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Section 1: 10-Q (QUARTERLY REPORT)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

  

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the Quarterly Period Ended March 31, 2019

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)  

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from          to_________

 

Commission File Number 0-25923

 

Eagle Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland 52-2061461
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

 

7830 Old Georgetown Road, Third Floor, Bethesda, Maryland 20814
(Address of principal executive offices) (Zip Code)

(301) 986-1800

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

 

Securities Registered under Section 12(b) of the Act:

 

Title of Each Class   Trading Symbol(s)   Name of Each Exchange on Which Registered
Common Stock, $0.01 par value   EGBN   The Nasdaq Stock Market, LLC

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

  Large accelerated filer ☒ Accelerated filer ☐
  Non-accelerated filer ☐ Smaller Reporting Company ☐
    Emerging Growth Company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act  Yes ☐ No ☒

 

As of April 30, 2019, the registrant had 34,540,319 shares of Common Stock outstanding.

 

 

 

EAGLE BANCORP, INC.

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements (Unaudited)
  Consolidated Balance Sheets
 

Consolidated Statements of Operations

  Consolidated Statements of Comprehensive Income
  Consolidated Statements of Changes in Shareholders’ Equity
  Consolidated Statements of Cash Flows
  Notes to Consolidated Financial Statements
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 35 
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 58 
     
Item 4. Controls and Procedures 58 
     
PART II. OTHER INFORMATION  
     
Item 1. Legal Proceedings 59 
     
Item 1A. Risk Factors 59 
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 59 
     
Item 3. Defaults Upon Senior Securities 59 
     
Item 4. Mine Safety Disclosures 59
     
Item 5. Other Information 59 
     
Item 6. Exhibits 59 
     
Signatures   62 

 

2  

 

PART I - FINANCIAL INFORMATION

 

Item 1 – Financial Statements (Unaudited)

 

 

EAGLE BANCORP, INC.

Consolidated Balance Sheets (Unaudited)

(dollars in thousands, except per share data)

 

Assets  March 31, 2019   December 31, 2018 
Cash and due from banks  $6,817   $6,773 
Federal funds sold   15,403    11,934 
Interest bearing deposits with banks and other short-term investments   99,870    303,157 
Investment securities available-for-sale, at fair value   772,229    784,139 
Federal Reserve and Federal Home Loan Bank stock   34,995    23,506 
Loans held for sale   20,268    19,254 
Loans   7,173,058    6,991,447 
Less allowance for credit losses   (69,943)   (69,944)
Loans, net   7,103,115    6,921,503 
Premises and equipment, net   15,798    16,851 
Operating lease right-of-use assets   28,928     
Deferred income taxes   31,763    33,027 
Bank owned life insurance   73,865    73,441 
Intangible assets, net   105,466    105,766 
Other real estate owned   1,394    1,394 
Other assets   78,495    88,392 
Total Assets  $8,388,406   $8,389,137 
           
Liabilities and Shareholders’ Equity          
Liabilities          
Deposits:          
Noninterest bearing demand  $2,216,270   $2,104,220 
Interest bearing transaction   588,326    593,107 
Savings and money market   2,515,269    2,949,559 
Time, $100,000 or more   791,956    801,957 
Other time   571,098    525,442 
Total deposits   6,682,919    6,974,285 
Customer repurchase agreements   26,418    30,413 
Other short-term borrowings   250,000     
Long-term borrowings   217,394    217,296 
Operating lease liabilities   32,752     
Other liabilities   30,435    58,202 
Total Liabilities   7,239,918    7,280,196 
           
Shareholders’ Equity          
Common stock, par value $.01 per share; shares authorized 100,000,000, shares issued and outstanding 34,537,193 and 34,387,919, respectively   343    342 
Additional paid in capital   530,894    528,380 
Retained earnings   618,243    584,494 
Accumulated other comprehensive loss   (992)   (4,275)
Total Shareholders’ Equity   1,148,488    1,108,941 
Total Liabilities and Shareholders’ Equity  $8,388,406   $8,389,137 

 

See notes to consolidated financial statements.

 

3  

 

EAGLE BANCORP, INC.

Consolidated Statements of Operations (Unaudited)

(dollars in thousands, except per share data)

 

   Three Months Ended March 31, 
   2019   2018 
Interest Income          
Interest and fees on loans  $97,821   $84,430 
Interest and dividends on investment securities   5,598    3,592 
Interest on balances with other banks and short-term investments   1,666    981 
Interest on federal funds sold   49    46 
Total interest income   105,134    89,049 
Interest Expense          
Interest on deposits   20,900    9,129 
Interest on customer repurchase agreements   98    50 
Interest on short-term borrowings   140    1,111 
Interest on long-term borrowings   2,979    2,979 
Total interest expense   24,117    13,269 
Net Interest Income   81,017    75,780 
Provision for Credit Losses   3,360    1,969 
Net Interest Income After Provision For Credit Losses   77,657    73,811 
           
Noninterest Income          
Service charges on deposits   1,694    1,614 
Gain on sale of loans   1,388    1,523 
Gain on sale of investment securities   912    42 
Increase in the cash surrender value of bank owned life insurance   425    344 
Other income   1,872    1,781 
Total noninterest income   6,291    5,304 
Noninterest Expense          
Salaries and employee benefits   23,644    16,858 
Premises and equipment expenses   3,852    3,929 
Marketing and advertising   1,148    937 
Data processing   2,375    2,317 
Legal, accounting and professional fees   1,709    2,973 
FDIC insurance   1,116    675 
Other expenses   4,460    3,432 
Total noninterest expense   38,304    31,121 
Income Before Income Tax Expense   45,644    47,994 
Income Tax Expense   11,895    12,279 
Net Income  $33,749   $35,715 
           
Earnings Per Common Share          
Basic  $0.98   $1.04 
Diluted  $0.98   $1.04 

 

See notes to consolidated financial statements.      

 

4  

 

EAGLE BANCORP, INC.

Consolidated Statements of Comprehensive Income (Unaudited)

(dollars in thousands)

 

   Three Months Ended March 31, 
   2019   2018 
Net Income  $33,749   $35,715 
           
Other comprehensive income (loss), net of tax:          
Unrealized gain (loss) on securities available for sale   5,440    (5,123)
Reclassification adjustment for net gains included in net income   (61)   (31)
Total unrealized gain (loss) on investment securities   5,379    (5,154)
Unrealized (loss) gain on derivatives   (1,154)   2,233 
Reclassification adjustment for amounts included in net income   (942)   (65)
Total unrealized (loss) gain on derivatives   (2,096)   2,168 
Other comprehensive income (loss)   3,283    (2,986)
Comprehensive Income  $37,032   $32,729 

 

See notes to consolidated financial statements.      

 

5  

 

EAGLE BANCORP, INC.

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(dollars in thousands except share data)

 

                   Accumulated     
           Additional       Other   Total 
   Common   Paid   Retained   Comprehensive   Shareholders’ 
   Shares   Amount   in Capital   Earnings   Income (Loss)   Equity 
Balance January 1, 2019   34,387,919   $342   $528,380   $584,494   $(4,275)  $1,108,941 
                               
Net Income               33,749        33,749 
Other comprehensive income, net of tax                   3,283    3,283 
Stock-based compensation expense           2,029            2,029 
Issuance of common stock related to options exercised, net of shares withheld for payroll taxes   26,034        296            296 
Vesting of time based stock awards issued at date of grant, net of shares withheld for payroll taxes   (10,944)   1    (1)            
Vesting of performance based stock awards, net of shares withheld for payroll taxes   17,655                     
Time based stock awards granted   112,636                     
Issuance of common stock related to employee stock purchase plan   3,893        190            190 
Balance March 31, 2019   34,537,193   $343   $530,894   $618,243   $(992)  $1,148,488 
                               
Balance January 1, 2018   34,185,163   $340   $520,304   $431,544   $(1,750)  $950,438 
                               
Net Income               35,715        35,715 
Other comprehensive income, net of tax                   (2,986)   (2,986)
Stock-based compensation expense           1,476            1,476 
Issuance of common stock related to options exercised, net of shares withheld for payroll taxes   32,230        338            338 
Vesting of time based stock awards issued at date of grant, net of shares withheld for payroll taxes   (12,106)   1    (1)            
Time based stock awards granted   94,344                     
Issuance of common stock related to employee stock purchase plan   3,425        199            199 
Reclassification of the income tax effects of the Tax Cuts and Jobs Act  from AOCI (ASU 2018-02)               674    (674)    
Balance March 31, 2018   34,303,056   $341   $522,316   $467,933   $(5,410)  $985,180 

 

See notes to consolidated financial statements.

 

6  

 

EAGLE BANCORP, INC.

Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)

 

   Three Months Ended March 31, 
   2019   2018 
Cash Flows From Operating Activities:          
Net Income  $33,749   $35,715 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for credit losses   3,360    1,969 
Depreciation and amortization   1,672    1,811 
Amortization of operating lease right-of-use assets   646     
Gains on sale of loans   (1,388)   (1,523)
Gains on sale of GNMA loans   (55)    
Securities premium amortization (discount accretion), net   1,371    1,087 
Origination of loans held for sale   (91,736)   (102,316)
Proceeds from sale of loans held for sale   92,165    103,062 
Net increase in cash surrender value of BOLI   (425)   (344)
Deferred income tax expense (benefit)   1,264    (1,433)
Net gain on sale of investment securities   (912)   (42)
Stock-based compensation expense   2,029    1,476 
Net tax benefits from stock compensation   10    108 
Decrease (increase) in other assets   9,897    (25,519)
Decrease in other liabilities   (23,943)   (5,430)
Net cash provided by operating activities   27,704    8,621 
Cash Flows From Investing Activities:          
Purchases of available-for-sale investment securities   (34,748)   (32,269)
Proceeds from maturities of available-for-sale securities   26,674    21,249 
Proceeds from sale/call of available-for-sale securities   22,808    17,266 
Purchases of Federal Reserve and Federal Home Loan Bank stock   (16,164)   (28,322)
Proceeds from redemption of Federal Reserve and Federal Home Loan Bank stock   4,675    29,878 
Net increase in loans   (184,972)   (191,918)
Bank premises and equipment acquired   (876)   (283)
Net cash used in investing activities   (182,603)   (184,399)
Cash Flows From Financing Activities:          
(Decrease) increase in deposits   (291,366)   267,817 
Decrease in customer repurchase agreements   (3,995)   (28,196)
Increase (decrease) in short-term borrowings   250,000    (50,000)
Proceeds from exercise of equity compensation plans   296    338 
Proceeds from employee stock purchase plan   190    199 
Net cash (used in) provided by financing activities   (44,875)   190,158 
Net (Decrease) Increase In Cash and Cash Equivalents   (199,774)   14,380 
Cash and Cash Equivalents at Beginning of Period   321,864    190,473 
Cash and Cash Equivalents at End of Period  $122,090   $204,853 
Supplemental Cash Flows Information:          
Interest paid  $26,749   $15,352 
Income taxes paid  $17,950   $16,500 
Non-Cash Investing Activities          
Initial recognition of operating lease right-of-use assets  $29,574   $ 
Initial recognition of operating lease liabilities  $33,535   $ 

 

See notes to consolidated financial statements.

 

7  

 

EAGLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

(Unaudited)

 

Note 1. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The Consolidated Financial Statements include the accounts of Eagle Bancorp, Inc. and its subsidiaries (the “Company”). Active subsidiaries include: EagleBank (the “Bank”), Eagle Insurance Services, LLC, and Bethesda Leasing, LLC, with all significant intercompany transactions eliminated.

 

The Consolidated Financial Statements of the Company included herein are unaudited. The Consolidated Financial Statements reflect all adjustments, consisting of normal recurring accruals that in the opinion of management, are necessary to present fairly the results for the periods presented. The amounts as of and for the three months ended March 31, 2019 were derived from audited Consolidated Financial Statements. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The Company applies the accounting policies contained in Note 1 to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. There have been no significant changes to the Company’s Accounting Policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. The Company believes that the disclosures are adequate to make the information presented not misleading. Certain reclassifications have been made to amounts previously reported to conform to the current period presentation.

