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452.9 No

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 September 30, 2020

or

☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to _____________

Commission file number: 001-38589

COASTAL FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Washington

56-2392007

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer Identification No.)

5415 Evergreen Way, Everett, Washington

98203

(Address of principal executive offices)

(Zip Code)

 

(425) 257-9000

(Registrant’s telephone number, including area code)

Not Applicable

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

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading symbol(s)

Name of each exchange on which registered

Common Stock, no par value per share

CCB

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 the 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 November 4, 2020 there were 11,950,908 shares of the issuer’s common stock outstanding.  

 

 

 

COASTAL FINANCIAL CORPORATION

 

Table of Contents

 

 

 

 

 

Page No.

Part I.   Financial Information

 

 

 

 

 

Item 1.

 

Condensed Consolidated Financial Statements (unaudited)

 

4

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019 (unaudited)

 

4

 

 

 

 

 

 

 

Condensed Consolidated Statements of Income for the Three and Nine months ended September 30, 2020 and 2019 (unaudited)

 

5

 

 

 

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the Three and Nine months ended September 30, 2020 and 2019 (unaudited)

 

6

 

 

 

 

 

 

 

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine months ended September 30, 2020 and 2019 (unaudited)

 

7

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine months ended September 30, 2020 and 2019 (unaudited)

 

8

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

 

9

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

28

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

66

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

67

 

 

 

 

 

Part II.   Other Information

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

69

 

 

 

 

 

Item 1A.

 

Risk Factors

 

69

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

70

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

70

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

70

 

 

 

 

 

Item 5.

 

Other Information

 

70

 

 

 

 

 

Item 6.

 

Exhibits

 

71

 

 

 

 

2

 

Forward-Looking Statements

This report may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. Any statements about our management’s expectations, beliefs, plans, predictions, forecasts, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “believes,” “can,” “could,” “may,” “predicts,” “potential,” “should,” “will,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “expects,” “intends” and similar words or phrases. All forward-looking statements, expressed or implied, included herewith are expressly qualified in their entirety by the cautionary statements contained or referred to herein. The inclusion of forward-looking information in this report should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs.

Factors that may affect our results are disclosed in “Item 1A. Risk Factors” in Part II of this report and in the section titled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019 (“Form 10-K”).  Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed include, but are not limited to, the following: the difficult market conditions and unfavorable economic conditions and uncertainties associated with the COVID-19 pandemic, particularly in the markets in which we operate and in which our loans are concentrated, including declines in housing markets, an increase in unemployment levels and slowdowns in economic growth; our expected future financial results; the overall health of the local and national real estate market; the credit risk associated with our loan portfolio, such as possible additional loan losses and impairment of collectability of loans as a result of the COVID-19 pandemic and policies and programs implemented by the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), including its automatic loan forbearance provisions and the effects on our loan portfolio from our Paycheck Protection Program (“PPP”) lending activities, specifically with our commercial real estate loans; our level of nonperforming assets and the costs associated with resolving problem loans; business and economic conditions generally and in the financial services industry, nationally and within our market area; our ability to maintain an adequate level of allowance for loan losses; our ability to successfully manage liquidity risk; our ability to implement our growth strategy and manage costs effectively; the composition of our senior leadership team and our ability to attract and retain key personnel; our ability to raise additional capital to implement our business plan; changes in market interest rates and impacts of such changes on our profits and business; the occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents; interruptions involving our information technology and telecommunications systems or third-party servicers; our ability to maintain our reputation; increased competition in the financial services industry; regulatory guidance on commercial lending concentrations; our relationship with broker-dealers and digital financial service providers; the effectiveness of our risk management framework; the costs and obligations associated with being a publicly traded company; the commencement and outcome of litigation and other legal proceedings and regulatory actions against us or to which we may become subject; the extensive regulatory framework that applies to us; the impact of recent and future legislative and regulatory changes and economic stimulus programs; and other changes in banking, securities and tax laws and regulations, and their application by our regulators; the impact on our operations due to epidemic illnesses, natural or man-made disasters, such as wildfires, the effects of regional or national civil unrest, and political developments that may disrupt or increase volatility in securities or otherwise affect economic conditions; the impact of benchmark interest rate reform in the U.S. and implementation of alternative reference rates, such as the Secured Overnight Funding Rate, to the London Interbank Offered Rate (“LIBOR”); fluctuations in the value of the securities held in our securities portfolio; governmental monetary and fiscal policies; material weaknesses in our internal control over financial reporting; and our success at managing the risks involved in the foregoing items.

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this report. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Furthermore, many of these risks and uncertainties are currently amplified by and may continue to be amplified by or may, in the future, be amplified by, the COVID-19 pandemic, including an anticipated second wave, the economic slowdown and the impact of varying governmental responses that affect our customers and the economies where they operate. You are cautioned not to place undue reliance on forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made and we undertake no obligation to update or revise any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events, except as required by law.

 

 

 

3

 

PART I.   FINANCIAL INFORMATION

Item 1. Financial Statements

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

(dollars in thousands)

 

ASSETS

 

 

 

September 30,

 

 

December 31,

 

 

 

2020

 

 

2019

 

Cash and due from banks

 

$

14,136

 

 

$

16,555

 

Interest earning deposits with other banks (restricted cash of $0 and $27,355

   at September 30, 2020 and December 31, 2019, respectively)

 

 

168,034

 

 

 

111,259

 

Investment securities, available for sale, at fair value

 

 

20,428

 

 

 

28,360

 

Investment securities, held to maturity, at amortized cost

 

 

3,354

 

 

 

4,350

 

Other investments

 

 

5,951

 

 

 

4,505

 

Loans receivable

 

 

1,509,389

 

 

 

939,103

 

Allowance for loan losses

 

 

(17,046

)

 

 

(11,470

)

Total loans receivable, net

 

 

1,492,343

 

 

 

927,633

 

Premises and equipment, net

 

 

16,881

 

 

 

13,108

 

Operating lease right-of-use assets

 

 

7,379

 

 

 

8,493

 

Accrued interest receivable

 

 

8,216

 

 

 

2,980

 

Bank-owned life insurance, net

 

 

7,031

 

 

 

6,882

 

Deferred tax asset, net

 

 

2,722

 

 

 

2,743

 

Other assets

 

 

3,144

 

 

 

1,658

 

Total assets

 

$

1,749,619

 

 

$

1,128,526

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

LIABILITIES

 

 

 

 

 

 

 

 

Deposits

 

$

1,360,011

 

 

$

967,959

 

Federal Home Loan Bank (“FHLB”) advances

 

 

24,999

 

 

 

10,000

 

Paycheck Protection Program Liquidity Facility

 

 

202,595

 

 

 

-

 

Subordinated debt

 

 

 

 

 

 

 

 

Principal amount $10,000 (less unamortized debt issuance costs of $11

   and $21 at September 30, 2020 and December 31, 2019, respectively)

 

 

9,989

 

 

 

9,979

 

Junior subordinated debentures

 

 

 

 

 

 

 

 

Principal amount $3,609 (less unamortized debt issuance costs of $25

   and $26 at September 30, 2020 and December 31, 2019, respectively)

 

 

3,584

 

 

 

3,583

 

Deferred compensation

 

 

891

 

 

 

974

 

Accrued interest payable

 

 

481

 

 

 

308

 

Operating lease liabilities

 

 

7,579

 

 

 

8,679

 

Other liabilities

 

 

4,258

 

 

 

2,871

 

Total liabilities

 

 

1,614,387

 

 

 

1,004,353

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Preferred stock, no par value:

 

 

 

 

 

 

 

 

Authorized: 25,000,000 shares at September 30, 2020 and December 31, 2019;

    issued and outstanding: zero shares at September 30, 2020 and December 31, 2019

 

 

-

 

 

 

-

 

Common stock, no par value:

 

 

 

 

 

 

 

 

Authorized: 300,000,000 shares at September 30, 2020 and December 31, 2019;

    11,930,243 voting shares at September 30, 2020 issued and outstanding

    and 11,913,885 voting shares at December 31, 2019 issued and outstanding

 

 

87,479

 

 

 

86,983

 

Retained earnings

 

 

47,707

 

 

 

37,222

 

Accumulated other comprehensive income (loss), net of tax

 

 

46

 

 

 

(32

)

Total shareholders’ equity

 

 

135,232

 

 

 

124,173

 

Total liabilities and shareholders’ equity

 

$

1,749,619

 

 

$

1,128,526

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

4

 

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

(dollars in thousands, except for per share data)

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2020

 

 

2019

 

2020

 

 

2019

 

INTEREST AND DIVIDEND INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

16,244

 

 

$

11,691

 

$

44,025

 

 

$

33,027

 

Interest on interest earning deposits with other banks

 

 

99

 

 

 

486

 

 

587

 

 

 

1,946

 

Interest on investment securities

 

 

27

 

 

 

168

 

 

199

 

 

 

481

 

Dividends on other investments

 

 

24

 

 

 

10

 

 

129

 

 

 

99

 

Total interest income

 

 

16,394

 

 

 

12,355

 

 

44,940

 

 

 

35,553

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest on deposits

 

 

880

 

 

 

1,435

 

 

3,530

 

 

 

4,291

 

Interest on borrowed funds

 

 

418

 

 

 

193

 

 

957

 

 

 

582

 

Total interest expense

 

 

1,298

 

 

 

1,628

 

 

4,487

 

 

 

4,873

 

Net interest income

 

 

15,096

 

 

 

10,727

 

 

40,453

 

 

 

30,680

 

PROVISION FOR LOAN LOSSES

 

 

2,200

 

 

 

637

 

 

5,708

 

 

 

1,724

 

Net interest income after provision for loan losses

 

 

12,896

 

 

 

10,090

 

 

34,745

 

 

 

28,956

 

NONINTEREST INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposit service charges and fees

 

 

824

 

 

 

795

 

 

2,224

 

 

 

2,302

 

BaaS fees

 

 

576

 

 

 

456

 

 

1,630

 

 

 

1,404

 

Loan referral fees

 

 

180

 

 

 

-

 

 

1,303

 

 

 

1,106

 

Mortgage broker fees

 

 

125

 

 

 

140

 

 

439

 

 

 

336

 

Sublease and lease income

 

 

30

 

 

 

16

 

 

91

 

 

 

36

 

Gain on sales of loans, net

 

 

47

 

 

 

369

 

 

47

 

 

 

490

 

Gain on sales of securities, net

 

 

-

 

 

 

171

 

 

-

 

 

 

171

 

Other income

 

 

160

 

 

 

141

 

 

399

 

 

 

359

 

Total noninterest income

 

 

1,942

 

 

 

2,088

 

 

6,133

 

 

 

6,204

 

NONINTEREST EXPENSE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

 

5,971

 

 

 

4,971

 

 

16,869

 

 

 

14,058

 

Occupancy

 

 

1,091

 

 

 

884

 

 

2,951

 

 

 

2,808

 

Data processing

 

 

577

 

 

 

509

 

 

1,749

 

 

 

1,537

 

Director and staff expenses

 

 

156

 

 

 

241

 

 

613

 

 

 

698

 

Excise taxes

 

 

291

 

 

 

184

 

 

756

 

 

 

529

 

Marketing

 

 

52

 

 

 

98

 

 

280

 

 

 

300

 

Legal and professional fees

 

 

381

 

 

 

170

 

 

1,178

 

 

 

872

 

Federal Deposit Insurance Corporation (“FDIC”) assessments

 

 

148

 

 

 

(4

)

 

292

 

 

 

205

 

Business development

 

 

72

 

 

 

122

 

 

245

 

 

 

320

 

Other expense

 

 

927

 

 

 

573

 

 

2,697

 

 

 

1,726

 

Total noninterest expense

 

 

9,666

 

 

 

7,748

 

 

27,630

 

 

 

23,053

 

Income before provision for income taxes

 

 

5,172

 

 

 

4,430

 

 

13,248

 

 

 

12,107

 

PROVISION FOR INCOME TAXES

 

 

1,082

 

 

 

919

 

 

2,763

 

 

 

2,514

 

NET INCOME

 

$

4,090

 

 

$

3,511

 

$

10,485

 

 

$

9,593

 

Basic earnings per common share

 

$

0.34

 

 

$

0.30

 

$

0.88

 

 

$

0.81

 

Diluted earnings per common share

 

$

0.34

 

 

$

0.29

 

$

0.86

 

 

$

0.79

 

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

11,919,850

 

 

 

11,901,873

 

 

11,915,513

 

 

 

11,893,734

 

Diluted

 

 

12,181,272

 

 

 

12,188,507

 

 

12,183,845

 

 

 

12,193,071

 

See accompanying Notes to Condensed Consolidated Financial Statements.

5

 

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 

(dollars in thousands)  

 

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

 

 

2020

 

 

2019

 

 

2020

 

 

2019

 

NET INCOME

 

$

4,090

 

 

$

3,511

 

 

$

10,485

 

 

$

9,593

 

OTHER COMPREHENSIVE INCOME, before tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding (loss) gain during the period

 

 

(6

)

 

 

61

 

 

 

99

 

 

 

1,396

 

Income tax benefit (expense) related to unrealized holding

   (loss) gain

 

 

1

 

 

 

(12

)

 

 

(21

)

 

 

(293

)

Reclassification adjustment for net gain from sale of

   investment securities available for sale included

   in income

 

 

-

 

 

 

171

 

 

 

-

 

 

 

171

 

Income tax provision related to net gain from sale of

   investment securities available for sale included in income

 

 

-

 

 

 

(36

)

 

 

-

 

 

 

(36

)

OTHER COMPREHENSIVE (LOSS) INCOME, net of tax

 

 

(5

)

 

 

184

 

 

 

78

 

 

 

1,238

 

COMPREHENSIVE INCOME

 

$

4,085

 

 

$

3,695

 

 

$

10,563

 

 

$

10,831

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

6

 

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

 

(dollars in thousands)

 

 

Shares of

Common

Stock

 

 

Amount of Common

Stock

 

 

Retained

Earnings

 

 

Accumulated

Other

Comprehensive

Income (Loss)

 

 

Total

 

BALANCE, June 30, 2019

 

 

11,908,185

 

 

$

86,730

 

 

$

30,103

 

 

$

(242

)

 

$

116,591

 

Net income

 

 

-

 

 

 

-

 

 

 

3,511

 

 

 

-

 

 

 

3,511

 

Exercise of stock options

 

 

3,930

 

 

 

25

 

 

 

-

 

 

 

-

 

 

 

25

 

Stock-based compensation

 

 

-

 

 

 

111

 

 

 

-

 

 

 

-

 

 

 

111

 

Other comprehensive income

 

 

-

 

 

 

-

 

 

 

-

 

 

 

184

 

 

 

184

 

BALANCE, September 30, 2019

 

 

11,912,115

 

 

$

86,866

 

 

$

33,614

 

 

$

(58

)

 

$

120,422

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, June 30, 2020

 

 

11,926,263

 

 

$

87,309

 

 

$

43,617

 

 

$

51

 

 

$

130,977

 

Net income

 

 

-

 

 

 

-

 

 

 

4,090

 

 

 

-

 

 

 

4,090

 

Exercise of stock options

 

 

3,980

 

 

 

26

 

 

 

-

 

 

 

-

 

 

 

26

 

Stock-based compensation

 

 

-

 

 

 

144

 

 

 

-

 

 

 

-

 

 

 

144

 

Other comprehensive loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(5

)

 

 

(5

)

BALANCE, September 30, 2020

 

 

11,930,243

 

 

$

87,479

 

 

$

47,707

 

 

$

46

 

 

$

135,232

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, December 31, 2018

 

 

11,893,203

 

 

$

86,431

 

 

$

24,021

 

 

$

(1,296

)

 

$

109,156

 

Net income

 

 

-

 

 

 

-

 

 

 

9,593

 

 

 

-

 

 

 

9,593

 

Issuance of restricted stock awards

 

 

2,352

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

Forfeiture of restricted stock awards

 

 

(1,200

)

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

Exercise of stock options

 

 

17,760

 

 

 

110

 

 

 

-

 

 

 

-

 

 

 

110

 

Stock-based compensation

 

 

-

 

 

 

325

 

 

 

-

 

 

 

-

 

 

 

325

 

Other comprehensive income

 

 

-

 

 

 

-

 

 

 

-

 

 

 

1,238

 

 

 

1,238

 

BALANCE, September 30, 2019

 

 

11,912,115

 

 

$

86,866

 

 

$

33,614

 

 

$

(58

)

 

$

120,422

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, December 31, 2019

 

 

11,913,885

 

 

$

86,983

 

 

$

37,222

 

 

$

(32

)

 

$

124,173

 

Net income

 

 

-

 

 

 

-

 

 

 

10,485

 

 

 

-

 

 

 

10,485

 

Issuance of restricted stock awards

 

 

6,248

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

Forfeiture of restricted stock awards

 

 

(3,500

)

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

Exercise of stock options

 

 

13,610

 

 

 

82

 

 

 

-

 

 

 

-

 

 

 

82

 

Stock-based compensation

 

 

-

 

 

 

414

 

 

 

-

 

 

 

-

 

 

 

414

 

Other comprehensive income

 

 

-

 

 

 

-

 

 

 

-

 

 

 

78

 

 

 

78

 

BALANCE, September 30, 2020

 

 

11,930,243

 

 

$

87,479

 

 

$

47,707

 

 

$

46

 

 

$

135,232

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

7

 

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

(dollars in thousands)

 

 

Nine Months Ended September 30,

 

 

 

2020

 

 

2019

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income

 

$

10,485

 

 

$

9,593

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Provision for loan losses

 

 

5,708

 

 

 

1,724

 

Depreciation and amortization

 

 

965

 

 

 

907

 

Loss on disposition of fixed assets

 

 

12

 

 

 

5

 

Decrease in operating lease right-of-use assets

 

 

1,129

 

 

 

756

 

Decrease in operating lease liabilities

 

 

(1,115

)

 

 

(702

)

Gain on sales of loans

 

 

(47

)

 

 

(490

)

Gain on sale of securities, net

 

 

-

 

 

 

(171

)

Net premium amortization (discount accretion) on investment securities

 

 

36

 

 

 

(36

)

Stock-based compensation

 

 

414

 

 

 

325

 

Increase in bank-owned life insurance value

 

 

(149

)

 

 

(144

)

Deferred tax benefit

 

 

-

 

 

 

(18

)

Net change in other assets and liabilities

 

 

(5,234

)

 

 

(2,413

)

Total adjustments

 

 

1,719

 

 

 

(257

)

Net cash provided by operating activities

 

 

12,204

 

 

 

9,336

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Net increase in interest earning deposits with other banks

 

 

(84,130

)

 

 

(21,007

)

Purchase of investment securities available for sale

 

 

(14,989

)

 

 

(19,948

)

Purchase of investment securities held-to-maturity

 

 

-

 

 

 

(3,182

)

Proceeds from sale of available for sale securities

 

 

-

 

 

 

30,026

 

Change in other investments, net

 

 

(1,446

)

 

 

(639

)

Principal paydowns of investment securities available-for-sale

 

 

35

 

 

 

41

 

Principal paydowns of investment securities held-to-maturity

 

 

945

 

 

 

64

 

Maturities and calls of investment securities available-for-sale

 

 

23,000

 

 

 

-

 

Purchase of participation loans

 

 

-

 

 

 

(7,238

)

Proceeds from sale of loans

 

 

694

 

 

 

1,581

 

Increase in loans receivable, net

 

 

(571,065

)

 

 

(100,309

)

Purchases of premises and equipment, net

 

 

(4,750

)

 

 

(912

)

Net cash used by investing activities

 

 

(651,706

)

 

 

(121,523

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Net increase in demand deposits, NOW and money market, and savings

 

 

409,017

 

 

 

124,363

 

Net decrease in time deposits

 

 

(16,965

)

 

 

(5,728

)

Net repayments from short term FHLB borrowing

 

 

(10,000

)

 

 

-

 

Net advances from long term FHLB borrowing

 

 

24,999

 

 

 

-

 

Net advances from Paycheck Protection Program Liquidity Facility

 

 

202,595

 

 

 

-

 

Proceeds from exercise of stock options

 

 

82

 

 

 

110

 

Net cash provided by financing activities

 

 

609,728

 

 

 

118,745

 

NET CHANGE IN CASH, DUE FROM BANKS AND RESTRICTED CASH

 

 

(29,774

)

 

 

6,558

 

CASH, DUE FROM BANKS AND RESTRICTED CASH, beginning of year

 

 

43,910

 

 

 

40,319

 

CASH, DUE FROM BANKS AND RESTRICTED CASH, end of quarter

 

$

14,136

 

 

$

46,877

 

SUPPLEMENTAL SCHEDULE OF OPERATING AND INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Interest paid

 

$

4,314

 

 

$

4,849

 

Income taxes paid

 

 

4,985

 

 

 

2,940

 

SUPPLEMENTAL SCHEDULE OF NONCASH TRANSACTIONS

 

 

 

 

 

 

 

 

Fair value adjustment of securities available-for-sale, gross

 

$

99

 

 

$

1,568

 

In conjunction with ASU 2016-02 as detailed in Note 6 to the Unaudited Consolidated

   Financial Statements, the following assets and liabilities were recognized:

 

 

 

 

 

 

 

 

Operating lease right-of-use assets

 

$

-

 

 

$

9,421

 

Operating lease liabilities

 

$

-

 

 

$

9,591

 

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements. 

8

 

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Note 1 - Description of Business and Summary of Significant Accounting Policies

Nature of operations - Coastal Financial Corporation (“Corporation” or “Company”) is a registered bank holding company whose wholly owned subsidiaries are Coastal Community Bank (“Bank”) and Arlington Olympic LLC (“LLC”). The Company is a Washington state corporation that was organized in 2003. The Bank was incorporated and commenced operations in 1997 and is a Washington state-chartered commercial bank and Federal Reserve System (“Federal Reserve”) state member bank. Arlington Olympic LLC was formed in 2019 and owns the Company’s Arlington branch, which the Bank leases from the LLC.

The Company provides a full range of banking services to small and medium-sized businesses, professionals, and individuals throughout the greater Puget Sound area through its 15 branches in Snohomish, Island, and King Counties, the Internet, and its mobile banking application. The Company opened its 15th branch in Arlington, Washington during the second quarter 2020.  The Bank’s main branch and the headquarters of the Bank and Company are located in Everett, Washington. The Bank’s deposits are insured in whole or in part by the FDIC. The Bank’s loans and deposits are primarily within the greater Puget Sound area, and the Bank’s primary funding source is deposits from customers. The Bank also provides banking as a service (“BaaS”) that allow the Company’s broker dealers and digital financial service providers to offer their customers banking services.  In 2021, the Bank expects to introduce a digital bank offering in collaboration with Google. The Bank is subject to regulation by the Federal Reserve and the Washington State Department of Financial Institutions Division of Banks. The Federal Reserve also has supervisory authority over the Company.

Financial statement presentation - The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim reporting requirements and with instructions to Form 10-Q and Article 10 of Regulation S-X, and therefore do not include all the information and notes included in the annual consolidated financial statements in conformity with GAAP. These interim condensed consolidated financial statements and accompanying notes should be read in conjunction with the Company’s audited consolidated financial statements and accompanying notes included in the Company’s Annual report on Form 10-K as filed with the U.S. Securities and Exchange Commission (“SEC”) on March 12, 2020. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for future periods.

Amounts presented in the consolidated financial statements and footnote tables are rounded and presented in thousands of dollars except per-share amounts, which are presented in dollars. In the narrative footnote discussion, amounts are rounded to thousands and presented in dollars.

In management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying consolidated financial statements have been made. These adjustments include normal and recurring accruals considered necessary for a fair and accurate presentation.

Principles of consolidation - The consolidated financial statements include the accounts of the Company and the Bank. All significant intercompany accounts have been eliminated in consolidation.

Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management believes that its critical accounting policies include determining the allowance for loan losses, the valuation of the Company’s deferred tax assets, and fair value of financial instruments. Actual results could differ significantly from those estimates.

Subsequent Events - The Company has evaluated events and transactions subsequent to September 30, 2020 for potential recognition or disclosure.  To the extent any events and conditions exist, disclosures are made regarding the nature of events and the estimated financial effects for those events and conditions. The Company is not aware of any subsequent events which would require recognition or disclosure in the consolidated financial statements.

9

 

Reclassifications - Certain amounts reported in prior quarters' consolidated financial statements have been reclassified to conform to the current presentation with no effect on stockholders’ equity or net income.

Note 2 - Recent accounting standards

Recent Accounting Guidance

In March 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, (the “agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by the COVID-19. The interagency statement was effective immediately and impacted accounting for loan modifications. Under Accounting Standards Codification 310-40, Receivables – Troubled Debt Restructurings by Creditors, a restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the Financial Accounting Standards Board (“FASB”) that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. To be eligible a loan modification must be (1) related to COVID-19; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the federal National Emergency or (B) December 31, 2020.  See Note 4 of the Condensed Consolidated Financial Statements of this Report for disclosure of the impact to date.

Recent Accounting Guidance Not Yet Effective

 

In September 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendment is effective for annual periods beginning after December 15, 2019 and interim period within those annual periods. As a smaller reporting company, the Company’s implementation will be effective January 1, 2023.  The Company is actively assessing the data and the model needs and are evaluating the impact of adopting the amendment. The Company expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period, January 2023, in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.

 

Note 3 - Investment Securities

The amortized cost and fair values of investment securities at the date indicated are as follows:

 

 

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Fair

Value

 

 

 

(dollars in thousands)

 

September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

19,996

 

 

$

45

 

 

$

-

 

 

$

20,041

 

U.S. Agency collateralized mortgage obligations

 

 

108

 

 

 

5

 

 

 

-

 

 

 

113

 

U.S. Agency residential mortgage-backed securities

 

 

11

 

 

 

-

 

 

 

-

 

 

 

11

 

Municipal bonds

 

 

255

 

 

 

8

 

 

 

-

 

 

 

263

 

Total available-for-sale securities

 

 

20,370

 

 

 

58

 

 

 

-

 

 

 

20,428

 

Held-to-maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Agency residential mortgage-backed securities

 

 

3,354

 

 

 

116

 

 

 

-

 

 

 

3,470

 

Total investment securities

 

$

23,724

 

 

$

174

 

 

$

-

 

 

$

23,898

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10

 

 

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Fair

Value

 

 

 

(dollars in thousands)

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

24,988

 

 

$

1

 

 

$

(44

)

 

$

24,945

 

U.S. Government agencies

 

 

3,000

 

 

 

-

 

 

 

(1

)

 

 

2,999

 

U.S. Agency collateralized mortgage obligations

 

 

129

 

 

 

-

 

 

 

-

 

 

 

129

 

U.S. Agency residential mortgage-backed securities

 

 

27

 

 

 

-

 

 

 

-

 

 

 

27

 

Municipal bonds

 

 

257

 

 

 

3

 

 

 

-

 

 

 

260

 

Total available-for-sale securities

 

 

28,401

 

 

 

4

 

 

 

(45

)

 

 

28,360

 

Held-to-maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Agency residential mortgage-backed securities

 

 

4,350

 

 

 

-

 

 

 

(21

)

 

 

4,329

 

Total investment securities

 

$

32,751

 

 

$

4

 

 

$

(66

)

 

$

32,689

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The amortized cost and fair value of debt securities at September 30, 2020, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers or the underlying borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities and collateralized mortgage obligations are shown separately, since they are not due at a single maturity date.

 

 

 

Available-for-Sale

 

 

Held-to-Maturity

 

 

 

Amortized

Cost

 

 

Fair

Value

 

 

Amortized

Cost

 

 

Fair

Value

 

 

 

(dollars in thousands)

 

September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts maturing in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One year or less

 

$

19,996

 

 

$

20,041

 

 

$

-

 

 

$

-

 

After one year through five years

 

 

255

 

 

 

263

 

 

 

-

 

 

 

-

 

 

 

 

20,251

 

 

 

20,304

 

 

 

-

 

 

 

-

 

U.S. Agency residential mortgage-backed securities and

   collateralized mortgage obligations

 

 

119

 

 

 

124

 

 

 

3,354

 

 

 

3,470

 

 

 

$

20,370

 

 

$

20,428

 

 

$

3,354

 

 

$

3,470

 

 

Investment securities with carrying values of $21,958,000 and $16,843,000 at September 30, 2020 and December 31, 2019, respectively, were pledged to secure public deposits and for other purposes as required or permitted by law.

