOLI policies are intended to be long-term investments to provide funding for long-term liabilities. We record these BOLI policies as a separate line item in the Consolidated Statements of Financial Condition at each policy's respective cash surrender value ("CSV") with changes recorded as a component of noninterest income in the Consolidated Statements of Income. As of December 31, 2020, the CSV of BOLI assets totaled $301.1 million. Income and proceeds for BOLI policies are not subject to income taxation.
As of December 31, 2020, 55% of our total BOLI portfolio is invested in general account life insurance distributed among fifteen insurance carriers, all of which carry investment grade ratings. This general account life insurance typically includes a feature guaranteeing minimum returns. The remaining 45% is in separate account life insurance, which is managed by third-party investment advisers under predetermined investment guidelines. Stable value protection is a feature available for separate
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account life insurance policies that is designed to protect a policy's CSV from market fluctuations, within limits, on underlying investments. Our entire separate account portfolio has stable value protection purchased from a highly rated financial institution. To the extent fair values on individual contracts fall below 80% of their CSV, the CSV of the specific contracts may be reduced or the underlying assets may be transferred to short-duration investments, resulting in lower earnings.
For the years ended December 31, 2020, 2019, and 2018, we had BOLI income of $7.4 million, $8.4 million, and $5.8 million, respectively.
GOODWILL
The carrying amount of goodwill was $862.4 million as of December 31, 2020 and $728.8 million as of December 31, 2019. Goodwill increased by $65.6 million from December 31, 2019, which consisted of $60.6 million related to the Park Bank acquisition, and a $5.0 million measurement period adjustment related to finalizing the fair values of assets acquired and liabilities assumed in the Bridgeview and Northern Oak acquisitions. For additional detail regarding goodwill, see Note 10 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Goodwill is tested annually for impairment or when events or circumstances indicate a need to perform interim tests, as described in Note 1 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K. During 2020, we performed our annual impairment test of goodwill at October 1, 2020 and determined that goodwill was not impaired at that date and there was no indication that goodwill was impaired as of December 31, 2020.
DEFERRED TAX ASSETS
Deferred tax assets and liabilities are recognized for the future tax consequences attributed to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. For additional discussion of income taxes, see Notes 1 and 16 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K. Income tax expense recorded due to changes in uncertain tax positions is also described in Note 16.
Table 22
Deferred Tax Assets
(Dollar amounts in thousands)
As of December 31,
% Change
Net DTAs
Management assessed whether it is more likely than not that all or some portion of the DTAs will not be realized. This assessment considered whether, in the periods of reversal, the DTAs can be realized through carryback to income in prior years, future reversals of existing deferred tax liabilities, and future taxable income, including taxable income resulting from the application of future tax planning strategies. The assessment also considered positive and negative evidence, including pre-tax income during the current and prior two years, actual performance compared to budget, trends in non-performing assets and corporate performing potential problem loans, the Company's capital position, and any unsettled circumstances that could impact future earnings. In connection with its acquisition of Bridgeview, DTAs related to certain acquired losses are subject to a valuation allowance due to the application of Internal Revenue Code Section 382. The allowance was $2.1 million as of December 31, 2020. With the exception of the Bridgeview DTAs for net operating losses, management has determined that it is more likely than not that all other DTAs will be fully realized and no additional valuation allowance is required as of December 31, 2020.
Net DTAs increased in 2020 due primarily to the impact of adoption of CECL on January 1, 2020 and current year additions to the allowance for credit losses, partially offset by reductions to deferred taxes related to other comprehensive income. Net DTAs decreased in 2019 due primarily to securities valuation adjustments and the recognition of the remaining deferred gain on a sale-leaseback transaction, partially offset by net DTAs acquired as part of the Bridgeview acquisition.
FUNDING AND LIQUIDITY MANAGEMENT
Liquidity measures the ability to meet current and future cash flows as they become due. Our approach to liquidity management is to obtain funding sources at a minimum cost to meet fluctuating deposit, withdrawal, and loan demand needs. Our liquidity policy establishes parameters to maintain flexibility in responding to changes in liquidity needs over a 12-month forward-looking period, including the requirement to formulate a quarterly liquidity compliance plan for review by the Bank's Board of Directors. The compliance plan includes an analysis that measures projected needs to purchase and sell funds and incorporates a set of projected balance sheet assumptions that are updated quarterly. Based on these assumptions, we determine our total cash liquidity on hand and excess collateral capacity from pledging, unused federal funds purchased lines, and other unused borrowing capacity, such as FHLB advances, resulting in a calculation of our total liquidity capacity. Our total policy-directed
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liquidity requirement is to have funding sources available to cover 50.0% of non-collateralized, non-FDIC insured, non-maturity deposits. Based on our projections as of December 31, 2020, we expect to have liquidity capacity in excess of policy guidelines for the forward twelve-month period.
