Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. You should not put undue reliance on any forward-looking statements.
Howard Bancorp, Inc.
General
Howard Bancorp, Inc., the parent company of Howard Bank, was incorporated in April 2005 under the laws of the State of Maryland to serve as the bank holding company of Howard Bank.
Howard Bank
Howard Bank is a Maryland-chartered trust company that was formed in March 2004 and commenced banking operations in August 2004. Howard Bank hasdoes not currently chosen not to seek and exercise trust powers, and our business, powers and regulatory structure are the same as a Maryland-chartered commercial bank. The Bank is subjecthas nine subsidiaries—six were formed to regulation, supervision and regular examination by the Maryland Office of the Commissioner of Financial Regulation (the “Commissioner”) and the Federal Deposit Insurance Corporation (“FDIC”), and our deposits are insured by the FDIC. The Bank has four operating subsidiaries, three of which hold foreclosed real estate (three of which are currently inactive), two own and manage real estate used for corporate purposes, and one holds historic tax credit investments.
In this report, unless the context suggests otherwise, references to the “Company” refer to Howard Bancorp, Inc. and references to “we,” “us,” and “our” mean the combined business of the Company and the other of which ownsBank and manages real estate that we use for one of our branch locations and that also contains office and retail space.its wholly-owned subsidiaries.
Howard Bank is headquartered in Ellicott City, which is located in Howard County, Maryland. The Bank has branches in Howard County as well as in Anne Arundel County, Baltimore County, Baltimore City, Cecil County and Harford County in Maryland. We operateconsider our primary market area to be the Greater Baltimore metropolitan area. We engage in a general commercial banking business, making various types of loans and accepting deposits. We originally focused on marketingmarket our financial services to smallsmall- and medium sizedmedium-sized businesses and their owners, professionals and executives, and high-net-worth individuals (the “mass affluent”) and, while this remainsindividuals. Our loans are primarily funded by core deposits of customers in our primary marketing focus, during the last few years we have expanded our deposit and mortgage offerings to meet the financial needs of consumers generally.market.
Our core business strategy involves driving organic growth by delivering advice and superior customer service to clients through local decision makers. We combine the Bank’s specializedOur customer focus on bothis small- and medium-sized businesses in our local markets and small and medium-sized business related market segments withwe compete by providing our customers a broad array of products, new technology and access to seasoned banking professionals to position the Bank differently from most competitors.professionals. Our experienced executives seek to establish a relationship with each client and bring value to all phases of a client’s business and personal banking needs. To develop this strategy, we have established long-standing relationships with key customers in the community and with local business leaders who can create business opportunities. It is this philosophy toward the business that has afforded the Company great success in attracting and retaining top-tier, high quality lending teams from other institutions.
Our primary source of revenue is net interest income, with fees generated by lending, mortgage banking and depository service charges constituting a smaller, but growing, percentage of revenues. We have positioned our balance sheet to hold a high percentage of earning assets and, in turn, to have those earning assets dominated by loans rather than investment securities. Generally speaking, our loans earn more attractive returns than investments and are a key source of product cross sales and customer referrals. Our underwriting and lending teams have allowed us to be successful in gaining market share while continuing to maintain solid asset quality ratios, an approach that is fundamental to our culture. In our efforts to drive revenue growth, we continue to invest in our infrastructure and talent with the long-term view of building the dominant Greater Baltimore bank. At all times, our revenue-generating activities and expenditures are viewed with an eye towards investor returns while not exceeding risk tolerance thresholds set by management and our board of directors.
Our leadership team is deep and experienced both as it relates to tenure with the Company as well asus and to industry experience. Our Chairman and CEO,Chief Executive Officer, Mary Ann Scully, founded the Company and has over 35 years of banking experience, mainly in senior executive roles with larger financial institutions. Our President, Robert D. Kunisch, Jr., joined our leadership team as a result of our merger with First Mariner Bank and has over 30 years of banking experience. In addition, the Company employswe employ a strong stable of next level senior leadership, which it believeswe believe is critical for the successful implementation of our strategic initiatives. It is this leadership experience that has driven the Company’sour growth since itsour founding. In addition to organic growth, the Company has completed and integrated one whole bank acquisition, one FDIC-assisted transaction and two branch acquisition transactions, as further discussed below. We consider this to be a critical component of furthering future growth and will continue to cultivate and pursue strategic initiatives provided they generate meaningful long-term stockholder returns.
Our strategic plan focuses on enhancing stockholder value through market share growth as reflected in balance sheet growth, related revenue growth and resulting growth in operating profits. During the past several years, we have expanded our branch locations both through opening new branches and acquiring branch offices via acquisition, asacquisition. More recently, we have done with the 14 branches acquiredfocused on branch optimization initiatives that have resulted in the First Mariner Bank merger, discussed below.a reduction in branches. While we anticipate openingmay open additional branches in the counties where we now operate and in contiguous counties over the next several years, other than a planned new location in Columbia, Maryland, we currently have no definitive plans or agreements in place with respect to any additional branches. Our long-term vision also includes supplementing our historically organic growth with strategically significantstrategic acquisitions. As discussed below, we have completed and integrated multiple bank acquisitions and we consider additional acquisitions to be a critical component of furthering our future growth. We believe that acquiring other financial institutions, - in whole or in part, (throughthrough business line spin-offs, branch salespurchases or the hiring of teams of individuals)individuals, will allow us to expand our market, achieve certain operating efficiencies, and grow our stockholder base and thus our share value and liquidity. We believe that our demonstrated expertise in commercial lending and deposit gathering (especially non-interest bearing transactional deposits), our demonstrated ability to attract additional investment and capital, and community leadership, positions us as an attractive acquirer. We also anticipate that increasing our capital levels will give us the ability to continue our organic asset growth and expand our relationships with key clients through a larger legal lending limit.
General RecentDevelopment of the Business
On February 1, 2017, Howard Bancorp closedDecember 18, 2019, we entered into an underwritten public offeringagreement to release certain management members of our mortgage division from their employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring our remaining mortgage employees. We also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly created LLC. In consideration of the release of the employment agreements, the transfer of our mortgage employees, and the sale of the domain name, the LLC paid us $750 thousand.
Under the agreement, there is a transition period of approximately 45 days, after which we have agreed to cease originating residential first lien mortgage loans and exit our mortgage banking activities. Accordingly, we expect to have the majority of the residential first lien mortgage pipeline processed by the end of the first quarter of 2020. In order to manage future loan run-off within our residential mortgage loan portfolio, we plan on buying first lien residential mortgage loans, on a servicing released basis, from both the LLC and other third-party originators.
On December 6, 2018, we entered into Subordinated Note Purchase Agreements with certain institutional accredited investors pursuant to which including the exercise in full by the underwriters of their option to purchase an additional 360,000 shares, we sold 2,760,000 sharesand issued $25.0 million in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes due December 6, 2028 (the “Notes”). We used the net proceeds from this offering for general corporate purposes, to provide for continued growth and to supplement our common stock at the public offering price of $15.00 per share. Gross proceeds raised in the offering, before underwriting discounts and expenses of the offering, was approximately $41.4 million.regulatory capital ratios.
On May 6, 2016, we redeemed all of the 12,562 shares of the Series AA Preferred Stock that we had previously issued to the U.S. Department of the Treasury (“Treasury”) under its Small Business Lending Fund (“SBLF”) program. The aggregate redemption price of the Series AA Preferred Stock was approximately $12.7 million, including dividends accrued but unpaid through the redemption date.
On August 28, 2015,March 1, 2018, we completed our acquisition of Patapsco Bancorp, Inc.,merger with First Mariner Bank, a Maryland chartered trust company (“First Mariner”). At the parent company of The Patapsco Bank, through the merger of Patapsco Bancorp with and into Howard Bancorp pursuant to the Agreement and Plan of Merger dated as of March 2, 2015, as amended, by and between the Company and Patapsco Bancorp. As a result of the merger, each outstanding share of common stock of Patapsco Bancorp was converted into the right to receive, at the holder’s election, $5.09 in cash or 0.3547 shares of our common stock, provided that (i) cash was paid in lieu of any fractional shares of our common stock and (ii) 20% of the shares of common stock of Patapsco Bancorp outstanding at theeffective time of the merger, were exchanged for cash in the merger, with the remaining shares of Patapsco Bancorp common stock exchanged for an aggregate of 560,891 shares of our common stock. The aggregate merger consideration was $10.064 million. In connection with the merger, immediately thereafter Patapsco BankFirst Mariner merged with and into the Bank, with the Bank continuing as the surviving bank. We acquired The Patapsco Bank’s four branches inAt the merger.
In October 2014, the Bank assumed all of the deposits and acquired essentially all of the assets of NBRS Financial Bank (“NBRS”) from the FDIC, as receiver for NBRS, pursuant to the terms of the Purchase and Assumption Agreement, dated as of October 17, 2014, by and among the FDIC, Receiver of NBRS, the FDIC and Howard Bank. We acquired five new branch locations, located in Harford and Cecil Counties in Maryland and Lancaster County in Pennsylvania (the Pennsylvania location was later closed), as a result of this acquisition. The acquisition added $135.6 million in assets and generated a bargain purchase gain of $16.1 million before tax and expanded our geographic reach.
In August 2014 Howard Bank purchased from NBRS its branch located at 800 Revolution Street, Havre de Grace, Maryland. Pursuant to the branch purchase, the Bank acquired $16.1 million in loans and $18.7 million in deposits. In connection with its purchase of the branch, the Bank made a net cash payment of $2.4 million, including a premium of approximately $384,000.
In August 2013, the Bank purchased from Cecil Bank its branch located at 3 West Bel Air Avenue, Aberdeen, Maryland. Pursuant to the transaction, the Bank acquired $37.1 million in loans and $35.2 million in deposits from Cecil Bank, as well as the branch premises and equipment at their book value. In connection with its purchase of the branch from Cecil Bank, the Bank made a net cash payment to Cecil Bank of $3.2 million, including a premium of approximately $240,000.
Recent Developments
On March 1, 2018, we completed our acquisition of First Mariner Bank (“First Mariner”) through the merger of First Mariner with and into Howard Bank pursuant to the Agreement and Plan of Reorganization dated as August 14, 2017, as amended, by and between the Company, Howard Bank and First Mariner. As a resulteffective time of the merger, each outstanding share of First Mariner common stock ofand First Mariner Series A Non-Voting Non-Cumulative Perpetual Preferred Stock issued and outstanding was cancelled and converted into the right to receive 1.6624 shares of Howard Bancorpour common stock provided thatwith cash was paid in lieu of any fractional shares. The aggregate merger consideration of $173.8 million included $9.2 million of cash and 9,143,2309,143,222 shares of our common stock, which was valued at approximately $164.6 million based on Howard Bancorp’s closing stock price of $18.00 on February 28, 2018. As indicated previously,million. In our merger with First Mariner, we acquired 14 branch locationsbranches located in Baltimore City and Baltimore, Harford, Howard and Anne Arundel counties. First Mariner had total assets with a fair value of $1.01 billion as of March 1, 2018, including $664.3 million of loans, net of purchase accounting adjustments.
On February 1, 2017, we closed an underwritten public offering of 2,760,000 shares of our common stock, which included the exercise in full of the underwriters’ over-allotment option, at a public offering price of $15.00 per share. The amount of gross proceeds raised in the offering was approximately $41.4 million, after underwriting discounts and estimated expenses, and the amount of net proceeds raised in this merger.offering was $38.4 million. We used the proceeds of the offering to pay off a $12.7 million loan to Raymond James Bank, N.A. and retained the remainder. This had a positive impact on our liquidity and capital position in 2017 and provided funds that allowed us to continue to grow our loans and investments.
Our Market Area
Our headquarters are located in EllicottBaltimore City, Maryland, and weMaryland. We consider our primary market area to be the Greater Baltimore Metropolitan Area in Maryland. We also have loans in our loan portfolio that are outside our market area, although to grow our loan portfolio we do not actively solicit business outside our primary market.
As of December 31, 2017,2019, we had 14 full services16 full-service branches and eight mortgage and commercial lending offices located throughout Maryland:Maryland. For additional detail regarding branch and lending offices, see “Item 2. Properties” below in this report.
Competitive PositionCompetition
Our primary market area is highly competitive and heavily branched by other financial institutions of all sizes. The principal methods of competition for financial services are price (interest rates paid on deposits, interest rates charged on loans and fees charged for services) and service (convenience and quality of services rendered to customers). In addition to competition from other commercial banks, we face significant competition from non-bank financial institutions, including savings and loan associations, credit unions, finance companies, insurance companies and investment firms. The financial services industry has become more competitive as technology advances have lowered barriers to entry, enabling more companies, including nonbank companies, to provide financial services. Many of our nonbank competitors which are not subject to the same extensive federal regulations that govern bank holding companies and banks, such as the Company and the Bank, may have certain competitive advantages. Technological advances may diminish the importance of depository institutions and other financial institutions. We also compete for deposits with a broad range of other types of investments, including mutual funds and annuities.
Mergers and acquisitions have also led to increased concentration in the banking industry, placing added competitive pressure on our core banking products and services as we see competitors enter some of our markets or offer similar products. While we believe that acquisitions of several local competitors by larger institutions headquartered outside of the State of Maryland during the last several years has enhanced our competitive position as a locally-headquartered and managed community bank, many of these competitors have substantially greater resources and lending limits than we do and offer services, such as extensive and established branch networks and trust services, that we do not expect to provide in the near future or ever.