11

 

There were no sales of available for sale securities during the three or nine months ended September 30, 2020.  There were five securities sold totaling $30.0 million during the three and nine months ended September 30, 2019, resulting in gross gains of $242,000 and gross losses of $71,000.

There were no gross unrealized losses as of September 30, 2020.  Information pertaining to securities with gross unrealized losses at the date indicated, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

 

 

 

Less Than 12 Months

 

 

12 Months or Greater

 

 

Total

 

 

 

Fair

Value

 

 

Gross

Unrealized

Losses

 

 

Fair

Value

 

 

Gross

Unrealized

Losses

 

 

Fair

Value

 

 

Gross

Unrealized

Losses

 

 

 

(dollars in thousands)

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

9,994

 

 

$

(3

)

 

$

4,956

 

 

$

(41

)

 

$

14,950

 

 

$

(44

)

U.S. Government agencies

 

 

-

 

 

 

-

 

 

 

2,999

 

 

 

(1

)

 

 

2,999

 

 

 

(1

)

Total available-for-sale securities

 

 

9,994

 

 

 

(3

)

 

 

7,955

 

 

 

(42

)

 

 

17,949

 

 

 

(45

)

Held-to-maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Agency residential mortgage-backed

   securities

 

 

3,140

 

 

 

(14

)

 

 

1,189

 

 

 

(7

)

 

 

4,329

 

 

 

(21

)

Total investment securities

 

$

13,134

 

 

$

(17

)

 

$

9,144

 

 

$

(49

)

 

$

22,278

 

 

$

(66

)

 

At September 30, 2020 and December 31, 2019, there were zero and six securities in an unrealized loss position, respectively. Unrealized losses have not been recognized into income because management does not intend to sell and does not expect that it will be required to sell the investments. The decline is largely due to changes in market conditions and interest rates, rather than credit quality. The fair value is expected to recover as the underlying securities in the portfolio approach maturity date and market conditions improve. The Company did not consider these securities to be other than temporarily impaired at December 31, 2019.

Note 4 - Loans and Allowance for Loan Losses

The composition of the loan portfolio is as follows as of the periods indicated:

 

 

 

September 30,

 

 

December 31,

 

 

 

2020

 

 

2019

 

 

 

 

 

 

 

 

 

 

Commercial and industrial loans

 

$

589,204

 

 

$

111,401

 

Real estate loans:

 

 

 

 

 

 

 

 

Construction, land, and land development

 

 

100,955

 

 

 

97,034

 

Residential real estate

 

 

121,147

 

 

 

115,011

 

Commercial real estate

 

 

705,186

 

 

 

613,398

 

Consumer and other loans

 

 

3,927

 

 

 

4,214

 

Gross loans receivable

 

 

1,520,419

 

 

 

941,058

 

Net deferred origination fees and premiums

 

 

(11,030

)

 

 

(1,955

)

Loans receivable

 

$

1,509,389

 

 

$

939,103

 

 

Included in consumer and other loans are overdrafts of $11,000 and $26,000 at September 30, 2020 and December 31, 2019, respectively. The Company has pledged loans totaling $378,645,000 and $163,522,000 at September 30, 2020 and December 31, 2019, respectively, for borrowing lines at the FHLB and Federal Reserve Bank (“FRB”).

The balance of Small Business Administration (“SBA”) and United States Department of Agriculture (“USDA”) loans was $487,536,000 and $36,592,000 at September 30, 2020 and December 31, 2019, respectively.  Paycheck Protection Plan (“PPP”) loans totaling $452,846,000 at September 30, 2020 are included in the commercial and industrial loans balance.  Net deferred origination fees and premiums include $8,586,000 of net fees from PPP loans as of September 30, 2020.  Included in these totals are SBA and USDA loans serviced for others amounting to $20,700,000 and $21,498,000 at September 30, 2020 and December 31, 2019, respectively .

12

 

The Company, at times, purchases individual loans at fair value as of the acquisition date. Purchased loans with remaining balances totaled $20,920,000 and $32,937,000 as of September 30, 2020 and December 31, 2019, respectively. Unamortized premiums totaled $324,000 and $527,000 as of September 30, 2020 and December 31, 2019, respectively, and are amortized into interest income over the life of the loans.

The Company has purchased participation loans with remaining balances totaling $41,465,000 and $31,352,000 as of September 30, 2020 and December 31, 2019, respectively.

The following is a summary of the Company’s loan portfolio segments:

Commercial and industrial loans - Commercial and industrial loans are secured by business assets including inventory, receivables and machinery and equipment of businesses located generally in the Company’s primary market area. Loan types include revolving lines of credit, term loans, and loans secured by liquid collateral such as cash deposits or marketable securities. The Company also issues letters of credit on behalf of its customers. Risk arises primarily due to the difference between expected and actual cash flows of the borrowers. In addition, the recoverability of the Company’s investment in these loans is also dependent on other factors primarily dictated by the type of collateral securing these loans. The fair value of the collateral securing these loans may fluctuate as market conditions change. In the case of loans secured by accounts receivable, the recovery of the Company’s investment is dependent upon the borrower’s ability to collect amounts due from its customers.   Also included in this category are SBA 7(a) loans, which allow small business owners to apply for financial assistance via the PPP as prescribed in the CARES Act.  These loans have a contractual rate of 1.0%, with maturity terms of two to five years, are unsecured, 100% guaranteed and loan proceeds may be forgiven by the U.S. Government / SBA if used for certain purposes.  To bolster the effectiveness of the SBA’s PPP loan program, the Federal Reserve is supplying liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. The Paycheck Protection Program Liquidity Facility extends credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. The interest rate is 0.35% and as PPP loans are paid down, the borrowing line must also be paid down.  

Construction, land and land development loans – The Company originates loans for the construction of 1-4 family, multifamily, and Commercial Real Estate (“CRE”) properties in the Company’s market area. Construction loans are considered to have higher risks due to construction completion and timing risk, the ultimate repayment being sensitive to interest rate changes, government regulation of real property and the availability of long-term financing. Additionally, economic conditions may impact the Company’s ability to recover its investment in construction loans, as adverse economic conditions may negatively impact the real estate market, which could affect the borrower’s ability to complete and sell the project. Additionally, the fair value of the underlying collateral may fluctuate as market conditions change. The Company occasionally originates land loans for the purpose of facilitating the ultimate construction of a home or commercial building. The primary risks include the borrower’s ability to pay and the inability of the Company to recover its investment due to a material decline in the fair value of the underlying collateral.

Residential real estate loans - Residential real estate loans include various types of loans for which the Company holds real property as collateral. Included in this segment are first lien single family loans, which are occasionally purchased to diversify the Company’s loan portfolio, and rental portfolios secured by one-to-four family homes. The primary risks of residential real estate loans include the borrower’s inability to pay, material decreases in the value of the collateral, and significant increases in interest rates which may make the loan unprofitable.

Commercial real estate (includes owner occupied and nonowner occupied) loans - Commercial real estate loans include various types of loans for which the Company holds real property as collateral. The primary risks of commercial real estate loans include the borrower’s inability to pay, material decreases in the value of the collateralized real estate and significant increases in interest rates, which may make the real estate loan unprofitable. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy.

Consumer and other loans – The Company originates a limited number of consumer loans, generally for banking customers only, which consist primarily of home equity lines of credit, saving account secured loans, and auto loans. This loan category also includes overdrafts. Repayment of these loans is dependent on the borrower’s ability to pay and the fair value of the underlying collateral.

13

 

The following table illustrates an age analysis of past due loans as of the dates indicated:

 

 

 

30-89

Days Past

Due

 

 

90 Days

or More

Past Due

 

 

Total

Past Due

 

 

Current

 

 

Total

Loans

 

 

Recorded

Investment

90 Days or

More Past

Due and

Still

Accruing

 

 

 

(dollars in thousands)

 

September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial loans

 

$

-

 

 

$

625

 

 

$

625

 

 

$

588,579

 

 

$

589,204

 

 

$

-

 

Real estate loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction, land and land development

 

 

-

 

 

 

3,269

 

 

 

3,269

 

 

 

97,686

 

 

 

100,955

 

 

 

-

 

Residential real estate

 

 

-

 

 

 

61

 

 

 

61

 

 

 

121,086

 

 

 

121,147

 

 

 

-

 

Commercial real estate

 

 

-

 

 

 

405

 

 

 

405

 

 

 

704,781

 

 

 

705,186

 

 

 

-

 

Consumer and other loans

 

 

-

 

 

 

-

 

 

 

-

 

 

 

3,927

 

 

 

3,927

 

 

 

-

 

 

 

$

-

 

 

$

4,360

 

 

$

4,360

 

 

$

1,516,059

 

 

$

1,520,419

 

 

$

-

 

Less net deferred origination fees and premiums

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(11,030

)

 

 

 

 

Loans receivable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

1,509,389

 

 

 

 

 

 

 

 

30-89

Days Past

Due

 

 

90 Days

or More

Past Due

 

 

Total

Past Due

 

 

Current

 

 

Total

Loans

 

 

Recorded

Investment

90 Days or

More Past

Due and

Still

Accruing

 

 

 

(dollars in thousands)

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial loans

 

$

143

 

 

$

965

 

 

$

1,108

 

 

$

110,293

 

 

$

111,401

 

 

$

-

 

Real estate loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction, land and land development

 

 

-

 

 

 

-

 

 

 

-

 

 

 

97,034

 

 

 

97,034

 

 

 

-

 

Residential real estate

 

 

-

 

 

 

65

 

 

 

65

 

 

 

114,946

 

 

 

115,011

 

 

 

-

 

Commercial real estate

 

 

417

 

 

 

-

 

 

 

417

 

 

 

612,981

 

 

 

613,398

 

 

 

-

 

Consumer and other loans

 

 

4

 

 

 

-

 

 

 

4

 

 

 

4,210

 

 

 

4,214

 

 

 

-

 

 

 

$

564

 

 

$

1,030

 

 

$

1,594

 

 

$

939,464

 

 

 

941,058

 

 

$

-

 

Less net deferred origination fees and premiums

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,955

)

 

 

 

 

Loans receivable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

939,103

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

14

 

A summary of information pertaining to impaired loans as of the period indicated:

 

 

 

Unpaid

Contractual

Principal

Balance

 

 

Recorded

Investment

With No

Allowance

 

 

Recorded

Investment

With

Allowance

 

 

Total

Recorded

Investment

 

 

Related

Allowance

 

 

 

(dollars in thousands)

 

September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial loans

 

$

922

 

 

$

625

 

 

$

-

 

 

$

625

 

 

$

-

 

Real estate loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction, land and land development

 

 

3,269

 

 

 

3,269

 

 

 

-

 

 

 

3,269

 

 

 

-

 

Residential real estate

 

 

190

 

 

 

178

 

 

 

-

 

 

 

178

 

 

 

-

 

Commercial real estate

 

 

413

 

 

 

405

 

 

 

-

 

 

 

405

 

 

 

-

 

Total

 

$

4,794

 

 

$

4,477

 

 

$

-

 

 

$

4,477

 

 

$

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial loans

 

$

1,431

 

 

$

965

 

 

$

-

 

 

$

965

 

 

$

-

 

Real estate loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

 

73

 

 

 

65

 

 

 

-

 

 

 

65

 

 

 

-

 

Consumer

 

 

2

 

 

 

-

 

 

 

2

 

 

 

2

 

 

 

2

 

Total

 

$

1,506

 

 

$

1,030

 

 

$

2

 

 

$

1,032

 

 

$

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The following tables summarize the Company’s average recorded investment and interest income recognized on impaired loans by loan class for the three and nine months ended September 30, 2020 and 2019:

 

 

 

Three Months Ended

 

 

 

September 30, 2020

 

 

September 30, 2019

 

 

 

Average

Recorded

Investment

 

 

Interest Income

Recognized

 

 

Average

Recorded

Investment

 

 

Interest Income

Recognized

 

 

 

(dollars in thousands)

 

Commercial and industrial loans

 

$

657

 

 

$

-

 

 

$

1,406

 

 

$

-

 

Real estate loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction, land and land development

 

 

3,270

 

 

 

-

 

 

 

-

 

 

 

-

 

Residential real estate

 

 

151

 

 

 

-

 

 

 

68

 

 

 

-

 

Commercial real estate

 

 

409

 

 

 

-

 

 

 

-

 

 

 

-

 

Total

 

$

4,487

 

 

$

-

 

 

$

1,474

 

 

$

-

 

 

 

Nine Months Ended

 

 

 

September 30, 2020

 

 

September 30, 2019

 

 

 

Average

Recorded

Investment

 

 

Interest Income

Recognized

 

 

Average

Recorded

Investment

 

 

Interest Income

Recognized

 

 

 

(dollars in thousands)

 

Commercial and industrial loans

 

$

748

 

 

$

-

 

 

$

933

 

 

$

-

 

Real estate loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction, land and land development

 

 

1,666

 

 

 

-

 

 

 

-

 

 

 

-

 

Residential real estate

 

 

153

 

 

 

-

 

 

 

71

 

 

 

-

 

Commercial real estate

 

 

204

 

 

 

-

 

 

 

315

 

 

 

-

 

Total

 

$

2,771

 

 

$

-

 

 

$

1,319

 

 

$

-

 

 

The Company grants restructurings in response to borrower financial difficulty, and generally provides for a temporary modification of loan repayment terms. The restructured loans on accrual status represent the only impaired loans accruing interest. In order for a restructured loan to be considered for accrual status, the loan’s collateral coverage generally will be greater than or equal to 100% of the loan balance, the loan is current on payments, and the borrower must either prefund an interest reserve or demonstrate the ability to make payments from a verified source of cash flow for an extended period of time, usually at least six months in duration.

 

15

 

No loans were restructured in the three or nine months ended September 30, 2020 and September 30, 2019 that qualified as troubled debt restructurings (“TDRs”). The Company has no commitments to loan additional funds to borrowers whose loans were classified as TDRs at September 30, 2020, as there were no outstanding TDRs at September 30, 2020.

The Company is in contact with borrowers with existing loans that have been impacted by COVID-19.  The Company has modified payments for loan customers during this uncertain time to help alleviate financial hardships.  There are 44 loans, representing $52.5 million in outstanding loans, and $1.4 million in unused commitments, that remain on deferred or modified payment status as of September 30, 2020.  In accordance with GAAP and interagency guidance issued on March 22, 2020, these short-term modifications, six months or less, made on a good faith basis in response to COVID-19 to borrowers that were current prior to any relief, are not considered troubled debt restructurings.  

When loans are placed on nonaccrual status, all accrued interest is reversed from current period earnings. Payments received on nonaccrual loans are generally applied as a reduction to the loan principal balance. If the likelihood of further loss is removed, the Company will recognize interest on a cash basis only. Loans may be returned to accruing status if the Company believes that all remaining principal and interest is fully collectible and there has been at least six months of sustained repayment performance since the loan was placed on nonaccrual.

An analysis of nonaccrual loans by category consisted of the following at the periods indicated:

 

 

 

September 30,

 

 

December 31,

 

 

 

2020

 

 

2019

 

 

 

 

 

 

 

(dollars in thousands)

 

Commercial and industrial loans

 

$

625

 

 

$

965

 

Real estate loans:

 

 

 

 

 

 

 

 

Construction, land and land development

 

 

3,269

 

 

 

-

 

Residential real estate

 

 

178

 

 

 

65

 

Commercial real estate

 

 

405

 

 

 

-

 

Total nonaccrual loans

 

$

4,477

 

 

$

1,030

 

 

Credit Quality and Credit Risk

Federal regulations require that the Company periodically evaluate the risks inherent in its loan portfolio. In addition, the Company’s regulatory agencies have authority to identify problem loans and, if appropriate, require them to be reclassified. There are three classifications for problem loans: Substandard, Doubtful, and Loss. Substandard loans have one or more defined weaknesses and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Doubtful loans have the weaknesses of loans classified as Substandard, with additional characteristics that suggest the weaknesses make collection or recovery in full after liquidation of collateral questionable on the basis of currently existing facts, conditions, and values. There is a high possibility of loss in loans classified as Doubtful. A loan classified as Loss is considered uncollectible and of such little value that continued classification of the credit as a loan is not warranted. If a loan or a portion thereof is classified as Loss, it must be charged-off, meaning the amount of the loss is charged against the allowance for loan losses, thereby reducing that reserve. The Company also classifies some loans as Watch or Other Loans Especially Mentioned (“OLEM”). Loans classified as Watch are performing assets and classified as pass credits but have elements of risk that require more monitoring than other performing loans and are reported in the OLEM column in the following table. Loans classified as OLEM are assets that continue to perform but have shown deterioration in credit quality and require close monitoring.

16

 

Loans by credit quality risk rating are as follows as of the periods indicated:

 

 

 

Pass

 

 

Other Loans

Especially

Mentioned

 

 

Sub-

Standard

 

 

Doubtful

 

 

Total

 

 

 

(dollars in thousands)

 

September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial loans

 

$

578,128

 

 

$

9,594

 

 

$

1,482

 

 

$

-

 

 

$

589,204

 

Real estate loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction, land, and land development

 

 

97,686

 

 

 

-

 

 

 

3,269

 

 

 

-

 

 

 

100,955

 

Residential real estate

 

 

120,559

 

 

 

410

 

 

 

178

 

 

 

-

 

 

 

121,147

 

Commercial real estate

 

 

688,621

 

 

 

16,160

 

 

 

405

 

 

 

-

 

 

 

705,186

 

Consumer and other loans

 

 

3,927

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

3,927

 

 

 

$

1,488,921

 

 

$

26,164

 

 

$

5,334

 

 

$

-

 

 

 

1,520,419

 

Less net deferred origination fees

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(11,030

)

Loans receivable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

1,509,389

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial loans

 

$

104,911

 

 

$

4,740

 

 

$

1,750

 

 

$

-

 

 

$

111,401

 

Real estate loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction, land, and land development

 

 

97,034

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

97,034

 

Residential real estate

 

 

114,823

 

 

 

123

 

 

 

65

 

 

 

-

 

 

 

115,011

 

Commercial real estate

 

 

608,773

 

 

 

4,625

 

 

 

-

 

 

 

-

 

 

 

613,398

 

Consumer and other loans

 

 

4,212

 

 

 

-

 

 

 

2

 

 

 

 

 

 

 

4,214

 

 

 

$

929,753

 

 

$

9,488

 

 

$

1,817

 

 

$

-

 

 

 

941,058

 

Less net deferred origination fees

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,955

)

Loans receivable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

939,103

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for Loan Losses

The Company’s allowance for loan losses (“ALLL”) covers estimated credit losses on individually evaluated loans that are determined to be impaired as well as estimated probable losses inherent in the remainder of the loan portfolio. The ALLL is prepared using the information provided by the Company’s credit review process together with economic information gathered from published sources.  Qualitative factors that are included in the analysis include industry data and data from peer institutions.

The loan portfolio is segmented into groups of loans with similar risk profiles. Each segment possesses varying degrees of risk based on the type of loan, the type of collateral, and the sensitivity of the borrower or industry to changes in external factors such as economic conditions. An estimated loss rate calculated from the Company’s actual historical loss rates adjusted for current portfolio trends, economic conditions, and other relevant internal and external factors, is applied to each group’s aggregate loan balances. The $452.8 million in PPP loans as of September 30, 2020 are 100% guaranteed and were not subject to the allowance analysis or assigned an allowance.  

The Company’s provision for credit losses of $2.2 million and $5.7 million during the three and nine months ended September 30, 2020, respectively, is related to an increase in qualitative factors primarily related to the uncertainties in the economic outlook from the COVID-19 pandemic and growth in the loan portfolio. The Company is not required to implement the provisions of the Current Expected Credit Loss (“CECL”) accounting standard until January 1, 2023 and is continuing to account for the allowance for loan losses under the incurred loss model.

17

 

The following tables summarize the allocation of the ALLL, as well as the activity in the ALLL attributed to various segments in the loan portfolio, as of and for the three and nine months ended September 30, 2020:

 

 

 

Commercial

and

Industrial

 

 

Construction,

Land, and

Land

Development

 

 

Residential

Real

Estate

 

 

Commercial

Real Estate

 

 

Consumer

and Other

 

 

Unallocated

 

 

Total

 

 

 

(dollars in thousands)

 

Three Months Ended September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALLL balance, June 30, 2020

 

$

2,853

 

 

$

3,378

 

 

$

2,669

 

 

$

5,235

 

 

$

140

 

 

$

572

 

 

$

14,847

 

Provision for loan losses or (recapture)

 

 

27

 

 

 

234

 

 

 

222

 

 

 

1,929

 

 

 

(9

)

 

 

(203

)

 

 

2,200

 

 

 

 

2,880

 

 

 

3,612

 

 

 

2,891

 

 

 

7,164

 

 

 

131

 

 

 

369

 

 

 

17,047

 

Loans charged-off

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(2

)

 

 

-

 

 

 

(2

)

Recoveries of loans previously charged-off

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

1

 

 

 

-

 

 

 

1

 

Net (charge-offs) recoveries

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(1

)

 

 

-

 

 

 

(1

)

ALLL balance, September 30, 2020

 

$

2,880

 

 

$

3,612

 

 

$

2,891

 

 

$

7,164

 

 

$

130

 

 

$

369

 

 

$

17,046

 

Nine Months Ended September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALLL balance, December 31, 2019

 

$

2,366

 

 

$

2,745

 

 

$

2,069

 

 

$

3,126

 

 

$

104

 

 

$

1,060

 

 

$

11,470

 

Provision for loan losses or (recapture)

 

 

639

 

 

 

867

 

 

 

822

 

 

 

4,038

 

 

 

33

 

 

 

(691

)

 

 

5,708

 

 

 

 

3,005

 

 

 

3,612

 

 

 

2,891

 

 

 

7,164

 

 

 

137

 

 

 

369

 

 

 

17,178

 

Loans charged-off

 

 

(130

)

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(9

)

 

 

-

 

 

 

(139

)

Recoveries of loans previously charged-off

 

 

5

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

2

 

 

 

-

 

 

 

7

 

Net (charge-offs) recoveries

 

 

(125

)

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(7

)

 

 

-

 

 

 

(132

)

ALLL balance, September 30, 2020

 

$

2,880

 

 

$

3,612

 

 

$

2,891

 

 

$

7,164

 

 

$

130

 

 

$

369

 

 

$

17,046

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALLL amounts allocated to

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

-

 

 

$

-

 

 

$

-

 

 

$

-

 

 

$

-

 

 

$

-

 

 

$

-

 

Collectively evaluated for impairment

 

 

2,880

 

 

 

3,612

 

 

 

2,891

 

 

 

7,164

 

 

 

130

 

 

 

369

 

 

 

17,046

 

ALLL balance September 30, 2020

 

$

2,880

 

 

$

3,612

 

 

$

2,891

 

 

$

7,164

 

 

$

130

 

 

$

369

 

 

$

17,046

 

Loans individually evaluated for impairment

 

$

625

 

 

$

3,269

 

 

$

178

 

 

$

405

 

 

$

-

 

 

 

 

 

 

$

4,477

 

Loans collectively evaluated for impairment

 

 

588,579

 

 

 

97,686

 

 

 

120,969

 

 

 

704,781

 

 

 

3,927

 

 

 

 

 

 

 

1,515,942

 

Loan balance, September 30, 2020

 

$

589,204

 

 

$

100,955

 

 

$

121,147

 

 

$

705,186

 

 

$

3,927

 

 

 

 

 

 

$

1,520,419

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

18

 

The following tables summarize the allocation of the ALLL, as well as the activity in the ALLL attributed to various segments in the loan portfolio, as of and for the three and nine months ended September 30, 2019:

 

 

 

Commercial

and

Industrial

 

 

Construction,

Land, and

Land

Development

 

 

Residential

Real

Estate

 

 

Commercial

Real Estate

 

 

Consumer

and Other

 

 

Unallocated

 

 

Total

 

 

 

(dollars in thousands)

 

Three months ended September 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, June 30, 2019

 

$

2,482

 

 

$

2,386

 

 

$

1,814

 

 

$

2,845

 

 

$

67

 

 

$

849

 

 

$

10,443

 

Provision for loan losses or (recapture)

 

 

195

 

 

 

136

 

 

 

140

 

 

 

107

 

 

 

22

 

 

 

37

 

 

 

637

 

 

 

 

2,677

 

 

 

2,522

 

 

 

1,954

 

 

 

2,952

 

 

 

89

 

 

 

886

 

 

 

11,080

 

Loans charged-off

 

 

(118

)

 

 

(75

)

 

 

-

 

 

 

-

 

 

 

(3

)

 

 

-

 

 

 

(196

)

Recoveries of loans previously charged-off

 

 

2

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

2

 

 

 

-

 

 

 

4

 

Net (charge-offs) recoveries

 

 

(116

)

 

 

(75

)

 

 

-

 

 

 

-

 

 

 

(1

)

 

 

-

 

 

 

(192

)

Balance, September 30, 2019

 

$

2,561

 

 

$

2,447

 

 

$

1,954

 

 

$

2,952

 

 

$

88

 

 

$

886

 

 

$

10,888

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2018

 

$

2,039

 

 

$

1,806

 

 

$

1,647

 

 

$

2,648

 

 

$

77

 

 

$

1,190

 

 

$

9,407

 

Provision for loan losses or (recapture)

 

 

643

 

 

 

716

 

 

 

307

 

 

 

333

 

 

 

29

 

 

 

(304

)

 

 

1,724

 

 

 

 

2,682

 

 

 

2,522

 

 

 

1,954

 

 

 

2,981

 

 

 

106

 

 

 

886

 

 

 

11,131

 

Loans charged-off

 

 

(125

)

 

 

(75

)

 

 

-

 

 

 

(29

)

 

 

(23

)

 

 

-

 

 

 

(252

)

Recoveries of loans previously charged-off

 

 

4

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

5

 

 

 

-

 

 

 

9

 

Net (charge-offs) recoveries

 

 

(121

)

 

 

(75

)

 

 

-

 

 

 

(29

)

 

 

(18

)

 

 

-

 

 

 

(243

)

Balance, September 30, 2019

 

$

2,561

 

 

$

2,447

 

 

$

1,954

 

 

$

2,952

 

 

$

88

 

 

$

886

 

 

$

10,888

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of September 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALLL amounts allocated to

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

230

 

 

$

-

 

 

$

-

 

 

$

-

 

 

$

-

 

 

$

-

 

 

$

230

 

Collectively evaluated for impairment

 

 

2,331

 

 

 

2,447

 

 

 

1,954

 

 

 

2,952

 

 

 

88

 

 

 

886

 

 

 

10,658

 

ALLL balance, September 30, 2019

 

$

2,561

 

 

$

2,447

 

 

$

1,954

 

 

$

2,952

 

 

$

88

 

 

$

886

 

 

$

10,888

 

Loans individually evaluated for impairment

 

$

1,233

 

 

$

-

 

 

$

67

 

 

$

-

 

 

$

-

 

 

 

 

 

 

$

1,300

 

Loans collectively evaluated for impairment

 

 

104,401

 

 

 

86,919

 

 

 

100,751

 

 

 

578,607

 

 

 

3,720

 

 

 

 

 

 

 

874,398

 

Loan balance, September 30, 2019

 

$

105,634

 

 

$

86,919

 

 

$

100,818

 

 

$

578,607

 

 

$

3,720

 

 

 

 

 

 

$

875,698

 

 

The following table summarizes the allocation of the ALLL attributed to various segments in the loan portfolio as of December 31, 2019.