 

These statements should be read in conjunction with the audited Consolidated Financial Statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. Operating results for the three months ended March 31, 2019 are not necessarily indicative of the results of operations to be expected for the remainder of the year, or for any other period.

 

Nature of Operations

 

The Company, through the Bank, conducts a full service community banking business, primarily in Northern Virginia, Suburban Maryland, and Washington, D.C. The primary financial services offered by the Bank include real estate, commercial and consumer lending, as well as traditional deposit and repurchase agreement products. The Bank is also active in the origination and sale of residential mortgage loans, the origination of small business loans, and the origination, securitization and sale of multifamily Federal Housing Administration (“FHA”) loans. The guaranteed portion of small business loans, guaranteed by the Small Business Administration (“SBA”), is typically sold to third party investors in a transaction apart from the loan’s origination. The Bank offers its products and services through twenty banking offices, five lending centers and various electronic capabilities, including remote deposit services and mobile banking services. Eagle Insurance Services, LLC, a subsidiary of the Bank, offers access to insurance products and services through a referral program with a third party insurance broker.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results may differ from those estimates and such differences could be material to the financial statements.

 

8  

 

New Authoritative Accounting Guidance

 

Accounting Standards Adopted in 2019

 

ASU 2016-02, “Leases (Topic 842).” ASU 2016-02 has, among other things, required lessees to recognize a lease liability, which is a lessee’s obligation to make lease payments, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model and ASC Topic 606, “Revenue from Contracts with Customers.” ASU 2016-02 became effective for us on January 1, 2019 and initially required transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. In July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842) – Targeted Improvements,” which, among other things, provides an additional transition method that allows entities to not apply the guidance in ASU 2016-02 in the comparative periods presented in the financial statements and instead recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In December 2018, the FASB also issued ASU 2018-20, “Leases (Topic 842) - Narrow-Scope Improvements for Lessors,” which provides for certain policy elections and changes lessor accounting for sales and similar taxes and certain lessor costs. Upon adoption of ASU 2016-02, ASU 2018-11 and ASU 2018-20 on January 1, 2019, we recognized right-of-use assets of $29.6 million and related lease liabilities of $33.5 million which reduced the March 31, 2019 total risk based capital ratio by six basis points. We elected to apply certain practical expedients provided under ASU 2016-02 whereby we did not reassess (i) whether any expired or existing contracts were or contained leases, (ii) the lease classification for any expired or existing leases and (iii) initial direct costs for any existing leases. We also elected to not apply the recognition requirements of ASU 2016-02 to any short-term leases (as defined by related accounting guidance). We utilized the modified-retrospective transition approach prescribed by ASU 2018-11.

 

Accounting Standards Pending Adoption

 

ASU 2016-13, “Measurement of Credit Losses on Financial Instruments (Topic 326).” This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. In issuing the standard, the FASB is responding to criticism that today’s guidance for determining the allowance for credit losses delays recognition of expected future credit losses. The standard will replace today’s “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. The CECL model does not apply to available-for-sale (“AFS”) debt securities. For AFS debt securities with unrealized losses, entities will measure credit losses in a manner similar to what they do today, except that the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. ASU 2016-13 also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU No. 2016-13 is effective for the Company beginning on January 1, 2020. Entities will apply any changes resulting from the application of the new standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). We have substantially concluded our data gap analysis and have contracted with a third party to develop a model to comply with CECL requirements. We have established a steering committee with representation from various departments across the enterprise. The committee has agreed to a project plan and has regular meetings to ensure adherence to our implementation timeline. The Company is currently evaluating the provisions of ASU No. 2016-13 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements.

 

Note 2. Cash and Due from Banks

 

Regulation D of the Federal Reserve Act requires that banks maintain noninterest reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. During 2019, the Bank maintained balances at the Federal Reserve sufficient to meet reserve requirements, as well as significant excess reserves, on which interest is paid.

 

Additionally, the Bank maintains interest bearing balances with the Federal Home Loan Bank of Atlanta and noninterest bearing balances with domestic correspondent banks as compensation for services they provide to the Bank.

 

9  

 

Note 3. Investment Securities Available-for-Sale

 

Amortized cost and estimated fair value of securities available-for-sale are summarized as follows:

 

       Gross   Gross   Estimated 
March 31, 2019  Amortized   Unrealized   Unrealized   Fair 
(dollars in thousands)  Cost   Gains   Losses   Value 
U. S. agency securities  $240,675   $435  $2,091   $239,019 
Residential mortgage backed securities   479,162    3,027    4,286    477,903 
Municipal bonds   44,929    684    80    45,533 
Corporate bonds   9,503    66    13    9,556 
Other equity investments   218            218 
   $774,487   $4,212   $6,470   $772,229 

 

       Gross   Gross   Estimated 
December 31, 2018  Amortized   Unrealized   Unrealized   Fair 
(dollars in thousands)  Cost   Gains   Losses   Value 
U. S. agency securities  $260,150   $228  $4,033   $256,345 
Residential mortgage backed securities   477,949    1,575    7,293    472,231 
Municipal bonds   45,814    439    484    45,769 
Corporate bonds   9,503    79    6    9,576 
Other equity investments   218            218 
   $793,634   $2,321   $11,816   $784,139 

 

In addition, at March 31, 2019 and December 31, 2018 the Company held $35.0 million and $23.5 million, respectively, in equity securities in a combination of Federal Reserve Bank (“FRB”) and Federal Home Loan Bank (“FHLB”) stocks, which are required to be held for regulatory purposes and which are not marketable, and therefore are carried at cost.

 

Gross unrealized losses and fair value by length of time that the individual available-for-sale securities have been in a continuous unrealized loss position are as follows:

 

       Less than   12 Months     
       12 Months   or Greater   Total 
       Estimated       Estimated       Estimated     
March 31, 2019  Number of   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
(dollars in thousands)  Securities   Value   Losses   Value   Losses   Value   Losses 
U. S. agency securities   56   $51,185   $325   $157,658   $1,766   $208,843   $2,091 
Residential mortgage backed securities   140    22,026    123    226,380    4,163    248,406    4,286 
Municipal bonds   6            13,974    80    13,974    80 
Corporate bonds   1    1,488    13            1,488    13 
    203   $74,699   $461   $398,012   $6,009   $472,711   $6,470 

 

       Less than   12 Months     
       12 Months   or Greater   Total 
       Estimated       Estimated       Estimated     
December 31, 2018  Number of   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
(dollars in thousands)  Securities   Value   Losses   Value   Losses   Value   Losses 
U. S. agency securities   58   $72,679   $533   $144,636   $3,500   $217,315   $4,033 
Residential mortgage backed securities   151    61,199    527    225,995    6,766    287,194    7,293 
Municipal bonds   11    4,299    50    17,041    434    21,340    484 
Corporate bonds   1    1,494    6            1,494    6 
    221   $139,671   $1,116   $387,672   $10,700   $527,343   $11,816 

 

The unrealized losses that exist are generally the result of changes in market interest rates and interest spread relationships since original purchases. The weighted average duration of debt securities, which comprise 99.9% of total investment securities, is relatively short at 3.3 years. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. The Company does not believe that the investment securities that were in an unrealized loss position as of March 31, 2019 represent an other-than-temporary impairment. The Company does not intend to sell the investments and it is more likely than not that the Company will not have to sell the securities before recovery of its amortized cost basis, which may be at maturity.

 

10  

 

The amortized cost and estimated fair value of investments available-for-sale at March 31, 2019 and December 31, 2018 by contractual maturity are shown in the table below. Expected maturities for residential mortgage backed securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

   March 31, 2019   December 31, 2018 
   Amortized   Estimated   Amortized   Estimated 
(dollars in thousands)  Cost   Fair Value   Cost   Fair Value 
U. S. agency securities maturing:                    
One year or less  $119,133   $118,203   $128,148   $125,545 
After one year through five years   113,513    112,943    119,856    118,883 
Five years through ten years   8,029    7,873    12,146    11,917 
Residential mortgage backed securities   479,162    477,903    477,949    472,231 
Municipal bonds maturing:                    
One year or less   8,085    8,131    8,097    8,167 
After one year through five years   14,203    14,372    15,025    15,081 
Five years through ten years   21,576    21,866    21,626    21,385 
After ten years   1,065    1,164    1,066    1,136 
Corporate bonds maturing:                    
After one year through five years   8,003    8,056    8,003    8,076 
After ten years   1,500    1,500    1,500    1,500 
Other equity investments   218    218    218    218 
   $774,487   $772,229   $793,634   $784,139 

 

For the three months ended March 31, 2019, gross realized gains on sales of investments securities were $912 thousand and there were no gross realized losses on sales of investment securities. For the three months ended March 31, 2018, gross realized gains on sales of investments securities were $67 thousand and gross realized losses on sales of investment securities were $25 thousand.

 

Proceeds from sales and calls of investment securities for the three months ended March 31, 2019 were $22.8 million compared to $17.3 million for the same period in 2018.

 

The carrying value of securities pledged as collateral for certain government deposits, securities sold under agreements to repurchase, and certain lines of credit with correspondent banks at March 31, 2019 and December 31, 2018 was $522.0 million and $528.2 million, respectively, which is well in excess of required amounts in order to operationally provide significant reserve amounts for new business. As of March 31, 2019 and December 31, 2018, there were no holdings of securities of any one issuer, other than the U.S. Government and U.S. agency securities, which exceeded ten percent of shareholders’ equity.

 

Note 4. Mortgage Banking Derivative

 

As part of its mortgage banking activities, the Bank enters into interest rate lock commitments, which are commitments to originate loans where the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. The Bank then locks in the loan and interest rate with an investor and commits to deliver the loan if settlement occurs (“best efforts”) or commits to deliver the locked loan in a binding (“mandatory”) delivery program with an investor. Certain loans under interest rate lock commitments are covered under forward sales contracts of mortgage backed securities (“MBS”). Forward sales contracts of MBS are recorded at fair value with changes in fair value recorded in noninterest income. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Bank determines the fair value of interest rate lock commitments and delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates, taking into consideration the probability that the interest rate lock commitments will close or will be funded.

 

11  

 

Certain additional risks arise from these forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. The Bank does not expect any counterparty to any MBS to fail to meet its obligation. Additional risks inherent in mandatory delivery programs include the risk that, if the Bank does not close the loans subject to interest rate risk lock commitments, it will still be obligated to deliver MBS to the counterparty under the forward sales agreement. Should this be required, the Bank could incur significant costs in acquiring replacement loans or MBS and such costs could have an adverse effect on mortgage banking operations.

 

The fair value of the mortgage banking derivatives is recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change.

 

At March 31, 2019 the Bank had mortgage banking derivative financial instruments with a notional value of $82.8 million related to its forward contracts as compared to $49.6 million at December 31, 2018. The fair value of these mortgage banking derivative instruments at March 31, 2019 was $288 thousand included in other assets and $222 thousand included in other liabilities as compared to $229 thousand included in other assets and $269 thousand included in other liabilities at December 31, 2018.

 

Included in other noninterest income for the three months ended March 31, 2019 was a net gain of $134 thousand relating to mortgage banking derivative instruments as compared to a net loss of $87 thousand as of March 31, 2018. The amount included in other noninterest income for the three months ended March 31, 2019 pertaining to its mortgage banking hedging activities was a net realized gain of $45 thousand as compared to a net realized gain of $91 thousand as of March 31, 2018.

 

Note 5. Loans and Allowance for Credit Losses

 

The Bank makes loans to customers primarily in the Washington, D.C. metropolitan area and surrounding communities. A substantial portion of the Bank’s loan portfolio consists of loans to businesses secured by real estate and other business assets.

 

Loans, net of unamortized net deferred fees, at March 31, 2019 and December 31, 2018 are summarized by type as follows:

 

   March 31, 2019   December 31, 2018 
(dollars in thousands)  Amount   %   Amount   % 
Commercial  $1,510,835    21%  $1,553,112    22%
Income producing - commercial real estate   3,370,692    47%   3,256,900    46%
Owner occupied - commercial real estate   990,372    14%   887,814    13%
Real estate mortgage - residential   101,860    1%   106,418    2%
Construction - commercial and residential   1,044,305    15%   1,039,815    15%
Construction - C&I (owner occupied)   64,845    1%   57,797    1%
Home equity   87,009    1%   86,603    1%
Other consumer   3,140        2,988     
Total loans   7,173,058    100%   6,991,447    100%
Less: allowance for credit losses   (69,943)        (69,944)     
Net loans  $7,103,115        $6,921,503      

 

Unamortized net deferred fees amounted to $24.4 million and $25.6 million at March 31, 2019 and December 31, 2018, respectively.