The liquidity needs of the Company on an unconsolidated basis (the "Parent Company") consist primarily of operating expenses, debt service payments, and dividend payments to our stockholders, which totaled $105.2 million for the year ended December 31, 2020. The primary source of liquidity for the Parent Company is dividends from subsidiaries. The Parent Company had $86.8 million of junior subordinated debentures, $148.0 million of subordinated notes, and cash and interest-bearing deposits of $442.8 million as of December 31, 2020. On September 27, 2016, the Company entered into a loan agreement with U.S. Bank National Association providing for a $50.0 million short-term, unsecured revolving credit facility. On September 26, 2020, the Company entered into a fourth amendment to this credit facility, which extends the maturity to September 26, 2021. As of December 31, 2020, no amount was outstanding under the facility. The Parent Company has the ability to enhance its liquidity position by raising capital or incurring debt.
Total deposits and borrowed funds as of December 31, 2020 are summarized in Notes 11 and 12 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K. The following table provides a comparison of average funding sources over the last three years. We believe that average balances, rather than period-end balances, are more meaningful in analyzing funding sources because of the normal fluctuations that may occur on a daily or monthly basis within funding categories.
Table 23
Funding Sources - Average Balances
(Dollar amounts in thousands)
Years Ended December 31,
% Change
Total
Total
Total
Demand deposits
Savings deposits
NOW accounts
Money market accounts
Core deposits
Time deposits
Brokered deposits
Total time deposits
Total deposits
Securities sold under
agreements to repurchase
Federal funds purchased
FHLB advances
Total borrowed funds
Subordinated debt
Total funding sources
Average Funding Sources
Total average funding sources of $17.5 billion for 2020 increased by $3.1 billion, or 21.2%, from 2019. The increase in total average funding sources was driven by higher customer deposit balances resulting from PPP funds and other government stimuli, deposits assumed in the Park Bank transaction in March 2020, and FHLB advances.
As of December 31, 2020, the Company had $8.0 billion of additional funding sources to provide ample capacity to support its clients, colleagues, and communities, with $4.6 billion of the additional funding comprised of $2.2 billion of unencumbered securities and cash, $861.4 million of Federal Reserve availability, and $1.6 billion of available FHLB capacity. In addition, the Company has the ability to utilize the Paycheck Protection Program Liquidity Facility ("PPPLF") to fund certain demand for PPP loans. As of December 31, 2020, no amount was outstanding under the PPPLF.
Total average funding sources of $14.4 billion for 2019 increased by $1.8 billion, or 14.2%, from 2018. The increase resulted from the deposits assumed in the Bridgeview transaction in May 2019 and Northern States in October 2018, FHLB advances, and organic deposit growth.
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Time Deposits
Table 24
Maturities of Time Deposits Greater Than $100,000
(Dollar amounts in thousands)
As of December 31, 2020
Three months or less
Greater than three months to six months
Greater than six months to twelve months
Greater than twelve months
Total
Borrowed Funds
Table 25
Borrowed Funds
(Dollar amounts in thousands)
Amount
Weighted-
Average
Rate %
Amount
Weighted-
Average
Rate %
Amount
Weighted-
Average
Rate %
At period-end:
Securities sold under agreements to
repurchase
Federal funds purchased
FHLB advances
Total borrowed funds
Average for the year-to-date period:
Securities sold under agreements to
repurchase
Federal funds purchased
FHLB advances
Total borrowed funds
Maximum amount outstanding at the end of any day during the period:
Securities sold under agreements to
repurchase
Federal funds purchased
FHLB advances
Average borrowed funds totaled $2.1 billion, $1.2 billion, and $946.5 million for 2020, 2019, and 2018, respectively. The increase in 2020 from 2019 and in 2019 from 2018 was due primarily to higher levels of FHLB advances. During 2020, the Company terminated longer term interest rate swaps with a notional amount of $1.6 billion, which eliminated the impact of hedging on the weighted-average rate on FHLB advances as of December 31, 2020. The weighted-average rate on FHLB advances for prior year-to-date periods was impacted by the hedging $560.0 million and $740.0 million of FHLB advances as of December 31, 2019 and 2018, respectively, using interest rate swaps through which the Company receives variable amounts and pays fixed amounts. The weighted-average interest rate paid on these interest rate swaps was 1.81% and 1.92% as of December 31, 2019 and 2018, respectively. For further discussion of interest rate swaps, see Note 20 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
During 2020, the Company renewed its loan agreement with U.S. Bank National Association providing for a $50.0 million short-term, unsecured revolving credit facility to provide that the credit facility will mature on September 26, 2021. Advances will bear interest at a rate equal to one-month LIBOR plus 1.75%, adjusted on a monthly basis, and the Company must pay an unused facility fee equal to 0.35% per annum on a quarterly basis. As of December 31, 2020, 2019, and 2018, no amount was outstanding under the facility.