 

 

 

Commercial

and

Industrial

 

 

Construction,

Land, and

Land

Development

 

 

Residential

Real

Estate

 

 

Commercial

Real Estate

 

 

Consumer

and Other

 

 

Unallocated

 

 

Total

 

 

 

(dollars in thousands)

 

As of December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ALLL amounts allocated to

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

-

 

 

$

-

 

 

$

-

 

 

$

-

 

 

$

2

 

 

$

-

 

 

$

2

 

Collectively evaluated for impairment

 

 

2,366

 

 

 

2,745

 

 

 

2,069

 

 

 

3,126

 

 

 

102

 

 

 

1,060

 

 

 

11,468

 

ALLL balance, December 31, 2019

 

$

2,366

 

 

$

2,745

 

 

$

2,069

 

 

$

3,126

 

 

$

104

 

 

$

1,060

 

 

$

11,470

 

Loans individually evaluated for impairment

 

$

965

 

 

$

-

 

 

$

65

 

 

$

-

 

 

$

2

 

 

 

 

 

 

$

1,032

 

Loans collectively evaluated for impairment

 

 

110,436

 

 

 

97,034

 

 

 

114,946

 

 

 

613,398

 

 

 

4,212

 

 

 

 

 

 

 

940,026

 

Loan balance, December 31, 2019

 

$

111,401

 

 

$

97,034

 

 

$

115,011

 

 

$

613,398

 

 

$

4,214

 

 

 

 

 

 

$

941,058

 

 

19

 

Note 5 - Deposits

The composition of consolidated deposits consisted of the following at the periods indicated:

 

 

 

September 30,

 

 

December 31,

 

 

 

2020

 

 

2019

 

 

 

(dollars in thousands)

 

Demand, noninterest bearing

 

$

570,664

 

 

$

371,243

 

NOW and money market

 

 

624,891

 

 

 

437,908

 

Savings

 

 

74,694

 

 

 

53,365

 

BaaS-brokered deposits

 

 

24,870

 

 

 

23,586

 

Time deposits less than $250,000

 

 

41,676

 

 

 

51,644

 

Time deposits $250,000 and over

 

 

23,216

 

 

 

30,213

 

Total deposits

 

$

1,360,011

 

 

$

967,959

 

 

The following table presents the maturity distribution of time deposits as of September 30, 2020 (dollars in thousands):

 

Twelve months

 

$

52,266

 

One to two years

 

 

8,013

 

Two to three years

 

 

2,531

 

Three to four years

 

 

974

 

Four to five years

 

 

1,108

 

 

 

$

64,892

 

 

Note 6 - Leases

The Company has committed to rent premises used in business operations under non-cancelable operating leases and determines if an arrangement meets the definition of a lease upon inception.

The Company adopted the provisions of ASU 2016-02 (Topic 842) on January 1, 2019. Operating lease right-of-use (“ROU”) assets represent a right to use an underlying asset for the contractual lease term. Operating lease liabilities represent an obligation to make lease payments arising from the lease.  Operating lease ROU assets and operating lease liabilities were recognized in the Company’s Unaudited Consolidated Balance Sheets for leases that existed at the adoption date, based on the present value of lease payments over the remaining lease term.  ROU assets were further adjusted for lease incentives.  Operating leases entered into after the adoption date were recognized as an operating lease ROU asset and operating lease liability at the commencement date of the new lease.

The Company’s leases do not provide an implicit interest rate, therefore the Company used its incremental collateralized borrowing rates commensurate with the underlying lease terms to determine the present value of operating lease liabilities. There were no new leases during the period.  

The Company’s operating lease agreements contain both lease and non-lease components, which are generally accounted for separately. The Company’s lease agreements do not contain any residual value guarantees.

Operating leases with terms of 12 months or less are not included in ROU assets and operating lease liabilities recorded in the Company’s consolidated balance sheets. Operating lease terms include options to extend when it is reasonably certain that the Company will exercise such options, determined on a lease-by-lease basis.  As of September 30, 2020, the Company does not have any leases that have not yet commenced.  At September 30, 2020, lease expiration dates ranged from six months to 25 years, with additional renewal options on certain leases typically ranging from 5 to 10 years. At September 30, 2020, the weighted average remaining lease term for the Company’s operating leases was 10.5 years.

Rental expense for operating leases is recognized on a straight-line basis over the lease term and amounted to $461,000 and $342,000, respectively, for the three months ended September 30, 2020 and 2019 and $1.1 million for both the nine months ended September 30, 2020 and 2019. Variable lease components, such as inflation adjustments, are expensed as incurred and not included in ROU assets and operating lease liabilities.

20

 

The following table presents the minimum annual lease payments under the terms of these leases, inclusive of renewal options that the Company is reasonably certain to renew, at September 30, 2020:

 

 

 

September 30,

 

(dollars in thousands)

 

2020

 

October 1, 2020 to December 31, 2020

 

$

318

 

2021

 

 

1,254

 

2022

 

 

1,258

 

2023

 

 

1,269

 

2024

 

 

864

 

2025 and thereafter

 

 

3,922

 

Total lease payments

 

 

8,885

 

Less:  amounts representing interest

 

 

1,306

 

Present value of lease liabilities

 

$

7,579

 

 

The following table presents the components of total lease expense and operating cash flows for the nine months ended September 30, 2020:

 

 

 

September 30,

 

(dollars in thousands)

 

2020

 

Lease expense:

 

 

 

 

Operating lease expense

 

$

983

 

Variable lease expense

 

 

239

 

Total lease expense (1)

 

$

1,222

 

Cash paid:

 

 

 

 

Cash paid reducing operating lease liabilities

 

$

1,206

 

 

 

 

 

 

(1) Included in net occupancy expense in the Condensed Consolidated Statements of Income (Unaudited).

 

 

 

 

 

Note 7 - Stock-Based Compensation

Stock Options and Restricted Stock

On April 30, 2018, the Company’s shareholders approved the Coastal Financial Corporation 2018 Omnibus Incentive Plan (“2018 Plan”). The 2018 Plan authorizes the Company to grant awards, including but not limited to, stock options restricted stock units, and restricted stock awards, to eligible employees, directors or individuals that provide service to the Company, up to an aggregate of 500,000 shares of common stock. The 2018 Plan replaces both the Company’s 2006 Stock Option and Equity Compensation Plan (“2006 Plan”) and its Directors’ Stock Bonus Plan.  Existing awards under the previous plans will vest under the terms granted and no further awards will be made under these plans. Shares available to be granted under the 2018 Plan totaled 275,323 at September 30, 2020.

Stock Option Awards

In January 2019, the Company granted 26,737 nonqualified stock options under the 2018 Plan to an employee, which vest ratably over 10 years. In January 2019, the Company also granted 99,100 qualified stock options under the 2018 Plan to employees, which vest ratably over 10 years.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of the Company’s stock and other factors. The Company uses the vesting term and contractual life to determine the expected life. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Compensation expense related to unvested stock option awards is reversed at date of forfeiture.

21

 

The following assumptions were used to estimate the value of options granted under the 2018 Plan as applicable in the period indicated.  There were no new stock options granted in the nine months ended September 30, 2020:

 

 

 

Nine months ended

September 30, 2019

 

Expected term

 

10.0 years

 

Expected stock price volatility

 

 

48.79

%

Risk-free interest rate

 

 

2.74

%

Expected dividends

 

Zero

 

Weighted average grant date fair value

 

$

9.22

 

 

A summary of stock option activity under the 2018 Plan and 2006 Plan during the nine months ended September 30, 2020:

 

Options

 

Shares

 

 

Weighted-

Average

Exercise

Price

 

 

Weighted-

Average

Remaining

Contractual

Term (Years)

 

 

Aggregate

Intrinsic Value

 

(dollars in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding at December 31, 2019

 

 

784,217

 

 

$

7.73

 

 

 

5.95

 

 

$

6,587

 

Granted

 

 

-

 

 

 

-

 

 

 

-

 

 

 

 

 

Exercised

 

 

(13,610

)

 

 

6.07

 

 

 

-

 

 

 

 

 

Forfeited or expired

 

 

(1,000

)

 

 

14.91

 

 

 

-

 

 

 

 

 

Outstanding at September 30, 2020

 

 

769,607

 

 

$

7.75

 

 

 

5.21

 

 

$

3,825

 

Vested or expected to vest at September 30, 2020

 

 

769,607

 

 

$

7.75

 

 

 

5.21

 

 

$

3,825

 

Exercisable at September 30, 2020

 

 

333,933

 

 

$

6.43

 

 

 

3.89

 

 

$

1,984

 

 

The total or aggregate intrinsic value (which is the amount by which the stock price exceeds the exercise price) of options exercised during the three and nine months ended September 30, 2020 was $28,000 and $121,000, respectively, and was $35,000 and $170,000 for the three and nine months ended September 30, 2019, respectively.

As of September 30, 2020, there was $2.0 million of total unrecognized compensation cost related to nonvested stock options granted under the 2018 Plan and 2006 Plan. Total unrecognized compensation costs are adjusted for unvested forfeitures. The Company expects to recognize that cost over a weighted-average period of approximately 6.8 years.   Compensation expense recorded related to stock options was $94,000 and $281,000 for the three and nine months ended September 30, 2020, respectively, and $101,000 and $295,000 for the three and nine months ended September 30, 2019, respectively.

Restricted Stock Units

In February 2020, the Company granted 78,756 restricted stock units under the 2018 Plan to employees, which vest ratably over 10 years. In April 2020, the Company granted 1,490 restricted stock units under the 2018 Plan to an employee, which vest ratably over 10 years.  In July 2020, the Company granted 6,902 restricted stock units under the 2018 Plan to employees, which cliff vest after 5 years.

The fair value of restricted stock units is equal to the fair value of the Company’s stock at the date of grant. Compensation expense is recognized over the vesting period that the awards are based. Restricted stock units are nonparticipating securities.

As of September 30, 2020, there was $1.3 million of total unrecognized compensation cost related to nonvested restricted stock units.  The Company expects to recognize that cost over the remaining weighted-average vesting period of approximately 9.2 years.  Compensation expense recorded related to restricted stock units was $39,000 and $96,000 for the three and nine months ended September 30, 2020, respectively.  There were no restricted stock units and no compensation expense recorded related to restricted stock units for the three and nine months ended September 30, 2019.

22

 

A summary of the Company’s nonvested shares at September 30, 2020 and changes during the nine-month period is presented below:

 

Nonvested shares

 

Shares

 

 

Weighted-

Average

Grant Date

Fair

Value

 

 

Total or Aggregate

Intrinsic Value

 

(dollars in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

Nonvested shares at December 31, 2019

 

 

-

 

 

$

-

 

 

$

-

 

Granted

 

 

87,148

 

 

 

17.47

 

 

 

 

 

Forfeited

 

 

(2,808

)

 

 

17.81

 

 

 

 

 

Vested

 

 

-

 

 

 

-

 

 

 

 

 

Nonvested shares at September 30, 2020

 

 

84,340

 

 

$

17.47

 

 

$

-

 

Restricted Stock Awards

Employees

In February 2020, there were 4,000 shares granted to an employee at an estimated fair value of $17.81 per share, vesting over eight years.

The fair value of restricted stock awards is equal to the fair value of the Company’s stock at the date of grant. Compensation expense is recognized over the vesting period that the awards are based. Restricted stock awards are participating securities.

As of September 30, 2020, there was $65,000 of total unrecognized compensation cost related to nonvested restricted stock awards.  The Company expects to recognize that cost over the remaining weighted-average vesting period of approximately 7.3 years.  Compensation expense recorded related to restricted stock awards was $2,000 and $5,000 for the three and nine months ended September 30, 2020, respectively, and was $2,000 and $5,000 for the three and nine months ended September 30, 2019, respectively.

 

Director’s Stock Bonus

The Company adopted and subsequently amended the Director’s Stock Bonus Plan (“Bonus Plan”). The Bonus Plan would have expired on May 31, 2018 but was replaced on April 30, 2018, when the shareholders approved the 2018 Plan.

Stock is granted to directors who attended at least 75% of the scheduled board meetings during the prior year. Grants cliff vest over two years from date awarded, contingent on the director still being a director of the Company. During the vesting period, the grants are considered participating securities.

Awards previously granted under the Bonus Plan will vest under the term granted.  Under the 2018 Plan, eligible directors are granted stock with a total market value of $5,000. Directors unable to receive stock will receive cash in lieu upon completion of the vesting period. Cash awards are recognized over the vesting period and recorded in other liabilities until paid.

In February 2020, there were 2,248 shares granted to eight directors at an estimated fair value of $17.81 per share. In January 2019, there were 2,352 shares granted to seven directors at an estimated fair value of $14.91 per share. Compensation expense recorded related to the 2018 Plan totaled $8,000 and $26,000 for the three and nine months ended September 30, 2020, respectively, and $8,000 and $25,000 for the three and nine months ended September 30, 2019, respectively.

23

 

A summary of the Company’s nonvested shares at September 30, 2020 and changes during the nine-month period is presented below:

 

Nonvested shares

 

Shares

 

 

Weighted-

Average

Grant Date

Fair

Value

 

 

Total or Aggregate

Intrinsic Value

 

(dollars in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

Nonvested shares at December 31, 2019

 

 

10,257

 

 

$

11.71

 

 

$

48,864

 

Granted

 

 

6,248

 

 

 

17.81

 

 

 

 

 

Forfeited

 

 

(3,500

)

 

 

15.35

 

 

 

 

 

Vested

 

 

(5,022

)

 

 

7.23

 

 

 

 

 

Nonvested shares at September 30, 2020

 

 

7,983

 

 

$

17.08

 

 

$

-

 

 

Note 8 - Fair Value Measurements

The following tables present estimated fair values of the Company’s financial instruments as of the period indicated, whether or not recognized or recorded in the consolidated balance sheets at the period indicated:

 

 

 

September 30, 2020

 

 

Fair Value Measurements Using

 

 

 

Carrying

Value

 

 

Estimated

Fair Value

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

 

(dollars in thousands)

 

Financial assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

14,136

 

 

$

14,136

 

 

$

14,136

 

 

$

-

 

 

$

-

 

Interest earning deposits with other banks

 

 

168,034

 

 

 

168,034

 

 

 

168,034

 

 

 

-

 

 

 

-

 

Investment securities

 

 

23,782

 

 

 

23,897

 

 

 

20,040

 

 

 

3,857

 

 

 

-

 

Other investments

 

 

5,951

 

 

 

5,951

 

 

 

-

 

 

 

5,201

 

 

 

750

 

Loans receivable

 

 

1,509,389

 

 

 

1,494,299

 

 

 

-

 

 

 

-

 

 

 

1,494,299

 

Accrued interest receivable

 

 

8,216

 

 

 

8,216

 

 

 

-

 

 

 

8,216

 

 

 

-

 

Financial liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

$

1,360,011

 

 

 

1,360,349

 

 

$

-

 

 

$

1,360,349

 

 

$

-

 

FHLB advances

 

 

24,999

 

 

 

24,936

 

 

 

-

 

 

 

24,936

 

 

 

-

 

Paycheck Protection Program Liquidity Facility

 

 

202,595

 

 

 

202,595

 

 

 

 

 

 

 

202,595

 

 

 

 

 

Subordinated debt

 

 

9,989

 

 

 

9,895

 

 

 

-

 

 

 

9,895

 

 

 

-

 

Junior subordinated debentures

 

 

3,584

 

 

 

3,057

 

 

 

-

 

 

 

3,057

 

 

 

-

 

Accrued interest payable

 

 

481

 

 

 

481

 

 

 

-

 

 

 

481

 

 

 

-

 

 

 

 

 

December 31, 2019

 

 

Fair Value Measurements Using

 

 

 

Carrying

Value

 

 

Estimated

Fair Value

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

 

(dollars in thousands)

 

Financial assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

16,555

 

 

$

16,555

 

 

$

16,555

 

 

$

-

 

 

$

-

 

Interest earning deposits with other banks

 

 

111,259

 

 

 

111,259

 

 

 

111,259

 

 

 

-

 

 

 

-

 

Investment securities

 

 

32,710

 

 

 

32,689

 

 

 

24,945

 

 

 

7,744

 

 

 

-

 

Other investments

 

 

4,505

 

 

 

4,505

 

 

 

-

 

 

 

4,005

 

 

 

500

 

Loans receivable, net

 

 

927,633

 

 

 

922,046

 

 

 

-

 

 

 

-

 

 

 

922,046

 

Accrued interest receivable

 

 

2,980

 

 

 

2,980

 

 

 

-

 

 

 

2,980

 

 

 

-

 

Financial liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

$

967,959

 

 

$

967,804

 

 

$

-

 

 

$

967,804

 

 

$

-

 

FHLB advances

 

 

10,000

 

 

 

10,000

 

 

 

-

 

 

 

10,000

 

 

 

-

 

Subordinated debt

 

 

9,979

 

 

 

9,879

 

 

 

-

 

 

 

9,879

 

 

 

-

 

Junior subordinated debentures

 

 

3,583

 

 

 

3,214

 

 

 

-

 

 

 

3,214

 

 

 

-

 

Accrued interest payable

 

 

308

 

 

 

308

 

 

 

-

 

 

 

308

 

 

 

-

 

 

The Company measures and discloses certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date

24

 

(that is, not a forced liquidation or distressed sale). GAAP establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements. Among other things, the accounting standard requires the reporting entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s estimates for market assumptions. These two types of inputs create the following fair value hierarchy:

 

•

Level 1 – Quoted prices in active markets for identical instruments. An active market is a market in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

 

•

Level 2 – Observable inputs other than Level 1 including quoted prices in active markets for similar instruments, quoted prices in less active markets for identical or similar instruments, or other observable inputs that can be corroborated by observable market data.

 

•

Level 3 – Unobservable 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 from nonbinding single dealer quotes not corroborated by observable market data.

The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize at a future date. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for certain financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.

Items measured at fair value on a recurring basis – The following fair value hierarchy table presents information about the Company’s assets that are measured at fair value on a recurring basis at the dates indicated:

 

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

Fair Value

 

 

 

(dollars in thousands)

 

September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

20,041

 

 

$

-

 

 

$

-

 

 

$

20,041

 

U.S. Agency collateralized mortgage obligations

 

 

-

 

 

 

113

 

 

 

-

 

 

 

113

 

U.S. Agency residential mortgage-backed securities

 

 

-

 

 

 

11

 

 

 

-

 

 

 

11

 

Municipals

 

 

-

 

 

 

263

 

 

 

-

 

 

 

263

 

 

 

$

20,041

 

 

$

387

 

 

$

-

 

 

$

20,428

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

24,945

 

 

$

-

 

 

$

-

 

 

$

24,945

 

U.S. Government agencies

 

 

-

 

 

 

2,999

 

 

 

-

 

 

 

2,999

 

U.S. Agency collateralized mortgage obligations

 

 

-

 

 

 

129

 

 

 

-

 

 

 

129

 

U.S. Agency residential mortgage-backed securities

 

 

-

 

 

 

27

 

 

 

-

 

 

 

27

 

Municipals

 

 

-

 

 

 

260

 

 

 

-

 

 

 

260

 

 

 

$

24,945

 

 

$

3,415

 

 

$

-

 

 

$

28,360

 

 

The following methods were used to estimate the fair value of the class of financial instruments above:

Investment securities - The fair value of securities is based on quoted market prices, pricing models, quoted prices of similar securities, independent pricing sources, and discounted cash flows.

Limitations: The fair value estimates presented herein are based on pertinent information available to management as of September 30, 2020 and December 31, 2019. The factors used in the fair values estimates are subject to change subsequent to the dates the fair value estimates are completed, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

25

 

Assets measured at fair value using significant unobservable inputs (Level 3)

The following table provides a description of the valuation technique, unobservable inputs, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a nonrecurring basis at the dates indicated:

 

 

 

Valuation Technique

 

Unobservable Inputs

 

September 30, 2020

Weighted

Average Rate

 

 

December 31, 2019

Weighted

Average Rate

 

Impaired loans

 

Collateral valuations

 

Discount to appraised value

 

 

8

%

 

 

10

%

 

Items measured at fair value on a nonrecurring basis – The following table presents financial assets and liabilities measured at fair value on a nonrecurring basis and the level within the fair value hierarchy of the fair value measurements for those assets at the dates indicated:

 

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

Fair Value

 

 

 

(dollars in thousands)

 

September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

-

 

 

$

-

 

 

$

4,477

 

 

$

4,477

 

Total

 

$

-

 

 

$

-

 

 

$

4,477

 

 

$

4,477

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

-

 

 

$

-

 

 

$

1,030

 

 

$

1,030

 

Total

 

$

-

 

 

$

-

 

 

$

1,030

 

 

$

1,030

 

 

The amounts disclosed above represent the fair values at the time the nonrecurring fair value measurements were made, and not necessarily the fair value as of the dates reported on.

Impaired loans - A loan is considered impaired when it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Impairment is measured based on the fair value of the underlying collateral or the discounted cash expected future cash flows. Subsequent changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported. Impaired loans are evaluated quarterly to determine if valuation adjustments should be recorded. The need for valuation adjustments arises when observable market prices or current appraised values of collateral indicate a shortfall in collateral value compared to current carrying values of the related loan. If the Company determines that the value of the impaired loan is less than the carrying value of the loan, the Company either establishes an impairment reserve as a specific component of the allowance for loan losses or charges off the impairment amount. These valuation adjustments are considered nonrecurring fair value adjustments.

26

 

Note 9 - Earnings Per Common Share

The following is a computation of basic and diluted earnings per common share at the periods indicated:

 

 

 

Three months ended

 

 

Nine months ended

 

 

 

September 30, 2020

 

 

September 30, 2019

 

 

September 30, 2020

 

 

September 30, 2019

 

 

 

(dollars in thousands, except share data)

 

Net Income

 

$

4,090

 

 

$

3,511

 

 

$

10,485

 

 

$

9,593

 

Basic weighted average number common shares outstanding

 

 

11,919,850

 

 

 

11,901,873

 

 

 

11,915,513

 

 

 

11,893,734

 

Dilutive effect of share-based compensation

 

 

261,422

 

 

 

286,634

 

 

 

268,332

 

 

 

299,337

 

Diluted weighted average number common shares outstanding

 

 

12,181,272

 

 

 

12,188,507

 

 

 

12,183,845

 

 

 

12,193,071

 

Basic earnings per share

 

$

0.34

 

 

$

0.30

 

 

$

0.88

 

 

$

0.81

 

Diluted earnings per share

 

$

0.34

 

 

$

0.29

 

 

$

0.86

 

 

$

0.79

 

Antidilutive stock options and restricted stock outstanding

 

 

224,177

 

 

 

138,689

 

 

 

224,177

 

 

 

138,689

 

 Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings, however the difference in the two-class method was not significant.

 

 

27

 

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

Overview

We are a bank holding company that operates through our wholly owned subsidiaries, Coastal Community Bank (the “Bank”) and Arlington Olympic LLC. We are headquartered in Everett, Washington, which by population is the largest city in, and the county seat of, Snohomish County. We focus on providing a wide range of banking products and services to consumers and small to medium sized businesses in the broader Puget Sound region in the state of Washington. We currently operate 15 full-service banking locations, 12 of which are located in Snohomish County, where we are the largest community bank by deposit market share, and three of which are located in neighboring counties (one in King County and two in Island County). The Bank also provides banking as a service (“BaaS”) that allows our broker-dealer and digital financial service providers to offer their customers banking services and expects to introduce a digital bank offering in collaboration with Google in 2021.  As of September 30, 2020, we had total assets of $1.75 billion, total gross loans of $1.51 billion, total deposits of $1.36 billion and total shareholders’ equity of $135.2 million.

The following discussion and analysis presents our financial condition and results of operations on a consolidated basis. However, because we conduct all of our material business operations through the Bank, the discussion and analysis relate to activities primarily conducted by the Bank.

As a bank holding company that operates through one segment, community banking, we generate most of our revenue from interest on loans and investments. Our primary source of funding for our loans is commercial and retail deposits from our customer relationships. We place secondary reliance on wholesale funding, primarily borrowings from the Federal Home Loan Bank (“FHLB”). We are utilizing the Paycheck Protection Program Liquidity Facility (“PPPLF”), which provides an additional source of low cost funding for the PPP loans, with a contractual interest rate of 0.35%.  The PPPLF borrowings are collateralized by Paycheck Protection Program (“PPP”) loans and must be paid down as the PPP loans are forgiven or paid down by customers.  Less commonly used sources of funding include borrowings from the Federal Reserve System (“Federal Reserve”) discount window, draws on established federal funds lines from unaffiliated commercial banks, brokered funds, which allows us to obtain deposits from sources that do not have a relationship with the Bank and can be obtained through certificate of deposit listing services, via the internet or through other advertising methods, or a one-way buy through an insured cash sweep (“ICS”) account, which allows us to obtain funds from other institutions that have deposited funds through ICS. Our largest expenses are salaries and related employee benefits, provision for loan losses, interest on deposits and borrowings, occupancy and data processing. Our principal lending products are commercial real estate loans, commercial and industrial loans, residential real estate loans, construction, land and land development loans, and to a lesser extent consumer loans.

28

 

Coronavirus Aid, Relief, and Economic Security (“CARES”) Act

On March 27, 2020, the CARES Act was enacted, providing wide ranging economic relief for individuals and businesses impacted by the COVID-19 pandemic. Among other things, the statute created the PPP, which is a stimulus response to the potential economic impacts of COVID-19, and its purpose is to provide forgivable loans to smaller businesses that use the proceeds of the loans for payroll and certain other qualifying expenses. The Small Business Administration ("SBA") manages and backs the PPP. If a loan is fully forgiven, the SBA will repay the lending bank in full. If a loan is partially forgiven or not forgiven at all, a bank must look to the borrower for repayment of unforgiven principal and interest. If the borrower defaults, the loan is guaranteed by the SBA.  The PPP program closed to new loan applicants on August 8, 2020. We accepted and processed requests for existing and new customers for the duration of the program. Deferral on PPP payments was extended as we await final guidance on these loans; however, we have begun accepting applications from customers for loan forgiveness.

The Company's Preparations and Responses to COVID-19 Pandemic

As part of its ongoing risk preparation and mitigation efforts, the Company had developed a detailed plan and action measures related to a possible pandemic scenario. This pandemic plan was implemented on March 12, 2020 and continued through the third quarter and into fourth quarter of 2020.  The Company carefully executed the plan with limited operational disruptions, with attention to ensure continued customer support, and with the utmost care to safeguard employees, customers and vendors. Management continues to monitor and, when appropriate, make changes to our planned response. To date we have:

•

Continued to serve customers through drive throughs, call center, mobile banking, online banking and ATMs, and closed branches except for drive throughs and appointments.

•

Dispersed workforce throughout facilities in order to maximize social distancing protocols, including successful employment of remote work solutions for many employees.

•

Continued participation in the SBA PPP with funded loans outstanding of $452.8 million, as of September 30, 2020.

•

Actively engaged borrowers and other businesses in discussion to identify short-term cash flow and other financial needs, and restructured payments on existing loans to alleviate financial hardship per regulatory guidance. As of October 31, 2020, $9.2 million, or 10 loans, remain on deferred or modified payment status.

•

Pledged 820 PPP loans, or $202.6 million as of September 30, 2020, which provides an additional source of funding for the PPP loans, through the PPPLF.  The borrowings must be paid down as PPP loan amounts are forgiven or when the customers pay their loans down.  PPPLF is a low cost source of funding and liquidity for PPP loans, with an interest rate of 0.35%, and favorable capital treatment.

•

Enhanced credit monitoring on loan segments that have been most impacted by COVID-19, monitoring and tracking loan payment deferrals and customer liquidity.

•

Majority of Washington State, including Snohomish County, migrated to Phase 2 in early June, after spending most of the second quarter of 2020 in Phase 1 of Washington State’s 4 phase approach to re-opening businesses.  We anticipate remaining in Phase 2 for the foreseeable future.  Phase 2 provides:

 

o

Gatherings of no more than 5 people outside one’s household per week

 

o

Travel to counties that are in other phases of reopening to participate in non-essential activities is not allowed

 

o

Opens certain businesses with social distancing and capacity restrictions

•

Refreshed and analyzed the Company's liquidity, funding and capital stress forecasts and risk assumptions.

