FINANCIÈRE BANKWELL: Management report and analysis of financial position and operating results (Form 10-Q)
This section presents management's perspective on our financial condition and results of operations. The following discussion and analysis should be read in conjunction with the unaudited interim consolidated financial statements and related notes contained elsewhere in this report on Form 10-Q. To the extent that this discussion describes prior performance, the descriptions relate only to the periods listed, which may not be indicative of future financial outcomes. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management's expectations. Factors that could cause such differences are discussed in the Company's Form 10-K filed for the year ended
December 31, 2020in the sections titled "Cautionary Note Regarding Forward-Looking Statements" and "Risk Factors." We assume no obligation to update any of these forward-looking statements.
Bankwell Financial Group, Inc.is a bank holding company headquartered in New Canaan, Connecticut. Through our wholly owned subsidiary, Bankwell Bank, or the Bank, we serve small and medium-sized businesses and retail customers in Connecticut, with the majority of the Company's loans in Fairfieldand New HavenCounties and some New Yorkmetro area counties. We have a history of building long-term customer relationships and attracting new customers through what we believe is our strong customer service and our ability to deliver a diverse product offering. The following discussion and analysis presents our results of operations and financial condition on a consolidated basis. However, because we conduct all of our material business operations through the Bank, the discussion and analysis relates to activities primarily conducted at the Bank. We generate most of our revenue from interest on loans and investments and fee-based revenues. Our primary source of funding for our loans is deposits. Our largest expenses are interest on deposits and salaries and related employee benefits. We measure our performance primarily through our net interest margin, efficiency ratio, ratio of allowance for loan losses to total loans, return on average assets and return on average equity, among other metrics, while maintaining appropriate regulatory leverage and risk-based capital ratios.
We strive to be the “local” bank and banking provider of choice in our very attractive market area, and to serve as a local alternative to our larger competitors. We aim to do this through:
• Responsive, customer-centric products and services with a community approach;
• Organic growth and strategic acquisitions when market opportunities arise;
• Use of an efficient and scalable infrastructure; and
• Disciplined focus on risk management.
Impact of COVID-19
The COVID-19 pandemic has resulted in significant economic disruption affecting our business and the clients we serve. As vaccination efforts have rapidly expanded, restrictions on businesses are being lifted and a return to more normal economic activity is expected. However, a significant degree of uncertainty still exists concerning the ultimate duration and magnitude of the COVID-19 pandemic. Given the ongoing and dynamic nature of the circumstances, it is still difficult to predict the full impact of the COVID-19 pandemic on our business. The extent of such impact will depend on future developments, including but not limited to the continued roll-out of vaccinations, which play an important role as to when the coronavirus can be controlled and abated.
Accounting policies and critical estimates
The discussion and analysis of our results of operations and financial condition are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires us to make significant estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from our current estimates, as a result of changing conditions and future events. 39 -------------------------------------------------------------------------------- We believe that accounting estimates related to the measurement of the allowance for loan losses, the valuation of derivative instruments, investment securities and deferred income taxes, and the evaluation of investment securities for other than temporary impairment are particularly critical and susceptible to significant near-term change.
Revenue and performance overview
For the three months ended
March 31, 2021, we had net interest income of $14.7 million, an increase of $1.4 millionor 10.3% when compared to the same period in 2020. The increase in net interest income was primarily due to a decline in interest expense from lower interest rates when compared to the same period in 2020. Noninterest income increased $0.9 millionto $2.0 millionfor the three months ended March 31, 2021compared to the same period in 2020. The increase in noninterest income for the three months ended March 31, 2021, when compared to the same periods in 2020, was primarily a result of resumed SBA loan sales, totaling $0.5 millionfor the quarter ended March 31, 2021. In addition, the increase was impacted by a one-time federal payroll tax credit for COVID-19 of $0.9 million, partially offset by $0.4 millionof non-recurring interest rate swap fees recognized in the quarter ended March 31, 2020. In the fourth quarter of 2020, the Company recognized a $3.9 millionone-time charge recorded in noninterest expense for office consolidation, vendor contract termination and employee severance costs. As of March 31, 2021, the Company has paid a total of $0.3 millionin employee severance costs and a total of $21 thousandin vendor contract termination costs. Reference the 2020 Form 10-K for further discussion on these charges.
Net income available to common shareholders was
Returns on average stockholders' equity and average assets for the three months ended
March 31, 2021were 12.67% and 1.02%, respectively, compared to 3.03% and 0.29%, respectively, for the three months ended March 31, 2020.