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We make interchangeable use of repurchase agreements, FHLB advances, and federal funds purchased to supplement deposits. Securities sold under agreements to repurchase and federal funds purchased generally mature within 1 to 90 days from the transaction date.
Subordinated Debt
Average subordinated debt increased $11.2 million, or 5.0%, from 2019 to 2020 and $25.6 million, or 12.9%, from 2018 to 2019. The increase resulted from the acquisition of Bridgeview Statutory Trust I and Bridgeview Capital Trust II, as part of the Bridgeview acquisition completed during May 2019 . See Note 13 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K for additional discussion regarding these transactions.
CONTRACTUAL OBLIGATIONS, COMMITMENTS, OFF-BALANCE SHEET RISK, AND CONTINGENT LIABILITIES
Through our normal course of operations, we enter into certain contractual obligations and other commitments. These obligations generally relate to the funding of operations through deposits or debt issuances, as well as leases for premises and equipment. As a financial services provider, we routinely enter into commitments to extend credit. While contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn. These commitments are subject to the same credit policies and approval process used for our loans.
The following table presents our significant fixed and determinable contractual obligations and significant commitments as of December 31, 2020. Further discussion of the nature of each obligation is included in the referenced note of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Table 26
Contractual Obligations, Commitments, Off-Balance Sheet Risk, and Contingent Liabilities
(Dollar amounts in thousands)
Payments Due In
Note
Reference
One Year or Less
Greater Than One to Three Years
Greater Than Three to
Five Years
Greater Than Five Years
Total
Core deposits (no stated maturity)
Time deposits
Borrowed funds
Subordinated debt
Operating leases
Pension liability
Uncertain tax positions liability
Commitments to extend credit
Letters of credit
N/M – Not meaningful.
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MANAGEMENT OF CAPITAL
Capital Measurements
A strong capital structure is required under applicable banking regulations and is crucial in maintaining investor confidence, accessing capital markets, and enabling us to take advantage of future growth opportunities. Our capital policy requires that the Company and the Bank maintain capital ratios in excess of the minimum regulatory guidelines. It serves as an internal discipline in analyzing business risks and internal growth opportunities and sets targeted levels of return on equity. On an annual basis management updates its capital plan which is approved by the Board of Directors. This plan includes a stress test exercise to capture key risks facing the Company, both financial and operational, and assesses the Company’s ability to maintain capital ratios in excess of the minimum regulatory guidelines even under stressed conditions.Under regulatory capital adequacy guidelines, the Company and the Bank are subject to various capital requirements set and administered by the federal banking agencies. The Company and the Bank are subject to the Basel III Capital rules, a comprehensive capital framework for U.S. banking organizations published by the Federal Reserve. These rules are discussed in the "Supervision and Regulation" section in Item 1, "Business" of this Form 10-K.
The following table presents the Company's and the Bank's measures of capital as of the dates presented and the capital guidelines established by the Federal Reserve for the Company and the Bank. We manage our capital ratios for both the Company and the Bank to consistently maintain these measurements in excess of the Federal Reserve's minimum levels. All regulatory mandated ratios for characterization of the Bank and Company as "well-capitalized" were exceeded as of December 31, 2020 and December 31, 2019.
Table 27
Capital Measurements
(Dollar amounts in thousands)
As of December 31, 2020
Minimum Requirement
Plus Capital
Conservation Buffer
Well-Capitalized (1)
As of December 31,
Excess
Over
Excess
Over
Minimum
Minimums
Minimum
Minimums
Bank regulatory capital ratios
Total capital to risk-weighted assets
Tier 1 capital to risk-weighted assets
CET1 to risk-weighted assets
Tier 1 capital to average assets
Company regulatory capital ratios
Total capital to risk-weighted assets
Tier 1 capital to risk-weighted assets
CET1 to risk-weighted assets
Tier 1 capital to average assets
Company tangible common equity ratios (2)(3)
Tangible common equity to tangible assets
Tangible common equity to tangible assets,
excluding PPP loans
Tangible common equity, excluding AOCI,
to tangible assets
Tangible common equity, excluding AOCI,
to tangible assets, excluding PPP loans
Tangible common equity to risk-weighted
assets
N/A – Not applicable.