PPP Overview

During the second and third quarters of 2020, focus was placed on helping the small businesses in our communities through the PPP.  These loans have had a significant impact on our financial statements for the quarter ended September 30, 2020 and will continue to impact our results in the future.  Throughout this discussion, we will address the impact of these loans, including borrowings received through PPPLF to help fund these loans and to aid in liquidity, increased customer deposit accounts from unused disbursements, and earnings and expenses related to these activities.  Any estimated adjusted ratios that exclude the impact of this activity are non- U.S. generally accepted accounting principles (“GAAP”) measures.  For more information about non-GAAP financial measures, see the non-GAAP disclosure “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures”.

29

 

The table below summarizes key information regarding the PPP loans as of the period indicated:

 

 

 

Loan Size

 

 

 

As of September 30, 2020

 

 

 

$0.00 -

$50,000.00

 

$50,0000.01 -

$150,000.00

 

$150,000.01 -

$350,000.00

 

$350,000.01 -

$2,000,000.00

 

> 2,000,000.01

 

Totals

 

(Dollars in thousands; unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

Principal outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Existing customer

 

$

11,232

 

$

27,696

 

$

29,806

 

$

86,302

 

$

52,299

 

$

207,335

 

New customer

 

 

20,604

 

 

34,355

 

 

42,793

 

 

86,707

 

 

61,052

 

 

245,511

 

Total principal outstanding

 

 

31,836

 

 

62,051

 

 

72,599

 

 

173,009

 

 

113,351

 

 

452,846

 

Deferred fees outstanding

 

 

(1,161

)

 

(2,116

)

 

(2,417

)

 

(3,375

)

 

(752

)

 

(9,821

)

Deferred costs outstanding

 

 

629

 

 

278

 

 

174

 

 

134

 

 

19

 

 

1,234

 

Net deferred fees

 

$

(532

)

$

(1,838

)

$

(2,243

)

$

(3,241

)

$

(733

)

$

(8,587

)

Total principal, net of deferred

    fees

 

$

31,304

 

$

60,213

 

$

70,356

 

$

169,768

 

$

112,618

 

$

444,259

 

Weighted average maturity

   (years)

 

 

2.21

 

 

1.75

 

 

1.63

 

 

1.63

 

 

1.64

 

 

1.69

 

Number of loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Existing customer

 

 

498

 

 

307

 

 

129

 

 

108

 

 

13

 

 

1,055

 

New customer

 

 

1,107

 

 

386

 

 

193

 

 

119

 

 

19

 

 

1,824

 

Total loan count

 

 

1,605

 

 

693

 

 

322

 

 

227

 

 

32

 

 

2,879

 

Percent of total

 

 

55.7

%

 

24.1

%

 

11.2

%

 

7.9

%

 

1.1

%

 

100.0

%

30

 

Comparison of Operating Results for the Three Months Ended September 30, 2020 and September 30, 2019

Results of Operations

Net Income

Net income for the three months ended September 30, 2020, was $4.1 million, or $0.34 per diluted share, compared to $3.5 million, or $0.29 per diluted share, for the three months ended September 30, 2019. The increase in net income over the comparable period in the prior year was attributable to a $4.4 million increase in net interest income, largely related to increased interest earning assets, including PPP loans.  Interest and fee income related to PPP loans totaled $3.6 million for the three months ended September 30, 2020. Net deferred fees on PPP loans will be earned over the life of the loan, as a yield adjustment.  Forgiveness of principal, early paydowns and payoffs on PPP loans will increase interest income earned in those periods.   The increase in net interest income was partially offset by a $1.6 million  increase in the provision for loan losses, related to an increase in qualitative factors related to the change in the economic outlook caused by the COVID-19 pandemic along with the growth in the loan portfolio, and $1.9 million increase in noninterest expense, which includes $1.0 million more in salaries and employee benefits, $211,000 more in legal and professional fees, and $207,000 more in occupancy expenses.  Salaries and employee benefits were increased largely as a result of hiring staff for our BaaS CCBX division, legal and professional expenses increased due to development of contracts for CCBX customers and because of reporting related legal and professional services.  The increase in occupancy expense is related to a one-time $119,000 building operating expense and higher rent and depreciation expenses resulting from the opening of our Arlington branch in the second quarter of 2020 and our overall growth as a Company.

Net Interest Income

Net interest income for the three months ended September 30, 2020, was $15.1 million, compared to $10.7 million for the three months ended September 30, 2019, an increase of $4.4 million, or 40.7%. The increase in net interest income consisted of a $4.0 million, or 32.7%, increase in interest income coupled with a $330,000, or 20.3%, decrease in interest expense.

The increase in interest income was primarily attributable to a $627.4 million, or 72.5%, increase in average loans outstanding for the three months ended September 30, 2020, compared to the prior year period, partially offset by a 1.03% decrease in yield on loans.  The decrease in loan yields, as compared to the prior year period, was the result of the Federal Open Market Committee (“FOMC”) lowering the Fed funds rate five times since June 2019, totaling 2.25%, resulting in lower rates on our variable rate, new and renewing loans.  In addition, for the quarter ended September 30, 2020 there was an average of $448.3 million in PPP loans, which have a 1.0% interest rate and an approximate yield of 3.16% after including the amortization of deferred fees and costs, which contributed to the decline in loan yield. Contractual loan yields approximated 3.61% for the quarter ended September 30, 2020 compared to 5.24% for the quarter ended September 30, 2019.   Excluding PPP loans, the contractual loan yield approximated 4.69% for the three months ended September 30, 2020.  A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.” Although there are rate floors in place for $361.8 million, or 23.8%, in existing loans, the rate reductions by the FOMC have had a corresponding impact on loan yields and subsequently the net interest margin in future periods. We expect that the FOMC will maintain the Fed funds rate low for some time.  We have continued to focus on our loan growth initiatives, including the deepening of relationships with existing customers and developing new loan and deposit relationships with new customers and non-Bank PPP customers. During the quarter ended September 30, 2020, our focus continued to be on working with small businesses within our communities as business owners navigate through the uncertainty and change resulting from the COVID-19 pandemic.  We experienced a significant increase in commercial and industrial SBA 7(a) loans during the second and into the third quarter of 2020, as small business owners applied for relief via the PPP as prescribed in the CARES Act. The PPP program closed to new loan applicants on August 8, 2020, and the Bank is no longer originating any PPP loans.

The decrease in interest expense for the three months ended September 30, 2020 was the result of a 39 basis point decrease in cost of funds, bringing it to 0.33% as of September 30, 2020, compared to 0.72% at September 30, 2019.  In addition to the aforementioned rate reductions by the FOMC, which ultimately resulted in a lowering of the interest rate paid on interest-bearing deposit accounts, we gained new customer relationships by making PPP loans to noncustomers and they continued to move their banking/deposit relationships to the Bank.  These increases in noninterest bearing and low rate interest bearing deposits helped contribute to the improved cost of funds for the quarter ended September 30, 2020, as compared to the prior year period.  The increase in borrowed funds is largely the result of utilizing the PPPLF to help fund PPP loans.  The PPPLF extends low cost borrowing lines, 0.35% interest rate, to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. Borrowings are required to be paid down as the pledged PPP loans are paid down or forgiven.  The average balance for the three months ended September 30, 2020 was $199.1 million, resulting in $176,000 in interest expense.

31

 

The average balance of interest-bearing deposits increased $195.1 million, or 35.1%, compared to the prior year period, but the average rate paid on interest bearing deposits was 55 basis points less for the quarter ended September 30, 2020, compared to the quarter ended September 30, 2019.  As previously mentioned, the Fed funds rate reductions by the FOMC have impacted the rates that are paid on interest bearing accounts and management lowered deposit rates in response to these rate reductions.  The average rate paid on BaaS-brokered deposits decreased 164 basis points and NOW and money market accounts decreased 51 basis points for the three months ended September 30, 2020.  The average rate paid on BaaS-brokered deposits was higher in the three months ended September 30, 2019 as a result of a temporary negotiated rate for that period.   The average rate paid on time deposits also decreased.  For time deposits less than $100,000, the rate decreased 31 basis points and for time deposits over $100,000, the average rate decreased 66 basis points, as compared to the prior year period.  The average rate paid on NOW, money market, and time deposit accounts in the quarter ended September 30, 2020 is the result of the recent decreased Fed funds rates and management lowering rates on these accounts in response.  We continue to evaluate rates and anticipate that additional rates reductions may occur in the fourth quarter.  Many deposit rates were either lowered late in the first quarter or at the start of the second quarter, and some rates were further lowered at the start of the third quarter of 2020, so the impact of these reductions were largely seen in the quarter ended September 30, 2020 and the full impact will continue to be seen in future periods. The average balance of BaaS-brokered deposits was $21.7 million for the three months ended September 30, 2020, which was up $8.9 million from the prior year period.  The average balance of savings accounts grew $21.4 million, or 40.8%, and the average balance of time deposits declined $29.6 million, or 30.8%, to $66.0 million in the three months ended September 30, 2020, compared to the three months ended September 30, 2019, in an intentional effort to focus more on core deposit growth.

We do not regularly advertise time deposit rates or money market rates, although we occasionally advertise promotional rates in targeted portions of our market area. Our branch managers, business development officers, and lenders collaborate to provide consistent and coordinated customer service and to seek deposits from new and existing customers.  

For the three months ended September 30, 2020, net interest margin (annualized net interest income divided by average total interest earning assets) and net interest spread (average yield on total interest earning assets minus average cost of total interest bearing liabilities) were 3.62% and 3.41%, respectively, compared to 4.29% and 3.81%, respectively, for the three months ended September 30, 2019.  

32

 

The following table presents an analysis of the average balances of net interest income, net interest spread and net interest margin for the periods indicated. Loan fees included in interest income totaled $2.7 million and $255,000 for the three months ended September 30, 2020 and 2019, respectively. A total of $2.4 million in PPP loan fees were recognized in the quarter ended September 30, 2020.  Yield on loans receivable was 4.33% for the three months ended September 30, 2020, compared to 5.36% for the three months ended September 30, 2019.  Excluding PPP loans, the yield on loans receivable was 4.78% for the three months ended September 30, 2020.  A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”   For the three months ended September 30, 2020 and 2019, the amount of interest income not recognized on nonaccrual loans was not material.

 

 

 

Average Balance Sheets

 

 

 

For the Three Months Ended September 30,

 

 

 

2020

 

 

2019

 

 

 

Average

 

 

Interest &

 

 

Yield /

 

 

Average

 

 

Interest &

 

 

Yield /

 

(Dollars in thousands)

 

Balance

 

 

Dividends

 

 

Cost (4)

 

 

Balance

 

 

Dividends

 

 

Cost (4)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest earning deposits

 

$

137,568

 

 

$

99

 

 

 

0.29

%

 

$

85,406

 

 

$

486

 

 

 

2.26

%

Investment securities, available for sale (1)

 

 

20,373

 

 

 

22

 

 

 

0.43

 

 

 

32,581

 

 

 

134

 

 

 

1.63

 

Investment securities, held to maturity (1)

 

 

3,509

 

 

 

5

 

 

 

0.57

 

 

 

4,393

 

 

 

34

 

 

 

3.07

 

Other investments

 

 

5,951

 

 

 

24

 

 

 

1.60

 

 

 

3,621

 

 

 

10

 

 

 

1.10

 

Loans receivable (2)

 

 

1,493,024

 

 

 

16,244

 

 

 

4.33

 

 

 

865,674

 

 

 

11,691

 

 

 

5.36

 

Total interest earning assets

 

 

1,660,425

 

 

 

16,394

 

 

 

3.93

 

 

 

991,675

 

 

 

12,355

 

 

 

4.94

 

Noninterest earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

 

(15,711

)

 

 

 

 

 

 

 

 

 

 

(10,548

)

 

 

 

 

 

 

 

 

Other noninterest earning assets

 

 

60,160

 

 

 

 

 

 

 

 

 

 

 

50,842

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,704,874

 

 

 

 

 

 

 

 

 

 

$

1,031,969

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing deposits

 

$

750,790

 

 

$

880

 

 

 

0.47

%

 

$

555,665

 

 

$

1,435

 

 

 

1.02

%

PPPLF borrowings

 

 

199,076

 

 

 

176

 

 

 

0.35

 

 

 

-

 

 

 

-

 

 

 

0.00

 

FHLB advances and other borrowings

 

 

24,999

 

 

 

71

 

 

 

1.13

 

 

 

539

 

 

 

3

 

 

 

2.21

 

Subordinated debt

 

 

9,987

 

 

 

148

 

 

 

5.90

 

 

 

9,973

 

 

 

148

 

 

 

5.89

 

Junior subordinated debentures

 

 

3,584

 

 

 

23

 

 

 

2.55

 

 

 

3,582

 

 

 

42

 

 

 

4.65

 

Total interest bearing liabilities

 

 

988,436

 

 

 

1,298

 

 

 

0.52

 

 

 

569,759

 

 

 

1,628

 

 

 

1.13

 

Noninterest bearing deposits

 

 

569,615

 

 

 

 

 

 

 

 

 

 

 

330,553

 

 

 

 

 

 

 

 

 

Other liabilities

 

 

12,781

 

 

 

 

 

 

 

 

 

 

 

12,756

 

 

 

 

 

 

 

 

 

Total shareholders' equity

 

 

134,042

 

 

 

 

 

 

 

 

 

 

 

118,901

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

 

$

1,704,874

 

 

 

 

 

 

 

 

 

 

$

1,031,969

 

 

 

 

 

 

 

 

 

Net interest income

 

 

 

 

 

$

15,096

 

 

 

 

 

 

 

 

 

 

$

10,727

 

 

 

 

 

Interest rate spread

 

 

 

 

 

 

 

 

 

 

3.41

%

 

 

 

 

 

 

 

 

 

 

3.81

%

Net interest margin (3)

 

 

 

 

 

 

 

 

 

 

3.62

%

 

 

 

 

 

 

 

 

 

 

4.29

%

(1)

For presentation in this table, average balances and the corresponding average rates for investment securities are based upon historical cost, adjusted for amortization of premiums and accretion of discounts.

(2)

Includes nonaccrual loans.

(3)

Net interest margin represents annualized net interest income divided by average total interest earning assets.

(4)

Yields and costs are annualized.

33

 

The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest earning assets and interest bearing liabilities and distinguishes between the changes attributable to changes in volume and changes attributable to changes in interest rates. The table illustrates the $6.8 million increase in loan interest income is attributed to an increase in loan volume.  This increase is partially offset by a $2.2 million decrease in loan interest income due to lower interest rates, however that decrease is largely due to low rate PPP loans, which yielded approximately 3.16%, after including the amortization of the deferred fees and costs, for the three months ended September 30, 2020.  For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to volume.  

 

 

 

Three Months Ended September 30, 2020

 

 

 

Compared to

 

 

 

Three Months Ended September 30, 2019

 

 

 

Increase (Decrease)

 

 

 

 

 

 

 

Due to

 

 

Total Increase

 

(Dollars in thousands)

 

Volume

 

 

Rate

 

 

(Decrease)

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

Interest earning deposits

 

$

37

 

 

$

(424

)

 

$

(387

)

Investment securities, available for sale

 

 

(13

)

 

 

(99

)

 

 

(112

)

Investment securities, held to maturity

 

 

(1

)

 

 

(28

)

 

 

(29

)

Other Investments

 

 

9

 

 

 

5

 

 

 

14

 

Loans receivable

 

 

6,800

 

 

 

(2,247

)

 

 

4,553

 

Total increase in interest income

 

 

6,832

 

 

 

(2,793

)

 

 

4,039

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing deposits

 

 

227

 

 

 

(782

)

 

 

(555

)

PPPLF borrowings

 

 

176

 

 

 

-

 

 

 

176

 

FHLB advances and other borrowings

 

 

69

 

 

 

(1

)

 

 

68

 

Subordinated debt

 

 

-

 

 

 

-

 

 

 

-

 

Junior subordinated debentures

 

 

-

 

 

 

(19

)

 

 

(19

)

Total increase in interest expense

 

 

472

 

 

 

(802

)

 

 

(330

)

Increase in net interest income

 

$

6,360

 

 

$

(1,991

)

 

$

4,369

 

Provision for Loan Losses

The provision for loan losses is an expense we incur to maintain an allowance for loan losses at a level that management deems appropriate to absorb inherent losses on existing loans. For a description of the factors taken into account by our management in determining the allowance for loan losses see “—Financial Condition—Allowance for Loan Losses.”

The provision for loan losses for the three months ended September 30, 2020 was $2.2 million, compared to $637,000 for the three months ended September 30, 2019. The allowance for loan losses as a percentage of loans was 1.13% at September 30, 2020, compared to 1.25% at September 30, 2019. For the three months ended September 30, 2020, there were $452.8 million in PPP loans included in our portfolio.  These loans are 100% guaranteed by the SBA, therefore we have not allocated any portion of our allowance to these 100% guaranteed loans.  The allowance for loan losses to loans receivable, excluding the guaranteed PPP loans, is 1.60%.  A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”  The provision for loan losses was increased due to an increase in qualitative factors related to the change in economic outlook caused by the COVID-19 pandemic along with loan growth.  We are not required to implement the provisions of the Current Expected Credit Loss (“CECL”) accounting standard until January 1, 2023, therefore we are continuing to account for the allowance for loan losses under the incurred loss model.  Credit quality has remained stable through September 30, 2020, as demonstrated by the low level of charge-offs and nonperforming loan balance.  Nonperforming loans increased $42,000 in the three months ended September 30, 2020, as compared to $4.4 million in the three months ended June 30, 2020.  Nonperforming assets to total assets was 0.26% at September 30, 2020 compared to 0.12% at September 30, 2019.  For a description of the Company’s nonperforming assets see “—Financial Condition—Nonperforming Assets.”

Pursuant to federal guidance, the Company deferred and/or modified payments on loans to assist customers financially during the COVID-19 pandemic and economic shutdown.  The majority of those loans have successfully returned to active status.  At September 30, 2020, the Company had 44 loans, or $52.5 million, that remained outstanding with deferred or modified payments, compared to $207.2 million, or 215 loans, as of June 30, 2020.   All of the loans that have migrated to active status are current, with 128 loans or $93.1 million, successfully resuming payments and 65 loans or $76.0 million back on active status with an initial

34

 

payment due in the fourth quarter of 2020.  In addition, $3.0 million of deferred and/or modified loans paid-in-full or closed as of September 30, 2020.  The purpose of this program was to provide cash flow relief for small businesses as they navigated through the uncertainty of the COVID-19 pandemic.  We believe that the Company’s deferral program was successful as evidenced by customers’ ability to migrate from deferral to active status and resume making payments as planned. However, as additional loans migrate to active status, we anticipate that there will be borrowers that are unable to resume making payments as planned.  There is uncertainty surrounding the economy, the continuation of unemployment benefits, stimulus payments, political uncertainty, and the continued restrictions on businesses, all of which lead to uncertainty with our customers and their ability to remain current on their financial obligations.  These factors all contributed to the additional reserve to loan losses that was made in the three months ended September 30, 2020.

Net charge-offs for the three months ended September 30, 2020 totaled $1,000, or 0.00% (annualized), of total average loans, as compared to $192,000, or 0.09% (annualized) of total average loans, for the three months ended September 30, 2019. The full extent of the short-term and long-term economic impact of the COVID-19 pandemic is unknown; however, we remain diligent in our efforts to communicate and proactively work with borrowers to help mitigate potential credit deterioration and loan losses.

Noninterest Income

Our primary sources of recurring noninterest income are deposit service charges and fees, BaaS fees, mortgage broker fees and loan referral fees. Noninterest income does not include loan origination fees including PPP loans fees, which to the extent they exceed the direct loan origination costs, are generally recognized over the life of the related loan as an adjustment to yield using the interest or similar method and recognized in interest and fees on loans as part of interest income.

For the three months ended September 30, 2020, noninterest income totaled $1.9 million, a decrease of $146,000, or 7.0%, compared to $2.1 million for the three months ended September 30, 2019.

The following table presents, for the periods indicated, the major categories of noninterest income:

 

 

 

Three Months

 

 

 

 

 

 

 

 

 

 

 

Ended September30,

 

 

Increase

 

 

Percent

 

(Dollars in thousands)

 

2020

 

 

2019

 

 

(Decrease)

 

 

Change

 

Deposit service charges and fees

 

$

824

 

 

$

795

 

 

$

29

 

 

 

3.6

%

BaaS fees

 

 

576

 

 

 

456

 

 

 

120

 

 

 

26.3

 

Loan referral fees

 

 

180

 

 

 

-

 

 

 

180

 

 

 

100.0

 

Mortgage broker fees

 

 

125

 

 

 

140

 

 

 

(15

)

 

 

(10.7

)

Gain on sales of loans, net

 

 

47

 

 

 

369

 

 

 

(322

)

 

 

(87.3

)

Gain on sale of securities, net

 

 

-

 

 

 

171

 

 

 

(171

)

 

 

(100.0

)

Other

 

 

190

 

 

 

157

 

 

 

33

 

 

 

21.0

 

Total noninterest income

 

$

1,942

 

 

$

2,088

 

 

$

(146

)

 

 

(7.0

)%

 

Deposit Service Charges and Fees. Deposit service charges and fees include service charges on accounts, point-of-sale fees, merchant services fees and overdraft fees. Together they constitute one of the largest components of our noninterest income. Deposit service charges were $824,000 for the three months ended September 30, 2020, an increase of $29,000, or 3.6%, from $795,000 over the same period in the prior year. The increase in deposit service charges and fees was primarily the result of $61,000 increase in point of sale fees partially offset by $32,000 less overdraft fee income in the quarter ended September 30, 2020 compared to the prior year period.

BaaS Fees. Our CCBX division provides BaaS offerings that enable our broker dealer and digital financial service providers to offer their customers banking services.  In exchange for providing these services, we earn fixed fees, volume-based fees and reimbursement of costs depending on the contract.  BaaS fee income for the three months ended September 30, 2020 was $576,000 compared to $456,000 for the three months ended September 30, 2019.  The increase is the result of adding additional CCBX customers to active and implementation status.  As of September 30, 2020, there were four active CCBX relationships, one in friends and family trials, four in onboarding/implementation, two signed letters of intent and a solid pipeline of potential new relationships.  As more CCBX customers move to active status, we expect that BaaS fees will increase.

Loan Referral Fees. We earn loan referral fees when we originate a variable rate loan and the borrower enters into an interest rate swap agreement with a third party to fix the interest rate for an extended period, usually 20 or 25 years. We recognize the loan referral fee for arranging the interest rate swap. By facilitating interest rate swaps to our clients, we are able to provide them with a long-term, fixed interest rate without assuming the interest rate risk. We had $180,000 in income from loan referral fees for the three months

35

 

ended September 30, 2020, compared to zero in the same period in the prior year. Interest rate volatility, swap rates, and the timing of loan closings all impact the demand for long-term fixed rate swaps. The recognition of loan referral fees fluctuates in response to these market conditions and as a result we may not recognize any, or recognize more or fewer, loan referral fees in some periods.

Mortgage Broker Fees. We earn mortgage broker fees for residential real estate loans that we broker through mortgage lenders. Mortgage broker fees decreased $15,000 in the three months ended September 30, 2020 to $125,000, compared to $140,000 in the same period in 2019 as a result of lower demand; however, low mortgage rates continue to make homes more affordable and mortgage refinancing an attractive option.  

Gain on Sales of Loans, net. Gain on sales of loans occurs when we sell in the secondary market the guaranteed portion (generally 75% of the principal balance) of the SBA and U.S. Department of Agriculture (“USDA”) loans that we originate. This activity fluctuates based on SBA and USDA loan activity.  Gain on sale of loans decreased $322,000, or 87.3%, to $47,000 for the three months ended September 30, 2020, compared to $369,000 for the same period in 2019 as a result of fewer SBA and USDA loans being originated and sold to the secondary market.  Our focus on loans in the second and third quarter of 2020 was on PPP loans administered by the SBA.

Gain on Sale of Securities, net. In the third quarter of 2019, we restructured our investment portfolio to improve the rate of return, interest rate and pricing risk on the portfolio.  As a result of this restructuring we were able to recognize $171,000 in net gains on the securities sold during the three months ended September 30, 2019 while decreasing the overall weighted average maturity of the investment portfolio.  No securities were sold in the three months ended September 30, 2020.

Other. This category includes a variety of other income-producing activities, lease and sublease income, annuity broker fees, and SBA and USDA servicing fees. Other noninterest income increased $33,000 in the three months ended September 30, 2020, compared to the same period in 2019 primarily from higher SBA and USDA servicing fee income.

Noninterest Expense

Generally, noninterest expense is composed of all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships and providing bank services. The largest component of noninterest expense is salaries and employee benefits. Noninterest expense also includes operational expenses, such as occupancy expense, data processing expense, legal and professional fees, director and staff expense and software licenses, maintenance and subscriptions.

For the three months ended September 30, 2020, noninterest expense totaled $9.7 million, an increase of $1.9 million, or 24.8%, compared to $7.7 million for the three months ended September 30, 2019.

The following table presents, for the periods indicated, the major categories of noninterest expense:

 

 

 

Three Months

 

 

 

 

 

 

 

 

 

 

 

Ended September 30,

 

 

Increase

 

 

Percent

 

(Dollars in thousands)

 

2020

 

 

2019

 

 

(Decrease)

 

 

Change

 

Salaries and employee benefits

 

$

5,971

 

 

$

4,971

 

 

$

1,000

 

 

 

20.1

%

Occupancy

 

 

1,091

 

 

 

884

 

 

 

207

 

 

 

23.4

 

Data processing

 

 

577

 

 

 

509

 

 

 

68

 

 

 

13.4

 

Legal and professional fees

 

 

381

 

 

 

170

 

 

 

211

 

 

 

124.1

 

Software licenses, maintenance and subscriptions

 

 

337

 

 

 

181

 

 

 

156

 

 

 

86.2

 

Excise taxes

 

 

291

 

 

 

184

 

 

 

107

 

 

 

58.2

 

Director and staff expenses

 

 

156

 

 

 

241

 

 

 

(85

)

 

 

(35.3

)

Federal Deposit Insurance Corporation (“FDIC”) assessments

 

 

148

 

 

 

(4

)

 

 

152

 

 

 

3800.0

 

Business development

 

 

72

 

 

 

122

 

 

 

(50

)

 

 

(41.0

)

Marketing

 

 

52

 

 

 

98

 

 

 

(46

)

 

 

(46.9

)

Other

 

 

590

 

 

 

392

 

 

 

198

 

 

 

50.5

 

Total noninterest expense

 

$

9,666

 

 

$

7,748

 

 

$

1,918

 

 

 

24.8

%

 

36

 

Salaries and Employee Benefits. Salaries and employee benefits are the largest component of noninterest expense and include payroll expense, incentive compensation costs, benefit plans, health insurance and payroll taxes. Salaries and employee benefits were $6.0 million for the three months ended September 30, 2020, an increase of $1.0 million, or 20.1%, compared to $5.0 million for the three months ended September 30, 2019. The increase was primarily due to continued hiring staff for our BaaS CCBX division and additional staff for our ongoing banking related growth initiatives, including hiring staff for opening our Arlington branch in June 2020, as well as employing temporary help to assist with operations related to the PPP loans. As our BaaS activities and customers grow, we expect to continue to add employees to support this line of business.  As of September 30, 2020, we had 234 full-time equivalent employees, compared to 192 at September 30, 2019, a 22.0% increase.

Occupancy. Occupancy expenses were $1.1 million for the three months ended September 30, 2020, compared to $884,000 for the three months ended September 30, 2019. This category includes building, leasehold, furniture, fixtures and equipment depreciation totaling $345,000 and $301,000 for the three months ended September 30, 2020 and 2019, respectively. Occupancy expenses increased as a result of $119,000 in a one-time building operating expense, with the opening of our 15th branch late in the second quarter of 2020 and as a result of the growth in CCBX.  As we continue to grow, we expect occupancy expenses to increase.  

Data Processing. Data processing costs were $577,000 for the three months ended September 30, 2020, compared to $509,000 for the three months ended September 30, 2019. Data processing costs include all of our customer transaction processing and data storage, computer processing, and network costs.  Data processing costs grow as we grow and add new products, customers and branches.  Additionally, CCBX data processing expenses are included in this category and are expected to increase incrementally as the CCBX division grows.