Results of operations
Net interest income
Net interest income is the difference between interest earned on loans and securities and interest paid on deposits and other borrowings, and is the primary source of our operating income. Net interest income is affected by the level of interest rates, changes in interest rates and changes in the amount and composition of interest earning assets and interest bearing liabilities. Included in interest income are certain loan fees, such as deferred origination fees and late charges. We convert tax-exempt income to a fully taxable equivalent ("FTE") basis using the statutory federal income tax rate adjusted for applicable state income taxes net of the related federal tax benefit. The average balances are principally daily averages. Interest income on loans includes the effect of deferred loan fees and costs accounted for as yield adjustments. Premium amortization and discount accretion are included in the respective interest income and interest expense amounts. FTE net interest income for the three months ended
March 31, 2021and 2020 was $14.7 millionand $13.3 million, respectively. FTE interest income for the three months ended March 31, 2021decreased by $1.3 million, or 6.6%, to $18.8 million, compared to FTE interest income for the three months ended March 31, 2020. This decrease was due to lower loan yields as loans re-priced at lower interest rates throughout 2020. Interest expense for the three months ended March 31, 2021decreased by $2.7 million, or 39.5%, compared to interest expense for the three months ended March 31, 2020. This decrease is due to lower interest rates on deposits.
Net interest margin decreased 24 basis points to 2.74% for the quarter ended
Breakdown of assets, liabilities and equity; Interest rate and interest differential
The following table shows the average balances and returns earned on interest-bearing assets and the average balances and weighted average rates paid on our financing liabilities for the quarter ended.
Three Months Ended March 31, 2021 2020 Yield / Rate Yield / Rate (Dollars in thousands) Average Balance Interest (5) Average Balance Interest (5) Assets: Cash and Fed funds sold
$ 401,900 $ 1080.11 % $ 73,497 $ 2861.56 % Securities (1) 101,176 788 3.11 98,566 775 3.15 Loans: Commercial real estate 1,129,224 12,731 4.51 1,108,709 13,024 4.65 Residential real estate 112,053 964 3.44 143,826 1,357 3.77 Construction (2) 94,075 885 3.76 100,437 1,215 4.78 Commercial business 294,756 3,271 4.44 258,848 3,386 5.18 Consumer 5,039 49 3.94 156 3 8.37 Total loans 1,635,147 17,900 4.38 1,611,976 18,985 4.66 Federal Home Loan Bank stock 6,508 31 1.96 7,325 103 5.65 Total earning assets 2,144,731 $ 18,8273.51 % 1,791,364 $ 20,1494.45 % Other assets 113,561 111,585 Total assets $ 2,258,292 $ 1,902,949Liabilities and shareholders' equity: Interest bearing liabilities: NOW $ 101,057 $ 430.17 % $ 67,925 $ 280.17 % Money market 736,659 950 0.52 438,588 1,492 1.37 Savings 160,347 125 0.32 185,478 672 1.46 Time 611,153 1,996 1.32 640,580 3,517 2.21 Total interest bearing deposits 1,609,216 3,114 0.78 1,332,571 5,709 1.72 Borrowed money 152,485 1,008 2.64 172,464 1,101 2.53 Total interest bearing liabilities 1,761,701 $ 4,1220.95 % 1,505,035 $ 6,8101.82 % Noninterest bearing deposits 269,863 179,066 Other liabilities 44,670 37,721 Total Liabilities 2,076,234 1,721,822 Shareholders' equity 182,058 181,127 Total liabilities and shareholders' equity $ 2,258,292 $ 1,902,949Net interest income (3) $ 14,705 $ 13,339Interest rate spread 2.56 % 2.63 % Net interest margin (4) 2.74 % 2.98 % (1)Average balances and yields for securities are based on amortized cost. (2)Includes commercial and residential real estate construction. (3)The adjustment for securities and loans taxable equivalency amounted to $50 thousandand $53 thousandfor the three months ended March 31, 2021and 2020, respectively. (4)Annualized net interest income as a percentage of earning assets. (5)Yields are calculated using the contractual day count convention for each respective product type. 41 --------------------------------------------------------------------------------
Effect of changes in interest rates and the volume of average productive assets and average interest-bearing liabilities
The following table shows the extent to which changes in interest rates and changes in the volume of average earning assets and average interest bearing liabilities have affected net interest income. For each category of earning assets and interest bearing liabilities, information is provided relating to: changes in volume (changes in average balances multiplied by the prior year's average interest rates); changes in rates (changes in average interest rates multiplied by the prior year's average balances); and the total change. Changes attributable to both volume and rate have been allocated proportionately based on the relationship of the absolute dollar amount of change in each. Three Months Ended March 31, 2021 vs 2020 Increase (Decrease) (In thousands) Volume Rate Total Interest and dividend income: Cash and Fed funds sold $ 300