(1) "Well-capitalized" minimum CET1 to risk-weighted assets and Tier 1 capital to average assets ratios are not formally defined under applicable banking regulations for bank holding companies.
(2) Ratios are not subject to formal Federal Reserve regulatory guidance.
(3) Tangible common equity ratios are non-GAAP financial measures. For a discussion of non-GAAP financial measures, see the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations."
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The Company's total and Tier 1 capital to risk-weighted assets ratios increased compared to December 31, 2019 as a result of retained earnings, the issuance of preferred stock, and the mix of risk-weighted assets. In addition, all Company capital ratios were impacted by the approximately 50 basis point decrease due to the Park Bank acquisition, and 15 basis point decrease due to stock repurchases. The Company elected CECL transition relief for regulatory capital which retained approximately 30 basis points of CET1 and Tier 1 capital as of December 31, 2020.
In February of 2019, the federal bank regulatory agencies issued a final rule, the 2019 CECL Rule, that revised certain capital regulations to account for changes to credit loss accounting under GAAP. The 2019 CECL Rule included a transition option that allows banking organizations to phase in, over a three-year period, the day-one adverse effects of CECL on their regulatory capital ratios (three-year transition option). During 2020, the federal bank regulatory agencies issued a rule that maintains the three year transition option of the 2019 CECL Rule and also provides banking organizations that were required under GAAP (as of January 2020) to implement CECL before the end of 2020 the option to delay for two years an estimate of the effect of CECL on regulatory capital, relative to the incurred loss methodology's effect on regulatory capital, followed by a three-year transition period (five-year transition option). The Company elected to adopt the five-year transition option, which retained approximately 30 basis points of CET1 and Tier 1 capital as of December 31, 2020. This election of the transition option is applicable only to regulatory capital computations under federal banking regulations and does not otherwise impact the financial statements prepared in accordance with GAAP.
The Board reviews the Company's capital plan each quarter, considering the current and expected operating environment as well as evaluating various capital alternatives. For further details of the regulatory capital requirements and ratios as of December 31, 2020 and 2019 for the Company and the Bank, see Note 19 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Issuance of Preferred Stock
During 2020, the Company issued 4.3 million depositary shares, each representing a 1/40th interest in a share of the Company's 7.000% Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series A, and 4.9 million depositary shares, each representing a 1/40th interest in a share of the Company's 7.000% Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series C, for an aggregate of $230.5 million. The Company received proceeds of $221.2 million, net of underwriting discounts and commissions and issuance costs and expects to use the proceeds for general corporate purposes.
Stock Repurchase Programs
On February 26, 2020, the Company announced a stock repurchase program, under which the Company is authorized to repurchase up to $200 million of its outstanding common stock through December 31, 2021. This stock repurchase program replaced the prior $180 million program, which was scheduled to expire in March 2020. Stock repurchases under the program may be made from time to time on the open market, in privately negotiated transactions or through accelerated share repurchase programs. The timing, pricing and amount of any repurchases under the program will be determined by the Company’s management in its discretion. The stock repurchase program does not obligate the Company to repurchase a specific dollar amount or number of shares, and the program may be extended, modified, or discontinued at any time.
The Company suspended stock repurchases in March 2020 as it shifted its capital deployment strategy in response to the pandemic. Prior to this action, the Company repurchased 1.2 million shares of its common stock at a total cost of $22.6 million during 2020 under both the current and prior stock repurchase programs.
Shares repurchased, whether as part of or outside of the Board-approved program, are held as treasury stock and are available for issuance in connection with our qualified and nonqualified retirement plans, share-based compensation plans, and other general corporate purposes. We reissued 128,943 treasury shares in 2020 and 131,392 treasury shares in 2019 pursuant to these plans.
Dividends
The Board declared a quarterly cash dividend on the Company's common stock of $0.11 per share for the first three quarters of 2018 with an increase in the quarterly cash dividend to $0.12 per share for each of the fourth quarter of 2018 and first quarter of 2019. The quarterly cash dividend increased to $0.14 per share for each of the quarters from the second quarter of 2019 through the fourth quarter of 2020. The dividend for the fourth quarter of 2020 represents the 152 nd consecutive cash dividend paid by the Company since its inception in 1983.