Legal and Professional Fees. Legal and professional costs were $381,000 for the quarter ended September 30, 2020, compared to $170,000 for the quarter ended September 30, 2019.  Legal and professional costs fluctuate with the development of contracts for CCBX customers and are also impacted by our reporting cycle and timing of legal and professional services.  The increase in legal and professional expenses is associated with BaaS activities through CCBX operations and higher costs related to legal and accounting work related to reporting.

Software Licenses, Maintenance and Subscriptions. Software licenses, maintenance and subscriptions includes expenses related to obtaining and maintaining software required for various functions throughout the Company.   Software licenses, maintenance and subscriptions were $337,000 for the quarter ended September 30, 2020, compared to $181,000 for the prior year period.  Late in 2019, we changed how we were expensing these costs, consolidating all related expenses to one category, which contributed to the increase over the prior year period.  Additionally, software related expenses are expected to continue to increase as we grow product lines and our CCBX division.     

Excise Taxes. Excise taxes were $291,000 for the three months ended September 30, 2020, compared to $184,000 for the three months ended September 30, 2019.  Excise taxes are based on gross income of $18.4 million and $14.4 million for the three months ended September 30, 2020 and 2019, respectively.  Gross income is reduced by certain allowed deductions to arrive at the taxable base; however, as gross income increases, so does the excise tax expense.  In addition, the tax rate that is applied to our industry increased 25 basis points effective April 1, 2020, which contributed to the increase in excise tax.

Director and Staff Expenses. Director and staff expenses includes compensation for director service, continuing education for employees and other director and staff related expenses.   Director and staff expenses were $156,000 for the three months ended September 30, 2020, compared to $241,000 for the three months ended September 30, 2019, a decrease of 85,000 or 35.3%.  Decreased expenses related to employee travel as a result of restrictions related to the COVID-19 pandemic contributed to the decrease in the quarter ended September 30, 2020 compared to quarter ended September 30, 2019.  

FDIC Assessments. FDIC assessments are assessed to fund the Deposit Insurance Fund (“DIF”) to insure and protect the depositors of insured banks and to resolve failed banks.  The assessment rate is based on a number of factors and recalculated each quarter.  FDIC assessments were $148,000 for the three months ended September 30, 2020, compared to $4,000 credit for the three months ended September 30, 2019, an increase of $152,000.  The DIF’s reserve was in excess of the required ratio in 2019, resulting in a credit for the three months ended September 30, 2019 based on past activity and payments.  The DIF reserve ratio is currently below the required ratio.  

Business Development. Business development costs were $72,000 for the three months ended September 30, 2020, compared to $122,000 for the three months ended September 30, 2019.  Business development costs include sponsorships and other activities to cultivate business and community development.  As expected, these expenses were reduced as a result of restrictions on in person meetings and business related activities due to the COVID-19 pandemic.

Marketing. Marketing costs were $52,000 for the three months ended September 30, 2020, compared to $98,000 for the three months ended September 30, 2019.  Marketing costs decreased year over year due to a conscious effort to reduce general advertising costs

37

 

during the COVID-19 pandemic. The bank is using more cost-effective advertising options; however, we expect to see advertising expenses increase as we deploy more branding and targeted advertising.

Other. This category includes dues and memberships, office supplies, mail services, telephone, examination fees, internal loan expenses, services charges from banks, operational losses, directors and officer’s insurance, donations, provision for unfunded commitments, and miscellaneous other expenses. Other noninterest expense was $590,000 for the three months ended September 30, 2020, compared to $392,000 for the three months ended September 30, 2019. The increase was largely due to a $191,000 increase in BaaS expenses and overall growth for the three months ended September 30, 2020, as compared to the same period last year.

Income Tax Expense

The amount of income tax expense we incur is impacted by the amounts of our pre-tax income, tax-exempt income and other nondeductible expenses. Deferred tax assets and liabilities are reflected at current income tax rates in effect for the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are established when necessary to reduce our deferred tax assets to the amount expected to be realized. For the three months ended September 30, 2020, income tax expense totaled $1.1 million, compared to $919,000 for the three months ended September 30, 2019. Our effective tax rates for the three months ended September 30, 2020 and 2019 were 20.9% and 20.7%, respectively.

38

 

Comparison of Operating Results for the Nine months ended September 30, 2020 and September 30, 2019

Results of Operations

Net Income

Net income for the nine months ended September 30, 2020, was $10.5 million, or $0.86 per diluted share, compared to $9.6 million, or $0.79 per diluted share, for the nine months ended September 30, 2019. The increase in net income over the comparable period in the prior year was attributable to a $9.8 million increase in net interest income, largely related to organic loan growth combined with growth from PPP loans, partially offset by a $4.0 million  increase in the provision for loan losses, related to an increase in qualitative factors related to the change in the economic outlook caused by the COVID-19 pandemic along with the growth in the loan portfolio, and $4.6 million increase in noninterest expense, which includes $2.8 million more in salaries and employee benefits and $306,000 more in legal and professional fees. Salaries and employee benefits were increased largely as a result of hiring staff for our BaaS CCBX division. Legal and professional fees increased due to BaaS activities through our CCBX division and as a result of higher costs related to legal and accounting work related to reporting.  

Net Interest Income

Net interest income for the nine months ended September 30, 2020, was $40.5 million, compared to $30.7 million for the nine months ended September 30, 2019, an increase of $9.8 million, or 31.9%. The increase in net interest income consisted of $11.0 million, or 33.3%, in increased loan interest income.  An increase in loan volume drove income up, despite a decrease in interest rates.  Additionally, interest expense on deposits decreased $761,000, or 17.7%, and was partially offset by $375,000, or 64.4%, increase in interest on borrowed funds.  

The increase in interest income was primarily attributable to a $445.1 million, or 54.2%, increase in average loans outstanding for the nine months ended September 30, 2020, compared to the prior year period, partially offset by a 73 basis point decrease in yield on loans.  The decrease in loan yields, as compared to the prior year period, was the result of the FOMC lowering rates five times since June 2019, totaling 2.25%, which resulted in lower rates on new and renewing loans as well as loans tied to indexes.  In addition, for the nine months ended September 30, 2020 there was an average of $261.9 million in PPP loans, which have a 1.0% interest rate and an approximate yield of 3.23% after including the amortization of deferred fees and costs.  Contractual loan yields approximated 4.08% for the nine months ended September 30, 2020 compared to 5.23% for the nine months ended September 30, 2019.   Excluding PPP loans, the contractual loan yield approximated 4.86%.  A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”  Although we have rate floors in place for $361.8 million, or 23.8%, in existing loans, the rate reductions by the FOMC have had a corresponding impact on loan yields and subsequently the net interest margin in future periods. We expect that the FOMC will maintain the Fed funds rate low for some time.  We have continued to focus on our loan growth initiatives, but most recently much of our focus has been on working with small businesses within our communities, providing assistance as business owners navigate through the uncertainty and change resulting from the COVID-19 pandemic.  We experienced a significant increase in commercial and industrial loans during the second and third quarters of 2020, as small business owners applied for financial assistance via the PPP through the SBA as prescribed in the CARES Act.

The decrease in interest expense for the nine months ended September 30, 2020 was the result of a $761,000 decrease in interest expense on deposit accounts partially offset by a $375,000 increase in interest on borrowed funds.  Cost of funds decreased 29 basis points to 0.45% as of September 30, 2020, compared to 0.74% at September 30, 2019.  The increases in noninterest bearing and low rate interest bearing deposits helped contribute to the improved cost of funds for the nine months ended September 30, 2020, as compared to the prior year period.  We gained new customer relationships by making PPP loans to noncustomers and they continued to move their banking/deposit relationships to the Bank.  The increase in borrowed funds is largely the result of utilizing the PPPLF to help fund PPP loans as disbursements are withdrawn from deposit accounts.  The PPPLF extends low cost borrowing lines, 0.35% interest rate, to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. Borrowings are required to be paid down as the pledged PPP loans are paid down or forgiven.  The average balance for the nine months ended September 30, 2020 was $102.5 million, resulting in $269,000 in interest expense.

The average balance of interest-bearing deposits increased $136.9 million, or 24.5%, compared to the prior year period, but the average rate paid on interest bearing deposits was 35 basis points less for the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019.  As previously discussed, the Fed funds rate reductions by the FOMC have impacted the rates that are paid on interest bearing accounts and management lowered deposit rates in response to these rate reductions.  The average rate

39

 

paid on BaaS-brokered deposits decreased 1.72% and NOW and money market accounts decreased 21 basis points for the nine months ended September 30, 2020.  The average rate paid on BaaS-brokered deposits was higher in the nine months ended September 30, 2019 as a result of the temporary rate negotiated for BaaS-brokered deposits for that period.   The average rate paid on time deposits also decreased.  For time deposits less than $100,000 the rate decreased 19 basis points and for time deposits over $100,000 the average rate decreased 36 basis points, as compared to the prior year period.  The average rate paid on NOW, money market, and time deposit accounts in the nine months ended September 30, 2020 is the result of the recent decreased Fed funds rate and management lowering rates in response.  We continue to evaluate rates and anticipate that additional rates reductions may occur in the fourth quarter. Many deposit rates were either lowered late in the first quarter or at the start of the second quarter of 2020, and some were further decreased at the start of the third quarter, so the impact of these reductions will continue to be seen in future periods.  The average balance of NOW and money market accounts grew $155.5 million, or 41.4%, in the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019.  The average balance of BaaS-brokered deposits was $21.8 million for the nine months ended September 30, 2020, which was down $13.6 million, or 38.4%, from the prior year period. The higher balance in the prior year period was the result of a temporary increase in BaaS deposits for that period, and a subsequent planned exit of balances.  The average balance of savings accounts grew $12.8 million, or 24.5%, and the average balance of time deposits declined $17.8 million, or 18.5%, to $78.2 million in the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019, in an intentional effort to focus on more on core deposit growth.

We do not regularly advertise time deposit rates or money market rates, although we occasionally advertise promotional rates in targeted portions of our market area. Our branch managers, business development officers, and lenders collaborate to provide consistent and coordinated customer service and to seek deposits from new and existing customers.  

For the nine months ended September 30, 2020, net interest margin and net interest spread were 3.81% and 3.51%, respectively, compared to 4.22% and 3.76%, respectively, for the nine months ended September 30, 2019.  

The following table presents an analysis of the average balances of net interest income, net interest spread and net interest margin for the periods indicated. Loan fees included in interest income totaled $5.3 million and $920,000 for the nine months ended September 30, 2020 and 2019, respectively. The increase in loan fees for the nine months ended September 30, 2020 is due to the PPP loans.  Yield on loans receivable was 4.65% for the nine months ended September 30, 2020, compared to 5.38% for the nine months ended September 30, 2019.  Excluding PPP loans, the yield on loans receivable was 4.99% for the nine months ended September 30, 2020.  A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.” For the nine months ended September 30, 2020 and 2019, the amount of interest income not recognized on nonaccrual loans was not material.

40

 

 

 

 

Average balance sheets

 

 

 

For the Nine Months Ended September 30,

 

 

 

2020

 

 

2019

 

 

 

Average

 

 

Interest &

 

 

Yield /

 

 

Average

 

 

Interest &

 

 

Yield /

 

(Dollars in thousands)

 

Balance

 

 

Dividends

 

 

Cost (4)

 

 

Balance

 

 

Dividends

 

 

Cost (4)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest earning deposits

 

$

122,941

 

 

$

587

 

 

 

0.64

%

 

$

108,230

 

 

$

1,946

 

 

 

2.40

%

Investment securities, available for sale (1)

 

 

20,302

 

 

 

155

 

 

 

1.02

 

 

 

36,367

 

 

 

425

 

 

 

1.56

 

Investment securities, held to maturity (1)

 

 

3,950

 

 

 

44

 

 

 

1.49

 

 

 

2,516

 

 

 

56

 

 

 

2.98

 

Other Investments

 

 

5,435

 

 

 

129

 

 

 

3.17

 

 

 

3,479

 

 

 

99

 

 

 

3.80

 

Loans receivable (2)

 

 

1,265,705

 

 

 

44,025

 

 

 

4.65

 

 

 

820,560

 

 

 

33,027

 

 

 

5.38

 

Total interest earning assets

 

 

1,418,333

 

 

 

44,940

 

 

 

4.23

 

 

 

971,152

 

 

 

35,553

 

 

 

4.89

 

Noninterest earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

 

(13,651

)

 

 

 

 

 

 

 

 

 

 

(10,068

)

 

 

 

 

 

 

 

 

Other noninterest earning assets

 

 

57,830

 

 

 

 

 

 

 

 

 

 

 

49,536

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,462,512

 

 

 

 

 

 

 

 

 

 

$

1,010,620

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing deposits

 

$

696,051

 

 

$

3,530

 

 

 

0.68

%

 

$

559,119

 

 

$

4,291

 

 

 

1.03

%

PPPLF borrowings

 

 

102,527

 

 

 

269

 

 

 

0.35

 

 

 

-

 

 

 

-

 

 

 

0.00

 

FHLB advances and other borrowings

 

 

19,304

 

 

 

164

 

 

 

1.13

 

 

 

794

 

 

 

14

 

 

 

2.36

 

Subordinated debt

 

 

9,984

 

 

 

441

 

 

 

5.90

 

 

 

9,970

 

 

 

439

 

 

 

5.89

 

Junior subordinated debentures

 

 

3,583

 

 

 

83

 

 

 

3.09

 

 

 

3,582

 

 

 

129

 

 

 

4.81

 

Total interest bearing liabilities

 

 

831,449

 

 

 

4,487

 

 

 

0.72

 

 

 

573,465

 

 

 

4,873

 

 

 

1.14

 

Noninterest bearing deposits

 

 

488,296

 

 

 

 

 

 

 

 

 

 

 

309,270

 

 

 

 

 

 

 

 

 

Other liabilities

 

 

12,607

 

 

 

 

 

 

 

 

 

 

 

12,971

 

 

 

 

 

 

 

 

 

Total shareholders' equity

 

 

130,160

 

 

 

 

 

 

 

 

 

 

 

114,914

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

 

$

1,462,512

 

 

 

 

 

 

 

 

 

 

$

1,010,620

 

 

 

 

 

 

 

 

 

Net interest income

 

 

 

 

 

$

40,453

 

 

 

 

 

 

 

 

 

 

$

30,680

 

 

 

 

 

Interest rate spread

 

 

 

 

 

 

 

 

 

 

3.51

%

 

 

 

 

 

 

 

 

 

 

3.76

%

Net interest margin (3)

 

 

 

 

 

 

 

 

 

 

3.81

%

 

 

 

 

 

 

 

 

 

 

4.22

%

 

 

(1)

For presentation in this table, average balances and the corresponding average rates for investment securities are based upon historical cost, adjusted for amortization of premiums and accretion of discounts.

 

(2)

Includes nonaccrual loans.

 

(3)

Net interest margin represents annualized net interest income divided by average total interest earning assets.

 

(4)

Yields and costs are annualized.

41

 

The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest earning assets and interest bearing liabilities and distinguishes between the changes attributable to changes in volume and changes attributable to changes in interest rates.  This table illustrates the $15.5 million increase in loan interest income as a result of increased loan volume was significantly more than the $4.5 million decrease in interest income due to lower interest rates on loans, resulting in an overall increase in loan interest income for the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019.  Similarly, the volume of interest bearing deposits has increased by $702,000, but the reduced interest rate paid on interest bearing deposits resulted in an overall decrease in interest expense on interest bearing deposits for the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019.  For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to volume.  

 

 

 

Nine Months Ended September 30, 2020

 

 

 

Compared to

 

 

 

Nine Months Ended September 30, 2019

 

 

 

Increase (Decrease)

 

 

 

 

 

 

 

Due to

 

 

Total Increase

 

(Dollars in thousands)

 

Volume

 

 

Rate

 

 

(Decrease)

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

Interest earning deposits

 

$

76

 

 

$

(1,435

)

 

$

(1,359

)

Investment securities, available for sale

 

 

(122

)

 

 

(148

)

 

 

(270

)

Investment securities, held to maturity

 

 

16

 

 

 

(28

)

 

 

(12

)

Other Investments

 

 

47

 

 

 

(17

)

 

 

30

 

Loans receivable

 

 

15,526

 

 

 

(4,528

)

 

 

10,998

 

Total increase in interest income

 

 

15,543

 

 

 

(6,156

)

 

 

9,387

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing deposits

 

 

702

 

 

 

(1,463

)

 

 

(761

)

PPPLF borrowings

 

 

269

 

 

 

-

 

 

 

269

 

FHLB advances

 

 

157

 

 

 

(7

)

 

 

150

 

Subordinated debt

 

 

1

 

 

 

1

 

 

 

2

 

Junior subordinated debentures

 

 

-

 

 

 

(46

)

 

 

(46

)

Total increase in interest expense

 

 

1,129

 

 

 

(1,515

)

 

 

(386

)

Increase in net interest income

 

$

14,414

 

 

$

(4,641

)

 

$

9,773

 

Provision for Loan Losses

The provision for loan losses is an expense we incur to maintain an allowance for loan losses at a level that management deems appropriate to absorb inherent losses on existing loans. For a description of the factors taken into account by our management in determining the allowance for loan losses see “—Financial Condition—Allowance for Loan Losses.”

The provision for loan losses for the nine months ended September 30, 2020 was $5.7 million, compared to $1.7 million for the nine months ended September 30, 2019. The allowance for loan losses as a percentage of loans was 1.13% at September 30, 2020, compared to 1.25% at September 30, 2019. As of September 30, 2020, there were $452.8 million in PPP loans in our portfolio.  These loans are 100% guaranteed by the SBA and we have not allocated any portion of our allowance to these 100% guaranteed loans.  The allowance for loan losses to loans receivable, excluding the guaranteed PPP loans, is 1.60%.  A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”  The provision for loan losses was increased due to an increase in qualitative factors related to the change in economic outlook caused by the COVID-19 pandemic along with loan growth.  We are not required to implement the provisions of the CECL accounting standard until January 1, 2023, therefore we are continuing to account for the allowance for loan losses under the incurred loss model.  We are working with customers impacted by COVID-19 and have deferred or modified payments in accordance with federal guidance on $52.5 million as of September 30, 2020, compared to $207.2 million as of June 30, 2020.  Credit quality has remained stable through September 30, 2020, as demonstrated by the low level of charge-offs and nonperforming loan balance. Nonperforming assets to total assets was 0.26% at September 30, 2020 compared to 0.12% at September 30, 2019.  For a description of the Company's nonperforming assets, see "—Financial Condition—Nonperforming Assets."

Pursuant to federal guidance, the Company deferred and/or modified payments on loans to assist customers financially during the COVID-19 pandemic and economic shutdown.  The majority of those loans have successfully returned to active status.  At September 30, 2020, the Company had 44 loans, or $52.5 million, that remained outstanding with deferred or modified payments, compared to $207.2 million, or 215 loans, as of June 30, 2020.   All of the loans that have migrated to active status are current, with

42

 

128 loans or $93.1 million, successfully resuming payments and 65 loans or $76.0 million back on active status with an initial payment due in the fourth quarter of 2020.  In addition, $3.0 million of deferred and/or modified loans paid-in-full or closed as of September 30, 2020.  The purpose of this program was to provide cash flow relief for small businesses as they navigated through the uncertainty of the COVID-19 pandemic.  We believe that the Company’s deferral program was successful as evidenced by customers’ ability to migrate from deferral to active status and resume making payments as planned. However, as additional loans migrate to active status, we anticipate that there will be borrowers that are unable to resume making payments as planned.  There is uncertainty surrounding the economy, the continuation of unemployment benefits, stimulus payments, political uncertainty, and the continued restrictions on businesses, all of which lead to uncertainty with our customers and their ability to remain current on their financial obligations. These factors all contributed to the additional reserve to loan losses that was made in the nine months ended September 30, 2020.  

Net charge-offs for the nine months ended September 30, 2020 totaled $132,000, or 0.01% (annualized) of total average loans, as compared to $243,000, or 0.04% (annualized) of total average loans, for the nine months ended September 30, 2019. The full extent of the short-term and long-term economic impact of the COVID-19 pandemic is unknown; however, we remain diligent in our efforts to communicate and proactively work with borrowers to help mitigate potential credit deterioration and future losses.

Noninterest Income

Our primary sources of recurring noninterest income are deposit service charges and fees, loan referral fees, BaaS fees, and mortgage broker fees. Noninterest income does not include loan origination fees, including PPP loan fees, which are generally recognized over the life of the related loan as an adjustment to yield using the interest or similar method and recognized in interest and fees on loans as part of interest income.

For the nine months ended September 30, 2020, noninterest income totaled $6.1 million, a decrease of $71,000, or 1.1%, compared to $6.2 million for the nine months ended September 30, 2019.

The following table presents, for the periods indicated, the major categories of noninterest income:

 

 

 

Nine Months

 

 

 

 

 

 

 

 

 

 

 

Ended September 30,

 

 

Increase

 

 

Percent

 

(Dollars in thousands)

 

2020

 

 

2019

 

 

(Decrease)

 

 

Change

 

Deposit service charges and fees

 

$

2,224

 

 

$

2,302

 

 

$

(78

)

 

 

(3.5

)%

BaaS fees

 

 

1,630

 

 

 

1,404

 

 

 

226

 

 

 

16.1

 

Loan referral fees

 

 

1,303

 

 

 

1,106

 

 

 

197

 

 

 

17.8

 

Mortgage broker fees

 

 

439

 

 

 

336

 

 

 

103

 

 

 

30.7

 

Gain on sales of loans, net

 

 

47

 

 

 

490

 

 

 

(443

)

 

 

(90.4

)

Gain on sales of securities, net

 

 

-

 

 

 

171

 

 

 

(171

)

 

 

(100.0

)

Other

 

 

490

 

 

 

395

 

 

 

95

 

 

 

24.1

 

Total noninterest income

 

$

6,133

 

 

$

6,204

 

 

$

(71

)

 

 

(1.1

)%

 

Deposit Service Charges and Fees. Deposit service charges and fees include service charges on accounts, point-of-sale fees, merchant services fees and overdraft fees. Together they constitute one of the largest components of our noninterest income. Deposit service charges were $2.2 million for the nine months ended September 30, 2020, a decrease of $78,000, or 3.5%, from $2.3 million over the same period in the prior year. The decrease in deposit service charges and fees was primarily the result of $118,000 less overdraft fee income in the nine months ended September 30, 2020 compared to the prior year period which may be attributed to the stay-at-home order in place for Washington State during part of the first half of 2020, and overall reduced activity as a result of COVID-19 restrictions.  An increase in point-of-sale fees of $49,000 partially offset some of these reductions.

BaaS Fees. Our CCBX division provides BaaS offerings that enable our broker dealer and digital financial service providers to offer their customers banking services.  In exchange for providing these services, we earn fixed fees, volume-based fees and reimbursement of costs depending on the contract.  BaaS fee income for the nine months ended September 30, 2020 was $1.6 million compared to $1.4 million for the nine months ended September 30, 2019.  The increase is the result of increased relationships with broker dealers and digital financial service providers.  At September 30, 2020 there were four active CCBX relationships, one in friends and family trials, four in onboarding/implementation, two signed letters of intent and a solid pipeline of potential new relationships.  As more CCBX customers move to active status, we expect that BaaS fees will increase.

43

 

Loan Referral Fees. We earn loan referral fees when we originate a variable rate loan and the borrower enters into an interest rate swap agreement with a third party to fix the interest rate for an extended period, usually 20 or 25 years. We recognize the loan referral fee for arranging the interest rate swap. By facilitating interest rate swaps to our clients, we are able to provide them with a long-term, fixed interest rate without assuming the interest rate risk. We had $1.3 million in income from loan referral fees for the nine months ended September 30, 2020 compared to $1.1 million for the nine months ended September 30, 2019. Interest rate volatility, swap rates, and the timing of loan closings all impact the demand for long-term fixed rate swaps. The recognition of loan referral fees fluctuates in response to these market conditions and as a result we may not recognize any, or recognize more or fewer, loan referral fees in some periods.

Mortgage Broker Fees. We earn mortgage broker fees for residential real estate loans that we broker through mortgage lenders. Mortgage broker fees increased $103,000 in the nine months ended September 30, 2020 to $439,000, compared to $336,000 in the same period in 2019 as a result of increased demand from lower interest rates on mortgages which continue to make homes more affordable and mortgage refinancing an attractive option.

Gain on Sales of Loans, net. Gain on sales of loans occurs when we sell in the secondary market the guaranteed portion (generally 75% of the principal balance) of the SBA and USDA loans that we originate. This activity fluctuates based on SBA and USDA loan activity.  Income from the sale of loans was $47,000 for the nine months ended September 30, 2020, compared to $490,000 for the nine months ended September 30, 2019, a decrease of $443,000 or 90.4%, as a result of fewer SBA and USDA loans being originated and sold to the secondary market.

Gain on Sale of Securities, net. In the third quarter of 2019, we restructured our investment portfolio to improve the rate of return, interest rate and pricing risk on the portfolio.  As a result of this restructuring we were able to recognize $171,000 in net gains on the securities sold during the nine months ended September 30, 2019 while decreasing the overall weighted average maturity of the investment portfolio.  No securities were sold in the nine months ended September 30, 2020.

Other. This category includes a variety of other income-producing activities, annuity broker fees, and SBA and USDA servicing fees. Other noninterest income increased $95,000 in the nine months ended September 30, 2020, compared to the same period in 2019 primarily as a result of higher SBA and USDA servicing fees and higher lease and sublease income.

Noninterest Expense

Generally, noninterest expense is composed of all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships and providing bank services. The largest component of noninterest expense is salaries and employee benefits. Noninterest expense also includes operational expenses, such as occupancy expense, data processing expense, legal and professional fees, director and staff expense and software licenses, maintenance and subscriptions.

For the nine months ended September 30, 2020, noninterest expense totaled $27.6 million, an increase of $4.6 million, or 19.9%, compared to $23.1 million for the nine months ended September 30, 2019.

The following table presents, for the periods indicated, the major categories of noninterest expense:

 

 

 

Nine Months

 

 

 

 

 

 

 

 

 

 

 

Ended September 30,

 

 

Increase

 

 

Percent

 

(Dollars in thousands)

 

2020

 

 

2019

 

 

(Decrease)

 

 

Change

 

Salaries and employee benefits

 

$

16,869

 

 

$

14,058

 

 

$

2,811

 

 

 

20.0

%

Occupancy

 

 

2,951

 

 

 

2,808

 

 

 

143

 

 

 

5.1

 

Data processing

 

 

1,749

 

 

 

1,537

 

 

 

212

 

 

 

13.8

 

Legal and professional fees

 

 

1,178

 

 

 

872

 

 

 

306

 

 

 

35.1

 

Software licenses, maintenance and subscriptions

 

 

919

 

 

 

501

 

 

 

418

 

 

 

83.4

 

Excise taxes

 

 

756

 

 

 

529

 

 

 

227

 

 

 

42.9

 

Director and staff expenses

 

 

613

 

 

 

698

 

 

 

(85

)

 

 

(12.2

)

FDIC assessments

 

 

292

 

 

 

205

 

 

 

87

 

 

 

42.4

 

Marketing

 

 

280

 

 

 

300

 

 

 

(20

)

 

 

(6.7

)

Business development

 

 

245

 

 

 

320

 

 

 

(75

)

 

 

(23.4

)

Other

 

 

1,778

 

 

 

1,225

 

 

 

553

 

 

 

45.1

 

Total noninterest expense

 

$

27,630

 

 

$

23,053

 

 

$

4,577

 

 

 

19.9

%

 

44

 

Salaries and Employee Benefits. Salaries and employee benefits are the largest component of noninterest expense and include payroll expense, incentive compensation costs, benefit plans, health insurance and payroll taxes. Salaries and employee benefits were $16.9 million for the nine months ended September 30, 2020, an increase of $2.8 million, or 20.0%, compared to $14.1 million for the nine months ended September 30, 2019. The increase was primarily due to continued hiring staff for our BaaS CCBX division and additional staff for our ongoing banking related growth initiatives, as well as employing temporary help to assist with operations related to the PPP loans. The increase in expense would have been greater if not for an increase in deferred loan costs recorded as salary offsets, largely from originating PPP loans, which was $1.4 million higher and lowered expense by that same amount, for the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019. As our BaaS banking activities grow, we expect to continue to add employees to support this line of business.  As of September 30, 2020, we had 234 full-time equivalent employees, compared to 192 at September 30, 2019, a 22.0% increase.