As a community bank with over $1$2 billion in assets, positions uswe believe that we are well positioned to navigate the ongoing market consolidation and heightened regulatory environment. We continue to have the ability to outsource certain activities (internal audit, compliance review, information security monitoring) and to source new products and services in a highly efficient manner, and thusallowing us to avoid the risk of impairment of operating earnings faced by some banks that, webanks. We believe arethis offers an advantage over our competitors which may be locked into legacy systems, and are findingor which may find the onslaught of new regulations and evolving consumer expectations challenging. Strategic partnerships for these outsourced activities include contractual relationships with some of the largest and strongest providers of item processing, data processing, information monitoring and payment systems alternatives. We believe that this provides the Bankus with the best of technology and product selection without sacrificing the more intimate delivery advantages of a community bank. We further believe the current economic and regulatory environment will continue to result in greater consolidation among financial institutions, including community banks. Some of that consolidation will occur with larger banks, thus exacerbating the scarcity of banks able to underwrite traditionally and offer advice in interactions with customers as we do, which we believe gives us a wider window of opportunity to extend our brand and value proposition. We believe, however, that to the extent some of that consolidation occurs between and among smaller banks, the resulting combined institutions will be better positioned to differentiate themselves. Areas of our primary market are currently experiencing significant disruption due to industry consolidation, management turnover and de novo banking activities. We believe these disruptions will continue in the short-term and may accelerate, which could create additional opportunities for us.
We believe that “Our Mission to Build our “Hands On”Legacy by Helping Others to Build Theirs” approach to delivering services to small and medium-sized businesses is essential to our competitive position. Through a very broadteam of experienced advisors, we provide our customers with access to local policy and deepdecision makers. We also offer an array of competitive credit and cash management services through a team of experienced advisors and providing them with access to local policy and decision makersthat we feel fills a “white space” in the market. We believe that we fit well between the sophisticated, but often distracted large banks whose best personnel work with the largest companies and the small banks who are very responsive, but less capable of being proactive in providing advice.small banks. Our relationship managers, team leaders and executive management generally have decades of banking experiences and are well established in the communities that they serve. They are able to interface with clients directly to share that experience and to provide connections with their own network of other specialized advisors. We believe we also benefit from our committed leadership, at both the executive management and board level, who bring a broad array of skills and experiences to our company and who are able to position the Bankus for consistent profitable growth.
Lending Activities
General
Our primary market focus is on making loans to and gathering deposits from small and medium sizemedium-sized businesses and their owners, professionals and executives, and high-net-worth individuals in our primary market area. Our loans are made to customers primarily in the Greater Baltimore market. Our lending activities consist generally of short to medium termmedium-term commercial lending, commercial mortgage lending for both owner occupied and investment properties, residential mortgage lending, and consumer lending, both secured and unsecured. A substantial portion of our loan portfolio consists of loans to businesses secured by real estate and/or other business assets.
Credit Policies and Administration
We have adopted a comprehensive lending policy that includes stringent underwriting standards for all types of loans. Our lending teams follow pricing guidelines established periodically by our management team. In an effort to manage risk, only smallminimal lending authority is given to individual loan officers. Most loan officers can approve loans of up to $100,000. The Chief Lending Officer, the Chief Credit Officer and$100,000 (with a select number of senior managersloan officers having the authority to $1,000,000). The Chief Credit Officer, the Chief Commercial Banking Officer, the Chief Executive Officer and the President can approve loans up to $750,000,$2,000,000, or any two together can approve loans up to $1,500,000. Our Chief Executive Officer can approve loans of up to $2,000,000.$4,000,000. Loans above these amounts must beare reviewed and approved by an officers’ loan committee.our Loan Committee. Under the leadership of our executive management team, we believe that we employ experienced lending officers, secure appropriate collateral, and carefully monitor the financial conditionscondition of our borrowers and the concentration of loans in our portfolio.
In addition to the normal repayment risks, all loans in the portfolio are subject to the state of the economy and the related effects on the borrower and/or the real estate market. Generally, longer-term loans have periodic interest rate adjustments and/or call provisions. Senior management monitors the loan portfolio closely to ensure that we minimize past due loans and that we swiftly deal with potential problem loans.
Howard BankWe also retainsretain an outside, independent firm to annually perform a detailed review theof our loan portfolio. This firm performs a detailed annual review. We use the results of the firm’s report primarily to validate the risk ratings applied to loans in the portfolio and identify any systemic weaknesses in underwriting, documentation or management of the portfolio. Results of the annual review are presented to executive management, the Asset Quality Committee of the board of directors of the Bank and the full board of directors of the Bank and are available to and used by regulatory examiners when they review the Bank’s asset quality. We currently use the firm of CliftonLarsenAllen to perform this review.
The Bank maintains the normal checks and balances on the loan portfolio not only through the underwriting process but through the utilization ofWe also use an internal credit administration group that both assists us in the underwriting and serves as an additional reviewer of underwriting. TheIn addition, a separately-managed loan administration group also has oversight foroversees documentation, compliance and timeliness of collection activities. Our outsourced internal audit firm also reviews documentation, compliance and file management.
Commercial Lending
Our commercial lending consists of lines of credit, revolving credit facilities, accounts receivable and inventory financing, term loans, equipment loans, equipment leases, small business administration (“SBA”) loans, stand-by letters of credit and unsecured loans. We originate commercial loans for any business purpose, including the financing of leasehold improvements and equipment, the carrying of accounts receivable, general working capital, contract administration and acquisition activities. These loans typically have maturities of seven years or less. We have a diverse client base and we do not have a concentration of these types of loans in any specific industry segment. We generally secure commercial business loans with accounts receivable and inventory, equipment, indemnity deeds of trust and other collateral such as marketable securities, cash value of life insurance, and time deposits at Howardthe Bank. Commercial business loans have a higher degree of risk than residential mortgage loans because the availability of funds for repayment generally depends on the success of the business. To help manage this risk, we establish parameters/covenants at the inception of the loan to provide early warning systems before payment default. We normally seek to obtain appropriate collateral and personal guarantees from the borrower’s principal owners. We are able, given our business model, to proactively monitor the financial condition of the business.
Commercial Mortgage Lending
We finance commercial real estate for our clients, for both owner-occupied properties and investment properties (including residential properties). We generally will finance owner occupied commercial real estate at a maximum loan–to-valueloan-to-value of 85% and non-owner occupied at a maximum loan-to-value of 80%. Our underwriting policies and processes focus on the underlying credit of the owner for owner occupied real estate and on the rental income stream (including rent terms and strength of tenants) for non-owner occupied real estate as well as an assessment of the underlying real estate. Risks inherent in managing a commercial real estate portfolio relate to vacancy rates/absorption rates for surrounding properties, sudden or gradual drops in property values as well as changes in the economic climate. We attempt to mitigate these risks by carefully underwriting loans of this type as well as by following appropriate loan-to-value standards. We are cash flow lenders and neverwe generally do not rely solely on property valuations in reaching a lending decision. Personal guarantees are often required for commercial real estate loans as they are for other commercial loans. Most of our real estate loans carry fixed interest rates and amortize over 20 -to 25 years but have five-five to seven-year maturities. Properties securing our commercial real estate loans primarily include office buildings, office condominiums, distribution facilities and manufacturing plants. Substantially all of our commercial real estate loans are secured by properties located in our market area.
Commercial real estate loans generally carry higher interest rates and have shorter terms than one- to four-familyone-to-four family residential mortgage loans. Commercial real estate loans, however, entail significant additional risks as compared with residential mortgage lending, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment of loans secured by income-producing properties typically depends on the successful operation of the property, as repayment of the loan generally is dependent, in large part, on sufficient income from the property to cover operating expenses and debt service. Changes in economic conditions that are not in the control of the borrower or lender could affect the value of the collateral for the loan or the future cash flow of the property. Additionally, any decline in real estate values may be more pronounced for commercial real estate than residential properties.
Construction Lending
Construction lending can cover funding for land acquisition, land development and/or construction of residential or commercial structures. Our construction loans generally bear a variable rate of interest and have terms of one to two years. Funds are advanced on a percentage-of-completion basis. These loans are generally repaid at the end of the development or construction phase, although loans for both residential and commercial construction will often convert into a permanent mortgage loan at the end of the term of the loan. Loan to value parameters range from 65% of the value of land to 75% for developed land, 80% for commercial or multifamily construction and 85% for residential construction. These loan-to-value ratios represent the upper limit of advance rates to remain in compliance with Bank policy. Typically, loan-to-value ratios should be somewhat lower than these upper limits, requiring the borrower to provide significant equity at the inception of the loan. Our underwriting looks not only at the value of the property but the expected cash flows to be generated by sale of the parcels or completed construction. TheWe expect the borrower must haveto demonstrate solid experience in this type of construction and personal guarantees are usually required.
Construction lending entails significant risks compared with residential mortgage lending. These risks involve larger loan balances concentrated with single borrowers with funds advanced upon the security of the land or the project under construction. The value of the project is estimated prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan to value ratios. If the estimate of construction or development cost proves to be inaccurate, we may be required to advance additional funds beyond the amount originally committed in order to protect the value of the property. Moreover, if the estimated value of the completed project proves to be inaccurate, the borrower may hold a property with a value that is insufficient to assure full repayment. To mitigate these risks, in addition to the underwriting considerations noted above, we maintain an in-house construction monitoring unit that has oversight for the projects and we require both site visits and frequent reporting before funds are advanced.
Residential Mortgage Lending
We offer a variety
With the exit of consumer-orientedour mortgage banking activities, we will cease to originate residential real estate loans. Residentialfirst-lien mortgage loans consist primarily ofin early 2020. However, in order to manage loan run-off within our residential mortgage loan portfolio, we plan on buying first lien residential mortgage loans, on a servicing released basis, from both the LLC and other third-party originators. We previously originated first mortgage loans to individuals, most of which havehad a loan to value not exceeding 85%. The remainder of this portion of our portfolio consists of home equity lines of credit and fixed rate home equity loans.
Our residential mortgage loans are generally for owner-occupied single family homes. These loans are generally for a primary residence although we will occasionally originateoriginated loans for a second home where the borrower has extremely strong credit. We originateoriginated adjustable rate residential mortgage loans with initial fixed-rate terms of five to seven years, as well as fixed rate residential mortgage loans with primarily 1515- or 30 year30-year terms. In general, we made residential mortgage loans based on the borrower’s ability to repay the loan from his or her salary and other income; such loans are secured by residential real estate, the value of which is generally readily ascertainable. We made these loans consistent with our appraisal and real estate lending policies, which detail maximum loan-to-value ratios and maturities. We generally made residential mortgage loans and home equity lines of credit secured by owner-occupied property within the guidelines of our regular purchasers of these loans.
Our home equity loans and home equity lines of credit are primarily secured by a second mortgage on owner occupied one-to four-familyone-to-four family residences. Our home equity loans are originated at fixed interest rates and with terms of between five and 30 years for primary residences and between five and 15 years for secondary and rental properties, and are fully amortizing. Our home equity lines allow for the borrower to draw against the line for ten years, after which the line is refinanced into a ten-year fixed loan, with the possibility of a one-time extension of five years.20-year fixed-rate loan. Home equity lines of credit carry a variable rate of interest and minimum monthly payments during the draw period, which are the greater of (i) $50.00 or (ii) depending on credit score, loan-to-value and debt-to-income ratios, either the interest due or interest due plus 1% of the outstanding loan balance. Home equity loans and lines of credit are generally underwritten with a maximum loan-to-value ratio of 85% (80% when appraised value is greater than $1 million) for a primary residence when combined with the principal balance of the existing mortgage loan; for home equity loans on secondary and rental properties, the maximum loan-to-value ratio is 65%. We require appraisals on all real estate loans – both commercial and residential.loan. At the time we close a home equity loan or line of credit, we record a mortgage to perfect our security interest in the underlying collateral.
Home equity loans and lines of credit generally have greater risk than one- to four-family residential mortgage loans. In these cases, we face the risk that collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. In particular, because home equity loans are secured by second mortgages, decreases in real estate values could adversely affect the value of the property serving as collateral for these loans. Thus, the recovery of such property could be insufficient to repay us for the value of these loans.
Loans secured by second mortgages have greater risk than owner-occupied residential loans secured by first mortgages. When customers default on their loans we attempt to foreclose on the property. However, the value of the collateral may not be sufficient to repay the amount of the unpaid loan, and we may be unsuccessful in recovering the remaining balance from these customers. In addition, decreases in property values could adversely affect the value of properties used as collateral for the loans. These second lien loans represent a smaller portion of our portfolio than our first lien residential mortgage loans.
Our home equity and home improvement loan portfolio gives us a diverse client base. Although most of these loans are in our primary market area, we believe the diversity of the individual loans in the portfolio reduces our potential risk.
Consumer Lending
We offer various types of secured and unsecured consumer loans. Generally, our consumer loans are made for personal, family or household purposes as a convenience to our customer base. As a general guideline, a consumer’s total debt service should not exceed 40% of their gross income. The underwriting standards for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of his or her ability to meet existing obligations and payments on the proposed loan.
Consumer loans may present greater credit risk than residential mortgage loans because many consumer loans are unsecured or are secured by rapidly depreciating assets. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance because of the greater likelihood of damage, loss or depreciation. Consumer loan collections also depend on the borrower’s continuing financial stability. If a borrower suffers personal financial difficulties, the loan may not be repaid. Also, various federal and state laws, including bankruptcy and insolvency laws, may limit the amount we can recover on such loans.
Loan Originations, Purchases, Sales, Participations and Servicing
All loans that we originate or purchase are underwritten pursuant to our policies and procedures, which incorporate standard underwriting guidelines. We originate both fixed and variable rate loans. Our loan origination activity may be adversely affected by a rising interest rate environment that typically results in decreased loan demand. We generally retain in our portfolio the majority of loans that we originate, except for first lien residential mortgage loans where we sell the majority of the loans into the secondary market. With the exit of our mortgage banking activities, we will cease to originate residential first lien mortgage loans in early 2020. However, in order to manage loan run-off within our residential mortgage loan portfolio, we plan on buying first lien residential mortgage loans, on a servicing released basis, from both the LLC and other third-party originators. We do not retain the servicing rights on sold loans.