During the fourth and third quarters of 2020, the Board of Directors also approved a quarterly cash dividend of $17.50 per share of preferred stock. The cash dividend of $17.50 per share of preferred stock for the second quarter of 2020 was prorated based on the date of issuance during the quarter.
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QUARTERLY EARNINGS
Table 28
Quarterly Earnings Performance (1)
(Dollar amounts in thousands, except per share data)
Fourth
Third
Second
First
Fourth
Third
Second
First
Interest income
Interest expense
Net interest income
Provision for loan losses
Noninterest income
Noninterest expense
Income before income
tax expense
Income tax expense
Net income
Preferred dividends
Net income applicable to
non-vested restricted shares
Net income applicable to
common shares
Basic earnings per common share
Diluted earnings per common
share
Diluted earnings per common
share, adjusted (2)
Dividends declared per common
share
Return on average common equity
Return on average common equity,
adjusted (2)
Return on average assets
Return on average assets,
adjusted (2)
Tax-equivalent net interest
income/margin
(1) All ratios are presented on an annualized basis.
(2) These ratios are non-GAAP financial measures. For a discussion of non-GAAP financial measures, see the section of this Item 7 titled "Non-GAAP Financial Information and Reconciliations."
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are prepared in accordance with GAAP and are consistent with general practices within the banking industry. Application of GAAP requires management to make estimates, assumptions, and judgments based on the best available information as of the date of the financial statements that affect the amounts reported in the consolidated financial statements and accompanying notes. Critical accounting estimates are those estimates that management believes are the most important to our financial position and results of operations. Future changes in information may impact these estimates, assumptions, and judgments, which may have a material effect on the amounts reported in the financial statements.
The most significant of our accounting policies and estimates are presented in Note 1 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K. Along with the disclosures presented in the other financial statement notes and in this discussion, these policies provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, estimates, assumptions, and judgments underlying those amounts, management determined that our accounting policies for the allowance for credit losses, valuation of securities, income taxes, and goodwill and other intangible assets are considered to be our critical accounting estimates.
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Allowance for Credit Losses
The determination of the allowance for credit losses is inherently subjective since it requires significant estimates and management judgment, including the amounts and timing of expected future cash flows, actual loss experience, consideration of current national, regional, and local economic trends and conditions, reasonable and supportable forecasts about the future, changes in interest rates and property values, various internal and external qualitative factors, and other factors, all of which are susceptible to significant change. Credit exposures deemed to be uncollectible are charged-off against the allowance for loan losses, while recoveries of amounts previously charged-off are credited to the allowance for credit losses. Additions to the allowance for credit losses are established through the provision for credit losses charged to expense. The amount charged to operating expense depends on a number of factors, including historic loan growth, changes in the composition of the loan portfolio, net charge-off levels, and our assessment of the allowance for credit losses, including our estimate of the impact of the pandemic. For additional discussion of the allowance for credit losses, see Notes 1 and 7 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Valuation of Securities
The fair values of securities are based on quoted prices obtained from third-party pricing services or dealer market participants where a ready market for such securities exists. In the absence of quoted prices or where a market for the security does not exist, management judgment and estimation is used, which may include modeling-based techniques. The use of different judgments and estimates to determine the fair value of securities could result in a different fair value estimate.
On a quarterly basis, the Company assesses securities with unrealized losses to determine whether impairment has occurred. In evaluating impairment, management considers many factors, including the severity of the impairment, the financial condition and near-term prospects of the issuer, including external credit ratings and recent downgrades for debt securities, intent to hold the security until its value recovers, and the likelihood that the Company would be required to sell the securities before a recovery in value, which may be at maturity. If there is an unrealized loss on a security that is deemed to be a credit-related impairment, it is recorded as an allowance through a charge to expense through noninterest expense, limited to the difference between amortized cost and fair value. If there is an unrealized loss on a security that is not deemed to be a credit-related impairment, it is recorded through other comprehensive income (loss). The determination of impairment is subjective and different judgments and assumptions could affect the timing and amount of loss realization. For additional discussion of securities, see Notes 1 and 4 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Income Taxes
We determine our income tax expense based on management's judgments and estimates regarding permanent differences in the treatment of specific items of income and expense for financial statement and income tax purposes. These permanent differences result in an effective tax rate that differs from the federal statutory rate. In addition, we recognize deferred tax assets and liabilities in the Consolidated Statements of Financial Condition based on management's judgment and estimates regarding timing differences in the recognition of income and expenses for financial statement and income tax purposes.