 

As of March 31, 2019 and December 31, 2018, the Bank serviced $105.0 million and $111.1 million, respectively, of multifamily FHA loans, SBA loans and other loan participations which are not reflected as loan balances on the Consolidated Balance Sheets.

 

Loan Origination / Risk Management

 

The Company’s goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include: carefully enforcing loan policies and procedures, evaluating each borrower’s business plan during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and obtaining collateral to mitigate economic loss in the event of liquidation. Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations.

 

12  

 

The composition of the Company’s loan portfolio is heavily weighted toward commercial real estate, both owner occupied and income producing real estate. At March 31, 2019, owner occupied - commercial real estate and construction - C&I (owner occupied) represent approximately 15% of the loan portfolio. At March 31, 2019, non-owner occupied commercial real estate and real estate construction represented approximately 62% of the loan portfolio. The combined owner occupied and commercial real estate loans represent approximately 77% of the loan portfolio. Real estate also serves as collateral for loans made for other purposes, resulting in 84% of all loans being secured by real estate. These loans are underwritten to mitigate lending risks typical of this type of loan such as declines in real estate values, changes in borrower cash flow and general economic conditions. The Bank typically requires a maximum loan to value of 80% and minimum cash flow debt service coverage of 1.15 to 1.0. Personal guarantees may be required, but may be limited. In making real estate commercial mortgage loans, the Bank generally requires that interest rates adjust not less frequently than five years.

  

The Company is also an active traditional commercial lender providing loans for a variety of purposes, including working capital, equipment and account receivable financing. This loan category represents approximately 21% of the loan portfolio at March 31, 2019 and was generally variable or adjustable rate. Commercial loans meet reasonable underwriting standards, including appropriate collateral and cash flow necessary to support debt service. Personal guarantees are generally required, but may be limited. SBA loans represent approximately 2% of the commercial loan category. In originating SBA loans, the Company assumes the risk of non-payment on the unguaranteed portion of the credit as well as potential repairs to the SBA guarantees. The Company generally sells the guaranteed portion of the loan generating noninterest income from the gains on sale, as well as servicing income on the portion participated. SBA loans are subject to the same cash flow analyses as other commercial loans. SBA loans are subject to a maximum loan size established by the SBA as well as internal loan size guidelines.

 

Approximately 1% of the loan portfolio at March 31, 2019 consists of home equity loans and lines of credit and other consumer loans. These credits, while making up a small portion of the loan portfolio, demand the same emphasis on underwriting and credit evaluation as other types of loans advanced by the Bank.

 

Approximately 1% of the loan portfolio consists of residential mortgage loans. The repricing duration of these loans was 23 months. These credits represent first liens on residential property loans originated by the Bank. While the Bank’s general practice is to originate and sell (servicing released) loans made by its Residential Lending department, from time to time certain loan characteristics do not meet the requirements of third party investors and these loans are instead maintained in the Bank’s portfolio until they are resold to another investor at a later date or mature.

 

Loans are secured primarily by duly recorded first deeds of trust or mortgages. In some cases, the Bank may accept a recorded junior trust position. In general, borrowers will have a proven ability to build, lease, manage and/or sell a commercial or residential project and demonstrate satisfactory financial condition. Additionally, an equity contribution toward the project is customarily required.

 

Construction loans require that the financial condition and experience of the general contractor and major subcontractors be satisfactory to the Bank. Guaranteed, fixed price contracts are required whenever appropriate, along with payment and performance bonds or completion bonds for larger scale projects.

 

Loans intended for residential land acquisition, lot development and construction are made on the premise that the land: 1) is or will be developed for building sites for residential structures, and; 2) will ultimately be utilized for construction or improvement of residential zoned real properties, including the creation of housing. Residential development and construction loans will finance projects such as single family subdivisions, planned unit developments, townhouses, and condominiums. Residential land acquisition, development and construction loans generally are underwritten with a maximum term of 36 months, including extensions approved at origination.

 

Commercial land acquisition and construction loans are secured by real property where loan funds will be used to acquire land and to construct or improve appropriately zoned real property for the creation of income producing or owner user commercial properties. Borrowers are generally required to put equity into each project at levels determined by the appropriate Loan Committee. Commercial land acquisition and construction loans generally are underwritten with a maximum term of 24 months.

 

13  

 

Substantially all construction draw requests must be presented in writing on American Institute of Architects documents and certified either by the contractor, the borrower and/or the borrower’s architect. Each draw request shall also include the borrower’s soft cost breakdown certified by the borrower or their Chief Financial Officer. Prior to an advance, the Bank or its contractor inspects the project to determine that the work has been completed, to justify the draw requisition.

 

Commercial permanent loans are generally secured by improved real property which is generating income in the normal course of operation. Debt service coverage, assuming stabilized occupancy, must be satisfactory to support a permanent loan. The debt service coverage ratio is ordinarily at least 1.15 to 1.0. As part of the underwriting process, debt service coverage ratios are stress tested assuming a 200 basis point increase in interest rates from their current levels.

 

Commercial permanent loans generally are underwritten with a term not greater than 10 years or the remaining useful life of the property, whichever is lower. The preferred term is between 5 to 7 years, with amortization to a maximum of 25 years.

 

The Company’s loan portfolio includes ADC real estate loans including both investment and owner occupied projects. ADC loans amounted to $1.63 billion at March 31, 2019. A portion of the ADC portfolio, both speculative and non-speculative, includes loan funded interest reserves at origination. ADC loans that provide for the use of interest reserves represent approximately 71% of the outstanding ADC loan portfolio at March 31, 2019. The decision to establish a loan-funded interest reserve is made upon origination of the ADC loan and is based upon a number of factors considered during underwriting of the credit including: (1) the feasibility of the project; (2) the experience of the sponsor; (3) the creditworthiness of the borrower and guarantors; (4) borrower equity contribution; and (5) the level of collateral protection. When appropriate, an interest reserve provides an effective means of addressing the cash flow characteristics of a properly underwritten ADC loan. The Company recognizes that one of the risks inherent in the use of interest reserves is the potential masking of underlying problems with the project and/or the borrower’s ability to repay the loan. In order to mitigate this inherent risk, the Company employs a series of reporting and monitoring mechanisms on all ADC loans, whether or not an interest reserve is provided, including: (1) construction and development timelines which are monitored on an ongoing basis which track the progress of a given project to the timeline projected at origination; (2) a construction loan administration department independent of the lending function; (3) third party independent construction loan inspection reports; (4) monthly interest reserve monitoring reports detailing the balance of the interest reserves approved at origination and the days of interest carry represented by the reserve balances as compared to the then current anticipated time to completion and/or sale of speculative projects; and (5) quarterly commercial real estate construction meetings among senior Company management, which includes monitoring of current and projected real estate market conditions. If a project has not performed as expected, it is not the customary practice of the Company to increase loan funded interest reserves.

 

14  

 

The following tables detail activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2019 and 2018. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories. 

 

(dollars in thousands)  Commercial  

Income Producing - Commercial

Real Estate

  

Owner Occupied - Commercial

Real Estate

  

Real Estate

Mortgage -

Residential

   Construction - Commercial and Residential  

Home

Equity

  

Other

Consumer

   Total 
Three Months Ended
March 31, 2019
                       

 

 

 

                
Allowance for credit losses:                                        
Balance at beginning of period  $15,857   $28,034   $6,242   $965   $18,175   $599   $72   $69,944 
Loans charged-off   (4)   (3,496)                       (3,500)
Recoveries of loans previously charged-off   130            1            8    139 
Net loans charged-off   126    (3,496)       1            8    (3,361)
Provision for credit losses   1,212    2,227    (262)   (285)   294    6    168    3,360 
Ending balance  $17,195   $26,765   $5,980   $681   $18,469   $605   $248   $69,943 
                                         
As of March 31, 2019                                        
Allowance for credit losses:                                        
Individually evaluated for impairment  $5,892   $15   $600   $   $   $   $   $6,507 
Collectively evaluated for impairment   11,303    26,750    5,380    681    18,469    605    248    63,436 
Ending balance  $17,195   $26,765   $5,980   $681   $18,469   $605   $248   $69,943 
                                         
Three Months ended
March 31, 2018
                                        
Allowance for credit losses:                                        
Balance at beginning of period  $13,102   $25,376   $5,934   $944   $18,492   $770   $140   $64,758 
Loans charged-off   (853)   (121)   (132)                   (1,106)
Recoveries of loans previously charged-off   3        1    2    60    117    3    186 
Net loans (charged-off) recoveries   (850)   (121)   (131)   2    60    117    3    (920)
Provision for credit losses   1,106    1,213    (332)   (212)   190    (188)   192    1,969 
Ending balance  $13,358   $26,468   $5,471   $734   $18,742   $699   $335   $65,807 
As of March 31, 2018                                        
Allowance for credit losses:                                        
Individually evaluated for impairment  $3,014   $2,628   $500   $   $500   $   $80   $6,722 
Collectively evaluated for impairment   10,344    23,840    4,971    734    18,242    699    255    59,085 
Ending balance  $13,358   $26,468   $5,471   $734   $18,742   $699   $335   $65,807 

 

15  

 

The Company’s recorded investments in loans as of March 31, 2019 and December 31, 2018 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Company’s impairment methodology was as follows:

 

(dollars in thousands)  Commercial  

Income Producing - Commercial

Real Estate

  

Owner Occupied - Commercial

Real Estate

  

Real Estate

Mortgage -

Residential

   Construction - Commercial and Residential  

Home

Equity

  

Other

Consumer

   Total 
March 31, 2019                                        
Recorded investment in loans:                                        
Individually evaluated for impairment  $24,219   $58,208   $3,885   $5,367   $3,438   $487   $   $95,604 
Collectively evaluated for impairment   1,486,616    3,312,484    986,487    96,493    1,105,712    86,522    3,140    7,077,454 
Ending balance  $1,510,835   $3,370,692   $990,372   $101,860   $1,109,150   $87,009   $3,140   $7,173,058 
                                         
December 31, 2018                                        
Recorded investment in loans:                                        
Individually evaluated for impairment  $8,738   $61,747   $5,307   $1,228   $7,012   $487   $   $84,519 
Collectively evaluated for impairment   1,544,374    3,195,153    882,507    105,190    1,090,600    86,116    2,988    6,906,928 
Ending balance  $1,553,112   $3,256,900   $887,814   $106,418   $1,097,612   $86,603   $2,988   $6,991,447 

 

At March 31, 2019, nonperforming loans acquired from Fidelity & Trust Financial Corporation (“Fidelity”) and Virginia Heritage Bank (“Virginia Heritage”) have a carrying value of $277 thousand and $178 thousand, respectively, and an unpaid principal balance of $327 thousand and $982 thousand, respectively, and were evaluated separately in accordance with ASC Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality.” At December 31, 2018, nonperforming loans acquired from Fidelity and Virginia Heritage had a carrying value of $282 thousand and $202 thousand, respectively, and an unpaid principal balance of $332 thousand and $995 thousand, respectively, and were evaluated separately in accordance with ASC Topic 310-30. The various impaired loans were recorded at estimated fair value with any excess being charged-off or treated as a non-accretable discount. Subsequent downward adjustments to the valuation of impaired loans acquired will result in additional loan loss provisions and related allowance for credit losses.

 

16  

 

Credit Quality Indicators

 

The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company’s primary credit quality indicators are to use an internal credit risk rating system that categorizes loans into pass, watch, special mention, or classified categories. Credit risk ratings are applied individually to those classes of loans that have significant or unique credit characteristics that benefit from a case-by-case evaluation. These are typically loans to businesses or individuals in the classes which comprise the commercial portfolio segment. Groups of loans that are underwritten and structured using standardized criteria and characteristics, such as statistical models (e.g., credit scoring or payment performance), are typically risk rated and monitored collectively. These are typically loans to individuals in the classes which comprise the consumer portfolio segment.