Occupancy. Occupancy expenses were $3.0 million for the nine months ended September 30, 2020 compared to $2.8 million for the nine months ended September 30, 2019, an increase of $143,000 or 5.1%. This category includes building, leasehold, furniture, fixtures and equipment depreciation totaling $965,000 and $907,000 for the nine months ended September 30, 2020 and 2019, respectively. Occupancy expenses increased $143,000 year over year largely as the result of the opening of our 15th branch late in the second quarter of 2020.  As we continue to grow, we expect occupancy expenses to increase.  

Data Processing. Data processing costs were $1.7 million for the nine months ended September 30, 2020, compared to $1.5 million for the nine months ended September 30, 2019. Data processing costs include all of our customer transaction processing and data storage, computer processing, and network costs.  Data processing costs grow as we add new products, customers and branches.  Additionally, CCBX data processing expenses are included in this category and are expected to increase incrementally as the CCBX division expands.

Legal and Professional Fees. Legal and professional costs were $1.2 million for the nine months ended September 30, 2020 compared to $872,000 for the nine months ended September 30, 2019.  Legal and professional costs fluctuate with the development of contracts for CCBX customers and are also impacted by our reporting cycle and timing of legal services.  

Software Licenses, Maintenance and Subscriptions. Software licenses, maintenance and subscriptions includes expenses related to obtaining and maintaining software required for various functions throughout the Company.   Software licenses, maintenance and subscriptions were $919,000 for the quarter ended September 30, 2020, compared to $501,000 for the prior year period.  Late in 2019, we changed how we were expensing these costs, consolidating all related expenses to one category, which contributed to the increase over the prior year period.  Software related expenses is expected to continue to increase as we grow product lines and expand our CCBX division.     

Excise Taxes. Excise taxes were $756,000 for the nine months ended September 30, 2020, compared to $529,000 for the nine months ended September 30, 2019.  Excise taxes are based on gross income of $51.1 million and $41.8 million for the nine months ended September 30, 2020 and 2019, respectively.  Gross income is reduced by certain allowed deductions to arrive at the taxable base; however, as gross income increases, so does the excise tax expense.  In addition, the tax rate that is applied to our industry increased 25 basis points effective April 1, 2020, which contributed to the increase in excise taxes.

Director and Staff Expenses. Director and staff expenses includes compensation for director service, continuing education for employees and other director and staff related expenses.   Director and staff expenses were $613,000 for the nine months ended September 30, 2020 and $698,000 for the nine months ended September 30, 2019, a decrease of $85,000.  The decrease is the result of decreased expenses related to employee travel expenses as a result of restrictions related to COVID-19 partially offset by increased training expenses in the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019.  

FDIC Assessments. FDIC assessments are assessed to fund the DIF to insure and protect the depositors of insured banks and to resolve failed banks.  The assessment rate is based on a number of factors and is recalculated each quarter.  FDIC assessments were $292,000 for the nine months ended September 30, 2020, compared to $205,000 for the nine months ended September 30, 2019, an increase of $87,000.  The DIF’s reserve was in excess of the required ratio in 2019, resulting in a credit for the third quarter of 2019, reducing the amount assessed.  

Marketing. Marketing costs were $280,000 for the nine months ended September 30, 2020, compared to $300,000 for the nine months ended September 30, 2019.  Marketing costs decreased year over year due to a conscious effort to reduce general advertising costs during the COVID-19 pandemic. The bank is using more cost-effective advertising options; however, we expect to see advertising expenses increase as we deploy more branding and targeted advertising.

Business Development. Business development costs were $245,000 for the nine months ended September 30, 2020, compared to $320,000 for the nine months ended September 30, 2019.  Business development costs include sponsorships and other activities to

45

 

cultivate business and community development.  As expected, these expenses were reduced as a result of restrictions on in person meetings and business related activities due to the COVID-19 pandemic.

Other. This category includes dues and memberships, office supplies, mail services, telephone, examination fees, internal loan expenses, services charges from banks, operational losses, directors and officer’s insurance, donations, provision for unfunded commitments, and miscellaneous other expenses. Other noninterest expenses were $1.8 million for the nine months ended September 30, 2020, compared to $1.2 million for the nine months ended September 30, 2019. The increase was largely due to a $108,000 increase in bank examination fees, $56,000 increase in telephone costs, $47,000 increase in service charges from banks, $42,000 increase in operational losses, $32,000 increase in donations and overall increases resulting from growth for the nine months ended September 30, 2020, as compared to the same period last year.

Income Tax Expense

The amount of income tax expense we incur is impacted by the amounts of our pre-tax income, tax-exempt income and other nondeductible expenses. Deferred tax assets and liabilities are reflected at current income tax rates in effect for the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are established when necessary to reduce our deferred tax assets to the amount expected to be realized. For the nine months ended September 30, 2020, income tax expense totaled $2.8 million, compared to $2.5 million for the nine months ended September 30, 2019. Our effective tax rates for the nine months ended September 30, 2020 and 2019, was 20.9% and 20.8%, respectively.

46

 

Financial Condition

The Company’s total assets increased $621.1 million, or 55.0%, to $1.75 billion at September 30, 2020 from $1.13 billion at December 31, 2019.  The increase is primarily the result of $570.3 million in gross loan growth during the nine months ended September 30, 2020.  Included in the loan growth is $452.8 million in PPP loans.  These PPP loans are 100% guaranteed by the SBA and have a rate of 1.0%, an approximate yield of 3.23%.  Interest earning deposits with other banks also increased $56.8 million, compared to September 30, 2019.  

Loan Portfolio

The quarter ended September 30, 2020 closed with the global COVID-19 pandemic continuing to impact the economic health of our community and nation.  The provision for loan losses allowances was $5.7 million during the nine months ended September 30, 2020, as a result of an increase in qualitative factors related to uncertainties in the economic outlook from the COVID-19 pandemic and loan growth.  As a preferred SBA lender, we worked diligently with the SBA in the second quarter and third quarters of 2020 to offer assistance to small businesses as provided in the CARES Act, which significantly increased our loan totals.  These SBA loans are discussed further in this section under “Commercial and Industrial Loans”.  As part of our ongoing commitment to our customers we have been proactive in contacting customers impacted by the stay-at-home order in Washington State, temporary business closures, or that have otherwise been impacted by the COVID-19 pandemic and responses thereto.  In addition to the PPP loans we made to assist customers, as of September 30, 2020, we have $52.5 million in deferred or modified payments, pursuant to federal guidance, representing 44 loans.  During the quarter ended September 30, 2020, there were an additional 7 loans, or $10.2 million, that were granted deferred or modified payments and 169 loans, representing $161.9 million, that moved back to active status from deferral status.  In total, we have deferred or modified payments on 245 loans, or $224.6 million.  As of September 30, 2020, $93.1 million, or 128 loans, have successfully resumed payments as scheduled, $76.0 million, or 65 loans, have moved to active status and have a payment due in the fourth quarter of 2020, $3.0 million, or 8 loans, have closed and paid-in-full, leaving $52.5 million, or 44 loans, on deferral.  All of the loans on deferred or modified status as of September 30, 2020 are scheduled to return to active status in the fourth quarter of 2020.  The graph below illustrates the status of all the loans that were part of the COVID-19 deferral program:

47

 

The graph below indicates the percentage of loans that remain on a COVID-19 deferral.  This illustration is based on total loans outstanding as of as of September 30, 2020.

 

Remaining deferrals by industry as of September 30, 2020:

 

                    

As a result of proactively reaching out to customers to offer deferment to help reduce cash flow pressure we did not see material downgrades in credit during the nine months ended September 30, 2020.  We will continue to be diligent in monitoring credit and changes in the economy, keeping the lines of communication open with our customers, but the full impact of these challenging economic times on our financial condition and liquidity remains to be seen at this time.  

In accordance with GAAP and interagency guidance issued on March 22, 2020, short-term modifications, made on a good faith basis in response to the COVID-19 pandemic to borrowers that were current prior to any relief, are not classified as troubled debt restructurings.  

Our primary source of income is derived through interest earned on loans. A substantial portion of our loan portfolio consists of commercial real estate loans and commercial and industrial loans in the Puget Sound region. Our loan portfolio represents the highest yielding component of our earning assets.

As of September 30, 2020, gross loans totaled $1.51 billion, an increase of $570.3 million, or 60.7%, compared to December 31, 2019. The increase was largely due to our efforts to provide community assistance through the PPP loans, which resulted in $452.8 million in PPP loans as of September 30, 2020, coupled with an additional $117.5 million in loan growth.  

48

 

Loans as a percentage of deposits were 111.0% as of September 30, 2020, compared to 97.0% as of December 31, 2019.  We are focused on serving our communities and markets by growing loans and funding those loans with customer deposits. The increase in the loan to deposit ratio is largely due to the large volume of PPP loans.  

The following table summarizes our loan portfolio by type of loan as of the dates indicated:

 

 

 

As of September 30, 2020

 

 

As of December 31, 2019

 

(Dollars in thousands)

 

Amount

 

 

Percent

 

 

Amount

 

 

Percent

 

Commercial and industrial loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PPP loans

 

$

452,846

 

 

 

29.8

%

 

$

-

 

 

 

0.0

%

All other commercial & industrial loans

 

 

136,358

 

 

 

8.9

 

 

 

111,401

 

 

 

11.8

 

Total commercial and industrial loans:

 

 

589,204

 

 

 

38.7

 

 

 

111,401

 

 

 

11.8

 

Real estate loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction, land and land development

 

 

100,955

 

 

 

6.6

 

 

 

97,034

 

 

 

10.3

 

Residential real estate

 

 

121,147

 

 

 

8.0

 

 

 

115,011

 

 

 

12.2

 

Commercial real estate

 

 

705,186

 

 

 

46.4

 

 

 

613,398

 

 

 

65.2

 

Consumer and other loans

 

 

3,927

 

 

 

0.3

 

 

 

4,214

 

 

 

0.5

 

Gross loans receivable

 

 

1,520,419

 

 

 

100.0

%

 

 

941,058

 

 

 

100.0

%

Net deferred origination fees - PPP loans

 

 

(8,586

)

 

 

 

 

 

 

-

 

 

 

 

 

Net deferred origination fees - all other loans

 

 

(2,444

)

 

 

 

 

 

 

(1,955

)

 

 

 

 

Loans receivable

 

$

1,509,389

 

 

 

 

 

 

$

939,103

 

 

 

 

 

 

Commercial and Industrial Loans. Commercial and industrial loans increased $477.8 million, or 428.9%, to $589.2 million as of September 30, 2020, from $111.4 million as of December 31, 2019. Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and effectively. These loans are primarily made based on the borrower’s ability to service the debt from income. Most commercial and industrial loans are secured by the assets being financed or other business assets, such as accounts receivable, inventory or equipment, and we generally obtain personal guarantees on these loans.

Included in this balance is $43.8 million in capital call lines resulting from relationships with our BaaS customers as of September 30, 2020.

 

Our work with the SBA to help small businesses as provided in the CARES Act resulted in $452.8 million in PPP loans, with $8.6 million in net unearned deferred fees, which are included in commercial and industrial loans.  This includes 2,879 loans, helping over 40,600 employees in our communities.  We were able to provide loans to our existing customers and also provide assistance to new customers, by taking a proactive approach and reaching out to the communities we serve to offer aid through the PPP.  We have received approximately $14.5 million in loan fees from the SBA for originating and servicing the PPP loans, net of fees paid to agents.  These SBA 7(a) loans allowed small business owners to apply for financial relief under the PPP.  This program allowed business owners that are impacted by the COVID-19 pandemic to apply for and receive financial relief to help pay for employee wages and certain other expenses.  PPP loans have a maximum maturity of five years; however, the majority of our PPP loans are two years, bear a 1.0% interest rate and may be forgiven by the government if certain criteria are met.  These fees are or will be recognized in interest income over the life of the loans; however, if loans are forgiven or paid off remaining deferred fees will be recognized in the period the forgiveness or payoff occurs. These fees are recognized as interest income and will provide a source of income to the Company as we navigate through these changes in our business and economy, so we may continue to provide financial services to our customers and communities.

 

We accepted and processed requests through the duration of the program, which ended on August 8, 2020.  We have begun accepting applications from customers for loan forgiveness; however, we are awaiting further guidance and cannot approve an application or submit it to the SBA until the specific criteria have been disclosed.  In order to obtain loan forgiveness, a PPP borrower must submit a forgiveness application to us, which we must review and forward to the SBA. In October 2020, we started to receive some forgiveness payments from the SBA.  It is still uncertain how quickly the SBA will be processing forgiveness requests, but we anticipate that forgiveness of PPP loans will begin in fourth quarter 2020, and the pace of forgiveness will increase in the first half of 2021.  The initial payment deferral period on PPP loans was extended and customers with two-year loans can work with their lender to extend to a five year maturity, which we anticipate could be a good option for customers that are not eligible for forgiveness.

Commercial Real Estate Loans. Commercial real estate loans increased $91.8 million, or 15.0%, to $705.2 million as of September 30, 2020, from $613.4 million as of December 31, 2019.  We make commercial mortgage loans collateralized by owner-occupied and non-owner-occupied real estate, as well as multi-family residential loans. The real estate securing our existing commercial real estate loans includes a wide variety of property types, such as manufacturing and processing facilities, business parks, warehouses, retail centers,

49

 

convenience stores, hotels and motels, office buildings, mixed-use residential and commercial, and other properties. We originate both fixed- and adjustable-rate loans with terms up to 20 years. Fixed-rate loans typically amortize over a 10-to-25 year period with balloon payments at the end of five to ten years. Adjustable-rate loans are generally based on the prime rate and adjust with the prime rate or are based on term equivalent FHLB rates. At September 30, 2020, approximately 39.3% of the commercial real estate loan portfolio consisted of fixed rate loans. Commercial real estate loans represented 46.4% of our loan portfolio at September 30, 2020 and are historically our largest source of revenue. The addition of the $452.8 million in PPP loans as commercial and industrial loans has significantly impacted the composition of our loan portfolio; without the PPP loans, commercial real estate loans would represent approximately 66.1% of the loan portfolio, which is more in line with what it has been historically.  The Bank actively seeks commercial real estate loans in our markets and our lenders are experienced in originating and competing for these loans.  Our credit administration team has substantial experience in underwriting, managing, monitoring and working out commercial real estate loans, and remains diligent in communicating and proactively working with borrowers to help mitigate potential credit deterioration.  

Construction, Land and Land Development Loans. Construction, land and land development loans increased $3.9 million, or 4.0%, to $101.0 million as of September 30, 2020, from $97.0 million as of December 31, 2019. We have a number of construction loans that have been approved, primarily for commercial projects, where the borrower has not requested the funds, resulting in our unfunded construction and development commitments increasing to $76.3 million at September 30, 2020, from $63.7 million at December 31, 2019.

Although we have seen a strong commercial and residential real estate market in the Puget Sound region thus far in 2020, the full extent of the short-term and long-term effects of the COVID-19 pandemic remain to be seen.  We anticipate that as projects continue we will see drawdowns on the available commitments.  

Residential Real Estate Loans.  Our residential loans increased $6.1 million, or 5.3%, from $115.0 million at December 31, 2019 to $121.1 million at September 30, 2020. We originate one-to-four adjustable-rate mortgage (“ARM”), loans for our portfolio and operate as a mortgage broker for mortgage lenders we have agreements with for customers who want a 15-year to 30-year, fixed-rate mortgage loan. As of September 30, 2020, the balance of our ARM portfolio loans was $14.0 million, compared to $11.7 million at December 31, 2019.  Our ARM loans typically do not meet the guidelines for sale in the secondary market due to characteristics of the property, the loan terms or exceptions from agency underwriting guidelines, which enables us to earn a higher interest rate. We also purchase residential mortgages originated by other financial institutions to hold for investment with the intent to diversify our residential mortgage loan portfolio, meet certain regulatory requirements and increase our interest income.  As of September 30, 2020, we held $17.9 million in purchased residential real estate mortgage loans, compared to $28.6 million at December 31, 2019.  These loans purchased typically have a fixed rate with a term of 15 to 30 years and are collateralized by one-to-four family residential real estate. We have a defined set of credit guidelines that we use when evaluating these loans. Although purchased loans were originated and underwritten by another institution, our mortgage, credit, and compliance departments conduct an independent review of each underlying loan that includes re-underwriting each of these loans to our credit and compliance standards. We also make one-to-four family loans to investors to finance their rental properties and to business owners to secure their business loans.  As of September 30, 2020, residential real estate loans made to investors and business owners totaled $75.6 million.

Like our commercial real estate loans, our residential real estate loans are secured by real estate, the value of which may fluctuate significantly over a short period of time as a result of market conditions in the area in which the real estate is located. Adverse developments affecting real estate values in our market areas could therefore increase the credit risk associated with these loans, impair the value of property pledged as collateral on loans, and affect our ability to sell the collateral upon foreclosure without a loss or additional losses.

Consumer and Other. Consumer and other loans totaled $3.9 million as of September 30, 2020, decreasing $287,000 from $4.2 million at December 31, 2019. Our consumer and other loans are comprised of personal lines of credit, automobile, boat, and recreational vehicle loans, and secured term loans.

Industry Exposure and Categories of Loans

We have a diversified loan portfolio, representing a wide variety of industries.  Three of our largest categories of our loans are commercial real estate, commercial and industrial, and construction, land and land development loans.  Together they represent $942.5 million in outstanding loan balances, or 88.3% of total gross loans outstanding, excluding PPP loans of $452.8 million.  When combined with $232.4 million in unused commitments the total of these three categories is $1.17 billion, or 89.0% of total outstanding loans and loan commitments.

Commercial Real Estate Loans. Commercial real estate represents the largest segment of our loans, comprising 66.1% of our total balance of outstanding loans, excluding PPP loans, as of September 30, 2020.  Unused commitments to extend credit represents an

50

 

additional $15.6 million, the combined total exposure in commercial real estate loans represents $720.8 million, or 54.6% of our total outstanding loans and loan commitments, excluding PPP loans.

The following table summarizes our concentration by industry for our commercial real estate loan portfolio as of September 30, 2020:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands, unaudited)

 

Outstanding Balance

 

 

Available Loan Commitments

 

 

Total Exposure

 

 

% of Total Loans

(Outstanding Balance & Available Commitment)

 

 

Average Loan Balance

 

 

Number of Loans

 

Hotel/Motel

 

$

111,316

 

 

$

986

 

 

$

112,302

 

 

 

8.5

%

 

$

4,281

 

 

 

26

 

Apartments

 

 

92,556

 

 

 

3,159

 

 

 

95,715

 

 

 

7.3

 

 

 

1,402

 

 

 

66

 

Retail

 

 

73,247

 

 

 

55

 

 

 

73,302

 

 

 

5.6

 

 

 

927

 

 

 

79

 

Office

 

 

76,151

 

 

 

3,012

 

 

 

79,163

 

 

 

6.0

 

 

 

810

 

 

 

94

 

Mixed use

 

 

68,011

 

 

 

4,428

 

 

 

72,439

 

 

 

5.5

 

 

 

791

 

 

 

86

 

Convenience Store

 

 

69,725

 

 

 

-

 

 

 

69,725

 

 

 

5.3

 

 

 

1,835

 

 

 

38

 

Warehouse

 

 

62,611

 

 

 

14

 

 

 

62,625

 

 

 

4.7

 

 

 

1,181

 

 

 

53

 

Manufacturing

 

 

35,810

 

 

 

500

 

 

 

36,310

 

 

 

2.8

 

 

 

995

 

 

 

36

 

Mini Storage

 

 

33,169

 

 

 

857

 

 

 

34,026

 

 

 

2.6

 

 

 

3,317

 

 

 

10

 

Groups < 2.0% of total

 

 

82,590

 

 

 

2,593

 

 

 

85,183

 

 

 

6.5

 

 

 

1,073

 

 

 

77

 

Total

 

$

705,186

 

 

$

15,604

 

 

$

720,790

 

 

 

54.6

%

 

$

1,248

 

 

 

565

 

Commercial and Industrial Loans. Commercial and industrial loans comprise 12.8% of our total balance of outstanding loans, excluding PPP loans, as of September 30, 2020.  Unused commitments to extend credit represents an additional $140.5 million, the combined total exposure in commercial and industrial loans represents $276.9 million, or 21.0% of our total outstanding loans and loan commitments, excluding PPP loans.

The following table summarizes our concentration by industry for our commercial and industrial loan portfolio as of September 30, 2020:

 

(Dollars in thousands, unaudited)

 

Outstanding Balance

 

 

Available Loan Commitments

 

 

Total Exposure

 

 

% of Total Loans

(Outstanding Balance & Available Commitment)

 

 

Average Loan Balance

 

 

Number of Loans

 

Capital Call Lines

 

$

43,776

 

 

$

79,238

 

 

$

123,014

 

 

 

9.3

%

 

$

1,122

 

 

 

39

 

Construction/Contractor

     Services

 

 

14,052

 

 

 

22,916

 

 

 

36,968

 

 

 

2.8

 

 

 

96

 

 

 

146

 

Financial Institutions

 

 

15,400

 

 

 

-

 

 

 

15,400

 

 

 

1.2

 

 

 

3,850

 

 

 

4

 

Family and Social Services

 

 

9,994

 

 

 

5,247

 

 

 

15,241

 

 

 

1.2

 

 

 

769

 

 

 

13

 

Manufacturing

 

 

8,293

 

 

 

6,172

 

 

 

14,465

 

 

 

1.1

 

 

 

151

 

 

 

55

 

Medical / Dental /

     Other Care

 

 

13,584

 

 

 

483

 

 

 

14,067

 

 

 

1.1

 

 

 

203

 

 

 

67

 

Groups < 1.0% of total

 

 

31,259

 

 

 

26,480

 

 

 

57,739

 

 

 

4.4

 

 

 

101

 

 

 

311

 

Total

 

$

136,358

 

 

$

140,536

 

 

$

276,894

 

 

 

21.0

%

 

$

215

 

 

 

635

 

51

 

Construction, Land and Land Development Loans. Construction, land and land development loans comprise 9.5% of our total balance of outstanding loans, excluding PPP loans, as of September 30, 2020.  Unused commitments to extend credit represents an additional $76.3 million, the combined total exposure in construction, land and land development loans represents $177.3 million, or 13.4% of our total outstanding loans and loan commitments, excluding PPP loans.

The following table details our concentration for our construction, land and land development loan portfolio as of September 30, 2020:

 

(Dollars in thousands, unaudited)

 

Outstanding Balance

 

 

Available Loan Commitments

 

 

Total Exposure

 

 

% of Total Loans

(Outstanding Balance & Available Commitment)

 

 

Average Loan Balance

 

 

Number of Loans

 

Commercial construction

 

$

46,674

 

 

$

53,820

 

 

$

100,494

 

 

 

7.6

%

 

$

2,223

 

 

 

21

 

Residential construction

 

 

24,149

 

 

 

14,493

 

 

 

38,642

 

 

 

2.9

 

 

 

894

 

 

 

27

 

Developed land loans

 

 

13,097

 

 

 

236

 

 

 

13,333

 

 

 

1.0

 

 

 

409

 

 

 

32

 

Undeveloped land loans

 

 

9,726

 

 

 

332

 

 

 

10,058

 

 

 

0.8

 

 

 

486

 

 

 

20

 

Land development

 

 

7,309

 

 

 

7,423

 

 

 

14,732

 

 

 

1.1

 

 

 

731

 

 

 

10

 

Total

 

$

100,955

 

 

$

76,304

 

 

$

177,259

 

 

 

13.4

%

 

$

918

 

 

 

110

 

Nonperforming Assets

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 applicable regulations. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. In general, we place loans on nonaccrual status when they become 90 days past due. We also place loans on nonaccrual status if they are less than 90 days past due if the collection of principal or interest is in doubt. We are not required to report as nonperforming a loan for which we have allowed the borrower to defer payment on a short term basis because of financial pressure related to COVID-19.  When loans are placed on nonaccrual status, all unpaid accrued interest is reversed from income and all interest accruals are stopped. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal balance. Loans are returned to accrual status if we believe that all remaining principal and interest is fully collectible and there has been at least six months of sustained repayment performance since the loan was placed on nonaccrual status.  We define nonperforming loans as loans on nonaccrual status and accruing loans 90 days or more past due.  Nonperforming assets also include other real estate owned and repossessed assets.  

We believe our lending practices and active approach to managing nonperforming assets has resulted in sound asset quality and timely resolution of problem assets. We have procedures in place to assist us in maintaining the overall credit quality of our loan portfolio. We have established underwriting guidelines, concentration limits and we also monitor our delinquency levels for any negative or adverse trends. We actively manage problem assets to reduce our risk for loss.

We had $4.5 million in nonperforming assets, as of September 30, 2020, compared to $1.0 million as of December 31, 2019. There were no loans more than 90 days past due and still accruing interest as of September 30, 2020 and December 31, 2019.  Our nonperforming loans to loans receivable ratio was 0.30% at September 30, 2020, compared to 0.11% at December 31, 2019.  Construction, land and land development loans totaled $3.3 million, representing one loan that was added in the second quarter of 2020. Commercial and industrial nonaccrual loans totaled $625,000 at September 30, 2020 and consisted of three lending relationships.  Commercial real estate loans totaled $405,000, representing one loan, which was added during the second quarter of 2020.  During the third quarter of 2020, one loan for $117,000 in residential real estate moved to nonperforming status. The addition of this loan to nonperforming status in the third quarter was partially offset by principal reductions and resulted in an overall increase in our ratios of nonperforming loans and nonperforming assets to total assets compared to December 31, 2019.

Credit quality has remained stable in 2020 thus far as demonstrated by the low level of charge-offs and nonperforming loan balance.  The full extent of the short-term and long-term economic impact of the COVID-19 pandemic is unknown; however, we remain diligent in our efforts to communicate and proactively work with borrowers to help mitigate potential credit deterioration. Credit administration is closely analyzing higher risk segments within the loan portfolio, monitoring and tracking loan payment deferrals and customer liquidity, and providing timely reporting to management and the board of directors.

52

 

The following table presents information regarding nonperforming assets at the dates indicated:

 

 

 

As of

 

 

As of

 

 

 

September 30,

 

 

December 31,

 

(Dollars in thousands)

 

2020

 

 

2019

 

Nonaccrual loans:

 

 

 

 

 

 

 

 

Commercial and industrial loans

 

$

625

 

 

$

965

 

Real estate loans:

 

 

 

 

 

 

 

 

Construction, land and land development

 

 

3,269

 

 

 

-

 

Residential real estate

 

 

178

 

 

 

65

 

Commercial real estate

 

 

405

 

 

 

-

 

Total nonaccrual loans

 

 

4,477

 

 

 

1,030

 

Accruing loans past due 90 days or more:

 

 

 

 

 

 

 

 

Total accruing loans past due 90 days or more

 

 

-

 

 

 

-

 

Total nonperforming loans

 

 

4,477

 

 

 

1,030

 

Real estate owned

 

 

-

 

 

 

-

 

Repossessed assets

 

 

-

 

 

 

-

 

Troubled debt restructurings, accruing

 

 

-

 

 

 

-

 

Total nonperforming assets

 

$

4,477

 

 

$

1,030

 

Total nonperforming loans to loans receivable

 

 

0.30

%

 

 

0.11

%

Total nonperforming assets to total assets

 

 

0.26

%

 

 

0.09

%

 

Allowance for Loan Losses

We maintain an allowance for loan losses that represents management’s best estimate of the loan losses and risks inherent in our loan portfolio. The amount of the allowance for loan losses should not be interpreted as an indication that charge-offs in future periods will necessarily occur in those amounts. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of our loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, and current economic factors.