We assess the likelihood that any DTAs will be realized through the reduction or refund of taxes in future periods and establish a valuation allowance for those assets for which recovery is not more likely than not. In making this assessment, management makes judgments and estimates regarding the ability to realize the asset through carryback to taxable income in prior years, the future reversal of existing taxable temporary differences, future taxable income, and the possible application of future tax planning strategies. Management believes that it is more likely than not that DTAs included in the accompanying Consolidated Statements of Financial Condition will be fully realized, although there is no guarantee that those assets will be recognizable in future periods.
Management also makes certain interpretations of federal and state income tax laws for which the outcome of the tax position may not be certain. Uncertain tax positions are periodically evaluated and we may establish tax reserves for benefits that may not be realized. For additional discussion of income taxes, see Notes 1 and 16 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the fair value of the net assets acquired using the acquisition method of accounting. This method requires that all identifiable assets acquired and liabilities assumed in the transaction, both intangible and tangible, be recorded at their estimated fair value upon acquisition. Determining the fair value often involves estimates based on third-party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. Goodwill is not amortized, instead, we assess the potential for impairment on an annual basis or more frequently if events and circumstances indicate that goodwill might be impaired.
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Other intangible assets represent purchased assets that lack physical substance, but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. The determination of the useful lives over which an intangible asset will be amortized is subjective. Intangible assets are reviewed for impairment annually or more frequently when events or circumstances indicate that the carrying amount may not be recoverable. For additional discussion of goodwill and other intangible assets, see Notes 1 and 10 of "Notes to the Consolidated financial Statements" in Item 8 of this Form 10-K.
NON-GAAP FINANCIAL INFORMATION AND RECONCILIATIONS
The Company's accounting and reporting policies conform to GAAP and general practices within the banking industry. As a supplement to GAAP, the Company provides non-GAAP performance results, which the Company believes are useful because they assist investors in assessing the Company's operating performance. These non-GAAP financial measures include earnings per share ("EPS"), adjusted, the efficiency ratio, return on average assets, adjusted, tax-equivalent net interest income (including its individual components), tax-equivalent net interest margin, tax-equivalent net interest margin, adjusted, noninterest expense, adjusted, return on average common equity, adjusted, tangible common equity to tangible assets, tangible common equity, excluding AOCI, to tangible assets, tangible common equity to risk-weighted assets, return on average tangible common equity, return on average tangible common equity, adjusted, non-accrual loans, excluding PCD loans, non-accrual loans to total loans, excluding PPP loans, non-accrual loans to total loans, excluding PCD and PPP loans, non-performing loans to total loans, excluding PPP loans, non-performing loans to total loans, excluding PCD and PPP loans, non-performing assets to total loans plus foreclosed assets, excluding PPP loans, non-performing assets to total loans plus foreclosed assets, excluding PCD and PPP loans, net loan charge-offs, excluding PCD loans, and net loan charge-offs to average loans, excluding PPP loans, net loan charge-offs to average loans, excluding PCD and PPP loans, and performing loans classified as substandard and special mention to average corporate loans, excluding PPP loans.
The Company presents EPS, the efficiency ratio, return on average assets, return on average common equity, and return on average tangible common equity, all adjusted for certain significant transactions. These transactions include swap termination costs (2020), optimization costs (2020), net securities gains (2020), income tax benefits (2020 and third quarter and full year 2018), acquisition and integration related expenses associated with completed and pending acquisitions (all periods presented, excluding first and second quarter 2018), Delivering Excellence implementation costs (all periods in 2019 and 2018, excluding first quarter 2018), revaluation of DTAs (2017), certain actions resulting in securities losses and gains (2017), a special bonus to colleagues (2017), a charitable contribution to the First Midwest Charitable Foundation (2017), a net gain on sale-leaseback transaction (2016), a lease cancellation fee recognized as a result of the Company's planned 2018 corporate headquarters relocation (2016), and property valuation adjustments (2015). In addition, net OREO expense is excluded from the calculation of the efficiency ratio. Management believes excluding these transactions from EPS, the efficiency ratio, return on average assets, return on average common equity, and return on average tangible common equity may be useful in assessing the Company's underlying operational performance since these transactions do not pertain to its core business operations and their exclusion facilitates better comparability between periods. Management believes that excluding acquisition and integration related expenses from these metrics may be useful to the Company, as well as analysts and investors, since these expenses can vary significantly based on the size, type, and structure of each acquisition. Additionally, management believes excluding these transactions from these metrics may enhance comparability for peer comparison purposes.