We occasionally sell participations in commercial loans to correspondent banks if the amount of the loan exceeds our internal limits. More rarely, we purchase loan participations from correspondent banks in the local market as well. Those loans are underwritten in-house with the same care of loans directly originated.
Loan Approval Procedures and Authority
Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by our board of directors. The loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan, and the adequacy of the value of the collateral that will secure the loan, if applicable. To assess a business borrower’s ability to repay, we review and analyze, among other factors, current income, credit history including the Bank’sour prior experience with the borrower, cash flow, any secondary sources of repayment, other debt obligations in regards to the equity/net worth of the borrower and collateral available to the Bankus to secure the loan.
We generally require appraisals of all real property securing one- to four-family residential and commercial real estate loans and home equity loans and lines of credit. All appraisers are state-licensed or state-certified appraisers, and our practice is to have local appraisers approved by theour board of directors annually.
Mortgage Banking
Our residential mortgage loans consist ofAs previously noted, on December 18, 2019, we entered into an agreement to cease originating residential first and second mortgage loans, residential construction loans and home equity lines of credit and term loans secured by the residences of borrowers. Borrowers use second mortgage and home equity lines of credit for home improvements, education and other personal expenditures. We make mortgage loans with a variety of terms, including fixed, floating and variable interest rates, with maturities ranging from three months to 30 years.
In general, we make residential mortgage loans based on the borrower’s ability to repay the loan from his or her salary and other income; such loans are secured by residential real estate, the value of which is generally readily ascertainable. We make these loans consistent with our appraisal and real estate lending policies, which detail maximum loan-to-value ratios and maturities. We generally make residentiallien mortgage loans and home equity lines of credit secured by owner-occupied property withinexit our mortgage banking activities in early 2020. Our mortgage banking activities, prior to the guidelines of our regular purchasersexit of these loans.
Howard Bank generatesactivities, generated revenue by providing an extensive line of consumer real estate products and services to customers nationwide. We offerhistorically offered products available to customers through a retail network of mortgage loan officers and bankers as well as a sales force offering our customers direct telephone access to our products.
The Bank originatesUntil we cease originating residential first lien mortgage loans in early 2020, we will continue to originate residential mortgage loans that remain in our pipeline primarily as a correspondent lender. Activity in the residential mortgage loan market is highly sensitive to changes in interest rates and product availability. While the Bank doeswe do have delegated underwriting authority from most of itsour loan purchasers, at times itwe also employsemploy the services of the purchaser to underwrite the loans. Because the loans are originated within purchaser guidelines and designated automated underwriting and product specific requirements as part of the loan application, the loans sold have a limited recourse provision. Most contracts with investors contain recourse periods. In general, the Bankwe may be required to repurchase a previously sold mortgage loan or indemnify the purchaser if there is non-compliance with defined loan origination or documentation standards, including fraud, negligence or material misstatement in the loan documents. In addition, the Bankwe may have an obligation to repurchase a loan if the mortgagor has defaulted early in the loan term. The potential default repurchase period varies by purchaser but can be up to approximately 12 months after sale of the loan to the purchaser. The recourse period for fraud, material misstatement, breach of representations and warranties, noncompliance with law, or similar matters could be as long as the term of the loan. Mortgages subject to recourse are collateralized by single-family residential properties, follow purchaser guidelines, and carry private mortgage insurance, where applicable.
The Bank entersUntil we cease originating residential first lien mortgage loans in early 2020, we will continue to enter into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitments). Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. To protect against the price risk inherent in residential mortgage loan commitments, the Bank utilizeswe use “best efforts” in delivering to purchasers. Under a “best efforts” contract, the Bank commitswe commit to deliver an individual mortgage loan of a specified principal amount and quality to a purchaser and the purchaser commits to a price that it will purchase the loan from the Bankus if the loan to the underlying borrower closes. TheWe protect the Bank protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the purchaser commits to purchase a loan at a price representing a premium on the day the borrower commits to an interest rate with the intent that the purchaser has assumed the interest rate risk on the loan. As a result, the Bank iswe are not generally exposed to losses on loans sold utilizing best efforts. Nor will itwe realize gains related to rate lock commitments due to changes in interest rates. The market values of rate lock commitments and best efforts contracts are not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded. Because of the high correlation between rate lock commitments and best efforts contracts, we do not expect to incur any gain or loss on the rate lock commitments.
Investments and Funding
We balance our liquidity needs based on loan and deposit growth via thethrough both our investment portfolio and both short and long term borrowings.borrowings portfolios. It is our goal to provide adequate funding in support of loan growth and ample contingent liquidity to supportagainst unusual funding needs. A portion of our loan growth. We useinvestment portfolio is generally kept in highly liquid securities, and a portion of the generally short term investments that represent our liquidityportfolio is used to generate additional positive earnings. Howard Bank’sOur primary source of funds is, and will continue to be, core deposits generated from the local marketplace.our market area. Additional funding is provided by overnight unsecured master notes, customer repurchase agreements, Federal Home Loan Bank of Atlanta (“FHLB”) advances, the Board of Governors of the Federal Reserve (the “FRB”) Discount Window, subordinated debentures and other purchased funds. Other purchased funds may include certificates of deposit (“CDs”) over $100,000, federal funds purchased, and institutional or brokered deposits. Lines of credit are maintained to protect liquidity levels resulting from unexpected deposit withdrawals and natural-market credit demand.
Our investment policy is reviewed annually by our board of directors. TheOur board of directors has appointed its ExecutiveBoard Asset Liability Committee to serve as the Investment Committee, and the ExecutiveCommittee. The Board Asset Liability Committee therefore meets at regular intervals (not less than quarterly) and provides a report on the investment portfolio performance to theour full board of directors. The investment officer is designated by the PresidentChief Executive Officer and is responsible for managing the day-to-day activitiesmanagement of the liquidity and investmentsthe investment portfolio in accordance with the policies approved by theour board of directors. We actively monitor our investment portfolio and we classify the majority of the portfolio as “available for sale.” In general, under such a classification, we may sell investment instruments as management deems appropriate.
Other Banking Products
We offer our customers wire transfer services, ATM and check cards, automated teller machines (“ATMs”) at all of our branch locations, safe deposit boxes at most branches and credit cards through a third party processor. Additionally,In addition, we offer our business customers merchant card services, overnight sweep services, ACH origination capabilities, ACH and check positive pay and remote deposit capture devices for those customers who have a high volume of checks to deposit.
We also provide Internet banking capabilities to our customers and merchant card services for our business customers. With our Internet banking service, our customers may open accounts online, view their accounts on lineonline and electronically remit bill payments including an option for same day payment. Our commercial account services include an overnight sweep serviceOnline and remote deposit capture service.
We complement our existing Internet banking services with Mobiliti Mobile Banking PopMoneycapabilities allow both consumer and eStatement products. These state of the art products provide the Bank's consumerbusiness customers to essentially do their banking from anywhere at any time. All customers have the ability to check balances, view account information andeStatements, pay bills, pay people via PopMoney, set real-time account alerts, manage cards, and deposit checks from their mobile device, easily make payments directly to individuals and, with eStatements, to replace their paper monthly statement with an electronically delivered statement.devices.
Deposit Activities
Deposits are the major source of our funding. We offer a broad array of consumer and business deposit products that include demand, money market, savings, and individual retirement accounts, as well asand certificates of deposit. We offer throughUtilizing key technology partnerships, we offer a competitive array of commercial cash management products which in combination with our in-house courier service and remote deposit/ check imaging service,that allow us to attract demand deposits. We believe that we pay competitive rates on our interest bearing deposits. As a relationship-oriented organization, we generally seek to obtain deposit relationships with our loan clients.
We also use customer repurchase agreements, FHLB advances, the FRB Discount Window and other purchased funds as a funding mechanism. Other purchased funds may include certificates of deposits over $100,000, federal funds purchased and institutional or brokered deposits.Employees
Employees
Howard Bank has 300We have 299 full-time and sixeight part-time employees as of December 31, 2017.2019. None of our employees are represented by any collective bargaining unit, and we believe that relations with our employees are good. Howard Bancorp has no employees.
Lending Limit
The Bank’s legal lending limit for loans to one borrower was $18.7$35.8 million as of December 31, 2017,2019, and we further monitor our exposure to one borrower through a policy to limit our “in-house” lending limit to $15.0$25.0 million (asas of December 31, 2017),2019, which in-house limit can be exceeded on a limited basis. As part of our risk management strategy, we may attempt to participate a portion of larger loans to other financial institutions. This strategy allows us to maintain customer relationships yet observe the legal lending limit and manage credit exposure. However, this strategy may not always be available.
CompetitionAvailable Information
Our primary market areaThe Company is highly competitive and heavily branched by other financial institutions of all sizes. We also compete with Internet-based banks. Competition for loansa public company subject to small and medium sized businesses and their owners, professionals and executives, and high-net-worth individuals is intense, and pricing is important. We believe that acquisitions of several local competitors by larger institutions headquartered outsidethe reporting requirements of the StateU.S. Securities and Exchange Commission (the “SEC”). We file electronically with the SEC our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of Maryland during the last several years have enhancedSecurities Exchange Act of 1934, as amended (the “Exchange Act”). We make available on the Bank’s position as a locally headquartered and managed community bank, but manyinvestor relations page of our website at www.howardbank.com, free of charge, copies of these competitors now have substantially greater resources and lending limits than we do and offer services, suchreports as extensive and established branch networks and trust services, that we dosoon as reasonably practicable after filing or furnishing them to the SEC. The information on our website is not expect to provideincorporated by reference in the near future or ever. Moreover, larger institutions operating in our primary market area may have access to borrowed funds at a lower rate than is available to us. Deposit competition is also strong among institutions in our primary market area.this Annual Report on Form 10-K.
However, recent mergers of other area banks into large regional and national financial institutions have created opportunities for community-focused and prudently managed community banks. While our board of directors is aware of the competition that these larger institutions and alternative providers of financial services offer, we believe that local independent banks play and will continue to play a significant role in our primary market area. Our board of directors believes it is a significant and distinct advantage to be a locally owned and operated state bank interested in serving the needs of small and medium sized businesses and their owners, professionals and executives, and high-net-worth individuals.
SUPERVISION AND REGULATION
As a financial institution, we operate in a highly regulated environment. The regulatory framework under which we operate is intended primarily for the protection of depositors and the Federal Deposit Insurance Corporation’s (the “FDIC’s”) Deposit Insurance Fund and not for the protection of our stockholders and creditors. The following is a general summary of the material aspects of certain statutes and regulations applicable to us. These summary descriptions are not complete, and you should refer to the full text of the statutes, regulations, and corresponding guidance for more information. These statutes and regulations are subject to change, and additional statutes, regulations, and corresponding guidance may be adopted. We are unable to predict these future changes or the effects, if any, that these changes could have on our business, revenues, and results of operations.
Howard Bancorp, Inc.
We are a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). We are subject to regulation and examination by the FRBBoard of Governors of the Federal Reserve (the “FRB”) and the Maryland Office of the Commissioner of Financial Regulation (the “Commissioner”) and are required to file periodic reports and any additional information that the FRB and the Commissioner may require. In addition, the FRB and the Commissioner have enforcement authority over Howard Bancorp, Inc.,the Company, which includes the power to remove officers and directors and the authority to issue cease and desist orders to prevent Howard Bancorpus from engaging in unsafe or unsound practices or violating laws or regulations governing itsour business. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.
The status of Howard Bancorp as a registered bank holding company under the BHC Act and a Maryland-chartered bank holding company does not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.
Source of Strength
Under FRB regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. Under this requirement, Howard Bancorpwe could, in the future, could be required to provide financial assistance to Howardthe Bank should Howardthe Bank experience financial distress. In addition, in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice, a violation of FRB regulations or both. The FRB may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the FRB’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition.
Acquisitions
The primary purpose of a bank holding company is to control and manage banks. The BHC Act generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHC Act), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its FDIC-insured institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company. Furthermore, in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), bank holding companies must be well-capitalized and examiners must rate them well-managed in order to effect interstate mergers or acquisitions.
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Change in Control
The BHC Act requires regulatory filings by a stockholder or other party that seeks to acquire direct or indirect “control” of a bank, as defined in the BHC Act. The determination whether an investor “controls” a bank is based on all of the facts and circumstances surrounding the investment. As a general matter, a party is deemed to control a bank or other company if the party: (i) owns or controls 25% or more of any class of voting securities of the bank or other company; (ii) can elect or appoint a majority of the board of directors, or similar body, of the bank or other company; or (iii) exercises a "controlling influence"“controlling influence” over the bank or other company. SubjectThe FRB may require a company that owns between 5% and 25% of any class of voting securities of a bank or bank holding company to rebuttal,make certain non-control or “passivity” commitments. If a party may be presumedwere deemed to control“control” the Company for BHC Act purposes, the party would become a depository institution orbank holding company and subject it to filing and other company if theregulatory requirements.
Separately, an investor that owns or controls 10% or more of any class of voting stock of a bank or bank holding company and (i) the institution has registered securities under Section 12 of the Securities Exchange Act of 1934 and (ii) no other person owns, controls or has the power to vote a greater percentage of that class of voting securities. Ownershipsecurities is considered a “control” person under the Change in Bank Control Act (the “CIBC Act”) and may be required to file a change in control notice with the primary federal regulator of the bank or with the FRB. For the purposes of both the BHC Act and the CIBC Act, ownership by affiliated parties, or parties acting in concert, is typically aggregated for these purposes. If a party’s ownership of Howard Bancorp were to exceed certain thresholds, the investor could be deemed to “control” Howard Bancorp for regulatory purposes. This could subject the investor to regulatory filings or other regulatory consequences.aggregated.