In connection with our allowance for loan loss review, we consider risk elements applicable to particular loan types or categories in assessing the quality of individual loans. Some of the risk elements we consider include:

 

•

for commercial and industrial loans, the debt service coverage ratio (income from the business in excess of operating expenses compared to loan repayment requirements), the operating results of the commercial, professional or agricultural enterprise, the borrower’s business, professional and financial ability and expertise, the specific risks and volatility of income and operating results typical for businesses in that category and the value, nature and marketability of collateral;

 

•

for commercial real estate loans, the debt service coverage ratio, operating results of the owner in the case of owner-occupied properties, the loan-to-value ratio, the age and condition of the collateral and the volatility of income, property value and future operating results typical of properties of that type;

 

•

for residential real estate loans, the borrower’s ability to repay the loan, including a consideration of the debt-to-income ratio and employment and income stability, the loan-to-value ratio, and the age, condition and marketability of the collateral; and

 

•

for construction, land and land development loans, the perceived market feasibility of the project including the ability to sell developed lots or improvements constructed for resale or the ability to lease property constructed for lease, the quality and nature of contracts for presale or prelease, if any, experience and ability of the developer and loan-to-value ratio.

As of September 30, 2020, the allowance for loan losses totaled $17.0 million, or 1.13% of total loans. As of December 31, 2019, the allowance for loan losses totaled $11.5 million, or 1.22% of total loans. Included in total loans is $452.8 million in PPP loans which are 100% guaranteed by the SBA.  The allowance for loan losses to loans receivable, excluding the guaranteed PPP loans, is approximately 1.60%.  A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”  Our allowance for loan losses as of September 30, 2020 increased by $5.6 million, or 48.6%, compared to December 31, 2019, due to an increase in our qualitative factors primarily related to the current economic environment from the COVID-19 pandemic on our loan portfolio and loan growth.

53

 

The following table presents, as of and for the periods indicated, an analysis of the allowance for loan losses and other related data:

 

 

 

As of and for the Three

 

 

As of and for the Nine

 

 

 

Months Ended

 

 

Months Ended

 

 

 

September 30,

 

 

September 30,

 

(Dollars in thousands)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Allowance at beginning of period

 

$

14,847

 

 

$

10,443

 

 

$

11,470

 

 

$

9,407

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

 

2,200

 

 

 

637

 

 

 

5,708

 

 

 

1,724

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Charge-offs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial loans

 

 

-

 

 

 

118

 

 

 

130

 

 

 

125

 

Real estate loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate loans

 

 

-

 

 

 

75

 

 

 

-

 

 

 

75

 

Commercial real estate

 

 

-

 

 

 

-

 

 

 

-

 

 

 

29

 

Consumer and other

 

 

2

 

 

 

3

 

 

 

9

 

 

 

23

 

Total charge-offs

 

 

2

 

 

 

196

 

 

 

139

 

 

 

252

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recoveries:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial loans

 

 

-

 

 

 

2

 

 

 

5

 

 

 

4

 

Consumer and other

 

 

1

 

 

 

2

 

 

 

2

 

 

 

5

 

Total recoveries

 

 

1

 

 

 

4

 

 

 

7

 

 

 

9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net charge-offs

 

 

1

 

 

 

192

 

 

 

132

 

 

 

243

 

Allowance at end of period

 

$

17,046

 

 

$

10,888

 

 

$

17,046

 

 

$

10,888

 

Allowance to nonperforming loans

 

 

380.75

%

 

 

837.54

%

 

 

380.75

%

 

 

837.54

%

Allowance to loans receivable

 

 

1.13

%

 

 

1.25

%

 

 

1.13

%

 

 

1.25

%

Net charge-offs to average loans (1)

 

 

0.00

%

 

 

0.09

%

 

 

0.01

%

 

 

0.04

%

 

(1)Ratios for the three and nine months ended September 30, 2020 and 2019 are annualized.

Although we believe that we have established our allowance for loan losses in accordance with GAAP and that the allowance for loan losses was adequate to provide for known and inherent losses in the portfolio at all times shown above, future provisions for loan losses will be subject to ongoing evaluations of the risks in our loan portfolio.  As a result of the COVID-19 pandemic and the subsequent impact to the economy, we increased our provision during the nine months ended September 30, 2020.  If the COVID-19 pandemic worsens or continues indefinitely, preventing businesses and consumers from conducting business, the state and Puget Sound region may experience a continued economic downturn, and our asset quality could deteriorate, which may require material additional provisions for loan losses.  We remain focused on working with the communities we serve, offering payment deferrals and other resources available under the CARES Act to provide financial assistance to businesses and consumers until they are able recover from this uncertain and trying time.  

Securities

We use our securities portfolio primarily as a source of liquidity and collateral that can be readily sold or pledged for public deposits or other business purposes. At September 30, 2020, 83.9% of our investment portfolio consisted of U.S. Treasury securities. The remainder of our securities portfolio was invested in U.S. Government agency securities, U.S. Agency collateralized mortgage obligations and U.S. Agency residential mortgage-backed securities, and municipal bonds. Because we target a loan-to-deposit ratio in the range of 90% to 100%, we prioritize liquidity over the earnings of our securities portfolio. At September 30, 2020, our loan-to-deposit ratio was 111.0%, which is elevated as a result of the PPP loans.  Our securities portfolio represented less than 2% of assets. To the extent our securities represent more than 5% of assets, absent an immediate need for liquidity, we anticipate investing excess funds to provide a higher return.

54

 

As of September 30, 2020, the carrying amount of our investment securities totaled $23.8 million, a decrease of $8.9 million, or 27.3%, compared to $32.7 million as of December 31, 2019. The decrease in the securities portfolio was due to maturities and principal paydowns.  

Our investment portfolio consists of securities classified as available for sale and, to a lesser amount, held to maturity. The carrying values of our investment securities classified as available for sale are adjusted for unrealized gain or loss, and any gain or loss is reported on an after-tax basis as a component of other comprehensive income in shareholders’ equity.

The following table summarizes the amortized cost and estimated fair value of our investment securities as of the dates shown:

 

 

 

As of

 

 

As of

 

 

 

September 30, 2020

 

 

December 31, 2019

 

 

 

Amortized

 

 

Fair

 

 

Amortized

 

 

Fair

 

(Dollars in thousands)

 

Cost

 

 

Value

 

 

Cost

 

 

Value

 

Securities available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

19,996

 

 

$

20,041

 

 

$

24,988

 

 

$

24,945

 

U.S. Government securities

 

 

-

 

 

 

-

 

 

 

3,000

 

 

 

2,999

 

U.S. Agency collateralized mortgage obligations

 

 

108

 

 

 

113

 

 

 

129

 

 

 

129

 

U.S. Agency residential mortgage-backed

   securities

 

 

11

 

 

 

11

 

 

 

27

 

 

 

27

 

Municipal bonds

 

 

255

 

 

 

263

 

 

 

257

 

 

 

260

 

Total available-for-sale securities

 

 

20,370

 

 

 

20,428

 

 

 

28,401

 

 

 

28,360

 

Securities held-to-maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Agency residential mortgage-backed

   securities

 

 

3,354

 

 

 

3,470

 

 

 

4,350

 

 

 

4,329

 

Total held-to-maturity securities

 

 

3,354

 

 

 

3,470

 

 

 

4,350

 

 

 

4,329

 

Total investment securities

 

$

23,724

 

 

$

23,898

 

 

$

32,751

 

 

$

32,689

 

Deposits

We offer a variety of deposit products that have a wide range of interest rates and terms, including demand, savings, money market and time accounts as well as BaaS-brokered deposits. In addition, we recently added reciprocal deposits to our product offering. This enables us to extend FDIC insurance to customers that have balances in excess of the FDIC insurance limit.  This service trades our customers’ funds as CDs or interest bearing demand deposits in increments under the FDIC insured amount to other participating financial institutions and in exchange we receive CD or interest bearing demand investments from participating financial institutions in a reciprocal agreement.  We rely primarily on competitive pricing policies, convenient locations, electronic delivery channels (Internet and mobile), and personalized service to attract new deposits and retain existing deposits.

Total deposits as of September 30, 2020 were $1.36 billion, an increase of $392.1 million, or 40.5%, compared to $968.0 million as of December 31, 2019. The increase was largely in core deposits, which increased $407.7 million to $1.27 billion from $862.5 million at December 31, 2019.  The increase in core deposits is primarily the result of expanding and growing banking relationships with new customers, including deposit relationships from PPP loans made to noncustomers moving their banking relationship to the Bank.  We define core deposits as all deposits except time deposits and BaaS-brokered deposits. We focus on growing core deposits and our branch managers, business development officers, treasury service personnel and lenders work together to grow deposits from existing and new customers.

Noninterest bearing deposits as of September 30, 2020 were $570.7 million, an increase of $199.4 million, or 53.7%, compared to $371.2 million as of December 31, 2019. The increase is primarily the result of expanding and growing banking relationships with new customers, including deposit relationships from PPP loans made to noncustomers, who moved their banking relationship to the Bank.  Noninterest bearing deposits represent 42.0% and 38.4% of total deposits for September 30, 2020 and December 31, 2019, respectively.

Total interest bearing account balances, excluding time deposits, as of September 30, 2020 were $724.5 million, an increase of $209.6 million, or 40.7%, from $514.9 million as of December 31, 2019. Included in interest bearing account balances is $24.9 million in BaaS-brokered deposits, an increase of $1.3 million from December 31, 2019. Also included in interest bearing deposits is $9.7 million in reciprocal deposits.  In 2019 we introduced reciprocal deposits as a product available for time deposit customers and beginning in 2020 we added an interest bearing demand reciprocal deposit product.

55

 

Total time deposit balances as of September 30, 2020 were $64.9 million, a decrease of $17.0 million, or 20.7%, from $81.9 million as of December 31, 2019. The decrease is a conscious effort to not replace maturing time deposits, but rather to grow and retain less expensive core deposits.  We have seen competitors continue to offer higher rates on time deposits, and we have not globally matched their rates in response as we have been able to grow and retain less costly core deposits.

The following table sets forth deposit balances at the dates indicated.

 

 

 

As of

 

 

As of

 

 

 

September 30, 2020

 

 

December 31, 2019

 

 

 

 

 

 

 

Percent of

 

 

 

 

 

 

Percent of

 

(Dollars in thousands)

 

Amount

 

 

Total

Deposits

 

 

Amount

 

 

Total

Deposits

 

Demand, noninterest bearing

 

$

570,664

 

 

 

42.0

%

 

$

371,243

 

 

 

38.4

%

NOW and money market

 

 

624,891

 

 

 

45.9

 

 

 

437,908

 

 

 

45.2

 

Savings

 

 

74,694

 

 

 

5.5

 

 

 

53,365

 

 

 

5.5

 

Total core deposits

 

 

1,270,249

 

 

 

93.4

 

 

 

862,516

 

 

 

89.1

 

BaaS-brokered deposits

 

 

24,870

 

 

 

1.8

 

 

 

23,586

 

 

 

2.4

 

Time deposits less than $100,000

 

 

19,341

 

 

 

1.4

 

 

 

21,108

 

 

 

2.3

 

Time deposits $100,000 and over

 

 

45,551

 

 

 

3.3

 

 

 

60,749

 

 

 

6.3

 

Total

 

$

1,360,011

 

 

 

100.0

%

 

$

967,959

 

 

 

100.0

%

 

The following table sets forth the Company’s time deposits of $100,000 or more by time remaining until maturity as of the dates indicated:

 

(Dollars in thousands)

 

As of

September 30,

2020

 

 

As of

December 31,

2019

 

Maturity Period:

 

 

 

 

 

 

 

 

Three months or less

 

$

12,864

 

 

$

12,562

 

Over three through six months

 

 

10,848

 

 

 

20,940

 

Over six through twelve months

 

 

14,487

 

 

 

7,007

 

Over twelve months

 

 

7,352

 

 

 

20,240

 

Total

 

$

45,551

 

 

$

60,749

 

Weighted average maturity (in years)

 

 

0.70

 

 

 

0.73

 

 

Average deposits for the three and nine months ended September 30, 2020 were $1.32 billion and $1.18 billion, respectively, an increase of 49.0% and 36.4%, respectively, compared to the three and nine months ended September 30, 2019. The increase in average deposits was primarily due to an increase in core deposits, both in noninterest bearing deposits and in low rate interest bearing deposits.  Included in this increase is deposit relationships gained from PPP loans made to noncustomers that moved their banking/deposit relationship to the Bank.  We expect deposit to grow with continued growth in our primary market areas, the increase in commercial lending relationships for which we also seek deposit balances and the results of business development efforts by our business development officers, branch managers and lenders.

The average rate paid on total deposits was 0.27% and 0.40%, respectively, for the three and nine months ended September 30, 2020, compared to 0.64% and 0.66%, for the three and nine months ended September 30, 2019, respectively.  The average rate paid on BaaS-brokered deposits decreased 1.64% and 1.72% for the three and nine months ended September 30, 2020, respectively, compared to the prior year periods, and NOW and money market accounts decreased 51 basis points and 21 basis points, for the three and nine months ended September 30, 2020, respectively.  The average rate paid on NOW and money market accounts in the three and nine months ended September 30, 2020 is the result of the decreased Fed funds rates since June 2019; the impact of these rate decreases will continue to be reflected in future periods. Any further changes to the Fed funds rate along with competition are expected to continue to impact future cost of deposits and our pricing strategies.

56

 

The following table presents the average balances and average rates paid on deposits for the periods indicated:

 

 

 

For the Three Months Ended September 30,

 

 

For the Nine Months Ended September 30,

 

 

 

2020

 

 

2019

 

 

2020

 

 

2019

 

(Dollars in thousands)

 

Average

Balance

 

 

Average

Rate

 

 

Average

Balance

 

 

Average

Rate

 

 

Average

Balance

 

 

Average

Rate

 

 

Average

Balance

 

 

Average

Rate

 

Demand, noninterest bearing

 

$

569,615

 

 

 

0.00

%

 

$

330,553

 

 

 

0.00

%

 

$

488,296

 

 

 

0.00

%

 

$

309,270

 

 

 

0.00

%

NOW and money market

 

 

589,209

 

 

 

0.45

 

 

 

394,939

 

 

 

0.96

 

 

 

530,761

 

 

 

0.66

 

 

 

375,267

 

 

 

0.87

 

Savings

 

 

73,928

 

 

 

0.05

 

 

 

52,511

 

 

 

0.05

 

 

 

65,247

 

 

 

0.05

 

 

 

52,401

 

 

 

0.06

 

BaaS-brokered deposits

 

 

21,653

 

 

 

0.35

 

 

 

12,787

 

 

 

1.99

 

 

 

21,849

 

 

 

0.59

 

 

 

35,494

 

 

 

2.32

 

Time deposits less than $100,000

 

 

19,274

 

 

 

0.99

 

 

 

24,126

 

 

 

1.30

 

 

 

20,181

 

 

 

1.13

 

 

 

25,221

 

 

 

1.31

 

Time deposits $100,000 and over

 

 

46,726

 

 

 

1.17

 

 

 

71,302

 

 

 

1.84

 

 

 

58,013

 

 

 

1.45

 

 

 

70,736

 

 

 

1.81

 

Total deposits

 

$

1,320,405

 

 

 

0.27

%

 

$

886,218

 

 

 

0.64

%

 

$

1,184,347

 

 

 

0.40

%

 

$

868,389

 

 

 

0.66

%

 

The ratio of average noninterest bearing deposits to average total deposits for the three and nine months ended September 30, 2020 was 43.1% and 41.2%, respectively, compared to 37.3% and 35.6% for the three and nine months ended September 30, 2019, respectively.

Borrowings

We have the ability to utilize short-term to long-term borrowings to supplement deposits to fund our lending and investment activities, each of which is discussed below.

Federal Reserve Bank Line of Credit. The Federal Reserve allows us to borrow against our line of credit through a borrower in custody agreement utilizing the discount window, which is collateralized by certain loans. As of September 30, 2020, and December 31, 2019, total borrowing capacity of $20.8 and $21.4 million, respectively, was available under this arrangement.  As of September 30, 2020 and December 31, 2019, Federal Reserve advances totaled zero.

Paycheck Protection Program Liquidity Facility. To bolster the effectiveness of the SBA’s PPP loan program, the Federal Reserve is supplying liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. The PPP provided loans to small businesses so that they can keep their employees on the payroll and pay for other allowed expenses. If the borrowers meet certain criteria, the loan may be forgiven.  The PPPLF extends credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. The interest rate is 0.35% and as PPP loans are paid down, the borrowing line must also be paid down.  As of September 30, 2020, there was $202.6 million outstanding in PPPLF advances. This is a new borrowing arrangement that has favorable capital treatment and is specific to the PPP loan program, and therefore there was no balance at December 31, 2019.  

The table below provides details on PPPLF borrowings for the periods indicated:

 

 

 

As of and For the Three

 

 

As of and For the Nine

 

 

 

Months Ended

 

 

Months Ended

 

 

 

September 30,

 

 

September 30,

 

(Dollars in thousands)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Maximum amount outstanding at any month-end

   during period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PPPLF Advances

 

$

202,595

 

 

$

-

 

 

$

202,595

 

 

$

-

 

Average outstanding balance during period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PPPLF Advances

 

$

199,076

 

 

$

-

 

 

$

102,527

 

 

$

-

 

Weighted average interest rate during period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PPPLF Advances

 

 

0.35

%

 

 

0.00

%

 

 

0.35

%

 

 

0.00

%

Balance outstanding at end of period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PPPLF Advances

 

$

202,595

 

 

$

-

 

 

$

202,595

 

 

$

-

 

Weighted average interest rate at end of period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PPPLF Advances

 

 

0.35

%

 

 

0.00

%

 

 

0.35

%

 

 

0.00

%

57

 

 

Federal Home Loan Bank Advances. The FHLB allows us to borrow against our line of credit, which is collateralized by certain loans. As of September 30, 2020, and December 31, 2019, we had borrowing capacity of $92.7 million and $84.9 million, respectively, under this arrangement. As of September 30, 2020, we borrowed a total of $25.0 million in FHLB long term advances.  This includes $10.0 million for a 2.50-year remaining term and $15.0 million advance with a 4.50-year remaining term.  FHLB advances totaled $25.0 million as of September 30, 2020 and $10.0 million as of December 31, 2019.  There was $67.7 million and $74.9 million borrowing capacity remaining as of September 30, 2020, and December 31, 2019, respectively.  Although there are no immediate plans to borrow additional funds, additional borrowing capacity of $67.7 million was available under this arrangement as of September 30, 2020.

The table below provides details on FHLB short term borrowings for the periods indicated:

 

 

 

As of and For the Three

 

 

As of and For the Nine

 

 

 

Months Ended

 

 

Months Ended

 

 

 

September 30,

 

 

September 30,

 

(Dollars in thousands)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Maximum amount outstanding at any month-end

   during period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB Advances

 

$

-

 

 

$

20,000

 

 

$

-

 

 

$

20,000

 

Average outstanding balance during period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB Advances

 

$

-

 

 

$

870

 

 

$

89

 

 

$

740

 

Weighted average interest rate during period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB Advances

 

 

0.00

%

 

 

2.35

%

 

 

1.84

%

 

 

2.46

%

Balance outstanding at end of period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB Advances

 

$

-

 

 

$

20,000

 

 

$

-

 

 

$

20,000

 

Weighted average interest rate at end of period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB Advances

 

 

0.00

%

 

 

2.39

%

 

 

0.00

%

 

 

2.09

%

 

The table below provides details on the FHLB long term borrowings for the periods indicated:

 

 

 

As of and For the Three

 

 

As of and For the Nine

 

 

 

Months Ended

 

 

Months Ended

 

 

 

September 30,

 

 

September 30,

 

(Dollars in thousands)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Maximum amount outstanding at any month-end

   during period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB Advances

 

$

24,999

 

 

$

-

 

 

$

24,999

 

 

$

-

 

Average outstanding balance during period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB Advances

 

$

24,999

 

 

$

-

 

 

$

19,160

 

 

$

-

 

Weighted average interest rate during period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB Advances

 

 

1.13

%

 

 

0.00

%

 

 

1.13

%

 

 

0.00

%

Balance outstanding at end of period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB Advances

 

$

24,999

 

 

$

-

 

 

$

24,999

 

 

$

-

 

Weighted average interest rate at end of period:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB Advances

 

 

1.13

%

 

 

0.00

%

 

 

1.13

%

 

 

0.00

%

 

Junior Subordinated Debentures. In 2004, we issued $3.6 million in junior subordinated debentures to Coastal (WA) Statutory Trust I (the “Trust”), of which we own all of the outstanding common securities. The Trust used the proceeds from the issuance of its underlying common securities and preferred securities to purchase the debentures issued by the Company. These debentures are the Trust’s only assets and the interest payments from the debentures finance the distributions paid on the preferred securities. The debentures bear interest at a rate per annum equal to the 3-month LIBOR plus 2.10%. The effective rate as of September 30, 2020, and December 31, 2019, was 2.35% and 3.99%, respectively. We generally have the right to defer payment of interest on the debentures at any time or from time to time for a period not exceeding five years provided that no extension period may extend beyond the stated maturity of the debentures. During any such extension period, distributions on the Trust’s preferred securities will also be deferred, and our ability to pay dividends on our common stock will be restricted. The Trust’s preferred securities are mandatorily redeemable upon maturity of the debentures, or upon earlier redemption as provided in the indenture, subject to Federal Reserve approval. If the debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest. We unconditionally guarantee payment of accrued and unpaid distributions required to be paid on the Trust securities subject to certain

58

 

exceptions, the redemption price with respect to any Trust securities called for redemption and amounts due if the Trust is liquidated or terminated.

Subordinated Debt. In 2016, the Company issued a subordinated note to a commercial bank in the amount of $10.0 million. The note matures on August 1, 2026, and bears interest at the rate of 5.65% per year for five years and, thereafter, at a rate equal to The Wall Street Journal prime rate plus 2.50%. The five-year 5.65% interest period ends on August 1, 2021.  Principal payments of $500,000 per quarter commence November 1, 2021. We may redeem the subordinated note, in whole or in part, without premium or penalty after July 29, 2021, subject to any required regulatory approvals.

 

Liquidity and Capital Resources

Liquidity Management

Liquidity refers to our capacity to meet our cash obligations at a reasonable cost. Our cash obligations require us to have cash flow that is adequate to fund loan growth and maintain on-balance sheet liquidity while meeting present and future obligations of deposit withdrawals, borrowing maturities and other contractual cash obligations. In managing our cash flows, management regularly confronts situations that can give rise to increased liquidity risk. These include funding mismatches, market constraints in accessing sources of funds and the ability to convert assets into cash. Changes in economic conditions or exposure to credit, market, and operational, legal and reputational risks also could affect the Bank’s liquidity risk profile and are considered in the assessment of liquidity management.

We continually monitor our liquidity position to ensure that our assets and liabilities are managed in a manner to meet all reasonably foreseeable short-term, long-term and strategic liquidity demands. Management has established a comprehensive process for identifying, measuring, monitoring and controlling liquidity risk. Because of its critical importance to the viability of the Bank, liquidity risk management is fully integrated into our risk management processes. Critical elements of our liquidity risk management include: effective corporate governance consisting of oversight by the board of directors and active involvement by management; appropriate strategies, policies, procedures, and limits used to manage and mitigate liquidity risk; comprehensive liquidity risk measurement and monitoring systems that are commensurate with the complexity of our business activities; active management of intraday liquidity and collateral; an appropriately diverse mix of existing and potential future funding sources; adequate levels of highly liquid marketable securities free of legal, regulatory, or operational impediments, that can be used to meet liquidity needs in stressful situations; contingency funding policies and plans that sufficiently address potential adverse liquidity events and emergency cash flow requirements; and internal controls and internal audit processes sufficient to determine the adequacy of the Bank’s liquidity risk management process.

Our liquidity position is supported by management of our liquid assets and liabilities and access to alternative sources of funds. Our liquidity requirements are met primarily through our deposits, FHLB advances and the principal and interest payments we receive on loans and investment securities. Cash on hand, cash at third-party banks, investments available-for-sale and maturing or prepaying balances in our investment and loan portfolios are our most liquid assets. Other sources of liquidity that are routinely available to us include funds from retail, commercial, and BaaS deposits, advances from the FHLB and proceeds from the sale of loans. Less commonly used sources of funding include borrowings from the Federal Reserve discount window, draws on established federal funds lines from unaffiliated commercial banks, brokered funds, a one-way buy through an ICS account, and the issuance of debt or equity securities. We are also participating in the PPPLF, which provides an additional source of low cost funding, at a 0.35% interest rate, and favorable capital treatment for the PPP loans.  We have pledged 820 of these loans, or $202.6 million, as of September 30, 2020.  Under the terms of the agreement, the borrowings will be paid down as the loans are forgiven or paid down by the customer.  We also added a new liquidity source that would be classified as brokered deposits, but do not anticipate using it very often.  We believe we have ample liquidity resources to fund future growth and meet other cash needs as necessary and are closely monitoring liquidity in this uncertain economic environment.

The Company is a corporation separate and apart from our Bank and, therefore, must provide for its own liquidity, including liquidity required to meet its debt service requirements on its subordinated note and junior subordinated debentures. The Company’s main source of cash flow has been through equity and debt offerings. The Company has consistently retained a portion of the funds from equity and debt offerings so that is has sufficient funds for its operating and debt costs for the next few years. The Company down-streamed $7.5 million in capital to the Bank during the first quarter of 2020, bringing the Company’s cash holding to $5.6 million at September 30, 2020.  The Company uses approximately $1.3 million for debt servicing and operating purposes each year, leaving about $3.0 million for other purposes after deducting $2.6 million to cover operating purposes for the next two years.  In addition, the Bank can declare and pay dividends to the Company to meet the Company’s debt and operating expenses. There are statutory and regulatory limitations that affect the ability of the Bank to pay dividends to the Company. We believe that these limitations will not impact the ability of the Bank to pay dividends to the Company to meet ongoing operating needs. For contingency purposes, the Company maintains a minimum level of cash to fund one year’s projected operating cash flow needs and the Bank established a minimum liquidity ratio of 5% of assets. Both of these minimum liquidity levels are on-balance sheet sources. Per policy and the Bank’s liquidity contingency plan, in event of a liquidity emergency the Bank can utilize wholesale funds in an amount up to 30% of

59

 

assets. Since the Bank uses only a small portion of its borrowing or wholesale funding capacity, the Bank has access to funds if needed in a liquidity emergency.  Any PPPLF borrowings are excluded from the 30% of assets wholesale ratio as these funds are for a specific purpose and have favorable regulatory treatment.

Capital Adequacy

Capital management consists of providing equity and other instruments that qualify as regulatory capital to support current and future operations. Banking regulators view capital levels as important indicators of an institution’s financial soundness. As a general matter, FDIC-insured depository institutions and their holding companies are required to maintain minimum capital levels relative to the amount and types of assets they hold. We are subject to regulatory capital requirements at the bank level. The Company will become subject to regulatory capital requirements once its consolidated assets exceed $3.0 billion. Currently, the Federal Reserve assesses the capital position of the Company by reviewing its debt-to-equity ratio and assessing the Company's capacity to serve as a source of strength to the Bank.  During the first quarter of 2020, the Company contributed $7.5 million in capital to the Bank due to the volatile economic environment.  No additional contributions have been made; however, the Company could downstream additional funds to the Bank in the future, if necessary.

 

As of September 30, 2020, and December 31, 2019, the Bank was in compliance with all applicable regulatory capital requirements, and the Bank was classified as “well capitalized” for purposes of the Federal Reserve’s prompt corrective action regulations. As we deploy our capital and continue to grow our operations, our regulatory capital levels may decrease depending on our level of earnings. However, we expect to monitor and control our growth in order to remain in compliance with all regulatory capital standards applicable to us.  