 

The following are the definitions of the Company’s credit quality indicators:

 

Pass:Loans in all classes that comprise the commercial and consumer portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. Management believes that there is a low likelihood of loss related to those loans that are considered pass.

 

Watch:Loan paying as agreed with generally acceptable asset quality; however the obligor’s performance has not met expectations. Balance sheet and/or income statement has shown deterioration to the point that the obligor could not sustain any further setbacks. Credit is expected to be strengthened through improved obligor performance and/or additional collateral within a reasonable period of time.

 

Special Mention: Loans in the classes that comprise the commercial portfolio segment that have potential weaknesses that deserve management’s close attention. If not addressed, these potential weaknesses may result in deterioration of the repayment prospects for the loan. The special mention credit quality indicator is not used for classes of loans that comprise the consumer portfolio segment. Management believes that there is a moderate likelihood of some loss related to those loans that are considered special mention.

 

Classified:Classified (a) Substandard - Loans inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the company will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual loans classified substandard.
  
 Classified (b) Doubtful - Loans that have all the weaknesses inherent in a loan classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the assets, its classification as an estimated loss is deferred until its more exact status may be determined.

 

17  

 

The Company’s credit quality indicators are updated generally on a quarterly basis, but no less frequently than annually. The following table presents by class and by credit quality indicator, the recorded investment in the Company’s loans and leases as of March 31, 2019 and December 31, 2018.

 

       Watch and            
(dollars in thousands)  Pass  

Special

Mention

   Substandard   Doubtful  

Total

Loans

 
March 31, 2019                         
Commercial  $1,448,020   $38,596   $24,219   $   $1,510,835 
Income producing - commercial real estate   3,293,840    18,644    58,208        3,370,692 
Owner occupied - commercial real estate   946,074    40,413    3,885        990,372 
Real estate mortgage - residential   95,851    642    5,367        101,860 
Construction - commercial and residential   1,105,712        3,438        1,109,150 
Home equity   85,836    686    487        87,009 
Other consumer   3,140                3,140 
          Total  $6,978,473   $98,981   $95,604   $   $7,173,058 
                          
December 31, 2018                         
Commercial  $1,505,477   $25,584   $22,051   $   $1,553,112 
Income producing - commercial real estate   3,172,479    1,536    82,885        3,256,900 
Owner occupied - commercial real estate   844,286    38,221    5,307        887,814 
Real estate mortgage – residential   104,543    647    1,228        106,418 
Construction - commercial and residential   1,090,600        7,012        1,097,612 
Home equity   85,434    682    487        86,603 
Other consumer   2,988                2,988 
          Total  $6,805,807   $66,670   $118,970   $   $6,991,447 

 

Nonaccrual and Past Due Loans

 

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

During the first quarter of 2019, the Bank incurred an annualized net charge-off of 19 basis points of average loans substantially attributable to one residential condominium project sold at foreclosure to a third party during the first quarter of 2019. The foreclosure sale was ratified by the Court on April 8, 2019 and there is a 30 day closing requirement. Consistent with GAAP, the transaction remained in nonperforming loans as of March 31, 2019. The carrying value of the nonperforming loan at the end of the first quarter was $17.5 million, equal to the purchase price at foreclosure. No additional loss from this transaction is anticipated. Nonperforming loans increased significantly as a result of the residential condominium loan discussed above. Further increases included a $1.5 million loan characterized as nonperforming at March 31, 2019 which was paid in full shortly following the end of the first quarter. Excluding the $19.0 million of loan balances discussed above, nonperforming loans at March 31, 2019 would have been $21.3 million (0.30% of total loans).

 

18  

 

The following table presents, by class of loan, information related to nonaccrual loans as of March 31, 2019 and December 31, 2018.

 

(dollars in thousands)  March 31, 2019   December 31, 2018 
  Commercial  $9,763   $7,115 
  Income producing - commercial real estate   19,821    1,766 
  Owner occupied - commercial real estate   1,516    2,368 
  Real estate mortgage - residential   5,644    1,510 
  Construction - commercial and residential   3,030    3,031 
  Home equity   487    487 
  Total nonaccrual loans (1)(2)  $40,261   $16,277 

 

(1)Excludes troubled debt restructurings (“TDRs”) that were performing under their restructured terms totaling $26.2 million at March 31, 2019 and $24.0 million at December 31, 2018.

(2)Gross interest income of $701 thousand and $205 thousand would have been recorded for the three months ended March 31, 2019 and 2018, respectively, if nonaccrual loans shown above had been current and in accordance with their original terms, while there was no interest recorded on such loans for the three months ended March 31, 2019 and 2018, respectively. See Note 1 to the Consolidated Financial Statements for a description of the Company’s policy for placing loans on nonaccrual status.

 

The following table presents, by class of loan, an aging analysis and the recorded investments in loans past due as of March 31, 2019 and December 31, 2018.

 

   Loans   Loans   Loans           Total Recorded 
   30-59 Days   60-89 Days   90 Days or   Total Past   Current   Investment in 
(dollars in thousands)  Past Due   Past Due   More Past Due   Due Loans   Loans   Loans 
March 31, 2019                              
Commercial  $5,248   $2,102   $9,763   $17,113   $1,493,722   $1,510,835 
Income producing - commercial real estate   14,734    10,250    19,821    44,805    3,325,887    3,370,692 
Owner occupied - commercial real estate   21,670        1,516    23,186    967,186    990,372 
Real estate mortgage - residential   1,022        5,644    6,666    95,194    101,860 
Construction - commercial and residential   259    5,268    3,030    8,557    1,100,593    1,109,150 
Home equity   400    47    487    934    86,075    87,009 
Other consumer   13            13    3,127    3,140 
          Total  $43,346   $17,667   $40,261   $101,274   $7,071,784   $7,173,058 
                               
December 31, 2018                              
Commercial  $4,535   $2,870   $7,115   $14,520   $1,538,592   $1,553,112 
Income producing - commercial real estate   5,855    27,479    1,766    35,100    3,221,800    3,256,900 
Owner occupied - commercial real estate   5,051    2,370    2,368    9,789    878,025    887,814 
Real estate mortgage - residential   2,456    1,698    1,510    5,664    100,754    106,418 
Construction - commercial and residential   4,392        3,031    7,423    1,090,189    1,097,612 
Home equity   630    47    487    1,164    85,439    86,603 
Other consumer                   2,988    2,988 
          Total  $22,919   $34,464   $16,277   $73,660   $6,917,787   $6,991,447 

 

Impaired Loans

 

Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

 

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The following table presents, by class of loan, information related to impaired loans for the periods ended March 31, 2019 and December 31, 2018.

 

   Unpaid   Recorded   Recorded           Average Recorded   Interest Income 
   Contractual   Investment   Investment   Total       Investment   Recognized 
   Principal   With No   With   Recorded   Related   Quarter   Year   Quarter   Year 
(dollars in thousands)  Balance   Allowance   Allowance   Investment   Allowance   To Date   To Date   To Date   To Date 
March 31, 2019                                             
Commercial  $13,453   $4,124   $8,857   $12,981   $5,892   $10,561   $10,561   $19   $19 
Income producing - commercial real estate   42,939    39,397    46    39,443    15    30,423    30,423    263    263 
Owner occupied - commercial real estate   4,853    3,483    1,370    4,853    600    5,292    5,292    46    46 
Real estate mortgage – residential   5,644    5,644        5,644        3,577    3,577         
Construction - commercial and residential   4,190    3,030        3,030        3,031    3,031         
Home equity   487    487        487        487    487         
Other consumer                                    
   Total  $71,566   $56,165   $10,273   $66,438   $6,507   $53,371   $53,371   $328   $328 
                                              
December 31, 2018                                             
Commercial  $8,613   $2,057   $6,084   $8,141   $4,803   $10,306   $8,359   $(126)  $190 
Income producing - commercial real estate   21,402    1,720    19,682    21,402    2,465    15,331    12,309    189    550 
Owner occupied - commercial real estate   5,731    4,361    1,370    5,731    600    5,746    6,011    47    196 
Real estate mortgage – residential   1,510    1,510        1,510        1,516    1,688        2 
Construction - commercial and residential   3,031    3,031        3,031    1,050    3,031    2,028        68 
Home equity   487    487        487        487    491         
Other consumer                       46    69         
   Total  $40,774   $13,166   $27,136   $40,302   $8,918   $36,463   $30,955   $110   $1,006 

 

Modifications

 

A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company offers various types of concessions when modifying a loan. Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor is often requested. Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Construction loans modified in a TDR may also involve extending the interest-only payment period. As of March 31, 2019, all performing TDRs were categorized as interest-only modifications.

 

Loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan. An allowance for impaired consumer and commercial loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent. Management exercises significant judgment in developing these estimates.

 

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The following table presents by class, the recorded investment of loans modified in TDRs held by the Company for the periods ended March 31, 2019 and 2018.

 

   For the Three Months Ended March 31, 2019 
(dollars in thousands)  Number of Contracts   Commercial   Income Producing - Commercial Real Estate   Owner Occupied - Commercial Real Estate   Construction - Commercial Real Estate   Total 
Troubled debt restructurings                              
     Restructured accruing   10   $3,218   $19,622   $3,337   $   $26,177 
     Restructured nonaccruing   3    538                538 
Total   13   $3,756   $19,622   $3,337   $   $26,715 
                               
Specific allowance       $775   $3,000   $   $   $3,775 
                               
Restructured and subsequently defaulted       $   $   $   $   $ 

 

   For the Three Months Ended March 31, 2018 
(dollars in thousands)  Number of Contracts   Commercial   Income Producing - Commercial Real Estate   Owner Occupied - Commercial Real Estate   Construction - Commercial Real Estate   Total 
Troubled debt restructings                              
     Restructured accruing   8   $1,230   $9,198   $1,071   $   $11,499 
     Restructured nonaccruing   5    1,649                1,649 
Total   13   $2,879   $9,198   $1,071   $   $13,148 
                               
Specific allowance       $595   $2,350   $   $   $2,945 
                               
Restructured and subsequently defaulted       $   $121   $   $   $121 

 

The Company had thirteen TDR’s at March 31, 2019 totaling approximately $26.7 million. Ten of these loans totaling approximately $26.2 million are performing under their modified terms. For the first quarter of 2019, there were no performing TDR loans that defaulted on their modified terms, as compared to the three months ended March 31, 2018, when there was one default on a $121 thousand restructured loan which was charged off. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual. Commercial and consumer loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. The allowance may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan. For the three months ended March 31, 2019, there was one loan totaling $2.3 million modified in a TDR, as compared to the three months ended March 31, 2018 which had no loans modified in a TDR.

 

Note 6. Leases

 

A lease is defined as a contract that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. On January 1, 2019, the Company adopted ASU No. 2016-02 “Leases” (Topic 842) and all subsequent ASUs that modified Topic 842. For the Company, Topic 842 primarily affected the accounting treatment for operating lease agreements in which the Company is the lessee.

 

Substantially all of the leases in which the Company is the lessee are comprised of real estate property for branch offices, ATM locations, and corporate office space. Substantially all of our leases are classified as operating leases, and as such, were previously not recognized on the Company’s consolidated statements of condition. With the adoption of Topic 842, operating lease agreements are required to be recognized on the consolidated statements of condition as a right-of-use (“ROU”) asset and a corresponding lease liability.

 

On January 1, 2019, the Company recorded $29.6 million of right-of-use assets in the premises and equipment line item on the Company’s Consolidated Balance Sheets. On January 1, 2019, the Company recorded $33.5 million of lease liabilities in Other Liabilities on the Consolidated Balance Sheet. The Company elects not to recognize right of use assets and lease liabilities arising from short-term leases, leases with initial terms of twelve months or less, or equipment leases (deemed immaterial) on the Consolidated Statements of Condition.

 

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Our leases contain terms and conditions of options to extend or terminate the lease which are recognized as part of the right of use assets and lease liabilities when an economic benefit to exercise the option exists and there is a 90% probability that the Company will exercise the option. If these criteria are not met, the options are not included in our right of use assets and lease liabilities.