The Company presents the effective income tax rate, adjusted, which excludes certain income tax benefits and the revaluation of DTAs. Management believes that excluding these items from the effective income tax rate may be useful in assessing the Company's underlying operational performance as these items either do not pertain to its core business operations or their exclusion may facilitate better comparability between periods and for peer comparison purposes.
The Company presents noninterest expense, adjusted, which excludes optimization costs, acquisition and integration related expenses, and Delivering Excellence implementation costs. Management believes that excluding these items from noninterest expense may be useful in assessing the Company's underlying operational performance as these items either do not pertain to its core business operations or their exclusion may facilitate better comparability between periods and for peer comparison purposes.
The tax-equivalent adjustment to net interest income and net interest margin recognizes the income tax savings when comparing taxable and tax-exempt assets. Interest income and yields on tax-exempt securities and loans are presented using the current federal income tax rate of 21%. Management believes that it is standard practice in the banking industry to present net interest income and net interest margin on a fully tax-equivalent basis and that it may enhance comparability for peer comparison purposes. In addition, management believes that presenting the tax-equivalent net interest margin, adjusted, may enhance comparability for peer comparison purposes and may be useful to the Company, as well as analysts and investors, since acquired loan accretion income may fluctuate based on the size of each acquisition, as well as from period to period.
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In management's view, tangible common equity measures are capital adequacy metrics meaningful to the Company, as well as analysts and investors, in assessing the Company's use of equity and in facilitating comparisons with peers. These non-GAAP measures are valuable indicators of a financial institution's capital strength since they eliminate intangible assets from stockholders' equity and retain the effect of AOCI in stockholders' equity.
The Company presents non-accrual loans, non-accrual loans to total loans, non-performing loans to total loans, non-performing assets to total loans plus foreclosed assets, net loan charge-offs, net loan charge-offs to average loans, and performing loans classified as substandard and special mention to average corporate loans, all excluding PCD and/or PPP loans. Management believes excluding PCD and PPP loans is useful as it facilitates better comparability between periods. Prior to the adoption of CECL on January 1, 2020, PCI loans with an accretable yield were considered current and were not included in past due and non-accrual loan totals and the portion of PCI loans deemed to be uncollectible was recorded as a reduction of the credit-related acquisition adjustment, which was netted within loans. Subsequent to adoption, PCD loans, including those previously classified as PCI, are included in past due and non-accrual loan totals and an allowance for credit losses on PCD loans is established as of the acquisition date and the PCD loans are no longer recorded net of a credit-related acquisition adjustment. PCD loans deemed to be uncollectible are recorded as a charge-off through the allowance for credit losses. The Company began originating PPP loans during the second quarter of 2020 and the loans are fully guaranteed by the SBA and are expected to be forgiven by the SBA if the applicable criteria are met. Additionally, management believes excluding PCD and PPP loans from these metrics may enhance comparability for peer comparison purposes.
Although intended to enhance investors' understanding of the Company's business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. In addition, these non-GAAP financial measures may differ from those used by other financial institutions to assess their business and performance. See the previously provided tables and the following reconciliations for details on the calculation of these measures to the extent presented herein.
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Non-GAAP Reconciliations
(Amounts in thousands, except per share data)
Years Ended December 31,
Earnings Per Share
Net income
Dividends and accretion on preferred stock
Net income applicable to non-vested restricted shares
Net income applicable to common shares
Adjustments to net income:
Swap termination costs
Tax effect of swap termination costs
Optimization costs
Tax effect of optimization costs
Net securities (gains)
Tax effect of net securities (gains)
Acquisition and integration related expenses
Tax effect of acquisition and integration related expenses
Income tax benefits (1)
Delivering Excellence implementation costs
Tax effect of Delivering Excellence implementation costs
DTA revaluation
Losses from securities portfolio actions
Tax effect of losses from securities portfolio actions
Special bonus
Tax effect of special bonus
Charitable contribution
Tax effect of charitable contribution
Net gain on sale-leaseback transaction
Tax effect of net gain on sale-leaseback transaction
Lease cancellation fee
Tax effect of lease cancellation fee
Total adjustments to net income, net of tax
Net income applicable to common shares, adjusted
Weighted-average common shares outstanding:
Weighted-average common shares outstanding (basic)
Dilutive effect of common stock equivalents
Weighted-average diluted common shares outstanding
Basic EPS
Diluted EPS
Diluted EPS, adjusted (2)
Effective Tax Rate
Income before income tax expense
Income tax expense
Income tax benefits (1)
DTA revaluation
Income tax expense, adjusted
Effective income tax rate
Effective income tax rate, adjusted
Return on Average Assets
Net income
Total adjustments to net income, net of tax (2)
Net income, adjusted (2)
Average assets
Return on average assets (3)
Return on average assets, adjusted (2)(3)
Note: Non-GAAP Reconciliation footnotes are located at the end of this section.