$ (478) $ (178)Securities 21 (8) 13 Loans: Commercial real estate 238 (531) (293) Residential real estate (281) (112) (393) Construction (73) (257) (330) Commercial business 437 (552) (115) Consumer 49 (3) 46 Total loans 370 (1,455) (1,085) Federal Home Loan Bank stock (11) (61) (72) Total change in interest and dividend income 680 (2,002) (1,322) Interest expense: Deposits: NOW 14 1 15 Money market 687 (1,229) (542) Savings (81) (466) (547) Time (155) (1,366) (1,521) Total deposits 465 (3,060) (2,595) Borrowed money (131) 38 (93) Total change in interest expense 334 (3,022) (2,688) Change in net interest income $ 346 $ 1,020 $ 1,366Provision for Loan Losses The provision for loan losses is based on management's periodic assessment of the adequacy of our allowance for loan losses which, in turn, is based on interrelated factors such as the composition of our loan portfolio and its inherent risk characteristics, the level of nonperforming loans and net charge-offs, both current and historic, local economic and credit conditions, the direction of real estate values, and regulatory guidelines. The provision for loan losses is charged against earnings in order to maintain our allowance for loan losses and reflects management's best estimate of probable losses inherent in our loan portfolio as of the balance sheet date. The credit for loan losses for the three months ended March 31, 2021was $0.3 millioncompared to a provision for loan losses of $3.2 millionfor the three months ended March 31, 2020. The decrease in the provision for loan losses for the three months ended March 31, 2021was primarily due to improving economic trends, partially offset by increased reserves on impaired loans and overall higher loan balances. 42 --------------------------------------------------------------------------------
Noninterest income is a component of our revenue and is comprised primarily of fees generated from deposit relationships with our customers, fees generated from sales and referrals of loans, income earned on bank-owned life insurance and gains on sales of investment securities. The following table compares noninterest income for the three months ended
March 31, 2021and 2020: Three Months Ended March 31, Change (Dollars in thousands) 2021 2020 $ % Gains and fees from sales of loans $ 513$ - $ 513N/A Bank-owned life insurance 231 243 (12) (4.9) Service charges and fees 199 217 (18) (8.3) Other 1,013 612 401 65.5 Total noninterest income $ 1,956 $ 1,072 $ 88482.5 % Noninterest income increased by $0.9 million, or 82.5%, to $2.0 millionfor the three months ended March 31, 2021compared to the three months ended March 31, 2020. The increase in noninterest income was driven by resumed SBA loan sales, totaling $0.5 millionfor the quarter ended March 31, 2021. In addition, the increase was impacted by a one-time federal payroll tax credit for COVID-19 of $0.9 million, partially offset by $0.4 millionof non-recurring interest rate swap fees recognized in the quarter ended March 31, 2020.
The following table compares noninterest expense for the three months ended
March 31, 2021and 2020: Three Months Ended March 31, Change (Dollars in thousands) 2021 2020 $ %
Salaries and Benefits
(11.4) % Occupancy and equipment 2,406 1,909 497 26.0 Professional services 587 711 (124) (17.4) Data processing 512 536 (24) (4.5) FDIC insurance 403 70 333 475.7 Director fees 317 295 22 7.5 Marketing (9) 162 (171) (105.6) Other 653 596 57 9.6 Total noninterest expense
$ 9,638 $ 9,659 $ (21)(0.2) % Noninterest expense decreased by $21.0 thousand, or 0.2%, to $9.6 millionfor the three months ended March 31, 2021compared to the three months ended March 31, 2020. The decrease in noninterest expense was primarily driven by a decline in salaries and employee benefits and marketing expense, partially offset by an increase in occupancy and equipment expense and FDICinsurance expense. Salaries and employee benefits totaled $4.8 millionfor the quarter ended March 31, 2021, a decrease of $0.6 millionwhen compared to the same period in 2020. The decrease in salaries and employee benefits was primarily driven by a decrease in full time equivalent employees as a direct result of the Voluntary Early Retirement Incentive Plan offered to eligible employees and other employee actions taken during the fourth quarter of 2020. Full time equivalent employees totaled 123 at March 31, 2021compared to 154 for the same period in 2020. Salaries and employee benefits were also favorably impacted as higher loan originations enabled the bank to defer a greater amount of expenses. 43 -------------------------------------------------------------------------------- Occupancy and equipment expense totaled $2.4 millionfor the quarter ended March 31, 2021, an increase of $0.5 millionwhen compared to the same period in 2020. The increase in occupancy and equipment expense was primarily due to additional cleaning costs associated with precautions taken to prevent the spread of COVID-19. FDICinsurance expense totaled $0.4 millionfor the quarter ended March 31, 2021, an increase of $0.3 millionwhen compared to the same period in 2020. The increase in FDICinsurance expense was due to the application of available FDICinsurance credits in the first quarter of 2020.