 

As of March 31, 2019, our leases do not contain material residual value guarantees or impose restrictions or covenants related to dividends or the Company’s ability to incur additional financial obligations. As of March 31, 2019, there were no leases that have been signed but did not yet commence as of the reporting date that create significant rights and obligations for the Company.

 

The following table presents lease costs and other lease information.

 

   Three Months Ended 
(dollars in thousands)  March 31, 2019 
Lease Cost     
Operating Lease Cost (Cost resulting from lease payments)   1,863 
Variable Lease Cost (Cost excluded from lease payments)   244 
Sublease Income   (94)
Net Lease Cost   2,013 
      
Operating Lease - Operating Cash Flows (Fixed Payments)   2,024 
Operating Lease - Operating Cash Flows (Liability Reduction)   1,715 
Right-of-Use Assets - Operating Leases   28,928 
Weighted Average Lease Term - Operating Leases   5.50 yrs 
Weighted Average Discount Rate - Operating Leases   4.00%

 

Future minimum payments for operating leases with initial or remaining terms of one year or more as of March 31, 2019 were as follows:

 

(dollars in thousands)    
Twelve Months Ended:    
March 31, 2020   8,045 
March 31, 2021   7,380 
March 31, 2022   6,619 
March 31, 2023   4,234 
March 30, 2024   3,500 
Thereafter   5,894 
Total Future Minimum Lease Payments   35,672 
Amounts Representing Interest   (2,920)
Present Value of Net Future Minimum Lease Payments   32,752 

 

Note 7 – Affordable Housing Projects Tax Credit Partnerships

 

Included in Other Assets, the Company makes equity investments in various limited partnerships that sponsor affordable housing projects utilizing the Low Income Housing Tax Credit (“LIHTC”) pursuant to Section 42 of the Internal Revenue Code. The purpose of these investments is to achieve a satisfactory return on capital, to facilitate the sale of affordable housing products offerings, and to assist in achieving goals associated with the Community Reinvestment Act. The primary activities of the limited partnerships include the identification, development, and operation of multi-family housing that is leased to qualifying residential tenants. Generally, these types of investments are funded through a combination of debt and equity.

 

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The Company is a limited partner in each LIHTC limited partnership. Each limited partnership is managed by an unrelated third party general partner who exercises significant control over the affairs of the limited partnership. The general partner has all the rights, powers and authority granted or permitted to be granted to a general partner of a limited partnership. Duties entrusted to the general partner of each limited partnership include, but are not limited to: investment in operating companies, company expenditures, investment of excess funds, borrowing funds, employment of agents, disposition of fund property, prepayment and refinancing of liabilities, votes and consents, contract authority, disbursement of funds, accounting methods, tax elections, bank accounts, insurance, litigation, cash reserve, and use of working capital reserve funds. Except for limited rights granted to the limited partner(s) relating to the approval of certain transactions, the limited partner(s) may not participate in the operation, management, or control of the limited partnership’s business, transact any business in the limited partnership’s name or have any power to sign documents for or otherwise bind the limited partnership. In addition, the general partner may only be removed by the limited partner(s) in the event the general partner fails to comply with the terms of the agreement or is negligent in performing its duties.

 

The general partner of each limited partnership has both the power to direct the activities which most significantly affect the performance of each partnership and the obligation to absorb losses or the right to receive benefits that could be significant to the entities. Therefore, the Company has determined that it is not the primary beneficiary of any LIHTC partnership. The Company accounts for its affordable housing tax credit investments using the proportional amortization method. The Company’s net affordable housing tax credit investments were $27.2 million and related unfunded commitments were $15.4 million as of March 31, 2019 and are included in Other Assets and Other Liabilities in the Consolidated Statements of Condition. The Company’s net affordable housing tax credit investments were $28.2 million and related unfunded commitments were $15.0 million as of December 31, 2018.

 

Note 8. Interest Rate Swap Derivatives

 

The Company uses interest rate swap agreements to assist in its interest rate risk management. The Company’s objective in using interest rate derivatives designated as cash flow hedges is to add stability to interest expense and to better manage its exposure to interest rate movements. To accomplish this objective, the Company utilizes interest rate swaps as part of its interest rate risk management strategy intended to mitigate the potential risk of rising interest rates on the Bank’s cost of funds. The notional amounts of the interest rate swaps designated as cash flow hedges do not represent amounts exchanged by the counterparties, but rather, the notional amount is used to determine, along with other terms of the derivative, the amounts to be exchanged between the counterparties. The interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from one counterparty in exchange for the Company making fixed payments. The Company’s intent is to hedge its exposure to the variability in potential future interest rate conditions on existing financial instruments.

 

As of March 31, 2019, the Company had one designated cash flow hedge notional interest rate swap transaction outstanding amounting to $100 million associated with the Company’s variable rate deposits, as compared to three designated cash flow hedge notional interest rate swap transactions outstanding as of December 31, 2018 amounting to $250 million associated with the Company’s variable rate deposits. The decline in the amount of hedged variable rate deposits was due to a reduction in such deposits. The net unrealized gain before income tax on the swaps was $908 thousand at March 31, 2019 compared to a net unrealized gain before income tax of $3.7 million at December 31, 2018. The unrealized loss in value since year end 2018 was due to the termination of two of the interest rate swap transactions as part of the Company’s asset liability strategy. As a result of the swap terminations, the Company recognized $829 thousand in noninterest income during March 2019. Additionally, the Company will amortize $495 thousand of realized gain as a reduction to interest expense through the swap’s original maturity date of March 31, 2020.

 

For derivatives designated as cash flow hedges, changes in the fair value of the derivative are initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions.

 

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Amounts reported in accumulated other comprehensive income related to designated cash flow hedge derivatives will be reclassified to interest income/expense as interest payments are made/received on the Company’s variable-rate assets/liabilities. During the quarter ended March 31, 2019, the Company reclassified $462 thousand related to designated cash flow hedge derivatives from accumulated other comprehensive income to decrease interest expense. During the next twelve months, the Company estimates (based on existing interest rates) that $615 thousand will be reclassified as a decrease in interest expense.

 

The Company is exposed to credit risk in the event of nonperformance by the interest rate swap counterparty. The Company minimizes this risk by entering into derivative contracts with only large, stable financial institutions, and the Company has not experienced, and does not expect, any losses from counterparty nonperformance on the interest rate swaps. The Company monitors counterparty risk in accordance with the provisions of ASC Topic 815, “Derivatives and Hedging.” In addition, the interest rate swap agreements contain language outlining collateral-pledging requirements for each counterparty. Collateral must be posted when the market value exceeds certain threshold limits.

 

The designated cash flow hedge interest rate swap agreements detail: 1) that collateral be posted when the market value exceeds certain threshold limits associated with the secured party’s exposure; 2) if the Company defaults on any of its indebtedness (including default where repayment of the indebtedness has not been accelerated by the lender), then the Company could also be declared in default on its derivative obligations; 3) if the Company fails to maintain its status as a well capitalized institution then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements.

 

As of March 31, 2019, the aggregate fair value of our designated cash flow hedge derivative contract with credit risk contingent features (i.e., containing collateral posting or termination provisions based on our capital status) that was in a net asset position totaled $908 thousand (this contract was not in a net liability position as of March 31, 2019). The Company has a minimum collateral posting threshold with its derivative counterparty. As of March 31, 2019, the Company was not required to post collateral with its derivative counterparty against its obligations under this agreement because the agreement was in a net asset position. If the Company had breached any provisions under the agreement at March 31, 2019, it could have been required to settle its obligations under the agreement at the termination value.

 

During the third quarter of 2018, the Company entered into credit risk participation agreements (“RPAs”) with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower’s performance related to interest rate derivative contracts. The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers’ credit spread to that exposure. Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities. These derivatives are not designated as hedges, are not speculative, and have a notional value of $27.5 million as of March 31, 2019. The changes in fair value for these contracts are recognized directly in earnings.

 

The table below identifies the balance sheet category and fair values of the Company’s designated cash flow hedge derivative instruments and non-designated hedges as of March 31, 2019 and December 31, 2018.

 

   March 31, 2019  December 31, 2018
   Notional   Fair   Balance Sheet  Notional   Fair   Balance Sheet
   Amount   Value   Category  Amount   Value   Category
Derivatives designated as hedging instruments                  
                       
(dollars in thousands)                          
Interest rate product  $100,000   $908   Other Assets  $250,000   $3,727   Other Assets
                           
Derivatives not designated as hedging instruments                      
                           
(dollars in thousands)                          
Other Contracts  $27,500   $71   Other Liabilities  $27,500   $59   Other Liabilities

 

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The table below presents the pre-tax net gains (losses) of the Company’s designated cash flow hedges for the three months ended March 31, 2019 and 2018.

 

Derivatives in Subtopic 815-20 Hedging  

Amount of Gain or (Loss) Recognized in OCI on Derivative

Three Months Ended March 31,

    Location of Gain or (Loss) Recognized from Accumulated Other     Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income Three Months Ended March 31,  

Relationships (dollars in thousands)

  2019     2018     Comprehensive Income into Income   2019     2018  
Derivatives in Cash Flow Hedging Relationships                                    
Interest Rate Products   $ (1,034 )   $ 2,443     Interest Expense   $ 462     $ (88 )
Interest Rate Products               Gain on sale of investment securities     (829 )      
Total   $ (1,034 )   $ 2,443         $ (366 )   $ (88 )

 

The table below presents the effect of the Company’s derivative financial instruments on the Consolidated Statements of Operations for the three months ended March 31, 2019 and 2018.

 

   Location and Amount of Gain or (Loss) Recognized  
   March 31, 2019   March 31, 2018 
(dollars in thousands)  Interest Expense   Interest Expense 
Total amounts of income and expense line items presented in the        
statement of financial performance in which the effects of fair value or        
cash flow hedges are recorded  $(366)  $(88)
           
Gain or (loss) on cash flow hedging relationships in Subtopic 815-20          
Interest contracts          
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income  $462   $(88)
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income as a result that a forecasted transaction is no longer probable of occurring  $(829)  $ 

 

Effect of Derivatives Not Designated as Hedging Instruments on the Statement of Financial Performance 
  

Location of Gain or  

  Amount of Gain or (Loss) Recognized in
Income on Derivative
 

Derivatives Not Designated as Hedging  

 

(Loss) Recognized in  

  Three Months Ended March 31, 
Instruments under Subtopic 815-20  Income on Derivative  2019   2018 
(dollars in thousands)             
Other Contracts  Other income / (expense)  $(13)  $ 
Total     $(13)  $ 

 

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Balance Sheet Offsetting: Our designated cash flow hedge interest rate swap derivatives are eligible for offset in the Consolidated Balance Sheets and are subject to master netting arrangements. Our derivative transactions with counterparties are generally executed under International Swaps and Derivative Association (“ISDA”) master agreements which include “right of set-off” provisions. In such cases there is generally a legally enforceable right to offset recognized amounts and there may be an intention to settle such amounts on a net basis. The Company generally offsets such financial instruments for financial reporting purposes. The table below presents a gross presentation, the effects of offsetting, and a net presentation of the Company’s cash flow hedge derivatives as of March 31, 2019 and December 31, 2018.

 

As of March 31, 2019  
Offsetting of Derivative Assets (dollars in thousands)      Gross Amounts Not Offset in the Balance Sheet 
   Gross Amounts of Recognized Assets   Gross Amounts Offset in the Balance Sheet   Net Amounts of Assets presented in the Balance Sheet   Financial Instruments   Cash Collateral
Posted
   Net Amount 
Counterparty 1  $944   $   $944   $   $   $944 
Counterparty 2                        
Counterparty 3   (71)       (71)           (71)
   $873   $   $873   $   $   $873 

 

 

As of December 31, 2018  
Offsetting of Derivative Assets (dollars in thousands)      Gross Amounts Not Offset in the Balance Sheet 
   Gross Amounts of Recognized Assets   Gross Amounts Offset in the Balance Sheet   Net Amounts of Assets presented in the Balance Sheet   Financial Instruments   Cash Collateral Posted   Net Amount 
Counterparty 1  $2,948   $   $2,948   $   $   $2,948 
Counterparty 2   892        892            892 
Counterparty 3   (59)       (59)           (59)
   $3,781   $   $3,781   $   $   $3,781 

 

Note 9. Other Real Estate Owned

 

The activity within Other Real Estate Owned (“OREO”) for the three months ended March 31, 2019 and 2018 is presented in the table below. There were no residential real estate loans in the process of foreclosure as of March 31, 2019. For the three months ended March 31, 2019 and 2018, there were no sales of OREO property.