Activities
Pursuant to provisions of the BHC Act and regulations promulgated by the FRB thereunder, Howard Bancorp, Inc.the Company may only engage in or own companies that engage in activities deemed by the FRB to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto, and the holding company must obtain permission from the FRB prior to engaging in most new business activities. In addition,As a bank holding companies like Howard Bancorp mustcompany, we also can elect to be treated as a “financial holding company,” which would allow us to engage in a broader array of activities. In sum, a financial holding company can engage in activities that are financial in nature or incidental or complementary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services and underwriting services, and engaging in limited merchant banking activities. We have not sought financial holding company status, but we may elect that status in the future as our business matures. If we were to elect in writing for financial holding company status, we would be required to be well capitalized and well managed, in orderand each insured depository institution we control would also have to engage inbe well capitalized, well managed and have at least a satisfactory rating under the expanded financial activities permissible only for a financial holding company.Community Reinvestment Act (discussed below).
Capital Requirements
The FRB has adopted guidelines regarding theFederal Reserve imposes certain capital adequacy ofrequirements on a bank holding companies, which requirecompany under the BHC Act, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are essentially the same as those that apply to the Bank and are described below under “Howard Bank—Capital Requirements.” However, because the Company currently has less than $3.0 billion in consolidated assets, it currently qualifies as a small bank holding companiescompany, and these capital requirements do not currently apply to maintain specified minimum ratios ofthe Company. Subject to certain restrictions, we are able to borrow money to make a capital contribution to total assetsthe Bank, and capitalthese loans may be repaid from dividends paid from the Bank to risk weighted assets. See “— Capital Requirements.”the Company.
Dividends
The Company is a legal entity separate and distinct from the Bank. The FRB has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality, and overall financial condition. Under the prompt corrective action rules discussed below, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of Howard Bancorp, Inc.the Company to pay dividends or otherwise engage in capital distributions.
The status of Howard Bancorp, Inc. as a registered bank holding company under the BHC Act and a Maryland-chartered bank holding company does not exempt it from certain federal and state laws and regulations applicableIn addition, funds for cash distributions to corporations generally, including, without limitation, certain provisions of the federal securities laws.
Howard Bank
Howard Bank is a Maryland-chartered trust company (with all powers of a commercial bank), and its deposit accountsour stockholders are insured by the FDIC up to the maximum legal limits. It is subject to regulation, supervision and regular examination by the Commissioner and the FDIC. The regulations of these agencies govern most aspects of Howard Bank’s business, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowing, dividends and location and number of branch offices. The laws and regulations governing Howard Bank generally have been promulgated to protect depositors and the FDIC’s Deposit Insurance Fund (“DIF”), and not for the purpose of protecting Howard Bancorp, Inc. or its stockholders.
Set forth below is a brief description of the material regulatory requirements that are or will be applicable to Howard Bank and Howard Bancorp, Inc. The description below is limited to the material aspects of the statutes and regulations addressed, and is not intended to be a complete description of such statutes and regulations and their effects on Howard Bank and Howard Bancorp, Inc.
Financial Institutions Article of the Maryland Annotated Code
The Financial Institutions Article of the Maryland Annotated Code (the “Banking Code”) contains detailed provisions governing the organization, operations, corporate powers, commercial and investment authority, branching rights and responsibilities of directors, officers and employees of Maryland banking institutions. The Banking Code delegates extensive rulemaking power and administrative discretion to the Commissioner in its supervision and regulation of state-chartered banking institutions. The Commissioner may order any banking institution to discontinue any violation of law or unsafe or unsound business practice.
Capital Requirements
Federal regulations require FDIC-insured depository institutions to meet several minimum capital standards: a common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-based assets of 8.0%, and a 4.0% Tier 1 capital to total assets leverage ratio. The existing capital requirements were effective January 1, 2015 and are the result of a final rule implementing regulatory amendments based on recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”).
There are two main categories of capital under the capital adequacy guidelines. Tier 1 capital generally consists of the sum of common stockholders’ equity and perpetual preferred stock (subject in the case of the latter to limitations on the kind and amount of such stock) and, in certain circumstances and subject to certain limitations, minority investments in certain subsidiaries, less goodwill and other non-qualifying intangible assets, and certain other deductions. Tier 2 capital consists of perpetual preferred stock that is not otherwise eligible to be included as Tier 1 capital, hybrid capital instruments, term subordinated debt and intermediate-term preferred stock and, subject to limitations, general allowances for credit losses. Tier 2 capital is limited to the amount of Tier 1 capital. Accumulated other comprehensive income (positive or negative) must be reflected in regulatory capital.
Additionally, subject to a transition schedule, the regulations limit a banking organization’s ability to make capital distributions, engage in share repurchases and pay certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The regulations also require unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital unless Howard Bank elects to opt-out from this treatment, which it has.
Prompt Corrective Action
Under federal prompt corrective action regulations, the bank regulatory agencies are authorized and, under certain circumstances, required, to take various “prompt corrective actions” to resolve the problems of any bank subject to their jurisdiction that is not adequately capitalized, as set forth in the next sentence. Pursuant to the Federal Deposit Insurance Corporation Improvement Act the agencies have established five capital tiers for depository institutions: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under the prompt corrective action regulations, a bank is considered “well capitalized” if it: (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a common equity Tier 1 ratio of 6.5% or greater; (iv) a leverage capital ratio of 5.0% or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. As of December 31, 2017, Howard Bank remained “well capitalized” for this purpose and its capital exceeded all applicable requirements.
Howard Bank has been “well capitalized” since it commenced its business operations.
The bank regulatory agencies may impose higher capital requirements on certain banks, and future regulatory change could impose higher capital standards as a routine matter. The regulators may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.
As an additional means to identify problems in the financial management of depository institutions, the Federal Deposit Insurance Act requires federal bank regulatory agencies to establish certain non-capital safety and soundness standards for institutions for which they are the primary federal regulator. The standards relate generally to operations and management, asset quality, interest rate exposure and executive compensation. The agencies are authorized to take action against institutions that fail to meet such standards.
Dividends
Howard Bancorp, Inc. is a legal entity separate and distinct from Howard Bank. Virtually all of Howard Bancorp’s revenue available for the payment of dividends on its common stock resultsderived primarily from dividends paid to Howard Bancorp by Howardreceived from our Bank. Under Maryland law, Howard Bank may declare a cash dividend, after providing for due or accrued expenses, losses, interest and taxes, from its undivided profits or, with the prior approval of the Commissioner, from its surplus in excess of 100% of its required capital stock. Also, if Howard Bank’s surplus is less than 100% of its required capital stock, then, until its surplus is 100% of its capital stock, Howard Bank must transfer to its surplus annually at least 10% of its net earnings and may not declare or pay any cash dividends that exceed 90% of its net earnings. In addition to these specific restrictions, the bank regulatory agencies have the ability to prohibit or limit proposed dividends if such regulatory agencies determine the payment of such dividends would result in Howard Bank being in an unsafe and unsound condition.
Deposit Insurance Assessments
Howard Bank’s deposit accounts are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor. FDIC-insured depository institutions are required to pay deposit insurance assessments to the FDIC. The amount of a particular institution’s deposit insurance assessment is based on that institution’s risk classification under an FDIC risk-based assessment system. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators. Assessment rates (inclusive of possible adjustments) currently range from 1.5 to 30 basis points of each institution’s total assets less tangible capital. The FDIC may increase or decrease the range of assessments uniformly, except that no adjustment can deviate more than two basis points from the base assessment rate without notice and comment rulemaking. The FDIC’s current system represents a change, required by the Dodd-Frank Act, from its prior practice of basing the assessment on an institution’s aggregate deposits. The FDIC may terminate insurance of deposits upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Maryland Regulatory Assessment
The Commissioner annually assesses state banking institutions to cover the expense of regulating banking institutions. The Bank’s asset size determines the amount of the assessment.
Liquidity
HowardOur Bank is subject to the reservevarious general regulatory policies and requirements imposed by the State of Maryland. A Maryland banking institution is required to have at all times a reserve equal to at least 15% of its demand deposits. Howard Bank is also subjectrelating to the uniform reserve requirementspayment of dividends. Any restriction on the ability of our Bank to pay dividends will indirectly restrict the ability of the FRB’s Regulation D, which appliesCompany to all depository institutions with transaction accounts or non-personal time deposits. During 2017, amounts in transaction accounts above $15.5 million and uppay dividends to $99.6 million were required to have reserves held against them in the ratio of 3% of such amounts. Amounts above $99.6 million required reserves of $2,988,000 plus 10% of the amount in excess of $99.6 million. The FRB changes its reserve requirements on an annual basis and Howard Bank is subject to new requirements for 2018. Howard Bank was in compliance with its reserve requirements at December 31, 2017 and is in compliance with its current reserve requirements.our stockholders. See “Howard Bank—Dividends” below.
Loans-to-One-Borrower Limitation
With certain limited exceptions, a Maryland banking institution may lend to a single or related group of borrowers an amount equal to 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily marketable collateral, which is defined to include certain securities and bullion, but generally does not include real estate. Howard Bank is in compliance with the loans-to-one borrower limitations.
Community Reinvestment Act and Fair Lending Laws
Under the Community Reinvestment Act of 1977 (“CRA”), the FDIC is required to assess the record of all financial institutions regulated by it to determine if such institutions are meeting the credit needs of the community (including low and moderate income neighborhoods) which they serve. CRA performance evaluations are based on a four-tiered rating system: Outstanding, Satisfactory, Needs to Improve and Substantial Noncompliance. CRA performance evaluations are considered in evaluating applications for such things as mergers, acquisitions and applications to open branches. Howard Bank has a CRA rating of “Satisfactory.” In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the FDIC, the Department of Housing and Urban Development, and the Department of Justice, and in private civil actions by borrowers.
Transactions with Related Parties
Transactions between banks and their related parties or affiliates are limited by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank is any company or entity that controls, is controlled by or is under common control with the bank. In a holding company context, the parent bank holding company and any companies which are controlled by such parent holding company are affiliates of the bank.
Generally, Section 23A of the Federal Reserve Act and the FRB’sSecurities Regulation W limit the extent to which a bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10.0% of such bank’s capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20.0% of such bank’s capital stock and surplus. The term ‘‘covered transaction’’ includes the making of loans, purchase of assets, issuance of guarantees and other similar transactions. In addition, loans or other extensions of credit by the bank to an affiliate are required to be collateralized in accordance with regulatory requirements and the bank’s transactions with affiliates must be consistent with safe and sound banking practices and may not involve the purchase by the bank of any low-quality asset. Section 23B applies to covered transactions as well as certain other transactions and requires that all such transactions be on terms substantially the same, or at least as favorable, to the institution or subsidiary as those provided to non-affiliates.
Section 22(h) of the Federal Reserve Act and the FRB’s Regulation O govern extensions of credit made by a bank to its directors, executive officers, and principal stockholders (‘‘insiders’’). Among other things, these provisions require that extensions of credit to insiders be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features. Further, such extensions may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Howard Bank’s capital. Extensions of credit in excess of certain limits must also be approved by the board of directors.
Standards for Safety and Soundness
Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a “cease and desist” order or the imposition of civil money penalties.
Anti-Money Laundering and OFAC
Under federal law, financial institutions must maintain anti-money laundering programs that include established internal policies, procedures and controls; a designated compliance officer; an ongoing employee training program; testing of the program by an independent audit function; and enhanced due diligence of certain customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and law enforcement authorities have been granted increased access to financial information maintained by financial institutions. Bank regulators routinely examine institutions for compliance with these obligations, and they must consider an institution’s compliance in connection with the regulatory review of applications, including applications for banking mergers and acquisitions. The regulatory authorities have imposed “cease and desist” orders and civil money penalty sanctions against institutions found to be violating these obligations.
The Office of Foreign Assets Control, (“OFAC”) is responsible for helping to ensure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC sends bank regulatory agencies lists of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If Howard Bancorp or Howard Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, Howard Bancorp or Howard Bank must freeze such account, file a suspicious activity report and notify the appropriate authorities.
Consumer Protection Laws
Howard Bank is subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy. These laws include the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Fair and Accurate Credit Transactions Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, and various state law counterparts. Further, the Dodd-Frank Act established the Consumer Financial Protection Bureau (“CFPB”), which has the responsibility for making rules and regulations under the federal consumer protection laws relating to financial products and services. The CFPB also has a broad mandate to prohibit unfair, deceptive or abusive acts and practices and is specifically empowered to require certain disclosures to consumers and draft model disclosure forms. Failure to comply with consumer protection laws and regulations can subject financial institutions to enforcement actions, fines and other penalties. The FDIC will examine Howard Bank for compliance with CFPB rules and will enforce CFPB rules with respect to Howard Bank.
In addition, federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, a financial institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Further, under the ‘‘Interagency Guidelines Establishing Information Security Standards,’’ banks must implement a comprehensive information security program that includes administrative, technical, and physical safeguards to ensure the security and confidentiality of customer information. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.
Effect of Governmental Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The FRB’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the FRB affect the levels of bank loans, investments and deposits through the FRB’s control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
Federal and State Securities Laws
Our common stock is registered with the Securities and Exchange CommissionSEC under the Securities Exchange Act of 1934 (the “Exchange Act”).Act. As such, we are subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Exchange Act.