Income tax expense for the three months ended
March 31, 2021and 2020 totaled $1.6 millionand $0.2 million, respectively. The effective tax rates for the three months ended March 31, 2021and 2020 were 21.7% and 10.0%, respectively. For the three months ended March 31, 2021, the increase in the effective tax rate was primarily attributable to a discrete benefit recognized in the first quarter of 2020.The impact of these items on the effective tax rate varies with changes in pre-tax income. Financial Condition Summary At March 31, 2021total assets were $2.2 billion, a $9.3 million, or a 0.4% decrease compared to December 31, 2020. The decrease in assets is primarily due to a decrease in excess liquidity, partially offset by an increase in loans. Gross loans totaled $1.7 billionat March 31, 2021, an increase of $47.6 millioncompared to December 31, 2020. Excluding PPP loans, gross loans increased by $63.2 millionat March 31, 2021when compared to December 31, 2020. Deposits totaled $1.9 billionat March 31, 2021, compared to $1.8 billionat December 31, 2020. Total shareholders' equity at March 31, 2021and December 31, 2020was $187.9 millionand $176.6 million, respectively. The increase in shareholders' equity was primarily driven by (i) a $7.7 millionfavorable impact to accumulated other comprehensive income driven by fair value marks related to hedge positions involving interest rate swaps and (ii) net income for the quarter ended March 31, 2021of $5.7 million. The Company's interest rate swaps are used to hedge interest rate risk. The Company's current interest rate swap positions will cause a decrease to other comprehensive income in a falling interest rate environment and an increase in a rising interest rate environment. The increase in Shareholders' equity was partially offset by dividends paid of $1.1 millionand common stock repurchases of $1.4 million.
We provide commercial real estate loans, including construction loans, commercial business loans and other consumer loans. Our loan portfolio is the largest category of our earning assets.
Total loans before deferred loan fees and the allowance for loan losses were
$1.67 billionat March 31, 2021and $1.63 billionat December 31, 2020. Total gross loans increased $47.6 millionas of March 31, 2021compared to the year ended December 31, 2020. The following table compares the composition of our loan portfolio for the dates indicated: (In thousands) At March 31, 2021 At December 31, 2020 Change Real estate loans: Residential $ 109,752 $ 113,557 $ (3,805)Commercial 1,183,848 1,148,383 35,465 Construction 103,099 87,007 16,092 1,396,699 1,348,947 47,752 Commercial business 267,698 276,601 (8,903) Consumer 8,818 79 8,739 Total loans $ 1,673,215$ 1,625,627 $ 47,58844
We actively manage asset quality through our underwriting practices and collection operations. Our Board of Directors monitors credit risk management through two committees, the Directors Loan Committee ("DLC") and the Audit Committee. The DLC has primary oversight responsibility for the credit granting function including approval authority for credit granting policies, review of management's credit granting activities and approval of large exposure credit requests. The Audit Committee oversees management's systems and procedures to monitor the credit quality of our loan portfolio and the loan review program. These committees report the results of their respective oversight functions to our Board of Directors. In addition, our Board of Directors receives information concerning asset quality measurements and trends on a monthly basis. While we continue to adhere to prudent underwriting standards, our loan portfolio is not immune to potential negative consequences as a result of general economic weakness, such as a prolonged downturn in the housing market on a national scale. Decreases in real estate values could adversely affect the value of property used as collateral for loans. In addition, adverse changes in the economy could have a negative effect on the ability of borrowers to make scheduled loan payments, which would likely have an adverse impact on earnings. The Company has established credit policies applicable to each type of lending activity in which it engages. The Company evaluates the creditworthiness of each customer and extends credit of up to 80% of the market value of the collateral, depending on the borrower's creditworthiness and the type of collateral. The borrower's ability to service the debt is monitored on an ongoing basis. Real estate is the primary form of collateral. Other important forms of collateral are business assets, time deposits and marketable securities. While collateral provides assurance as a secondary source of repayment, the Company ordinarily requires the primary source of repayment for commercial loans, to be based on the borrower's ability to generate continuing cash flows. In the fourth quarter of 2017 management made the strategic decision to no longer