 

   Three Months Ended March 31, 
(dollars in thousands)  2019   2018 
Balance at January 1,  $1,394   $1,394 
Real estate acquired from borrowers        
Properties sold        
Ending balance  $1,394   $1,394 

 

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Note 10. Long-Term Borrowings

 

The following table presents information related to the Company’s long-term borrowings as of March 31, 2019 and December 31, 2018.

 

(dollars in thousands)  March 31, 2019   December 31, 2018 
Subordinated Notes, 5.75%  $70,000   $70,000 
Subordinated Notes, 5.0%   150,000    150,000 
Less: unamortized debt issuance costs   (2,606)   (2,704)
Long-term borrowings  $217,394   $217,296 

 

On August 5, 2014, the Company completed the sale of $70.0 million of its 5.75% subordinated notes, due September 1, 2024 (the “2024 Notes”). The 2024 Notes were offered to the public at par and qualify as Tier 2 capital for regulatory purposes to the fullest extent permitted under the Basel III Rule capital requirements. The net proceeds were approximately $68.8 million, which includes $1.2 million in deferred financing costs which are being amortized over the life of the 2024 Notes.

 

On July 26, 2016, the Company completed the sale of $150.0 million of its 5.00% Fixed-to-Floating Rate Subordinated Notes, due August 1, 2026 (the “2026 Notes”). The 2026 Notes were offered to the public at par and qualify as Tier 2 capital for regulatory purposes to the fullest extent permitted under the Basel III Rule capital requirements. The net proceeds were approximately $147.35 million, which includes $2.6 million in deferred financing costs which are being amortized over the life of the 2026 Notes.

 

Note 11. Net Income per Common Share

 

The calculation of net income per common share for the three months ended March 31, 2019 and 2018 was as follows.

 

   Three Months Ended March 31, 
(dollars and shares in thousands, except per share data)  2019   2018 
Basic:        
Net income  $33,749   $35,715 
Average common shares outstanding   34,481    34,261 
Basic net income per common share  $0.98   $1.04 
           
Diluted:          
Net income  $33,749   $35,715 
Average common shares outstanding   34,481    34,261 
Adjustment for common share equivalents   55    145 
Average common shares outstanding-diluted   34,536    34,406 
Diluted net income per common share  $0.98   $1.04 
           
Anti-dilutive shares   3     

 

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Note 12. Other Comprehensive Income

 

The following table presents the components of other comprehensive income (loss) for the three months ended March 31, 2019 and 2018.

 

(dollars in thousands)  Before Tax   Tax Effect   Net of Tax 
Three Months Ended March 31, 2019               
Net unrealized gain on securities available-for-sale  $7,322   $1,882   $5,440 
Less: Reclassification adjustment for net gains included in net income   (83)   (22)   (61)
Total unrealized gain   7,239    1,860    5,379 
                
Net unrealized loss on derivatives   (1,545)   (391)   (1,154)
Less: Reclassification adjustment for gain included in net income   (1,275)   (333)   (942)
Total unrealized loss   (2,820)   (724)   (2,096)
                
Other Comprehensive Income  $4,419   $1,136   $3,283 

 

Three Months Ended March 31, 2018               
Net unrealized loss on securities available-for-sale  $(6,221)  $1,098   $(5,123)
Less: Reclassification adjustment for net gains included in net income   (42)   (11)   (31)
Total unrealized loss   (6,263)   1,087    (5,154)
                
Net unrealized gain on derivatives   2,607    374    2,233 
Less: Reclassification adjustment for losses included in net income   (88)   (23)   (65)
Total unrealized gain   2,519    351    2,168 
                
Other Comprehensive Loss  $(3,744)  $1,438   $(2,986)

 

The following table presents the changes in each component of accumulated other comprehensive loss, net of tax, for the three months ended March 31, 2019 and 2018.

 

(dollars in thousands)  Securities Available For Sale   Derivatives   Accumulated Other Comprehensive Income (Loss) 
Three Months Ended March 31, 2019               
Balance at Beginning of Period  $(7,044)  $2,769   $(4,275)
Other comprehensive income (loss) before reclassifications   5,440    (1,154)   4,286 
Amounts reclassified from accumulated other comprehensive income (loss)   (61)   (942)   (1,003)
Net other comprehensive income (loss) during period   5,379    (2,096)   3,283 
Balance at End of Period  $(1,665)  $673   $(992)
                
Three Months Ended March 31, 2018               
Balance at Beginning of Period  $(3,131)  $1,381   $(1,750)
Other comprehensive income (loss) before reclassifications   (5,123)   2,233    (2,890)
Amounts reclassified from accumulated other comprehensive income (loss)   (31)   (65)   (96)
Net other comprehensive income (loss) during period   (5,154)   2,168    (2,986)
Reclassification of the Income Tax Effects of the Tax Cuts and Jobs Act from AOCI   (674)       (674)
Balance at End of Period  $(8,959)  $3,549   $(5,410)

 

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The following table presents the amounts reclassified out of each component of accumulated other comprehensive (loss) income for the three months ended March 31, 2019 and 2018.

 

Details about Accumulated Other  Amount Reclassified from   Affected Line Item in
Comprehensive Income Components  Accumulated Other   the Statement Where
(dollars in thousands)  Comprehensive (Loss) Income   Net Income is Presented
   Three Months Ended March 31,    
   2019   2018    
Realized gain on sale of investment securities  $83   $42   Gain on sale of investment securities
Realized gain on swap termination   829       Gain on sale of investment securities
Interest income (expense) derivative deposits   446    (88)  Interest expense on deposits
Income tax (expense) benefit   (355)   12   Income Tax Expense
Total Reclassifications for the Period  $1,003   $(34)  Net Income

 

Note 13. Fair Value Measurements

 

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

Level 1Quoted prices in active exchange markets for identical assets or liabilities; also includes certain U.S. Treasury and other U.S. Government and agency securities actively traded in over-the-counter markets.

 

Level 2Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data; also includes derivative contracts whose value is determined using a pricing model with observable market inputs or can be derived principally from or corroborated by observable market data. This category generally includes certain U.S. Government and agency securities, corporate debt securities, derivative instruments, and residential mortgage loans held for sale.

 

Level 3Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs for single dealer nonbinding quotes not corroborated by observable market data. This category generally includes certain private equity investments, retained interests from securitizations, and certain collateralized debt obligations.

 

29 

 

 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

 

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis as of March 31, 2019 and December 31, 2018.

 

(dollars in thousands) 

Quoted Prices

(Level 1)

   Significant Other Observable Inputs (Level 2)  

Significant Other Unobservable Inputs
(Level 3)

   Total
(Fair Value)
 
March 31, 2019                    
Assets:                    
Investment securities available-for-sale:                    
U. S. agency securities  $   $239,019   $   $239,019 
Residential mortgage backed securities       477,903        477,903 
Municipal bonds       45,533        45,533 
Corporate bonds           9,556    9,556 
Other equity investments           218    218 
Loans held for sale       20,268        20,268 
Mortgage banking derivatives           288    288 
Interest rate swap derivatives       908        908 
Total assets measured at fair value on a recurring basis as of
March 31, 2019
  $   $783,631   $10,062   $793,693 
                     
Liabilities:                    
Mortgage banking derivatives  $   $   $222   $222 
Total liabilities measured at fair value on a recurring basis as of
March 31, 2019
  $   $   $222   $222 
                     
December 31, 2018                    
Assets:                    
Investment securities available-for-sale:                    
U. S. agency securities  $   $256,345   $   $256,345 
Residential mortgage backed securities       472,231        472,231 
Municipal bonds       45,769        45,769 
Corporate bonds           9,576    9,576 
Other equity investments           218    218 
Loans held for sale       19,254        19,254 
Mortgage banking derivatives           229    229 
Interest rate swap derivatives       3,727        3,727 
Total assets measured at fair value on a recurring basis as of
December 31, 2018
  $   $797,326   $10,023   $807,349 
                     
Liabilities:                    
Mortgage banking derivatives  $   $   $269   $269 
Total liabilities measured at fair value on a recurring basis as of December 31, 2018  $   $   $269   $269 

 

Investment Securities Available-for-Sale: Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include U.S. agency debt securities, mortgage backed securities issued by Government Sponsored Entities (“GSE’s”) and municipal bonds. Securities classified as Level 3 include securities in less liquid markets, the carrying amounts approximate the fair value. 

 

Loans held for sale: The Company has elected to carry loans held for sale at fair value. This election reduces certain timing differences in the Consolidated Statement of Operations and better aligns with the management of the portfolio from a business perspective. Fair value is derived from secondary market quotations for similar instruments. Gains and losses on sales of residential mortgage loans are recorded as a component of noninterest income in the Consolidated Statements of Operations. Gains and losses on sales of multifamily FHA securities are recorded as a component of noninterest income in the Consolidated Statements of Operations. As such, the Company classifies loans subjected to fair value adjustments as Level 2 valuation.

 

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The following table summarizes the difference between the aggregate fair value and the aggregate unpaid principal balance for loans held for sale measured at fair value as of March 31, 2019 and December 31, 2018.

 

   March 31, 2019 
         Aggregate Unpaid      
(dollars in thousands)   Fair Value    Principal Balance    Difference 
Residential mortgage loans held for sale  $20,268   $19,825   $443 
FHA mortgage loans held for sale  $   $   $ 

 

    December 31, 2018 
         Aggregate Unpaid      
(dollars in thousands)   Fair Value    Principal Balance    Difference 
Residential mortgage loans held for sale  $19,254   $18,797   $457 
FHA mortgage loans held for sale  $   $   $ 

 

No residential mortgage loans held for sale were 90 or more days past due or on nonaccrual status as of March 31, 2019 or December 31, 2018.

 

Interest rate swap derivatives: These derivative instruments consist of forward starting interest rate swap agreements, which are accounted for as cash flow hedges under ASC 815. The Company’s derivative position is classified within Level 2 of the fair value hierarchy and is valued using models generally accepted in the financial services industry and that use actively quoted or observable market input values from external market data providers and/or non-binding broker-dealer quotations. The fair value of the derivatives is determined using discounted cash flow models. These models’ key assumptions include the contractual terms of the respective contract along with significant observable inputs, including interest rates, yield curves, nonperformance risk and volatility. Derivative contracts are executed with a Credit Support Annex, which is a bilateral agreement that requires collateral postings when the market value exceeds certain threshold limits. These agreements protect the interests of the Company and its counterparties should either party suffer a credit rating deterioration.

 

Credit Risk Participation Agreements: The Company enters into credit risk participation agreements (“RPAs”) with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower’s performance related to interest rate derivative contracts. The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers’ credit spread to that exposure. Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities. Accordingly, RPAs fall within Level 2.

 

Mortgage banking derivatives: The Company relies on a third-party pricing service to value its mortgage banking derivative financial assets and liabilities, which the Company classifies as a Level 3 valuation. The external valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale includes grouping the interest rate lock commitments by interest rate and terms, applying an estimated pull-through rate based on historical experience, and then multiplying by quoted investor prices determined to be reasonably applicable to the loan commitment groups based on interest rate, terms, and rate lock expiration dates of the loan commitment groups. The Company also relies on an external valuation model to estimate the fair value of its forward commitments to sell residential mortgage loans (i.e., an estimate of what the Company would receive or pay to terminate the forward delivery contract based on market prices for similar financial instruments), which includes matching specific terms and maturities of the forward commitments against applicable investor pricing.