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Years Ended December 31,
Return on Average Common and Tangible Common Equity
Net income applicable to common shares
Intangibles amortization
Tax effect of intangibles amortization
Net income applicable to common shares, excluding
intangibles amortization
Total adjustments to net income, net of tax (2)
Net income applicable to common shares, excluding
intangibles amortization, adjusted (2)
Average stockholders' common equity
Less: average intangible assets
Average tangible common equity
Return on average common equity
Return on average common equity, adjusted (2)
Return on average tangible common equity
Return on average tangible common equity, adjusted (2)
Efficiency Ratio Calculation
Noninterest expense
Less:
Net OREO expense
Optimization costs
Acquisition and integration related expenses
Delivering Excellence implementation costs
Special bonus
Charitable contribution
Lease cancellation fee
Total
Tax-equivalent net interest income (3)
Noninterest income
Less:
Swap termination costs
Net securities losses (gains)
Net gain on sale-leaseback
Total
Efficiency ratio
Efficiency ratio (prior presentation) (4)
Dividend Payout Ratio
Common dividends declared
EPS
EPS, adjusted (2)
Dividend payout ratio
Dividend payout ratio, adjusted (2)
Book Value Per Share
Stockholders' common equity
Less: intangible assets
Tangible common equity
Common shares outstanding
Common book value per share
Tangible common book value per share
Note: Non-GAAP Reconciliation footnotes are located at the end of this section.
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As of December 31,
Tangible Common Equity
Stockholders' common equity
Less: goodwill and other intangible assets
Tangible common equity
Less: AOCI
Tangible common equity, excluding AOCI
Total assets
Less: goodwill and other intangible assets
Tangible assets
Less: PPP loans
Tangible assets, excluding PPP loans
Risk-weighted assets
Tangible common equity to tangible assets
Tangible common equity to tangible assets, excluding PPP loans
Tangible common equity, excluding AOCI, to tangible assets
Tangible common equity, excluding AOCI, to tangible assets, excluding PPP loans
Tangible common equity to risk-weighted assets
Note: Non-GAAP Reconciliation footnotes are located at the end of this section.
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Fourth
Third
Second
First
Fourth
Third
Second
First
Quarterly Performance
Net income
Dividends and accretion on
preferred stock
Net income applicable to
non-vested restricted shares
Net income applicable
to common shares
Adjustments to net income:
Swap termination costs
Tax effect of swap
termination costs
Income tax benefits
Optimization costs
Tax effect of optimization
costs
Acquisition and
integration related
expenses
Tax effect of acquisition
and integration related
expenses
Net securities (gains)
losses
Tax effect of net securities
(gains) losses
Delivering Excellence
implementation costs
Tax effect of Delivering
excellence
implementation costs
Total adjustments to net
income, net of tax
Net income applicable
to common shares,
adjusted
Weighted-average common shares outstanding:
Weighted-average
common shares
outstanding (basic)
Dilutive effect of
common stock
equivalents
Weighted-average
diluted common
shares outstanding
Average stockholders'
common equity
Average assets
Diluted EPS
Diluted EPS, adjusted
Return on average common
equity (5)
Return on average common
equity, adjusted (2)(5)
Return on average assets (5)
Return on average assets,
adjusted (2)(5)
(1) Includes certain income tax benefits resulting from federal income tax reform.
(2) Adjustments to net income for each period presented are detailed in the EPS non-GAAP reconciliation above.
(3) Presented on a tax-equivalent basis, assuming a federal income tax rate of 21%.
(4) Presented as calculated prior to March 31, 2018, which included a tax-equivalent adjustment for BOLI. Management believes that removing this adjustment from the current calculation of this metric enhances comparability for peer comparison purposes.
(5) Annualized based on the actual number of days for each period presented.