originate residential mortgage loans. As of the beginning of the third quarter of 2019, the Company no longer offered home equity loans or lines of credit. The Company's policy for residential lending generally required that the amount of the loan may not exceed 80% of the original appraised value of the property. In certain situations, the amount may have exceeded 80% LTV either with private mortgage insurance being required for that portion of the residential loan in excess of 80% of the appraised value of the property or where secondary financing is provided by a housing authority program second mortgage, a community's low/moderate income housing program, or a religious or civic organization. Credit risk management involves a partnership between our relationship managers and our credit approval, portfolio management, credit administration and collections personnel. Disciplined underwriting, portfolio monitoring and early problem recognition are important aspects of maintaining our high credit quality standards and low levels of nonperforming assets since our inception in 2002. Nonperforming assets. Nonperforming assets include nonaccrual loans and property acquired through foreclosures or repossession. The following table presents nonperforming assets and additional asset quality data for the dates indicated: (In thousands) At March 31, 2021 At December 31, 2020 Nonaccrual loans: Real estate loans: Residential $ 1,289 $ 1,492 Commercial 19,277 21,093 Commercial business 1,803 1,834 Construction 8,997 8,997 Total nonaccrual loans 31,366 33,416 Other real estate owned - - Total nonperforming assets $ 31,366 $ 33,416 Nonperforming assets to total assets 1.40 % 1.48 % Nonaccrual loans to total gross loans 1.87 % 2.06 % Total past due loans to total gross loans 2.39 % 0.93 % 45
-------------------------------------------------------------------------------- Nonperforming assets totaled
$31.4 millionand represented 1.40% of total assets at March 31, 2021, compared to $33.4 millionand 1.48% of total assets at December 31, 2020. Nonaccrual loans totaled $31.4 millionat March 31, 2021. There was no other real estate owned at March 31, 2021or December 31, 2020. Allowance for Loan Losses We evaluate the adequacy of the allowance for loan losses at least quarterly, and in determining our 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 our allowance for loan losses is based on internally assigned risk classifications of loans, the Bank's and peer banks' historical loss experience, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates. Our general practice is to identify problem credits early and recognize full or partial charge-offs as promptly as practicable when it is determined that it is probable that the loan will not be repaid according to its original contractual terms, including principal and interest. Full or partial charge-offs on collateral dependent impaired loans are recognized when the collateral is deemed to be insufficient to support the carrying value of the loan. We do not recognize a recovery when an updated appraisal indicates a subsequent increase in value of the collateral. Our charge-off policies, which comply with standards established by our banking regulators, are consistently applied from period to period. Charge-offs are recorded on a monthly basis, as incurred. Partially charged-off loans continue to be evaluated on a monthly basis and additional charge-offs or loan loss provisions may be recorded on the remaining loan balance based on the same criteria.
The following table shows the activity of our allowance for loan losses and the associated ratios on the dates indicated:
Three Months Ended
March 31, (Dollars in thousands) 2021
Balance at beginning of period $ 21,009 $ 13,509 Charge-offs: Commercial real estate (163) - Commercial business - (8) Consumer (14) (2) Total charge-offs (177) (10) Recoveries: Commercial business - 1 Consumer 9 1 Total recoveries 9 2 Net charge-offs (168) (8) (Credit) provision charged to earnings (296) 3,185 Balance at end of period $ 20,545 $ 16,686 Net charge-offs to average loans 0.01 % - % Allowance for loan losses to total gross loans 1.23 % 1.03 %
The following table shows the breakdown of the allowance for loan losses and the percentage of these loans in relation to total loans on the dates indicated:
At March 31, 2021 At December 31, 2020 Percent of Loan Percent of Loan (Dollars in thousands) Amount Portfolio Amount Portfolio Residential real estate
$ 5016.56 % $ 6106.99 % Commercial real estate 16,259 70.75 16,425 70.64 Construction 297 6.16 221 5.35 Commercial business 3,452 16.00 3,753 17.02 Consumer 36 0.53 - - Total allowance for loan losses $ 20,545100.00 % $ 21,009100.00 % The allocation of the allowance for loan losses at March 31, 2021reflects our assessment of credit risk and probable loss within each portfolio. We believe that the level of the allowance for loan losses at March 31, 2021is appropriate to cover probable losses.