 

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The following is a reconciliation of activity for assets and liabilities measured at fair value based on Significant Other Unobservable Inputs (Level 3):

 

   Investment   Mortgage Banking     
(dollars in thousands)  Securities   Derivatives   Total 
Assets:               
Beginning balance at January 1, 2019  $9,794   $229   $10,023 
    Realized gain included in earnings       59    59 
    Unrealized loss included in other comprehensive income   (20)       (20)
    Principal redemption            
Ending balance at March 31, 2019  $9,774   $288   $10,062 
                
Liabilities:               
Beginning balance at January 1, 2019  $   $269   $269 
    Realized gain included in earnings       (47)   (47)
    Principal redemption            
Ending balance at March 31, 2019  $   $222   $222 

 

 

   Investment   Mortgage Banking     
(dollars in thousands)  Securities   Derivatives   Total 
Assets:               
Beginning balance at January 1, 2018  $1,718   $43   $1,761 
    Realized gain included in earnings       186    186 
    Purchases of available-for-sale securities   8,076        8,076 
    Principal redemption            
Ending balance at December 31, 2018  $9,794   $229   $10,023 
                
Liabilities:               
Beginning balance at January 1, 2018  $   $10   $10 
    Realized loss included in earnings       259    259 
    Principal redemption            
Ending balance at December 31, 2018  $   $269   $269 

 

The other equity securities classified as Level 3 consist of equity investments in the form of common stock of two local banking companies which are not publicly traded, and for which the carrying amount approximates fair value.

 

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

 

The Company measures certain assets at fair value on a nonrecurring basis and the following is a general description of the methods used to value such assets.

 

Impaired loans: The Company does not record loans at fair value on a recurring basis; however, from time to time, a loan is considered impaired and an allowance for loan loss is established. The Company considers a loan impaired when it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the note agreement, including both principal and interest. Management has determined that nonaccrual loans and loans that have had their terms restructured in a troubled debt restructuring meet this impaired loan definition. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC Topic 310, “Receivables.” The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At March 31, 2019, substantially all of the Company’s impaired loans were evaluated based upon the fair value of the collateral. In accordance with ASC Topic 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the estimated fair value of the underlying collateral for collateral-dependent loans, which the Company classifies as a Level 3 valuation.

 

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Other real estate owned: Other real estate owned is initially recorded at fair value less estimated selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral, which the Company classifies as a Level 3 valuation. Assets measured at fair value on a nonrecurring basis are included in the table below: 

 

(dollars in thousands) 

Quoted Prices

(Level 1)

  

Significant Other Observable Inputs

(Level 2)

   Significant Other Unobservable Inputs
(Level 3)
   Total
(Fair Value)
 
March 31, 2019                    
Impaired loans:                    
Commercial  $   $   $7,089   $7,089 
Income producing - commercial real estate           39,428    39,428 
Owner occupied - commercial real estate           4,253    4,253 
Real estate mortgage - residential           5,644    5,644 
Construction - commercial and residential           3,030    3,030 
Home equity           487    487 
Other real estate owned           1,394    1,394 
Total assets measured at fair value on a nonrecurring basis as of March 31, 2019  $   $   $61,325   $61,325 

 

(dollars in thousands)   

Quoted Prices

(Level 1)

    Significant Other Observable Inputs (Level 2)    Significant Other Unobservable Inputs
(Level 3)
    Total
(Fair Value)
 
December 31, 2018                    
Impaired loans:                    
Commercial  $   $   $3,338   $3,338 
Income producing - commercial real estate           18,937    18,937 
Owner occupied - commercial real estate           5,131    5,131 
Real estate mortgage - residential           1,510    1,510 
Construction - commercial and residential           1,981    1,981 
Home equity           487    487 
Other real estate owned           1,394    1,394 
Total assets measured at fair value on a nonrecurring basis as of December 31, 2018  $   $   $32,778   $32,778 

 

 

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The estimated fair values of the Company’s financial instruments at March 31, 2019 and December 31, 2018 are as follows:

 

           Fair Value Measurements 
              

Quoted

Prices

    

Significant

Other

Observable

Inputs

    

Significant

 Unobservable

Inputs

 
(dollars in thousands)   Carrying Value    Fair Value    (Level 1)    (Level 2)    (Level 3) 
March 31, 2019                         
Assets                         
Cash and due from banks  $6,817   $6,817   $   $6,817   $ 
Federal funds sold   15,403    15,403        15,403     
Interest bearing deposits with other banks   99,870    99,870        99,870     
Investment securities   772,229    772,229        762,455    9,774 
Federal Reserve and Federal Home Loan Bank stock   34,995    34,995        34,995     
Loans held for sale   20,268    20,268        20,268     
Loans   7,103,115    7,105,850            7,105,850 
Bank owned life insurance   73,865    73,865        73,865     
Annuity investment   12,290    12,290        12,290     
Mortgage banking derivatives   288    288            288 
Interest rate swap derivatives   908    908        908     
                          
Liabilities                         
Noninterest bearing deposits   2,216,270    2,216,270        2,216,270     
Interest bearing deposits   3,103,595    3,103,595        3,103,595     
Certificates of deposit   1,363,054    1,363,641        1,363,641     
Customer repurchase agreements   26,418    26,418        26,418     
Borrowings   467,394    460,272        460,272     
Mortgage banking derivatives   222    222            222 
                          
December 31, 2018                         
Assets                         
Cash and due from banks  $6,773   $6,773   $   $6,773   $ 
Federal funds sold   11,934    11,934        11,934     
Interest bearing deposits with other banks   303,157    303,157        303,157     
Investment securities   784,139    784,139        774,345    9,794 
Federal Reserve and Federal Home Loan Bank stock   23,506    23,506        23,506     
Loans held for sale   19,254    19,254        19,254     
Loans   6,921,503    6,921,048            6,921,048 
Bank owned life insurance   73,441    73,441        73,441     
Annuity investment   12,417    12,417        12,417     
Mortgage banking derivatives   229    229            229 
Interest rate swap derivatives   3,727    3,727        3,727     
                          
Liabilities                         
Noninterest bearing deposits   2,104,220    2,104,220        2,104,220     
Interest bearing deposits   3,542,666    3,542,666        3,542,666     
Certificates of deposit   1,327,400    1,325,209        1,325,209     
Customer repurchase agreements   30,413    30,413        30,413     
Borrowings   217,196    218,006        218,006     
Mortgage banking derivatives   269    269            269 

 

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Note 14. Supplemental Executive Retirement Plan

 

The Bank has entered into Supplemental Executive Retirement and Death Benefit Agreements (the “SERP Agreements”) with certain of the Bank’s executive officers other than Mr. Paul, which upon the executive’s retirement, will provide for a stated monthly payment for such executive’s lifetime subject to certain death benefits described below. The retirement benefit is computed as a percentage of each executive’s projected average base salary over the five years preceding retirement, assuming retirement at age 67. The SERP Agreements provide that (a) the benefits vest ratably over six years of service to the Bank, with the executive receiving credit for years of service prior to entering into the SERP Agreement, (b) death, disability and change-in-control shall result in immediate vesting, and (c) the monthly amount will be reduced if retirement occurs earlier than age 67 for any reason other than death, disability or change-in-control. The SERP Agreements further provide for a death benefit in the event the retired executive dies prior to receiving 180 monthly installments, paid either in a lump sum payment or continued monthly installment payments, such that the executive’s beneficiary has received payment(s) sufficient to equate to a cumulative 180 monthly installments.

 

The SERP Agreements are unfunded arrangements maintained primarily to provide supplemental retirement benefits and comply with Section 409A of the Internal Revenue Code. The Bank financed the retirement benefits by purchasing fixed annuity contracts with four insurance carriers in 2013 totaling $11.4 million that have been designed to provide a future source of funds for the lifetime retirement benefits of the SERP Agreements. The primary impetus for utilizing fixed annuities is a substantial savings in compensation expenses for the Bank as opposed to a traditional SERP Agreement. For the three months ended March 31, 2019 and 2018, the annuity contracts accrued $32 thousand and $27 thousand of income, respectively, which were included in other noninterest income on the Consolidated Statement of Operations. The cash surrender value of the annuity contracts was $12.3 million and $12.4 million at March 31, 2019 and December 31, 2018, respectively, and is included in other assets on the Consolidated Balance Sheet. For the three months ended March 31, 2019, the Company recorded benefit expense accruals of $101 thousand for this post retirement benefit. For the three months ended March 31, 2018, the Company recorded benefit expense accruals of $100 thousand for this post retirement benefit.

 

Upon death of a named executive, the annuity contract related to such executive terminates. The Bank has purchased additional bank owned life insurance contracts, which would effectively finance payments (up to a 15 year certain amount) to the executives’ named beneficiaries.

 

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion provides information about the results of operations, and financial condition, liquidity, and capital resources of the Company and its subsidiaries as of the dates and periods indicated. This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this report and the Management Discussion and Analysis in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

 

This report contains forward looking statements within the meaning of the Securities Exchange Act of 1934, as amended, including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies and regarding general economic conditions. In some cases, forward- looking statements can be identified by use of such words as “may,” “will,” “anticipate,” “believes,” “expects,” “plans,” “estimates,” “potential,” “continue,” “should,” and similar words or phrases. These statements are based upon current and anticipated economic conditions, nationally and in the Company’s market, interest rates and interest rate policy, competitive factors and other conditions, which by their nature are not susceptible to accurate forecast, and are subject to significant uncertainty. For details on factors that could affect these expectations, see the risk factors and other cautionary language included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 and in other periodic and current reports filed by the Company with the Securities and Exchange Commission. Because of these uncertainties and the assumptions on which this discussion and the forward-looking statements are based, actual future operations and results in the future may differ materially from those indicated herein. Readers are cautioned against placing undue reliance on any such forward looking statements.

 

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GENERAL
 

The Company is a growth-oriented, one-bank holding company headquartered in Bethesda, Maryland, which is currently celebrating twenty-one years of successful operations. The Company provides general commercial and consumer banking services through the Bank, its wholly owned banking subsidiary, a Maryland chartered bank which is a member of the Federal Reserve System. The Company was organized in October 1997, to be the holding company for the Bank. The Bank was organized in 1998 as an independent, community oriented, full service banking alternative to the super regional financial institutions, which dominate the Company’s primary market area. The Company’s philosophy is to provide superior, personalized service to its customers. The Company focuses on relationship banking, providing each customer with a number of services and becoming familiar with and addressing customer needs in a proactive, personalized fashion. The Bank currently has a total of twenty branch offices, including nine in Northern Virginia, six in Suburban Maryland, and five in Washington, D.C.

 

The Bank offers a broad range of commercial banking services to its business and professional clients as well as full service consumer banking services to individuals living and/or working primarily in the Bank’s market area. The Bank emphasizes providing commercial banking services to sole proprietors, small and medium-sized businesses, non-profit organizations and associations, and investors living and working in and near the primary service area. These services include the usual deposit functions of commercial banks, including business and personal checking accounts, “NOW” accounts and money market and savings accounts, business, construction, and commercial loans, residential mortgages and consumer loans, and cash management services. The Bank is also active in the origination and sale of residential mortgage loans and the origination of SBA loans. The residential mortgage loans are originated for sale to third-party investors, generally large mortgage and banking companies, under best efforts and mandatory delivery commitments with the investors to purchase the loans subject to compliance with pre-established criteria. The Bank generally sells the guaranteed portion of the SBA loans in a transaction apart from the loan origination generating noninterest income from the gains on sale, as well as servicing income on the portion participated. The Company originates multifamily FHA loans through the Department of Housing and Urban Development’s Multifamily Accelerated Program (“MAP”). The Company securitizes these loans through the Government National Mortgage Association (“Ginnie Mae”) MBS I program and sells the resulting securities in the open market to authorized dealers in the normal course of business and generally retains the servicing rights. Bethesda Leasing, LLC, a subsidiary of the Bank, holds title to and manages other real estate owned (“OREO”) assets. Eagle Insurance Services, LLC, a subsidiary of the Bank, offers access to insurance products and services through a referral program with a third party insurance broker. Additionally, the Bank offers investment advisory services through referral programs with third parties.

 

CRITICAL ACCOUNTING POLICIES

 

The Company’s Consolidated Financial Statements are prepared in accordance with GAAP and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the Consolidated Financial Statements; accordingly, as this information changes, the Consolidated Financial Statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or a valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The Company applies the accounting policies contained in Note 1 to Consolidated Financial Statements included in the Company’s Annual report on Form 10-K for the year ended December 31, 2018. There have been no significant changes to the Company’s Accounting Policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

 

36 

 

 

RESULTS OF OPERATIONS

 

Earnings Summary

 

Net income for the three months ended March 31, 2019 was $33.7 million, a 6% decrease over the $35.7 million net income for the three months ended March 31, 2018. Net income per both basic common and diluted shares for the three months ended March 31, 2019 was $0.98 compared to $1.04 for the same period in 2018, a 6% decrease.