Further, if we wish to sell common stock or other securities to raise capital in the future, we will be subject to the registration, anti-fraud, and other applicable provisions of state and federal securities laws. For example, we will have to register the sales of such securities under the Securities Act, the Maryland Securities Act, and the applicable securities laws of each state in which we offer or sell the securities, unless an applicable exemption from registration exists with respect to such sales. Such exemptions may, among other things, limit the number and types of persons we could sell such securities to and the manner in which we could market the securities. We would also be subject to federal and state anti-fraud requirements with respect to any statements we make to potential purchasers in connection with the offer and sale of such securities.
Sarbanes-Oxley Act of 2002
The Sarbanes Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. We have preparedadopted policies, procedures and systems designed to ensure compliance with the Sarbanes Oxley Act and related regulations.
Howard Bank
Howard Bank is a Maryland-chartered trust company (with all powers of a commercial bank), and its deposit accounts are insured by the FDIC up to the maximum legal limits. It is subject to regulation, supervision and regular examination by the Commissioner and the FDIC. The regulations of these agencies govern most aspects of the Bank’s business, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowing, dividends and location and number of branch offices.
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Financial Institutions Article of the Maryland Annotated Code
The Financial Institutions Article of the Maryland Annotated Code (the “Banking Code”) contains detailed provisions governing the organization, operations, corporate powers, commercial and investment authority, branching rights and responsibilities of directors, officers and employees of Maryland banking institutions. The Banking Code delegates extensive rulemaking power and administrative discretion to the Commissioner in its supervision and regulation of state-chartered banking institutions. The Commissioner may order any banking institution to discontinue any violation of law or unsafe or unsound business practice.
The Economic Growth, Regulatory Relief, and Consumer Protection Act
On May 24, 2018, President Trump signed into law the first major financial services reform bill since the enactment of the Dodd-Frank Act. The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Reform Law”) modifies or eliminates certain requirements on community and regional banks and nonbank financial institutions. For instance, under the Reform Act and related rule making:
| · | banks that have less than $10 billion in total consolidated assets and total trading assets and trading liabilities of less than five percent of total consolidated assets are exempt from Section 619 of the Dodd-Frank Act, known as the “Volcker Rule”, which prohibits “proprietary trading” and the ownership or sponsorship of private equity or hedge funds that are referred to as “covered funds”; |
| · | the asset threshold for bank holding companies to qualify for treatment under the “Small Bank Holding Company and Savings and Loan Holding Company Policy Statement” was raised from $1 billion to $3 billion, which exempts these institutions (including the Company) from certain regulatory requirements including the Basel III capital rules; |
| · | a new “community bank leverage ratio” was adopted, which is applicable to certain banks and bank holding companies with total assets of less than $10 billion (as described below under “Capital Requirements”); and |
| · | banks with up to $3 billion in total consolidated assets may be examined by their federal banking regulator every 18 months (as opposed to every 12 months). |
Capital Requirements
Regulatory capital rules adopted in July 2013 and fully phased in as of January 1, 2019, which we refer to as Basel III, impose minimum capital requirements for bank holding companies and banks. The Basel III rules apply to all national and state banks and savings and loan associations regardless of size and bank holding companies and savings and loan holding companies other than “small bank holding companies,” generally holding companies with consolidated assets of less than $3 billion. The Company is currently considered a “small bank holding company.” More stringent requirements are imposed on “advanced approaches” banking organizations-those organizations with $250 billion or more in total consolidated assets, $10 billion or more in total foreign exposures, or that have opted in to the Basel II capital regime. Specifically, the following minimum capital requirements apply to the Bank:
| · | a common equity Tier 1 (“CET1”) risk-based capital ratio of 4.5%; | |
| · | a Tier 1 risk-based capital ratio of 6%; | |
| · | a total risk-based capital ratio of 8%; and | |
| · | a leverage ratio of 4%. |
The final rules also established a “capital conservation buffer” above the regulatory minimum capital requirements, which must consist entirely of CET1 risk-based capital, which was phased in over several years. The fully phased-in capital conservation buffer of 2.500%, which became effective on January 1, 2019, resulted in the following effective minimum capital ratios beginning in 2019: (i) a CET1 risk-based capital ratio of 7.0%, (ii) a Tier 1 risk-based capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%. Under Basel III, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if their capital levels fall below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.
Under Basel III, Tier 1 capital includes two components: CET1 capital and additional Tier 1 capital. The highest form of capital, CET1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, otherwise referred to as AOCI, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital is primarily comprised of noncumulative perpetual preferred stock, Tier 1 minority interests and grandfathered trust preferred securities (as discussed below). Tier 2 capital generally includes the allowance for credit losses up to 1.25% of risk-weighted assets, qualifying preferred stock, subordinated debt and qualifying tier 2 minority interests, less any deductions in Tier 2 instruments of an unconsolidated financial institution. Cumulative perpetual preferred stock is included only in Tier 2 capital, except that the Basel III rules permit bank holding companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 Capital (but not in CET1 capital), subject to certain restrictions. The regulations also require unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital unless the Bank elected to opt-out from this treatment, which it did.
On December 21, 2018, the federal banking agencies issued a joint final rule to revise their regulatory capital rules to (i) address the upcoming implementation of a new credit impairment model, the Current Expected Credit Loss, or CECL model, an accounting standard under GAAP; (ii) provide an optional three-year phase-in period for the day-one adverse regulatory capital effects that banking organizations are expected to experience upon adopting CECL; and (iii) require the use of CECL in stress tests beginning with the 2020 capital planning and stress testing cycle for certain banking organizations that are subject to stress testing. We are currently evaluating the impact the CECL model will have on our accounting, and expect to recognize a one-time cumulative-effect adjustment to our allowance for credit losses as of the beginning of the first quarter of 2023, the first reporting period in which the new standard is effective for us. At this time, we cannot yet reasonably determine the magnitude of such one-time cumulative adjustment, if any, or of the overall impact of the new standard on our business, financial condition or results of operations.
In November 2019, the federal banking regulators published final rules implementing a simplified measure of capital adequacy for certain banking organizations that have less than $10 billion in total consolidated assets. Under the final rules, which went into effect on January 1, 2020, depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets and meet other qualifying criteria, including a leverage ratio of greater than 9%, off-balance-sheet exposures of 25% or less of total consolidated assets and trading assets plus trading liabilities of 5% or less of total consolidated assets, are deemed “qualifying community banking organizations” and are eligible to opt into the “community bank leverage ratio framework.” A qualifying community banking organization that elects to use the community bank leverage ratio framework and that maintains a leverage ratio of greater than 9% is considered to have satisfied the generally applicable risk-based and leverage capital requirements under the Basel III rules and, if applicable, is considered to have met the “well capitalized” ratio requirements for purposes of its primary federal regulator’s prompt corrective action rules, discussed below. The final rules include a two-quarter grace period during which a qualifying community banking organization that temporarily fails to meet any of the qualifying criteria, including the greater-than-9% leverage capital ratio requirement, is generally still deemed “well capitalized” so long as the banking organization maintains a leverage capital ratio greater than 8%. A banking organization that fails to maintain a leverage capital ratio greater than 8% is not permitted to use the grace period and must comply with the generally applicable requirements under the Basel III rules and file the appropriate regulatory reports. We do not have any immediate plans to elect to use the community bank leverage ratio framework but may make such an election in the future.
Prompt Corrective Action
Under federal prompt corrective action regulations, the bank regulatory agencies are authorized and, under certain circumstances, required, to take various “prompt corrective actions” to resolve the problems of any bank subject to their jurisdiction that is not adequately capitalized. Depending on their capital levels, every insured depository institution is in one of five capital tiers: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under the prompt corrective action regulations, a bank is considered “well capitalized” if it: (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a CET1 ratio of 6.5% or greater; (iv) a leverage capital ratio of 5.0% or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. Well capitalized status is a prerequisite for certain types of favorable regulatory treatment, including expedited processing of applications by the FDIC and the ability to rely on brokered deposits.
The Bank has been “well capitalized” since it commenced its business operations.
Effective with the March 31, 2020 Call Report, qualifying community banking organizations that elect to use the new community bank leverage ratio framework and that maintain a leverage ratio of greater than 9.0% will be considered to have satisfied the risk-based and leverage capital requirements to be deemed well-capitalized.
The bank regulatory agencies may impose higher capital requirements on certain banks, and future regulatory change could impose higher capital standards as a routine matter. The regulators may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.
As an additional means to identify problems in the financial management of depository institutions, the Federal Deposit Insurance Act requires federal bank regulatory agencies to establish certain non-capital safety and soundness standards for institutions for which they are the primary federal regulator. The standards relate generally to operations and management, asset quality, interest rate exposure and executive compensation. The agencies are authorized to take action against institutions that fail to meet such standards.
Dividends
The Company is a legal entity separate and distinct from the Bank. Virtually all of the Company’s revenue available for the payment of dividends on its common stock results from dividends paid to the Company by the Bank. Under Maryland law, the Bank may declare a cash dividend, after providing for due or accrued expenses, losses, interest and taxes, from its undivided profits or, with the prior approval of the Commissioner, from its surplus in excess of 100% of its required capital stock. Also, if the Bank’s surplus is less than 100% of its required capital stock, then, until its surplus is 100% of its capital stock, the Bank must transfer to its surplus annually at least 10% of its net earnings and may not declare or pay any cash dividends that exceed 90% of its net earnings. In addition, federal bank regulators have stated that paying dividends that deplete a banking organization’s capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally only pay dividends out of current earnings. The Bank must also maintain the CET1 capital conservation buffer of 2.5% to avoid becoming subject to restrictions on capital distributions, including dividends, as described above.
Deposit Insurance Assessments
The Bank’s deposit accounts are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor. FDIC-insured depository institutions are required to pay deposit insurance assessments to the FDIC. The amount of a particular institution’s deposit insurance assessment is determined by an FDIC risk-based assessment system. The assessment is a function of a financial ratios method that takes into account seven financial ratios and the institution’s weighted average CAMELS component ratings. The assessment must be within a range that depends on the institution’s composite CAMELS rating, and the assessment will be adjusted up or down to come within the range. Assessment rates (inclusive of possible adjustments) for institutions with less than $10 billion in consolidated assets currently range from 1.5 to 30 basis points of each institution’s total assets less tangible capital. The FDIC may increase or decrease the range of assessments uniformly, except that no adjustment can deviate more than two basis points from the base assessment rate without notice and comment rulemaking. The FDIC may terminate insurance of deposits upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
In addition to the ordinary assessments described above, the FDIC has the ability to impose special assessments in certain instances. For example, under the Dodd-Frank Act, the minimum designated reserve ratio for the Deposit Insurance Fund (“DIF”) was increased to 1.35% of the estimated total amount of insured deposits. On September 30, 2018, the DIF reached 1.36%, exceeding the statutorily required minimum reserve ratio of 1.35%. On reaching the minimum reserve ratio of 1.35%, FDIC regulations provided for two changes to deposit insurance assessments: (i) surcharges on insured depository institutions with total consolidated assets of $10 billion or more (large institutions) ceased; and (ii) small banks were to receive assessment credits for the portion of their assessments that contributed to the growth in the reserve ratio from between 1.15% and 1.35%, to be applied when the reserve ratio is at or above 1.38%. The Bank subsequently received such assessment credits.
Maryland Regulatory Assessment
The Commissioner annually assesses state banking institutions to cover the expense of regulating banking institutions. The Bank’s asset size determines the amount of the assessment.
Liquidity
The Bank is subject to the reserve requirements imposed by the State of Maryland. A Maryland banking institution is required to have at all times a reserve equal to at least 15% of its demand deposits. The Bank is also subject to the uniform reserve requirements of the FRB’s Regulation D, which applies to all insured depository institutions with transaction accounts or non-personal time deposits. During 2019, amounts in transaction accounts above $16.9 million and up to $110.6 million were required to have reserves held against them in the ratio of 3% of such amounts. Amounts above $110.6 million required reserves of $3.2 million plus 10% of the amount in excess of $110.6 million. The FRB changes its reserve requirements on an annual basis and the Bank is subject to new requirements for 2020. The Bank was in compliance with its reserve requirements at December 31, 2019 and is in compliance with its current reserve requirements.
Loans-to-One-Borrower Limitation
With certain limited exceptions, a Maryland banking institution may lend to a single or related group of borrowers an aggregate amount not more than 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily marketable collateral, which is defined to include certain securities and bullion, but generally does not include real estate. The Bank is in compliance with the loans-to-one borrower limitations.
Commercial Real Estate Loans
Commercial real estate (“CRE”) loans are subject to two types of regulatory oversight. If total reported loans for construction, land development, and other land represent more than 100% of a bank’s total capital or if total CRE loans represent 300% or more of total capital and have grown by 50% or more in the last 36 months, the bank is expected to have enhanced risk management and will be subject to greater regulatory scrutiny. In addition, the risk-based capital rules (so long as they are applicable) presumptively risk weight CRE loans at 100% but impose a 150% risk weight on loans deemed to be high volatility. Among other things, the capital rules required that a borrower contribute 15% of the equity of a financed project in order for the loan to qualify for the lower risk weight. The Reform Act narrowed the types of loans potentially subject to the higher risk weight but did not eliminate that risk weight.
Community Reinvestment Act and Fair Lending Laws
Under the Community Reinvestment Act of 1977 (“CRA”), the FDIC is required to assess the record of all financial institutions regulated by it to determine if such institutions are meeting the credit needs of the communities (including low and moderate income neighborhoods) that they serve. CRA performance evaluations are based on a four-tiered rating system: Outstanding, Satisfactory, Needs to Improve and Substantial Noncompliance. CRA performance evaluations are considered in evaluating applications for such things as mergers, acquisitions and new branches. The Bank has a CRA rating of “Satisfactory.”
In December 2019, the FDIC and the Office of the Comptroller of the Currency proposed changes to the regulations implementing the CRA, which, if adopted will result in changes to the current CRA framework. The FRB did not join the proposal.