Reserve for unfunded commitments
The reserve for unfunded commitments provides for probable losses inherent with funding the unused portion of legal commitments to lend. The unfunded reserve calculation is primarily based on our allowance for loan loss methodology for funded loans, adjusted for utilization expectations. The reserve for unfunded credit commitments is included within other liabilities in the accompanying Consolidated Balance Sheets. Changes in the reserve are reported as a component of other noninterest expense in the accompanying Consolidated Statements of Income.
March 31, 2021, the carrying value of our investment securities portfolio totaled $101.6 millionand represented 4.5% of total assets, compared to $106.9 million, or 4.7% of total assets, at December 31, 2020. The net unrealized gain position on our investment portfolio at March 31, 2021was $4.8 millionand included gross unrealized losses of $0.4 million. The net unrealized gain position on our investment portfolio at December 31, 2020was $7.5 millionand included no gross unrealized losses.
Depository activities and other sources of funds
At March 31, 2021 At December 31, 2020 Weighted Average Weighted Average (Dollars in thousands) Amount Percent Rate Amount Percent Rate Noninterest bearing demand
$ 280,94715.10 % - % $ 270,23514.79 % - % NOW 118,489 6.37 0.17 101,737 5.57 0.17 Money market 751,852 40.43 0.52 669,364 36.63 0.79 Savings 164,559 8.85 0.32 158,750 8.69 0.81 Time 543,961 29.25 1.32 627,230 34.32 1.77 Total deposits $ 1,859,808100.00 % 0.78 % $ 1,827,316100.00 % 1.23 %
The total deposits were
Brokered certificates of deposits totaled
$200.1 millionat March 31, 2021and $238.9 millionat December 31, 2020. Certificates of deposits from national listing services totaled $4.9 millionat March 31, 2021and $18.4 millionat December 31, 2020. Brokered money market accounts totaled $53.8 millionat March 31, 2021and $13.5 millionat December 31, 2020. Brokered deposits represent brokered certificates of deposit, brokered money market accounts and one way buy Certificate of Deposit Account Registry Service (CDARS), and one way buy Insured Cash Sweep (ICS). 47 -------------------------------------------------------------------------------- At March 31, 2021and December 31, 2020, time deposits with a denomination of $100 thousandor more, including CDARS and brokered deposits, totaled $444.1 millionand $519.8 million, respectively, maturing during the periods indicated in the table below: (Dollars in thousands) March 31, 2021 December 31, 2020 Maturing: Within 3 months $ 118,547$ 141,784 After 3 but within 6 months 77,166 67,064 After 6 months but within 1 year 68,824 118,880 After 1 year 179,524 192,051 Total $ 444,061$ 519,779 We utilize advances from the Federal Home Loan Bank of Boston, or FHLB, as part of our overall funding strategy and to meet short-term liquidity needs, and to a lesser degree, manage interest rate risk arising from the difference in asset and liability maturities. Total FHLB advances were $125.0 millionand $175.0 millionat March 31, 2021and December 31, 2020, respectively. The decrease of $50.0 million, or 28.6%, reflects the substitution of lower cost brokered deposits in lieu of FHLB advances. The Bank has additional borrowing capacity at the FHLB up to a certain percentage of the value of qualified collateral. In accordance with agreements with the FHLB, the qualified collateral must be free and clear of liens, pledges and encumbrances. At March 31, 2021, the Bank had pledged $814.3 millionof eligible loans as collateral to support borrowing capacity at the FHLB of Boston. As of March 31, 2021, the Bank had immediate availability to borrow an additional $384.7 millionbased on qualified collateral.
Liquidity and capital resources
Liquidity is defined as the ability to generate sufficient cash flows to meet all present and future funding requirements at reasonable costs. Our primary source of liquidity is deposits. While our generally preferred funding strategy is to attract and retain low cost deposits, our ability to do so is affected by competitive interest rates and terms in the marketplace. Other sources of funding include discretionary use of purchased liabilities (e.g., FHLB term advances and other borrowings), cash flows from our investment securities portfolios, loan sales, loan repayments and earnings. Investment securities designated as available for sale may also be sold in response to short-term or long-term liquidity needs.