 

First quarter 2019 earnings include nonrecurring charges related to share based compensation awards and the retirement of our former Chairman and Chief Executive Officer, Mr. Ronald D. Paul as announced in late March. For the first quarter of 2019, salaries and benefit expenses include $6.2 million ($0.13 per diluted share) of nonrecurring noninterest expenses.

 

Excluding nonrecurring costs, net earnings for the first quarter of 2019 were $38.5 million ($1.11 per diluted share) as compared to $35.7 million net income ($1.04 per diluted share) for the first quarter in 2018, an 8% increase.

 

Excluding nonrecurring costs, the increase in net income for the three months ended March 31, 2019 can be attributed primarily to an increase in total revenue (i.e. net interest income plus noninterest income) of 8% over the same period in 2018. The provision for income taxes was $11.9 million, a decrease of $384 thousand or 3% compared to the same period in 2018. The most significant portion of revenue is net interest income, which increased 7% for the three months ended March 31, 2019 over the same period in 2018 ($81.0 million versus $75.8 million), resulting from growth in average earning assets of 11%.

 

For the three months ended March 31, 2019, the Company reported an annualized return on average assets (“ROAA”) of 1.62% (1.85% excluding nonrecurring costs) as compared to 1.91% for the three months ended March 31, 2018. The annualized return on average common equity (“ROACE”) for the three months ended March 31, 2019 was 12.12% (13.84% excluding nonrecurring costs) as compared to 14.99% for the three months ended March 31, 2018. The annualized return on average tangible common equity (“ROATCE”) for the three months ended March 31, 2019 was 13.38% (15.26% excluding nonrecurring costs) as compared to 16.86% for the three months ended March 31, 2018.

 

The net interest margin, which measures the difference between interest income and interest expense (i.e. net interest income) as a percentage of earning assets, was 4.02% for the three months ended March 31, 2019 and 4.17% for the same period in 2018. Average earning asset yields increased 31 basis points to 5.21% for the three months ended March 31, 2019, as compared to 4.90% for the same period in 2018. The average cost of interest bearing liabilities increased by 78 basis points (to 1.96% from 1.18%) for the three months ended March 31, 2019 as compared to the same period in 2018. Combining the change in the yield on earning assets and the costs of interest bearing liabilities, the net interest spread decreased by 47 basis points for the three months ended March 31, 2019 as compared to 2018 (3.25% versus 3.72%).

 

The benefit of noninterest sources funding earning assets increased by 32 basis points to 77 basis points from 45 basis points for the three months ended March 31, 2019 versus the same period in 2018. The combination of a 47 basis point decrease in the net interest spread and a 32 basis point increase in the value of noninterest sources resulted in a 15 basis point decrease in the net interest margin for the three months ended March 31, 2019 as compared to the same period in 2018. The Company considers the value of its noninterest sources of funds as very significant to its business model and its overall profitability.

 

The Company believes it has effectively managed its net interest margin and net interest income over the past twelve months as market interest rates (on average) have trended higher. This factor has been significant to overall earnings performance over the past twelve months as net interest income represents 93% of the Company’s total revenue for the three months ended March 31, 2019.

 

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For the first three months of 2019, total loans grew 3% over December 31, 2018, and average loans were 9% higher in the first three months of 2019 as compared to the first three months of 2018. At March 31, 2019, total deposits were 4% lower than deposits at December 31, 2018, while average deposits were 15% higher for the first three months of 2019 compared with the first three months of 2018.

 

In order to fund growth in average loans of 9% over the three months ended March 31, 2019 as compared to the same period in 2018, as well as sustain significant liquidity, the Company has relied on both core deposit growth and brokered deposits. The major component of the growth in core deposits during the first quarter of 2019 has been growth in both noninterest bearing accounts primarily as a result of effectively building new and enhanced client relationships, and to a time deposit program to lock in more fixed rate deposits at terms approximating 10 months.

 

In terms of the average asset composition or mix, loans, which generally have higher yields than securities and other earning assets, represented 86% of average earning assets for the first three months of 2019 compared to 87% for the same period in 2018. For the first three months of 2019, as compared to the same period in 2018, average loans, excluding loans held for sale, increased $604.7 million, a 9% increase, due primarily to growth in owner occupied - commercial real estate, income producing - commercial real estate, and commercial loans. Average investment securities for the three months ended March 31, 2019 and 2018 amounted to 10% and 8% of average earning assets, respectively. The combination of federal funds sold, interest bearing deposits with other banks and loans held for sale represented 4% of average earning assets for both the first three months of 2019 and 2018. The average combination of federal funds sold, interest bearing deposits with other banks and loans held for sale increased $10.9 million for the three months ended March 31, 2019 as compared to the same period in 2018.

 

The provision for credit losses was $3.4 million for the three months ended March 31, 2019 as compared to $2.0 million for the three months ended March 31, 2018. Net charge-offs of $3.4 million in the first quarter of 2019 represented an annualized 0.19% of average loans, excluding loans held for sale, as compared to $920 thousand, or an annualized 0.06% of average loans, excluding loans held for sale, in the first quarter of 2018. Net charge-offs in the first quarter of 2019 were attributable primarily to commercial real estate loans ($3.5 million) offset by a net recovery in commercial loans ($126 thousand).

 

During the first quarter of 2019, the Bank incurred an annualized net charge-off of 19 basis points of average loans substantially attributable to one residential condominium project sold at foreclosure to a third party during the first quarter of 2019. The foreclosure sale was ratified by the Court on April 8, 2019 and there is a 30 day closing requirement. Consistent with GAAP, the transaction remained in nonperforming loans as of March 31, 2019. The carrying value of the nonperforming loan at the end of the first quarter was $17.5 million, equal to the purchase price at foreclosure. No additional loss from this transaction is anticipated. Nonperforming loans increased significantly as a result of the residential condominium loan discussed above. Further increases included a $1.5 million loan characterized as nonperforming at March 31, 2019 which was paid in full shortly following the end of the first quarter. Excluding the $19.0 million of loan balances discussed above, nonperforming loans at March 31, 2019 would have been $21.3 million (0.30% of total loans).

 

At March 31, 2019 the allowance for credit losses represented 0.98% of loans outstanding, as compared to 1.00% at December 31, 2018. The allowance for credit losses represented 174% of nonperforming loans at March 31, 2019, as compared to 492% at March 31, 2018 and 430% at December 31, 2018. Excluding the $19.0 million of nonperforming loans discussed above, the allowance for loan losses at March 31, 2019 would have been 329% of nonperforming loans, in line with prior quarters and well above peer banking companies.

 

Total noninterest income for the three months ended March 31, 2019 increased to $6.3 million from $5.3 million for the three months ended March 31, 2018, a 19% increase, due substantially to higher net investment gains in the first quarter of 2019 as compared to 2018. Net investment gains were $912 thousand for the three months ended March 31, 2019 compared to $42 thousand for the same period in 2018. Residential mortgage loans closed were $93 million for the first quarter of 2019 versus $100 million for the first quarter of 2018. As a result of lower volume, gains on the sale of residential mortgage loans were lower during the first quarter of 2019 compared to the same period in 2018 ($1.3 million versus $1.4 million). Gains on sales of FHA multifamily loans in the first quarter of 2019 were $55 thousand versus $48 thousand in the first quarter of 2018.

 

The efficiency ratio, which measures the ratio of noninterest expense to total revenue, was 43.87% for the first quarter of 2019, (36.82% excluding $6.2 million of nonrecurring costs defined above) as compared to 38.38% for the first quarter of 2018. Noninterest expenses totaled $38.3 million for the three months ended March 31, 2019, as compared to $31.1 million for the three months ended March 31, 2018, a 23% increase. Excluding $6.2 million nonrecurring salaries and benefit costs defined above, noninterest expenses were $32.2 million for the first quarter in 2019, a 3% increase over noninterest expenses in the first quarter of 2018.

 

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Cost increases for salaries and benefits were $6.8 million, $6.2 million of which were nonrecurring charges related to share based compensation awards and the retirement of Mr. Paul. The remaining increase was due primarily to increased staff and merit increases. Marketing and advertising costs increased $211 thousand due primarily to print and digital advertising and sponsorships. Legal, accounting and professional fees decreased $1.3 million, a significant portion of which was due to higher expenses during the first quarter of 2018 for independent consulting and professional services associated with the internet event late in 2017. FDIC expenses increased $441 thousand due substantially to a higher assessment base resulting from growth in total assets. Other expenses increased $1.0 million, due primarily to higher broker fees ($660 thousand).

 

 

The ratio of common equity to total assets increased to 13.69% at March 31, 2019 from 13.22% at December 31, 2018, due primarily to retained earnings. As discussed later in “Capital Resources and Adequacy,” the regulatory capital ratios of the Bank and Company remain above well capitalized levels.

 

Net Interest Income and Net Interest Margin

 

Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. Earning assets are composed primarily of loans and investment securities. The cost of funds represents interest expense on deposits, customer repurchase agreements and other borrowings. Noninterest bearing deposits and capital are other components representing funding sources (refer to discussion above under Results of Operations). Changes in the volume and mix of assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income.

 

For the three months ended March 31, 2019, net interest income increased 7% over the same period for 2018. Average loans increased by $604.7 million and average deposits increased by $924.5 million. The net interest margin was 4.02% for the three months ended March 31, 2019 and 4.17% for the same period in 2018.

 

The table below presents the average balances and rates of the major categories of the Company’s assets and liabilities for the three months ended March 31, 2019 and 2018. Included in the table is a measurement of interest rate spread and margin. Interest rate spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the interest rate paid on interest bearing liabilities. While the interest rate spread provides a quick comparison of earnings rates versus cost of funds, management believes that margin provides a better measurement of performance. The net interest margin (as compared to net interest spread) includes the effect of noninterest bearing sources in its calculation. Net interest margin is net interest income expressed as a percentage of average earning assets.

 

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Eagle Bancorp, Inc.

Consolidated Average Balances, Interest Yields And Rates (Unaudited)

(dollars in thousands)

 

   Three Months Ended March 31, 
   2019   2018 
  

Average

Balance

   Interest   Average Yield/Rate   Average Balance   Interest   Average Yield/Rate 
ASSETS                        
Interest earning assets:                              
Interest bearing deposits with other banks and other short-term investments  $301,020   $1,666    2.24%  $282,440   $981    1.41%
Loans held for sale (1)   17,919    200    4.46%   24,960    274    4.39%
Loans (1) (2)   7,038,472    97,621    5.62%   6,433,730    84,156    5.30%
Investment securities available for sale (2)   810,550    5,598    2.80%   614,064    3,592    2.37%
Federal funds sold   17,750    49    1.12%   18,341    46    1.02%
     Total interest earning assets   8,185,711    105,134    5.21%   7,373,535    89,049    4.90%
                               
Total noninterest earning assets   339,420              289,333           
Less: allowance for credit losses   69,451              65,383           
     Total noninterest earning assets   269,969              223,950           
     TOTAL ASSETS  $8,455,680             $7,597,485           
                               
LIABILITIES AND SHAREHOLDERS’ EQUITY                              
Interest bearing liabilities:                              
Interest bearing transaction  $590,853   $1,181    0.81%  $372,893   $464    0.50%
Savings and money market   2,792,552    11,963    1.74%   2,769,722    5,664    0.83%
Time deposits   1,330,939    7,756    2.36%   888,083    3,001    1.37%
     Total interest bearing deposits   4,714,344    20,900    1.80%   4,030,698    9,129    0.92%
Customer repurchase agreements   27,793    98    1.43%   68,043    50    0.30%
Other short-term borrowings   21,059    140    2.66%   238,356    1,111    1.86%
Long-term borrowings   217,357    2,979    5.48%   216,970    2,979    5.49%
     Total interest bearing liabilities   4,980,553    24,117    1.96%   4,554,067    13,269    1.18%