In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics, such as ethnicity, gender, and race, as specified in each statute. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the FDIC, the Department of Housing and Urban Development, and the Department of Justice, and in private civil actions by borrowers.
Transactions with Related Parties
Transactions between banks and their related parties or affiliates are limited by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank is any company or entity that controls, is controlled by or is under common control with the bank. In a holding company context, the parent bank holding company and any companies which are controlled by such parent holding company are affiliates of the bank.
Generally, Section 23A of the Federal Reserve Act and the FRB’s Regulation W limit the “covered transactions” in which a bank or its subsidiaries may engage with any one affiliate to an amount equal to 10% of such bank’s capital stock and surplus, and limit such covered transactions with all affiliates to an amount equal to 20% of such bank’s capital stock and surplus. The term ‘‘covered transaction’’ includes loans, asset purchases, issuances of guarantees, and other similar transactions that expose the bank to the credit risk of an affiliate. In addition, loans or other extensions of credit by the bank to an affiliate must be collateralized in accordance with regulatory requirements. The Bank’s transactions with affiliates must be consistent with safe and sound banking practices and may not involve the purchase by the Bank of any low-quality asset. Section 23B applies to covered transactions as well as certain other transactions and requires that all such transactions be on terms substantially the same, or at least as favorable, to the bank or subsidiary as those provided to non-affiliates.
Section 22(h) of the Federal Reserve Act and the FRB’s Regulation O govern extensions of credit made by a bank to its directors, executive officers, and principal stockholders (‘‘insiders’’). Among other things, these provisions require that extensions of credit to insiders be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features. Further, such extensions may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Howard Bank’s capital. Extensions of credit in excess of certain limits must also be approved by the board of directors.
On December 27, 2019, the federal banking agencies issued an interagency statement explaining that such agencies will provide temporary relief from enforcement action against banks or asset managers, which become principal stockholders of banks, with respect to certain extensions of credit by banks that otherwise would violate Regulation O, provided the asset managers and banks satisfy certain conditions designed to ensure that there is a lack of control by the asset manager over the bank. This temporary relief will apply while the Federal Reserve, in consultation with the other federal banking agencies, considers whether to amend Regulation O.
Standards for Safety and Soundness
Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard.
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Enforcement Powers
The Bank and its “institution-affiliated parties,” including its management, employees, agents, independent contractors, and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Potential civil penalties have been substantially increased. Criminal penalties for some financial institution crimes have been increased to 20 years.
In addition, regulators are provided with considerable flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies’ have expansive power to issue cease-and-desist orders. These orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts or take other actions as determined by the ordering agency to be appropriate.
Further, state attorneys general may bring civil actions or other proceedings under the Dodd-Frank Act or regulations against state-chartered banks, including the Bank.
Anti-Money Laundering and Office of Foreign Assets Control
Under federal law, financial institutions must maintain programs to prevent money laundering and the financing of terrorism that include established internal policies, procedures and controls; a designated compliance officer; an ongoing employee training program; testing of the program by an independent audit function; and a “know your customer” program with enhanced due diligence of certain customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering; they must file currency transaction reports for deposits and withdrawals of large amounts of currency and suspicious activity reports of possible criminal activity. Financial institutions also must assess their money laundering risk with respect to private banking and foreign correspondent banking relationships. Law enforcement authorities have been granted increased access to financial information maintained by financial institutions. Bank regulators routinely examine institutions for compliance with these obligations, and they must consider an institution’s compliance in connection with the regulatory review of applications, including applications for banking mergers and acquisitions. The regulatory authorities have imposed “cease and desist” orders and civil money penalty sanctions against institutions found to be violating these obligations.
Bank Secrecy Act and anti-money laundering compliance has been a special focus of the Federal banking agencies in recent years. Any non-compliance is likely to result in an enforcement action, often with substantial monetary penalties and reputation damage. A savings association or bank that is required to strengthen its compliance program often must put on hold any initiatives that require banking agency approval.
The Office of Foreign Assets Control, (“OFAC”) is responsible for helping to ensure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC sends bank regulatory agencies lists of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If we find a name on any transaction, account or wire transfer that is on an OFAC list, we must freeze such account, file a suspicious activity report and notify the appropriate authorities.
USA PATRIOT Act
The Patriot Act became effective on October 26, 2001 and amended the Bank Secrecy Act. The Patriot Act provides, in part, for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including:
| · | requiring standards for verifying customer identification at account opening; |
| · | rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; |
| · | reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and |
| · | filing suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations. |
The Patriot Act requires financial institutions to undertake enhanced due diligence of private bank accounts or correspondent accounts for non-U.S. persons that they administer, maintain, or manage. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.
Under the Patriot Act, the Financial Crimes Enforcement Network (“FinCEN”) can send the Bank a list of the names of persons suspected of involvement in terrorist activities or money laundering. The Bank may be requested to search its records for any relationships or transactions with persons on the list. If the Bank finds any relationships or transactions, it must report those relationships or transactions to FinCEN.
Consumer Protection Laws
We are subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy. These laws include the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Fair and Accurate Credit Transactions Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, and various state law counterparts. Further, the Dodd-Frank Act established the Consumer Financial Protection Bureau (“CFPB”), which has the responsibility for making rules and regulations under the federal consumer protection laws relating to financial products and services. The CFPB has the authority to supervise and examine depository institutions with more than $10 billion in assets for compliance with federal consumer laws. The authority to supervise and examine depository institutions with $10 billion or less in assets, such as the Bank, for compliance with federal consumer laws remains largely with those institutions’ primary regulators. However, the CFPB may participate in examinations of these smaller institutions on a “sampling basis” and may refer potential enforcement actions against such institutions to their primary regulators. As such, the CFPB may participate in examinations of the Bank. The CFPB also has a broad mandate to prohibit unfair, deceptive or abusive acts and practices and is specifically empowered to require certain disclosures to consumers and draft model disclosure forms. Failure to comply with consumer protection laws and regulations can subject financial institutions to enforcement actions, fines and other penalties.
In addition, federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and practices regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, a financial institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Further, under the ‘‘Interagency Guidelines Establishing Information Security Standards,’’ banks must implement a comprehensive information security program that includes administrative, technical, and physical safeguards to ensure the security and confidentiality of customer information. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.
Effect of Governmental Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The FRB’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through the FRB’s power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the FRB affect the levels of bank loans, investments and deposits through the FRB’s control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
You should consider carefully the following risks, along with the other information contained in and incorporated into this annual report. The risks and uncertainties described below are not the only ones that may affect us. Additional risks and uncertainties also may adversely affect our business and operations. If any of the following events actually occur, our business and financial results could be materially adversely affected.
Risk Factors Related to the Recent Merger with First Mariner Bank
Combining the two banks may be more difficult, costly or time-consuming than expected.
The success of the merger will depend, in part, on our ability to successfully combine the business of the former First Mariner into the business of Howard Bank. To realize the anticipated benefits of the merger, we must successfully integrate First Mariner’s business into our own. It is possible that the integration process could result in the loss of key employees, the disruption of our business or inconsistencies in standards, controls, procedures and policies that adversely affect the combined bank’s ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits of the merger. The loss of key employees could adversely affect our ability to successfully conduct our business in our markets, particularly in the areas in which the former First Mariner branches are located, which could have an adverse effect on our financial results and the value of our common stock. If we experience difficulties with the integration process, the anticipated benefits of the merger may not be realized fully or at all, or may take longer to realize than expected. As with any merger of financial institutions, there also may be business disruptions that cause us to lose customers, including former customers of First Mariner, or cause customers, including former First Mariner customers, to remove their accounts from Howard Bank and move their business to competing financial institutions. Integration efforts will also divert management attention and resources. These integration matters could have an adverse effect on us during this transition period and for an undetermined period following the recent after consummation of the merger.
We may fail to realize the anticipated cost savings resulting from the merger.
While we believe that we will achieve cost savings from the merger when the two banks have been fully integrated, it is possible that the estimates of the potential cost savings could turn out to be incorrect. The actual integration may result in additional and unforeseen expenses, and therefore we may not realize the anticipated cost savings of the merger. Actual growth and cost savings, if achieved, may be lower than what we expect and may take longer to achieve than we anticipate. If we are not able to adequately address integration challenges, we may be unable to successfully integrate Howard Bank’s and First Mariner’s former operations or to realize the anticipated benefits of the integration of the two banks.
The market price of our common stock may be affected by factors different from those that affected our shares prior to the merger.
Our business differs in important respects from that conducted by First Mariner prior to the merger and, accordingly, the results of operations of the combined bank and the market price of our common stock may be affected by factors different from those that affected Howard Bancorp’s independent results of operations and the market price of our common stock prior to the merger.
The market price of Howard common stock may decline as a result of the merger.
The market price of our common stock may decline as a result of the merger if we do not achieve the perceived benefits of the merger or the effect of the merger on our financial results is not consistent with the expectations of financial or industry analysts. In addition, existing Howard Bancorp stockholders, including former First Mariner stockholders, may not wish to continue to invest in the combined entity, or for other reasons may wish to dispose of some or all of their shares of Howard Bancorp; significant sales of our common stock following the merger, or the expectation that such sales may occur, may depress the market price of our common stock.
Our management has broad discretion as to the use of assets acquired from First Mariner, and may not use these assets effectively.
Our management has broad discretion in the application of the assets acquired in the merger and could utilize the assets in ways that do not improve our results of operations or enhance the value of our common stock. Our failure to utilize these assets effectively could have a material adverse effect on the Company, delay the development of products and cause the price of our common stock to decline.
Risk Factors Relating to Our Business and Our Common Stock
Because our loan portfolio consists largely of commercial business and commercial real estate loans, our portfolio carries a higher degree of risk than would a portfolio composed primarily of residential mortgage loans.
Our loan portfolio is made up largely of commercial business loans and commercial real estate loans, most of which is collateralized by real estate. These types of loans generally expose a lender to a higher degree of credit risk of non-payment and loss than do residential mortgage loans because of several factors, including dependence on the successful operation of a business or a project for repayment, the collateral securing these loans may not be sold as easily as residential real estate, and loan terms with a balloon payment rather than full amortization over the loan term. In addition, commercial real estate and commercial loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan. Underwriting and portfolio management activities cannot completely eliminate all risks related to these loans. Any significant failure to pay on time by our customers or a significant default by our customers would materially and adversely affect us.
We make both secured and some unsecured commercial and industrial loans. Unsecured loans generally involve a higher degree of risk of loss than do secured loans because, without collateral, repayment is wholly dependent upon the success of the borrowers’ businesses. Secured commercial and industrial loans are generally collateralized by accounts receivable, inventory, equipment or other assets owned by the borrower and include a personal guaranty of the business owner. Compared to real estate, that type of collateral is more difficult to monitor, its value is harder to ascertain, it may depreciate more rapidly and it may not be as readily saleable if repossessed. Further, commercial and industrial loans generally will be serviced primarily from the operation of the business, which may not be successful, and commercial real estate loans generally will be serviced from income on the properties securing the loans.
While any declines in the value of our real estate collateral securing loans have been reflected in existing reserves, the discounts and reserves we have taken against our loan portfolio based on our internal review of economic conditions and their impact on real estate values in our market areas may be insufficient. Further deteriorationDeterioration in the real estate market or a prolonged economic recoverythe economy could adversely affect the value of the properties securing the loans or revenues from borrowers’ businesses, thereby increasing the risk of non-performing loans and increased portfolio losses that could materially and adversely affect us.
The small businesses that make up the majority of our commercial borrowers generally do not have the cash reserves to help cushion them from an economic slowdown to the same extent that large borrowers do and thus may be more heavily impacted by an economic downturn. A continued sluggish economy return of recessionary conditions and/or another economic slowdownother negative developments in the domestic or international credit markets or economies may have a negative effect on the ability of our commercial borrowers to make timely repayments of their loans, which could have an adverse impact on our earnings.
Construction loans are subject to risks during the construction phase that are not present in standard residential real estate and commercial real estate loans. These risks include:
| · | the viability of the contractor; |
| · | the value of the project being subject to successful completion; |
| · | the contractor’s ability to complete the project, to meet deadlines and time schedules and to stay within cost estimates; and |
| · | concentrations of such loans with a single contractor and its affiliates. |
Real estate construction and land loans also present risks of default in the event of declines in property values or volatility in the real estate market during the construction phase. If we are forced to foreclose on a project prior to completion, we may not be able to recover the entire unpaid portion of the loan, may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate amount of time. If any of these risks were to occur, it could adversely affect our financial condition, results of operations and cash flows.
As of December 31, 2019, our commercial real estate loans were equal to 288% of our total risk-based capital. The federal banking agencies have issued guidance regarding high concentrations of commercial real estate loans within bank loan portfolios. The guidance requires financial institutions that exceed certain levels of commercial real estate lending compared with their total capital to maintain heightened risk management practices that address the following key elements: including board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending. If there is any deterioration in our commercial real estate or real estate construction and land portfolios or if our regulators conclude that we have not implemented appropriate risk management practices, it could adversely affect our business and result in a requirement of increasedthat we increase our capital levels, and such capital may not be available to us on acceptable terms or at that time.all.
We are subject toA failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and operational risks relating toother service providers or other third parties, including as a result of cyber-attacks, could disrupt our usebusinesses, result in the disclosure or misuse of technology that couldconfidential or proprietary information, damage our reputation, increase our costs and our business.cause losses.