The Bank’s liquidity positions are monitored daily by management. The Asset Liability Committee (“ALCO”) establishes guidelines to ensure that prudent levels of liquidity are maintained. ALCO reports to the Company’s Board of Directors.
The Bank has a detailed liquidity funding policy and a contingency funding plan that provide for the prompt and comprehensive response to unexpected demands for liquidity. We employ a stress testing methodology to estimate needs for contingent funding that could result from unexpected outflows of funds in excess of "business as usual" cash flows. The Bank has established unsecured borrowing capacity with the
Atlantic Community Bankers Bank("ACBB") (formerly Bankers' Bank Northeast), Zion's Bank and Texas Capital Bankand also maintains additional collateralized borrowing capacity with the FHLB in excess of levels used in the ordinary course of business. Our sources of liquidity include cash, unpledged investment securities, borrowings from the FHLB, lines of credit from ACBB, Zion's Bank and Texas Capital Bank, the brokered deposit market and national CD listing services. The Company anticipates that it will have sufficient funds available to meet its current loan and other commitments. As of March 31, 2021, the Company had cash and cash equivalents of $362.0 millionand available-for-sale securities of $83.2 million. At March 31, 2021, outstanding commitments to originate loans totaled $82.2 millionand undisbursed funds from approved lines of credit, home equity lines of credit and secured commercial lines of credit totaled $200.3 million. Capital Resources Shareholders' equity totaled $187.9 millionas of March 31, 2021, an increase of $11.3 millioncompared to December 31, 2020, primarily a result of (i) a $7.7 millionfavorable impact to accumulated other comprehensive income driven by fair value 48 -------------------------------------------------------------------------------- marks related to hedge positions involving interest rate swaps and (ii) net income for the quarter ended March 31, 2021of $5.7 million. The Company's interest rate swaps are used to hedge interest rate risk. The Company's current interest rate swap positions will cause a decrease to other comprehensive income in a falling interest rate environment and an increase in a rising interest rate environment. The increase in Shareholders' equity was partially offset by dividends paid of $1.1 millionand common stock repurchases of $1.4 million. As of March 31, 2021, the tangible common equity ratio and tangible book value per share were 8.27% and $23.99, respectively. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. At March 31, 2021, the Bank met all capital adequacy requirements to which it was subject and exceeded the regulatory minimum capital levels to be considered well-capitalized under the regulatory framework for prompt corrective action. At March 31, 2021, the Bank's ratio of Common Equity Tier 1 capital to risk-weighted assets was 11.02%, total capital to risk-weighted assets was 12.17%, Tier 1 capital to risk-weighted assets was 11.02% and Tier 1 capital to average assets was 8.82%. In July 2013, the Federal Reservepublished Basel III rules establishing a new comprehensive capital framework of U.S.banking organizations. Under the rules, effective January 1, 2015for the Company and Bank, the minimum capital ratios became a) 4.5% Common Equity Tier 1 to risk-weighted assets, b) 6.0% Tier 1 capital to risk weighted assets and c) 8.0% total capital to risk-weighted assets. In addition, the new regulations imposed certain limitations on dividends, share buy-backs, discretionary payments on Tier 1 instruments and discretionary bonuses to executive officers if the banking organization does not hold a "capital conservation buffer" consisting of 2.5% of common equity to risk weighted assets, in addition to the amounts necessary to meet the minimum risk-based capital requirements described above.