60

 

The following table presents the Company’s and the Bank’s regulatory capital ratios as of the dates presented, as well as the regulatory capital ratios that are required by Federal Reserve regulations to maintain “well-capitalized” status:

 

 

 

Actual

 

 

Minimum Required

for Capital

Adequacy Purposes

 

 

Required to be Well

Capitalized

Under the Prompt

Corrective Action

Provisions

 

 

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

 

 

(dollars in thousands)

 

September 30, 2020

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Leverage Capital (to average assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

138,531

 

 

 

9.20

%

 

$

60,226

 

 

 

4.00

%

 

$

75,282

 

 

 

5.00

%

Bank Only

 

 

141,866

 

 

 

9.43

%

 

 

60,199

 

 

 

4.00

%

 

 

75,249

 

 

 

5.00

%

Common Equity Tier I risk-based capital ratio (to

   risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

 

135,031

 

 

 

12.14

%

 

 

50,066

 

 

 

4.50

%

 

 

72,317

 

 

 

6.50

%

Bank Only

 

 

141,866

 

 

 

12.66

%

 

 

50,418

 

 

 

4.50

%

 

 

72,826

 

 

 

6.50

%

Tier I Capital (to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

 

138,531

 

 

 

12.45

%

 

 

66,754

 

 

 

6.00

%

 

 

89,006

 

 

 

8.00

%

Bank Only

 

 

141,866

 

 

 

12.66

%

 

 

67,224

 

 

 

6.00

%

 

 

89,632

 

 

 

8.00

%

Total Capital (to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

 

162,581

 

 

 

14.61

%

 

 

89,006

 

 

 

8.00

%

 

 

111,257

 

 

 

10.00

%

Bank Only

 

 

155,916

 

 

 

13.92

%

 

 

89,632

 

 

 

8.00

%

 

 

112,040

 

 

 

10.00

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Leverage Capital (to average assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

127,524

 

 

 

11.64

%

 

$

43,806

 

 

 

4.00

%

 

$

54,758

 

 

 

5.00

%

Bank Only

 

 

122,904

 

 

 

11.22

%

 

 

43,801

 

 

 

4.00

%

 

 

54,751

 

 

 

5.00

%

Common Equity Tier I risk-based capital ratio (to

   risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

 

124,024

 

 

 

12.78

%

 

 

43,659

 

 

 

4.50

%

 

 

63,064

 

 

 

6.50

%

Bank Only

 

 

122,904

 

 

 

12.43

%

 

 

44,504

 

 

 

4.50

%

 

 

64,283

 

 

 

6.50

%

Tier I Capital (to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

 

127,524

 

 

 

13.14

%

 

 

58,213

 

 

 

6.00

%

 

 

77,617

 

 

 

8.00

%

Bank Only

 

 

122,904

 

 

 

12.43

%

 

 

58,338

 

 

 

6.00

%

 

 

79,118

 

 

 

8.00

%

Total Capital (to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

 

149,416

 

 

 

15.40

%

 

 

77,617

 

 

 

8.00

%

 

 

97,021

 

 

 

10.00

%

Bank Only

 

 

134,796

 

 

 

13.63

%

 

 

79,118

 

 

 

8.00

%

 

 

98,897

 

 

 

10.00

%

 

Contractual Obligations

The following table summarizes contractual obligations and other commitments to make future payments (other than non-time deposit obligations), which consist of future cash payments associated with our contractual obligations, as of September 30, 2020.

 

 

 

 

 

 

 

Payments Due by Period

 

 

 

 

 

 

 

Less than

 

 

1 to 3

 

 

4 to 5

 

 

More than

 

(Dollars in thousands)

 

Total

 

 

1 Year

 

 

Years

 

 

Years

 

 

5 Years

 

Time Deposits

 

$

64,892

 

 

$

52,266

 

 

$

10,544

 

 

$

2,082

 

 

$

-

 

Paycheck Protection Program Liquidity Facility

 

 

202,595

 

 

 

-

 

 

 

202,595

 

 

 

-

 

 

 

-

 

FHLB advances

 

 

24,999

 

 

 

-

 

 

 

10,000

 

 

 

14,999

 

 

 

-

 

Subordinated note

 

 

10,000

 

 

 

-

 

 

 

3,500

 

 

 

4,000

 

 

 

2,500

 

Junior subordinated debentures

 

 

3,609

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

3,609

 

Deferred compensation plans

 

 

1,329

 

 

 

175

 

 

 

350

 

 

 

350

 

 

 

454

 

Operating leases

 

 

8,885

 

 

 

1,259

 

 

 

2,521

 

 

 

1,716

 

 

 

3,389

 

 

For a discussion of our borrowings, see “—Financial Condition—Borrowings” in this section.

61

 

We believe that we will be able to meet our contractual obligations as they come due. Adequate cash levels are expected through profitability, repayments from loans and securities, deposit gathering activity, access to borrowing sources and periodic loan sales.

Off-Balance Sheet Items

In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby and commercial letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets.

Our commitments associated with outstanding commitments to extend credit and standby and commercial letters of credit are summarized below. Since commitments associated with commitments to extend credit and letters of credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.

 

 

 

As of

 

 

As of

 

 

 

 

September 30,

 

 

December 31,

 

 

(Dollars in thousands)

 

2020

 

 

2019

 

 

Commitments to extend credit:

 

 

 

 

 

 

 

 

 

Commercial and industrial loans

 

$

140,536

 

 

$

66,563

 

 

Construction – commercial real estate loans

 

 

58,170

 

 

 

42,371

 

 

Construction – residential real estate loans

 

 

18,134

 

 

 

21,361

 

 

Residential real estate loans

 

 

19,096

 

 

 

9,888

 

 

Commercial real estate loans

 

 

15,604

 

 

 

19,082

 

 

Other

 

 

1,064

 

 

 

1,181

 

 

Total commitments to extend credit

 

$

252,604

 

 

$

160,446

 

 

Standby letters of credit

 

$

1,540

 

 

$

2,250

 

 

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being fully drawn upon, the total commitment amounts disclosed above do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if considered necessary by us, upon extension of credit, is based on management’s credit evaluation of the customer.

Standby and commercial letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event of nonperformance by the customer, we have rights to the underlying collateral, which can include commercial real estate, physical plant and property, inventory, receivables, cash and/or marketable securities. Our credit risk associated with issuing letters of credit is essentially the same as the risk involved in extending loan facilities to our customers.

62

 

Critical Accounting Policies

Our accounting policies are integral to understanding our results of operations. Our accounting policies are described in greater detail in “Note 1 - Description of Business and Summary of Significant Accounting Policies” and “Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” of our Form 10-K. We have procedures and processes in place to facilitate making these judgments. Actual results in these areas could differ from management’s estimates. There have been no significant changes concerning our critical accounting policies as described in our Form 10-K.

Selected Financial Data

The following table shows the Company’s key performance ratios for the periods indicated.  The table also includes ratios that were adjusted by removing the impact of the PPP loans on loans receivable related measures.  The adjusted ratios are non-GAAP measures.  For more information about non-GAAP financial measures, see “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures” section that follows.

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

(unaudited)

 

September 30,

2020

 

June 30,

2020

 

March 31,

2020

 

December 31, 2019

 

September 30, 2019

 

 

September 30, 2020

 

September 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on average assets (1)

 

 

0.95

%

 

0.96

%

 

0.96

%

 

1.31

%

 

1.35

%

 

 

0.96

%

 

1.27

%

Return on average equity (1)

 

 

12.14

%

 

11.37

%

 

8.66

%

 

11.66

%

 

11.72

%

 

 

10.73

%

 

11.16

%

Pre-tax, pre-provision return

     on average assets (1)(2)

 

 

1.72

%

 

1.72

%

 

1.77

%

 

1.95

%

 

1.95

%

 

 

1.73

%

 

1.83

%

Yield on earnings assets (1)

 

 

3.93

%

 

4.16

%

 

4.79

%

 

4.90

%

 

4.94

%

 

 

4.23

%

 

4.89

%

Yield on loans receivable (1)

 

 

4.33

%

 

4.57

%

 

5.25

%

 

5.36

%

 

5.36

%

 

 

4.65

%

 

5.38

%

Yield on loans receivable,

     as adjusted (1)(2)

 

 

4.78

%

 

4.94

%

n/a

 

n/a

 

n/a

 

 

 

4.99

%

n/a

 

Contractual yield on loans

     receivable, excluding earned

     fees (1)

 

 

3.61

%

 

3.91

%

 

5.08

%

 

5.15

%

 

5.24

%

 

 

4.08

%

 

5.23

%

Contractual yield on loans

     receivable, excluding earned

     fees, as adjusted (1)(2)

 

 

4.69

%

 

4.84

%

n/a

 

n/a

 

n/a

 

 

 

4.86

%

n/a

 

Cost of funds (1)

 

 

0.33

%

 

0.41

%

 

0.70

%

 

0.70

%

 

0.72

%

 

 

0.45

%

 

0.74

%

Cost of deposits (1)

 

 

0.27

%

 

0.35

%

 

0.64

%

 

0.63

%

 

0.64

%

 

 

0.40

%

 

0.66

%

Net interest margin (1)

 

 

3.62

%

 

3.78

%

 

4.15

%

 

4.26

%

 

4.29

%

 

 

3.81

%

 

4.22

%

Noninterest expense to average

     assets (1)

 

 

2.26

%

 

2.34

%

 

3.18

%

 

2.90

%

 

2.98

%

 

 

2.52

%

 

3.05

%

Efficiency ratio

 

 

56.73

%

 

57.66

%

 

64.26

%

 

59.86

%

 

60.46

%

 

 

59.31

%

 

62.50

%

Loans receivable to deposits

 

 

110.98

%

 

110.77

%

 

100.01

%

 

97.02

%

 

94.78

%

 

 

110.98

%

 

94.78

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) Annualized calculations shown for quarterly and nine month periods presented.

 

 

 

 

 

 

 

 

(2) A reconciliation of the non-GAAP measures are set forth  in “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures”.

 

 

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

 

The Company uses certain non-GAAP financial measures to provide meaningful supplemental information regarding the Company’s operational performance and to enhance investors’ overall understanding of such financial performance. However, these non-GAAP financial measures are supplemental and are not a substitute for an analysis based on GAAP measures. As other companies may use different calculations for these adjusted measures, this presentation may not be comparable to other similarly titled adjusted measures reported by other companies.  We believe these non-GAAP measures are useful to investors in evaluating our performance and in demonstrating resources available with and without provision for loan losses and income taxes.

 

The following non-GAAP measures are presented to illustrate the impact of provision for loan losses and provision for income taxes on net income and return on average assets.

 

63

 

Pre-tax, pre-provision net income is a non-GAAP measure that excludes the impact of provision for loan losses and provision for income taxes from net income.  The most directly comparable GAAP measure is net income.  

 

Pre-tax, pre-provision return on average assets is a non-GAAP measure that excludes the impact of provision for loan losses and provision for income taxes from return on average assets.  The most directly comparable GAAP measure is return on average assets.

 

Reconciliations of the GAAP and non-GAAP measures are presented below.

 

 

 

As of and for the

Three Months Ended

 

 

As of and for the

Nine Months Ended

 

(Dollars in thousands, unaudited)

 

September 30,

2020

 

 

June 30,

2020

 

 

March 31,

2020

 

 

December 31,

2019

 

 

September 30,

2019

 

 

September 30,

2020

 

 

September 30,

2019

 

Pre-tax, pre-provision net income and pre-tax, pre-provision return on average assets:

 

 

 

 

 

 

 

 

 

Total average assets

 

$

1,704,874

 

 

$

1,538,546

 

 

$

1,141,453

 

 

$

1,095,343

 

 

$

1,031,969

 

 

$

1,462,512

 

 

$

1,010,620

 

Total net income

 

 

4,090

 

 

 

3,671

 

 

 

2,724

 

 

 

3,608

 

 

 

3,511

 

 

 

10,485

 

 

 

9,593

 

Plus:  provision for loan

     losses

 

 

2,200

 

 

 

1,930

 

 

 

1,578

 

 

 

820

 

 

 

637

 

 

 

5,708

 

 

 

1,724

 

Plus:  provision for

     income taxes

 

 

1,082

 

 

 

967

 

 

 

714

 

 

 

947

 

 

 

919

 

 

 

2,763

 

 

 

2,514

 

Pre-tax, pre-provision net

     income

 

$

7,372

 

 

$

6,568

 

 

$

5,016

 

 

$

5,375

 

 

$

5,067

 

 

$

18,956

 

 

$

13,831

 

Return on average assets

 

 

0.95

%

 

 

0.96

%

 

 

0.96

%

 

 

1.31

%

 

 

1.35

%

 

 

0.96

%

 

 

1.27

%

Pre-tax, pre-provision

     return on average

     assets:

 

 

1.72

%

 

 

1.72

%

 

 

1.77

%

 

 

1.95

%

 

 

1.95

%

 

 

1.73

%

 

 

1.83

%

 

64

 

The following non-GAAP financial measures are presented to illustrate and identify the impact of PPP loans on loans receivable related measures.  By removing these significant items and showing what the results would have been without them, we are providing investors with the information to better compare results with periods that did not have these significant items.  We believe that these non-GAAP financial measures provide information that is important to investors and that is useful in understanding our results of operations. These measures include the following:

Adjusted allowance for loan losses to loans receivable is a non-GAAP measure that excludes the impact of PPP loans on balance sheet. The most directly comparable GAAP measure is allowance for loan losses to loans receivable.

Adjusted yield on loans receivable is a non-GAAP measure that excludes the impact of PPP loans on balance sheet. The most directly comparable GAAP measure is yield on loans.

Adjusted contractual yield on loans receivable, excluding earned fees is a non-GAAP measure that excludes the impact of PPP loans on balance sheet. The most directly comparable GAAP measure is contractual yield on loans, excluding fees.

 

Reconciliations of the GAAP and non-GAAP measures are presented in the following table:

 

 

 

As of and for the

 

 

As of and for the

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

(Dollars in thousands, unaudited)

 

September 30, 2020

 

 

September 30, 2020

 

Adjusted allowance for loan losses to loans receivable:

 

 

 

 

 

 

 

 

Total loans, net of deferred fees

 

$

1,509,389

 

 

$

1,509,389

 

Less: PPP loans

 

 

(452,846

)

 

 

(452,846

)

Less: net deferred fees on PPP loans

 

 

8,586

 

 

 

8,586

 

Adjusted loans, net of deferred fees

 

$

1,065,129

 

 

$

1,065,129

 

Allowance for loan losses

 

$

(17,046

)

 

$

(17,046

)

Allowance for loan losses to loans receivable

 

 

1.13

%

 

 

1.13

%

Adjusted allowance for loan losses to loans receivable

 

 

1.60

%

 

 

1.60

%

Adjusted yield on loans receivable:

 

 

 

 

 

 

 

 

Total average loans receivable

 

$

1,493,024

 

 

$

1,265,705

 

Less: average PPP loans

 

 

(448,313

)

 

 

(261,854

)

Plus: average deferred fees on PPP loans

 

 

9,599

 

 

 

6,112

 

Adjusted total average loans receivable

 

$

1,054,310

 

 

$

1,009,964

 

Interest income on loans

 

$

16,244

 

 

$

44,025

 

Less: interest and fee income on PPP loans

 

 

(3,566

)

 

 

(6,325

)

Adjusted interest income on loans

 

$

12,678

 

 

$

37,700

 

Yield on loans receivable

 

 

4.33

%

 

 

4.65

%

Adjusted yield on loans receivable:

 

 

4.78

%

 

 

4.99

%

Adjusted contractual yield on loans receivable, excluding earned fees and interest on PPP loans:

 

 

 

 

 

Total average loans receivable

 

$

1,493,024

 

 

$

1,265,705

 

Less: average PPP loans

 

 

(448,313

)

 

 

(261,854

)

Plus: average deferred fees on PPP loans

 

$

9,599

 

 

$

6,112

 

Adjusted total average loans receivable,

     excluding earned fees

 

$

1,054,310

 

 

$

1,009,964

 

Interest and earned fee income on loans

 

$

16,244

 

 

$

44,025

 

Less: earned fee income on loans

 

$

(2,693

)

 

$

(5,303

)

Less: interest income on PPP loans

 

 

(1,129

)

 

 

(1,966

)

Adjusted interest income on loans

 

$

12,422

 

 

$

36,756

 

Contractual yield on loans receivable,

     excluding earned fees

 

 

3.61

%

 

 

4.08

%

Adjusted contractual yield on loans receivable,

     excluding earned fees and interest on PPP loans:

 

 

4.69

%

 

 

4.86

%

 

65

 

Item 3.  Quantitative and Qualitative Disclosure about Market Risk

Quantitative and Qualitative Disclosures about Market Risk

As a financial institution, our primary component of market risk is interest rate volatility. Our asset liability and funds management policy provides management with the guidelines for effective funds management, and we have established a measurement system for monitoring our net interest rate sensitivity position. We have historically managed our sensitivity position within our established guidelines.

Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and the market value of all interest earning assets and interest bearing liabilities, other than those which have a short term to maturity. Interest rate risk is the potential for economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a decrease in current fair market values. Our objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income.

We manage our exposure to interest rates by structuring our balance sheet in the ordinary course of business. We do not enter into instruments such as leveraged derivatives, financial options, financial future contracts or forward delivery contracts for the purpose of reducing interest rate risk. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.

Our exposure to interest rate risk is managed by the Asset Liability Committee (“ALCO”), of the Bank and reviewed by the Asset Liability and Investment Committee of our board of directors in accordance with policies approved by our board of directors. ALCO formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, ALCO considers the impact on earnings and capital on the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. ALCO meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and sale activities, commitments to originate loans and the maturities of investments and borrowings. Additionally, ALCO reviews liquidity, cash flows, maturities of deposits and consumer and commercial deposit activity. Management employs various methodologies to manage interest rate risk including an analysis of relationships between interest earning assets and interest bearing liabilities and interest rate simulations using a model. The Asset Liability and Investment Committee of our board of directors meets quarterly to review the Bank’s interest rate risk profile, liquidity position, including contingent liquidity, and investment portfolio.

We use interest rate risk simulation models to test interest rate sensitivity of net interest income and fair value of equity, and the impact of changes in interest rates on other financial metrics. Contractual maturities and re-pricing opportunities of loans are incorporated in the model, as are prepayment assumptions, maturity data and call options within the investment portfolio. Average life of non-maturity deposit accounts are based on historical decay rates and assumptions and are incorporated into the model. The assumptions used are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.  To help ensure the accuracy of the model, we perform a quarterly back test against our actual results.

On a quarterly basis, we run multiple simulations under two different premises of which one is a static balance sheet and the other is a dynamic growth balance sheet. The static balance sheet approach produces results that show the interest risk currently inherent in our balance sheet at that point in time. The dynamic balance sheet includes our projected growth levels going forward and produces results that shows how net income, net interest income, and interest risk change based on our projected growth. These simulations test the impact on net interest income and fair value of equity from changes in market interest rates under various scenarios. Under the static and dynamic approaches, rates are shocked instantaneously and ramped over a 12-month horizon assuming parallel yield curve shifts. Parallel shock scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Non-parallel simulations are also conducted and involve analysis of interest income and expense under various changes in the shape of the yield curve including a forward curve, flat curve, steepening curve, and an inverted curve. Our internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net income at risk for the subsequent one- and two-year period should not decline by more than 10% for a 100 basis point shift, 15% for a 200 basis point shift, 20% for a 300 basis point shift, and 25% for a 400 basis point shift.

66

 

The following tables summarize the simulated change in net interest income over a 12-month horizon as of the dates indicated:

 

 

 

Estimated Increase (Decrease) in

Net Interest Income

Change in Market Interest Rates

 

Twelve Month Projection

September 30, 2020

 

Twelve Month Projection

December 31, 2019

Static Balance Sheet and Rate Shifts

 

 

 

 

+400 basis points

 

18.8%

 

14.9%

+300 basis points

 

14.1

 

11.0

+200 basis points

 

9.2

 

7.2

+100 basis points

 

4.5

 

3.5

-100 basis points

 

(3.3)

 

0.2

-200 basis points

 

(6.4)

 

(3.8)

-300 basis points

 

(9.0)

 

(5.1)

 

 

 

 

 

Dynamic Balance Sheet and Rate Shifts

 

 

 

 

+400 basis points

 

26.8

 

17.5

+300 basis points

 

20.0

 

13.0

+200 basis points

 

13.2

 

8.5

+100 basis points

 

6.5

 

4.2

-100 basis points

 

(4.9)

 

(0.5)

-200 basis points

 

(8.4)

 

(5.2)

-300 basis points

 

(11.4)

 

(6.8)

 

The results illustrate that the Bank is asset sensitive and generally performs better in an increasing interest rate environment. The results are primarily due to behavior of demand, money market and savings deposits during such rate fluctuations. We have found that, historically, interest rates on these deposits change more slowly than changes in the discount and federal funds rates. This assumption is incorporated into the simulation model. The assumptions incorporated into the model are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions, the shape of the interest yield curve, and the application and timing of various strategies.

 

Interest rates are at historical lows and as such, we believe rate decrease scenarios of -100, -200 and -300 are not as  relevant as Treasury rates are under 1%, except for the 30 year Treasury.

Impact of Inflation

Our consolidated financial statements and related notes to those financial statements included elsewhere in this report have been prepared in accordance with GAAP. GAAP requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.

Unlike many industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, other operating expenses do reflect general levels of inflation.

Item 4.  Controls and Procedures

Disclosure Controls and Procedures. An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)). Based on that evaluation, the Company's Chief Executive Officer and the Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s

67

 

management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.  

Change in Internal Control over Financial Reporting. There were no changes in the Company’s internal control over financial reporting occurred during the three months ended September 30, 2020, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

68

 

PART II.  OTHER INFORMATION

From time to time, we are a party to various litigation matters incidental to the conduct of our business. We do not believe that any currently pending legal proceedings will have a material adverse effect on our business, financial condition or earnings.

Item 1A.  Risk Factors

For information regarding the Company’s risk factors, see “Risk Factors” in the Company’s Annual Report on Form 10-K, which are incorporated by reference herein. As of September 30, 2020, the risk factors of the Company have not changed materially from those disclosed in the Form 10-K, other than those noted below.

The effects of COVID-19, and the impact of actions to mitigate it, has had and may continue to adversely affect our business, financial condition and results of operations, and the extent and duration of these effects remain uncertain. A second wave of COVID-19 may have a similar or worse impact on us.

Federal, state and local governments have enacted various restrictions in an attempt to limit the spread of COVID-19. Such measures have disrupted economic activity and contributed to job losses and reductions in consumer and business spending. In response to the economic and financial effects of COVID-19, the Federal Reserve has sharply reduced interest rates and instituted quantitative easing measures as well as domestic and global capital market support programs. In addition, the Trump Administration, Congress, various federal agencies and state governments have taken measures to address the economic and social consequences of the COVID-19 pandemic, including the passage of the CARES Act. The CARES Act, among other things, provides certain measures to support individuals and businesses in maintaining solvency through monetary relief, including in the form of financing, loan forgiveness and automatic forbearance. Beginning at the end of March 2020, we began processing loan applications under the PPP created under the CARES Act, and we continued to accept and process requests through the program end date of August 8, 2020. The Federal Reserve's Main Street Lending Program will provide liquidity to small and mid-sized businesses by purchasing 95% participations in 5-year loans with certain terms, including certain deferrals of payment of principal and interest. The Bank is a registered lender under the Main Street Lending Program, and we have accepted one application as of September 30, 2020.  Other banking regulatory agencies have encouraged lenders to extend additional loans, and the federal government is considering additional stimulus and support legislation focused on providing aid to various sectors, including small businesses.  Further, we expect to continue to restructure certain payments and/or defer payments for our loan customers during this uncertain time to help alleviate financial hardships. The full impact on our business activities as a result of new government and regulatory policies, programs and guidelines, as well as regulators’ reactions to such activities, remains uncertain.

The economic effects of the COVID-19 pandemic have had a destabilizing effect on financial markets, key market indices and overall economic activity. The uncertainty regarding the duration of the pandemic and the resulting economic disruption has caused increased market volatility and led to an economic recession and a significant decrease in consumer confidence and business generally. The continuation of these conditions (including whether due to a resurgence or a second wave of COVID-19 infections, particularly as our home county of Snohomish begins to re-open) as well as the impacts of the CARES Act and other federal and state measures, specifically with respect to loan forbearances, have had and can be expected to adversely impact our businesses and results of operations and the operations of our borrowers, customers and business partners. In particular, these events have had and/or can be expected to continue to have the following effects, among other things:

 

•

impair the ability of borrowers to repay outstanding loans or other obligations, resulting in increases in delinquencies;

 

•

impair the value of collateral securing loans (particularly with respect to real estate);

 

•

adversely affect our level of charge-offs and require an additional increase in our allowance for loan losses;

 

•

adversely affect the stability of our deposit base, or otherwise impair our liquidity;

 

•

create stress on our operations and systems associated with our participation in the PPP as a result of high demand and volume of applications;

 

•

result in increased compliance risk as we become subject to new regulatory and other requirements, including new and changing guidance, associated with the PPP and its loan forgiveness program, the Main Street Lending Program, and other new programs in which we participate;

 

•

impair the ability of loan guarantors to honor commitments;

 

•

negatively impact our regulatory capital ratios;

69

 

 

•

negatively impact the productivity and availability of key personnel and other employees necessary to conduct our business, and of third-party service providers who perform critical services for us, or otherwise cause operational failures due to changes in our normal business practices necessitated by the COVID-19 pandemic and related governmental actions;

 

•

increase cyber and payment fraud risk, and other operational risks given increased online and remote activity; and

 

•

broadly result in lost revenue and income.  

Our results of operations have been adversely affected by the factors described above. For example, in the quarter ended September 30, 2020, these factors caused a substantial increase in our provision for loan losses.

Prolonged measures by health or other governmental authorities encouraging or requiring significant restrictions on travel, assembly or other core business practices could further harm our business and those of our customers, in particular our small to medium sized business customers. Although we have business continuity plans and other safeguards in place, there is no assurance that they will be effective.

Our loan portfolio includes loans that are in forbearance, but which are not classified as TDRs because they were current at the time forbearance began. When the forbearance periods end, we may be required to classify a portion of these loans as TDRs, if the borrowers are unable to resume repayment.

The ultimate impact of these factors is highly uncertain at this time and we do not yet know the full extent of the impacts on our business, our operations or the global economy as a whole, as well as the pace of economic recovery when the COVID-19 pandemic subsides. However, the decline in economic conditions generally and a prolonged negative impact on small to medium sized businesses, in particular, due to COVID-19 may result in an adverse effect on our business, financial condition and results of operations and may heighten many of our known risks described in the “Risk Factors” section of our Form 10-K.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

There were no unregistered sales of the Company’s equity securities during the three months ended September 30, 2020.

The Company did not repurchase any of its equity securities during the three months ended September 30, 2020 and does not have any authorized share repurchase programs.

Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not applicable.

Item 5.  Other Information

None.

70

 

Item 6.  Exhibits

 

10.1+

First Amendment to the Coastal Financial Corporation 2006 Stock Option and Equity Compensation Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q (File No. 001-38589), filed with the Commission on August 7, 2020).

 

 

10.2+

Amended Non-Employee Director Compensation Policy, as amended on October 26, 2020.

 

 

  31.1

Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

  31.2

Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

  32.1

Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

101

The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter months ended September 30, 2020, formatted in inline XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statement of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to the Consolidated Financial Statements. Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

 

104

Cover Page Interactive Data (formatted as Inline XBRL and contained in Exhibit 101 filed herewith)

+ Management contract or compensatory plan, contract or arrangement.

 

 

71

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

 

COASTAL FINANCIAL CORPORATION

 

 

 

 

 

 

 

Dated:

November 6, 2020

 

By:

/s/ Eric M. Sprink

 

 

 

 

 

Eric M. Sprink

 

 

 

 

 

President and Chief Executive Officer

 

 

 

 

 

(Principal Executive Officer)

 

 

 

 

 

 

 

Dated:

November 6, 2020

 

By:

/s/ Joel G. Edwards

 

 

 

 

 

Joel G. Edwards

 

 

 

 

 

Executive Vice President and

 

 

 

 

 

Chief Financial Officer

 

 

 

 

 

(Principal Financial Officer)

 

 

 

72