We are subject to certain operational risks including, but not limited to, data processing system failures and errors, inadequate or failed internal processes, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. We rely heavily on data processing, software, communication,communications and information systems on a variety of computing platforms and networks and over the Internet to conduct our business. Despite instituted safeguards, we cannot be certain that all of our systems are entirely free from vulnerability to attack or other technological difficulties or failures. Information security risks for financial institutions such as ours have generally increased significantly due toin recent years in part because of the proliferation of new technologies, the use of online, telephonethe internet and mobile banking channels by clientstelecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. As client, public, and regulatory expectations regarding operational and information security have increased, our operational systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Our business, financial, accounting and data processing systems, or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors, including events that are wholly or partially beyond our control. For example, there could be electrical or telecommunications outages; natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics; events arising from local or larger scale political or social matters, including terrorist acts; and, as described below, cyber-attacks.
As noted above, our business relies on our digital technologies, computer and email systems, software, and networks to conduct its operations. Although we have information security procedures and controls in place, our technologies, systems, networks, and our clients’ devices have been subject to, and are likely to continue to bemay become the target of cyber-attacks, computer viruses, malicious code, phishing attackscyberattacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our clients’ confidential, proprietary and other information, the theft of client assets through fraudulent transactions or disruption ofotherwise disrupt our or our clients’ or other third parties’ business operations. SystemThird parties with whom we do business or that facilitate our business activities, including financial intermediaries, or vendors that provide services or security solutions for our operations, and other third parties, could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints.
While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or errors,security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. Our risk and exposure to these matters remains heightened because of the evolving nature of these threats. As a result, cybersecurity and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a focus for us. As threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support our Internet banking activitiesbusinesses and clients, or other communication and informationcyber-attacks or security breaches of the networks, systems or other technology difficulties or failures,devices that our clients use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.
We depend on information being losttechnology and telecommunications systems of third-party servicers, and systems failures, interruptions or misappropriated, interruptbreaches of security involving these systems could have an adverse effect on our operations, financial condition and results of operations.
Our business is highly dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems, third-party servicers accounting systems and mobile and online banking platforms. We outsource many of our major systems, such as data processing, deposit processing systems and online banking platforms. While we have selected these vendors carefully, we do not control their actions. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Financial or operational difficulties of a vendor could also hurt our operations if those difficulties interfere with the vendor’s ability to serve us. Furthermore, our vendors could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints. Replacing these third-party vendors could also create significant delay and expense. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to process new and renewal loans, gather deposits and provide customer service, compromise our ability to operate effectively, damage our reputation, result in a loss of customer business cause us to incur expenses to rectify,and/or subject us to additional regulatory scrutiny or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. We rely on standard Internet and other security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect our systems from damage or compromises or breaches of our security measures. We continue to monitor developments in this area and consider whether additional protective measures are necessary or appropriate, and we have obtained insurance protection intended to cover losses due to network security breaches; there is no guarantee, however, that such insurance would cover all costs associated with any breach, damage or failure of our computer systems and network infrastructure.
We rely on certain external vendors. Our business is dependent on the use of outside service providers that support our day-to-day operations including data processing and electronic communications.
Our business is dependent on the use of outside service providers that support our day-to-day operations including data processing and electronic communications. Our operations are exposed to the risk that a service provider may not perform in accordance with established performance standards required in our agreements for any number of reasons including equipment or network failure, a change in their senior management, their financial condition, their product line or mix and how they support existing customers, or a simple change in their strategic focus. While we have comprehensive policies and procedures in place to mitigate risk at all phases of service provider management from selection to performance monitoring and renewals, the failure of a service provider to perform in accordance with contractual agreements could be disruptive to our business, which could have a material adverse effect on our financial conditions and results of operations.
Because our loan portfolio includes residential real estate loans, our earnings are sensitive to the credit risks associated with these types of loans.
We originate and retain in our portfolioWhile we will cease originating residential first lien mortgage loans in early 2020, we will continue to originate home equity loans and intendhome equity lines of credit within our local market area. In addition, we will purchase residential first lien mortgage loans in order to increase our origination of these types of loans.offset portfolio runoff. While residential real estate loans are more diversified than loans to commercial borrowers, and our local real estate market and economy have performed better than many other markets, a downturn could cause higher unemployment, more delinquencies, and could adversely affect the value of properties securing loans in our portfolio. In addition, should values begin to decline again, the real estate market may take longer to recover or not recover to previous levels. These risks increase the probability of an adverse impact on our financial results as fewer borrowers would be eligible to borrow and property values could be below necessary levels required for adequate coverage on the requested loan.
Our residential lending departmentWe may not continuebe unable to provide us with significant noninterest income.successfully implement a disposition or wind-down of certain business activities which no longer fit our strategic plan.
WeIn December 2019, we entered into an agreement to sell in the secondary market mostcertain assets related to our mortgage business, and we agreed to cease originating residential first lien mortgage loans that we originate, earning noninterest income in the form of gains on sale and fees in connection with originating these loans.The residential mortgage business is highly competitive and highly susceptible to changes in market interest rates, consumer confidence levels, employment statistics, the capacity and willingness of secondary market purchasers to acquire and hold or securitize loans, and other factors beyond our control. Additionally, in many respects, the mortgage origination business is relationship-based and dependent on the services of individual mortgage loan officers. The loss of services of one or more loan officers could have the effect of reducing the level ofexit our mortgage production or the rate of growth of production. Further,when interest rates rise, as is expectedbanking activities in the near term, the demand for mortgage loans tends to fall and may reduce the number of loans available for sale.early 2020. In addition, to interest rate levels, weakwe may engage in future dispositions or deteriorating economic conditions also tend to reduce loan demand.Aswind-downs of certain business. Key risks associated with exiting a result of these factors we cannot be certain that we will not be able to continue to increase the volume or percentage of revenue or net income produced by the residential mortgage business.business include:
| our ability to price a sale transaction appropriately and otherwise negotiate acceptable terms; |
| · | our ability to identify and implement key customer, technology systems, and other transition actions to avoid or minimize negative effects on retained business activities; |
| · | our ability to assess and manage any loss of synergies that the exited business activity had with our retained business activities; |
| · | our ability to replace legacy earnings from the exited business or activity with new revenues; and |
| · | our ability to manage capital, liquidity, and other challenges that may arise if an exit results in significant legacy cash expenditures or financial loss. |
Our financial condition, earnings and asset quality could be adversely affected if we are required to repurchase loans originated for sale by our residential lending department.
As discussed in “Item 1. Business—Mortgage Banking,”most loans that we sell in the secondary market are with recourse. Therefore, wemay be required to repurchase a previously sold mortgage loan or indemnify the purchaser if there is non-compliance with defined loan origination or documentation standards, including fraud, negligence or material misstatement in the loan documents, if the mortgagor has defaulted early in the loan term, or noncompliance with applicable law. While to date we have had to repurchase only a minimal amount of loans previously sold, should repurchases become a material issue, our earnings and asset quality could be adversely impacted, which could adversely impact the market price of our common stock.
If our allowance for credit losses is not sufficient to cover actual loan losses, our earnings would decrease.
We are exposed to the risk that our customers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans will not be sufficient to ensure full repayment. Credit losses are inherent in the lending business and could have a material adverse effect on our operating results and ability to meet our obligations. Volatility and deterioration in domestic markets may also increase our risk for credit losses. We maintain an allowance for credit losses that we believe is adequate for absorbing any potential losses in our loan portfolio. Management, through a periodic review and consideration of our loan portfolio, determines the amount of the allowance for credit losses. We cannot, however, predict with certainty the amount of probable losses in our portfolio or be sure that our allowance will be adequate in the future. If management’s assumptions and judgments prove to be incorrect and the allowance for credit losses is inadequate to absorb future losses, our losses will increase and our earnings will suffer.
In particular, it is more difficult to estimate loan losses for those types of loans - commercial and commercial real estate - that constitute the majority of our portfolio as compared to, for example, residential mortgage loans. Also, because these types of loans tend to have large loan balances, a loss on a single loan could have a significant adverse effect on our operations.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for credit losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for credit losses may not be sufficient to cover probable incurred losses in our loan portfolio, resulting in additions to the allowance and a corresponding decrease to earnings. Material additions to the allowance could materially decrease our net income. If delinquencies and defaults should increase, we may be required to further increase our provision for loan losses.
In addition, if the loans we acquired in our acquisitions of First Mariner or Patapsco Bancorp do not perform as we have estimated, our allowance for credit losses may not be adequate. See “We have relatively limited or no experience with the performance of loans acquired in our acquisitions of Patapsco Bancorp and First Mariner. Certain of our estimates related to accounting for acquired loans may differ from actual results,” below.
Significant increases to our allowance would materially decrease our net income. In addition, bank regulators periodically review our allowance for credit losses and may require us to increase our provision for credit losses or recognize further loan charge-offs to the allowance for credit losses. Any increase in the allowance for credit losses or loan charge-offs might have a material adverse effect on our financial condition and results of operations.
The Financial Accounting Standards Board has adopted a newNew accounting standard that will become effective for us on January 1, 2020. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans and recognize the expected credit losses as allowances for credit losses. This will change the current method of providing allowances for credit losses that are probable, which would likelystandards could require us to increase our allowance for credit losses and to greatly increase the typesmay have a material adverse effect on our financial condition and results of data we would need to collect and review to determine the appropriate leveloperations.
The measure of theour allowance for credit losses is dependent on the adoption and interpretation of accounting standards. The Financial Accounting Standards Board, or FASB, recently issued a new credit impairment model, the Current Expected Credit Loss, or CECL model, which will become applicable to us in 2023. Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model currently required under GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for credit losses and could require us to significantly increase our allowance. Moreover, the CECL model may create more volatility in the level of our allowance for credit losses. If we are required to materially increase our level of allowance for credit losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
We have relatively limited experience with the performance of loans acquired in our recent acquisitions of First Mariner and Patapsco Bancorp. Certain of our estimates related to accounting for acquired loans may differ from actual results.
WeThe application of the purchase method of accounting in our mergers and any future mergers or acquisitions will impact our allowance for credit losses. Under the purchase method of accounting, all acquired First Mariner on March 1, 2018loans were recorded in our Consolidated Financial Statements at their estimated fair value at the time of acquisition and Patapsco Bancorp in August 2015. It is difficult to assess the future performance of loans recently added to our portfolio as part of these acquisitions because our relatively limited experience with such loans does not provide us with a significant history from which to judge future collectability. These loans may experience higher delinquency or charge-off levels than our historical loan portfolio experience, which could adversely affect our future performance.
In addition, under generally accepted principlesany related allowance for business combinations, there is no loan loss allowance initially recorded for acquired loans, which are recorded at netwas eliminated because credit quality, among other factors, was considered in the determination of fair value. To the extent that our estimates of fair value onare too high, we will incur losses associated with the acquisition date. This net fair value generally includes embedded loss estimates for acquired loans. The allowance associated with our acquired credit impaired loans with deteriorated credit quality. These estimates are based on projections of expectedreflects deterioration in cash flows for these problem loans,since acquisition resulting from our quarterly re-estimation of cash flows which in many cases relyinvolves complex cash flow projections and significant judgment on estimates deriving from the liquidationtiming of collateral.loan resolution.
If the estimates we have made regarding the performance of loans we have acquired are inaccurate, the fair value estimates may exceed the actual collectability of the balances, and this may result in the related loans being considered by us as impaired, which would result in a reduction in interest income. The tangible book value we measure is based in part on these estimates, and if fair value estimates differ from actual collectability, then subsequent earnings may also differ from original estimates. Measures of tangible book value and earnings impact of business combinations are frequently used in evaluating the merits and value of business combinations. Numerous assumptions and estimates are integral to purchased loan accounting, and actual results could be different from prior estimates.
Our growth strategy may not be successful, may be dilutive and may have other adverse consequences.
As previously mentioned, a key component of our growth strategy is to pursue acquisitions of other financial institutions or branches of other financial institutions.institutions, and we routinely evaluate opportunities to acquire additional financial institutions or branches or to open new branches. As consolidation of the banking industry continues, the competition for suitable acquisition candidates may increase. We compete with other banking companies for acquisition opportunities, and there are a limited number of candidates that meet our acquisition criteria. Consequently, we may not be able to identify suitable candidates for acquisitions. If we are unable to locate suitable acquisition candidates willing to sell on terms acceptable to us, our net income could decline and we would be required to find other methods to grow our business. We may also open additional branches organically and expand into new markets or offer new products and services. These
Our merger and acquisition activities could be material and could require us to use a substantial amount of common stock and dilute our existing stockholders, cash, other liquid assets, and/or incur debt. In addition, if goodwill recorded in connection with our prior or potential future acquisitions were determined to be impaired, then we would be required to recognize a charge against our earnings, which could materially and adversely affect our results of operations during the period in which the impairment was recognized.
Our expansion activities could involve a number of additional risks, including:
| · | the time and expense associated with identifying and evaluating potential |
| · | using inaccurate estimates and judgments to evaluate credit, operations, management and market risks with respect to the target institution or its branches or assets; |
| · | the time and expense associated with evaluating new markets for expansion, hiring experienced local management and opening new offices or branches as there may be a substantial time lag between these activities before we generate sufficient assets and deposits to support the costs of the expansion; |
| · | operating in markets in which we have had no or only limited experience; |
| · | taking a significant amount of time negotiating a transaction or working on expansion plans, resulting in management’s time and attention being diverted from the operation of our existing business; |
| · | we may not be able to correctly identify profitable or growing markets for new branches; |
| · |
| · | the possibility that we will be unable to successfully implement integration strategies, due to challenges associated with integrating complex systems, technology, banking centers, and other assets of the acquired bank in a manner that minimizes any adverse effect on customers, suppliers, employees, and other constituencies; |
| · | the possibility that the expected benefits of a transaction may not materialize in the timeframe expected or at all, or may be costlier to achieve; |
| · | the ability to realize the anticipated benefits of the merger or acquisition; |
| · | creating an adverse short-term effect on our results of operations; |
| · | losing key employees and customers as a result of |
| · |
| · |
| · | inability to obtain additional financing (including by issuing additional common equity), if necessary, on favorable terms or at all; and |
| · | unforeseen adjustments, write-downs, write-offs or restructuring or other impairment charges. |
In addition, we may not be able to integrate successfully or operate profitably any financial institutions we may acquire. We may experience disruption and incur unexpected expenses in integrating acquisitions. Any acquisitions we do make may not enhance our cash flows, business, financial condition, results of operations or prospects and may have an adverse effect on our results of operations, particularly during periods in which the acquisitions are being integrated into our operations.