Asset / liability management and interest rate risk
We measure interest rate risk using simulation analysis to calculate earnings and equity at risk. These risk measures are quantified using simulation software from one of the leading firms in the field of asset/liability modeling. Key assumptions relate to the behavior of interest rates and spreads, prepayment speeds and the run-off of deposits. From such simulations, interest rate risk, or IRR, is quantified and appropriate strategies are formulated and implemented. We model IRR by using two primary risk measurement techniques: simulation of net interest income and simulation of economic value of equity. These two measurements are complementary and provide both short-term and long-term risk profiles for the Company. Because both baseline simulations assume that our balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that ALCO could implement in response to rate shifts. The simulation analyses are updated quarterly. We use a net interest income at risk simulation to measure the sensitivity of net interest income to changes in market rates. This simulation captures underlying product behaviors, such as asset and liability repricing dates, balloon dates, interest rate indices and spreads, rate caps and floors, as well as other behavioral attributes. The simulation of net interest income also requires a number of key assumptions such as: (i) prepayment projections for loans and securities that are projected under each interest rate scenario using internal and external mortgage analytics; (ii) new business loan rates that are based on recent new business origination experience; and (iii) deposit pricing assumptions for non-maturity deposits reflecting the Bank's limited history, management judgment and core deposit studies. Combined, these assumptions can be inherently uncertain, and as a result, actual results may differ from simulation forecasts due to the timing, magnitude and frequency of interest rate changes, future business conditions, as well as unanticipated changes in management strategies. We use two sets of standard scenarios to measure net interest income at risk. For the Parallel Ramp Scenarios, rate changes are ramped over a twelve-month horizon based upon a parallel yield curve shift and then maintained at those levels over the remainder of the simulation horizon. Parallel Shock Scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Simulation analysis involves projecting a future balance sheet structure and interest income and expense under the various rate scenarios. Internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net interest income at risk for the subsequent one-year period should not decline by more than: 6% for a 100 basis point shift; 12% for a 200 basis point shift; and 18% for a 300 basis point shift. Per Company policy, the Bank should not be outside these limits for twelve consecutive months unless the Bank's forecasted capital ratios are considered to be "well capitalized". As of
March 31, 2021, the Bank has met all minimum regulatory capital requirements to be considered "well capitalized", reference footnote 7 to the consolidated financial statements for more detail. 49 -------------------------------------------------------------------------------- The following tables set forth the estimated percentage change in our net interest income at risk over one-year simulation periods beginning March 31, 2021and December 31, 2020: Parallel Ramp Estimated Percent Change in Net Interest Income Rate Changes (basis points) March 31, 2021 December 31, 2020 -100 (0.60) % 0.20 % +200 (1.60) (1.40) Parallel Shock Estimated Percent Change in Net Interest Income Rate Changes (basis points) March 31, 2021 December 31, 2020 -100 (1.30) % (0.30) % +100 (0.90) (1.00) +200 (1.40) (1.70) +300 (1.40) (2.00) The net interest income at risk simulation results indicate that, as of March 31, 2021, we remain liability sensitive. The liability sensitivity is due to the fact that there are more liabilities than assets subject to repricing as market rates change. We conduct an economic value of equity at risk simulation in tandem with net interest income simulations, to ascertain a longer term view of our interest rate risk position by capturing longer-term repricing risk and options risk embedded in the balance sheet. It measures the sensitivity of economic value of equity to changes in interest rates. The economic value of equity at risk simulation values only the current balance sheet and does not incorporate the growth assumptions used in one of the income simulations. As with the net interest income simulation, this simulation captures product characteristics such as loan resets, repricing terms, maturity dates, rate caps and floors. Key assumptions include loan prepayment speeds, deposit pricing elasticity and non-maturity deposit attrition rates. These assumptions can have significant impacts on valuation results as the assumptions remain in effect for the entire life of each asset and liability. All key assumptions are subject to a periodic review.
The benchmark economic value of equity at risk is calculated by estimating the net present value of all future cash flows from existing assets and liabilities using current interest rates. The baseline scenario assumes that future interest rates remain unchanged.
The following table shows the estimated percentage change in our economic value of equity at risk, assuming various changes in interest rates:
Change in the economic value of equity
Rate Changes (basis points) March 31, 2021 December 31, 2020 -100 (26.80) % (47.30) % +100 3.80 9.30 +200 5.10 13.80 +300 7.00 18.40 While ALCO reviews and updates simulation assumptions and also periodically back-tests the simulation results to ensure that the assumptions are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future net interest margin. Over time, the repricing, maturity and prepayment characteristics of financial instruments and the composition of our balance sheet may change to a different degree than estimated. ALCO recognizes that deposit balances could shift into higher yielding alternatives as market rates change. ALCO has modeled increased costs of deposits in the rising rate simulation scenarios presented above. In the minus 100 scenario above, the change in EVE of (26.8)% is outside of policy parameters. However, because the Bank continues to be well-capitalized, the downward rate scenarios are extremely unlikely in 50 --------------------------------------------------------------------------------
the current economic environment and interest rates. The result of this simulation has been discussed with the ALCO committee and the Company has decided not to take any further action at this time.
It should be noted that the static balance sheet assumption does not necessarily reflect our expectation for future balance sheet growth, which is a function of the business environment and customer behavior. Another significant simulation assumption is the sensitivity of core deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. Lastly, mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments. Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value. Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income.
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