Also, the costs to lease and start up new branch facilities or to acquire existing financial institutions or branches, and the additional costs to operate these facilities, may increase our noninterest expense. It also may be difficult to adequately and profitably manage the anticipated growth from the new branches. We can provide no assurance that any new branch sites will successfully attract a sufficient level of deposits and other banking business to offset their operating expenses.
Further, we plan to continue to make investments in our infrastructure in the future. We also currently plan to open additional branches in the areas where we now operate and in other markets over the next few years. We anticipate that this will have the short-term effect of, at least temporarily, increasing our expenses at a faster rate than revenue growth, which will have an adverse effect on net income.
If we grow too quickly and are not able to control costs and maintain asset quality, growth could materially and adversely affect our financial condition and results of operations. Further, we may not be successful in our growth strategy, which would negatively impact our financial condition and results of operations.
Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing consumers to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, which may increase as consumers become more comfortable with these new technologies and offerings, could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Strong competition within our market area may limit our growth and profitability.
Competition in the banking and financial services industry within our market area is intense. In our market area, we compete with, among others, commercial banks, savings institutions, mortgage brokerage firms, credit unions, mutual funds, insurance companies and brokerage and investment banking firms operating locally and elsewhere. There are also a number of smaller community-based banks that pursue similar operating strategies as Howardthe Bank. In addition, some of our competitors have recently offered loans with lower fixed rates and on more attractive terms than we have been willing to offer. Our continued profitability depends uponon our continued ability to successfully compete in our market area. The greater resources and broader range of deposit and loan products offered by our competition may limit our ability to increase our interest earning assets and profitability. See “Item 1. Business -Competition” for more information about competition in our market area.
We expect competition to remain intense in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Increased competition among financial services companies due to the recent consolidation of certain competing financial institutions may adversely affect our ability to market our products and services. Also, technological advances have lowered barriers to entry and made it possible for banks to compete in our market without a retail footprint by offering competitive rates and for non-banks to offer products and services that have traditionally been provided by banks. Additionally, due to their size, many of our competitors may offer a broader range of products and services as well as better pricing for certain products and services than we can, which could affect our ability to grow and remain profitable on a long-term basis. Our profitability depends uponon our ability to successfully compete in our market area, and competition for deposits and the origination of loans could limit our ability to successfully implement our business plan, and could adversely affect our results of operations in the future. Further, if we must raise interest rates paid on deposits or lower interest rates charged on our loans, our net interest margin and profitability could be adversely affected.
Furthermore, competition in the banking and financial services industry is coming not only from traditional competitors but from technology-oriented financial services (“FinTech”) companies, which are subject to limited regulation. They offer user friendly front-end, quick turnaround times for loans and other benefits. While we are considering the possibility of developing relationships with FinTech companies for efficiency in processing and/or as a source of loans and other benefits, we cannot limit the possibility that our customers or future prospects will work directly with a FinTech company instead. This could impact our growth and profitability going forward.
We continually encounter technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology driven by new or modified products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, uponon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse effect on our business and, in turn, our financial condition and results of operations.
We must comply with extensive and complex governmental regulation, which could have an adverse effect on our business and our growth strategy, and we may be adversely affected by changes in laws and regulations.
We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various federal and state regulatory agencies. The banking industryCompany is subject to FRB regulation, and the Bank is subject to extensive regulation, supervision and examination by statethe FDIC and federal banking authorities. the Commissioner.
Many of these regulations are intended to protect depositors, the public or the FDIC insurance funds, not stockholders. Regulatory requirements affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business. These requirements may constrain our operations, and changes in regulations could adversely affect us. The burden imposed by these federal and state regulations may place banks in general, and Howardthe Bank specifically, at a competitive disadvantage compared to less regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect our ability to operate profitably or increase profitability. See “Supervision and Regulation” for more information about applicable banking laws and regulations. Further, if we are not in compliance with such requirements, we could be subject to fines or other regulatory action that could restrict our ability to operate or otherwise have a material adverse effect on our business and financial condition. Although we believe we are in material compliance with all applicable regulations, it is possible there are violations of which we are unaware that could be discovered by our regulators in the course of an examination or otherwise, which could trigger such fines or other adverse consequences.
Further, regulatoryRegulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, classification of our assets and determination of the level of our allowance for credit losses. If regulators require Howard Bank to charge off loans or increase its allowance for credit losses, our earnings would suffer. Any change in such regulation and oversight, whether in the form of regulatory policy, regulation, legislation or supervisory action, may have a material impact on our operations. For a further discussion, see “Supervision and Regulation.”
In addition, because regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal or state regulation of financial institutions may change in the future and impact our operations. Changes in regulation and oversight, including in the form of changes to statutes, regulations or regulatory policies or supervisory guidance, including changes in interpretation or implementation of statutes, regulations, policies or policies,supervisory guidance, could affect us in substantial and unpredictable ways, including, among other things, subjecting us to increased capital, liquidity and risk management requirements, creating additional costs, limiting the types of financial services and products we may offer increaseand/or increasing the ability of non-banks to offer competing financial services and products. Failure to comply with laws, regulations or policies could also result in heightened regulatory scrutiny and in sanctions by regulatory agencies (such as a memorandum of understanding, a written supervisory agreement or a cease and desist order), civil money penalties and/or reputation damage. Any of these consequences could restrict our operating expenses, increase compliance challengesability to expand our business or could require us to raise additional capital or sell assets on terms that are not advantageous to us or our shareholders and otherwise adversely impactcould have a material adverse effect on our business, financial performancecondition and condition. In addition, the burden imposed by these federalresults of operations. While we have policies and state regulationsprocedures designed to prevent any such violations, such violations may place banks in general, and Howard Bank specifically, at a competitive disadvantage compared to less regulated competitors.
The Company and the Bank have implemented an enhanced organizational structure to ensure thatoccur despite our risk management activities are scaled to the entire enterprise.The office of strategic risk management, reporting to an executive vice president with direct reporting to the CEO and a dotted line reporting to the full board, is responsible for credit, compliance and operational, physical and IT security, legal, reputational and other on and off balance sheet risks.best efforts.
Further, as a public company, we incur significant legal, accounting, insurance and other expenses in connection with compliance with rules of the SEC and The Nasdaq Stock Market LLC.
Non-ComplianceWe face a risk of noncompliance and enforcement action with the USA PATRIOTPatriot Act, the Bank Secrecy Act orand other lawsanti-money laundering statutes and regulations could result in fines or sanctions.regulations.
Financial institutions are required under the USA PATRIOT andAct, Bank Secrecy ActsAct and other laws and regulations to, developamong other duties, institute and maintain effective anti-money laundering programs to prevent financial institutions from being used for money-laundering and terrorist activities. Financial institutions are also obligated to file suspicious activity and currency transaction reports with Treasury’s Department's Office of Financial Crimes Enforcement Network if such activities are detected.as appropriate. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. FailureThe federal Financial Crimes Enforcement Network, established by the U.S. Treasury Department to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of compliance with the rules enforced by the OFAC. Federal and state bank regulators also have begun to focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient or the inability to comply with these regulations could result in fines or penalties, curtailmentpolicies, procedures and systems of expansion opportunities, intervention or sanctions by regulators and costly litigation or expensive additional controls and systems. During the last few years, several bankingfinancial institutions have received large fines for non-compliance with these laws and regulations. In addition, the U.S. Government has previously imposed laws and regulations relating to residential and consumer lending activities that create significant new compliance burdens and financial risks. While we have developed policiesalready acquired or may acquire in the future are deficient, we would be subject to liability, including fines and procedures designedregulatory actions such as restrictions on our ability to assist in compliancepay dividends and the necessity to obtain regulatory approvals to proceed with these lawscertain aspects of our business plan, including our acquisition plans, which would negatively impact our business, financial condition and regulations, we cannot assure you that these policiesresults of operations. Failure to maintain and procedures will be effective in preventing violations of these lawsimplement adequate programs to combat money laundering and regulations.terrorist financing could also have serious reputational consequences for us.
Adverse changes inOur business may be adversely affected by economic conditions could adversely affect our business, results of operations and financial condition.conditions.
Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer and whose success we rely on to drive our growth, is highly dependent upon the business environment in the primary markets where we operate and earningsin the United States as a whole. Unlike larger banks that are affected by general businessmore geographically diversified, we are a regional bank that provides banking and financial services to customers primarily in the Great Baltimore Metropolitan area. The economic conditions in this local market may be different from, and in some instances worse than, the economic conditions in the United States as well asa whole. In addition, due to the proximity of our primary market area to Washington, D.C., decreases in spending by the Federal government or cuts to Federal government employment could impact us to a greater degree than banks that serve a larger or a different geographical area. Such risks are beyond our control and may have a material adverse effect on our financial condition and results of operations and, in turn, the value of our common stock. Some elements of the business environment that affect our financial performance include short-term and long-term interest rates, the prevailing yield curve, inflation and price levels, monetary and trade policy, unemployment and the strength of the domestic economy and the local economy in the markets in which we operate. Unfavorable market area. We continue to operateconditions can result in a challengingdeterioration in the credit quality of our borrowers and the demand for our products and services, an increase in the number of loan delinquencies, defaults and charge-offs, additional provisions for loan losses, adverse asset values of the collateral securing our loans and an overall material adverse effect on the quality of our loan portfolio. Unfavorable or uncertain economic environment. Since the recession ended almost nine years ago,and market conditions can be caused by declines in economic growth, has been slow by historic standards and uneven. Further,business activity or investor or business confidence; limitations on the current expansion is already the third longest in U.S. history, and many economists believe that the risk of a recessionavailability or increases in the medium-term (2019-2020) is increasing.cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; epidemics or pandemics; or a combination of these or other factors.
During 2019, the U.S. economy has continued to grow across a wide range of industries and regions in the United States. However, there are continuing concerns related to, among other things, the level of U.S. government debt and fiscal actions that may be taken to address that debt, the potential effects of the novel coronavirus on international trade (including supply chains and export levels), travel, employee productivity and other economic activities, depressed oil prices and the U.S.-China trade disputes and related tariffs, that may have a destabilizing effect on financial markets and economic activity. There can be no assurance that current economic conditions will continue or improve, and economic conditions could worsen. Economic pressure on consumers and uncertainty regarding continuing economic improvement may result in changes in consumer and business spending, borrowing and saving habits. A return toof recessionary conditions and/or prolonged stagnantother negative developments in the domestic or deteriorating economic conditions couldinternational credit markets or economies may significantly affect the markets in which we do business, the demand for our products and services, the value of our loans and investments, and our ongoing operations, costs and profitability. Economic uncertainties even outside of a recession, including concerns about U.S. debt levels, tariffs on imports into the United States, Congress’ inability to pass yearly budgets, and cutsDeclines in government spending, may negatively impact economic conditions going forward. A return to elevated levels of unemployment, declines in the values of real estate values and sales volumes and high unemployment or other events that negatively affect household and/or corporate incomesunderemployment may also result in higher than expected loan delinquencies, increases in our levels of nonperforming and criticized classified assets and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity and financial condition.
Changes in U.S. trade policies and other factors beyond our control, including the imposition of tariffs and retaliatory tariffs and the impacts of epidemics or pandemics, may adversely impact our business, financial condition and results of operations.
There have been changes and discussions with respect to U.S. trade policies, legislation, treaties and tariffs, including trade policies and tariffs affecting other countries, including China, the European Union, Canada and Mexico and retaliatory tariffs by such countries. Tariffs and retaliatory tariffs have been imposed, and additional tariffs and retaliation tariffs have been proposed. Such tariffs, retaliatory tariffs or other trade restrictions on products and materials that our customers import or export could cause the prices of our customers’ products to increase which could reduce demand for such products, or reduce our customer margins, and adversely impact their revenues, financial results and ability to service debt; which, in turn, could adversely affect our financial condition and results of operations. In addition, to the extent changes in the political environment have a negative impact on us or on the markets in which we operate our business, results of operations and financial condition could be materially and adversely impacted in the future. It remains unclear what the U.S. Administration or foreign governments will or will not do with respect to tariffs already imposed, additional tariffs that may be imposed, or international trade agreements and policies. On January 26, 2020, President Trump signed a new trade deal between the United States, Canada and Mexico to replace the North American Free Trade Agreement. The full impact of this agreement on us, our customers and on the economic conditions in our primary banking markets is currently unknown. In addition, the novel coronavirus and concerns regarding the extent to which it may spread have affected, and may increasingly affect, international trade (including supply chains and export levels), travel, employee productivity and other economic activities. A trade war or other governmental action related to tariffs or international trade agreements or policies, as well as coronavirus or other potential epidemics or pandemics, have the potential to negatively impact ours and/or our customers’ costs, demand for our customers' products, and/or the U.S. economy or certain sectors thereof and, thus, adversely affect our business, financial condition, and results of operations.
Our profitability depends on interest rates, and changes in interest rates could have an adverse impact on our results of operations and financial condition.
Our results of operations depends to a large extent on our “net interest income,” which is the difference between the interest income received from our interest-earning assets, such as loans and investment securities, and the interest expense incurred in connection with our interest-bearing liabilities, such as interest on deposit accounts. Changes in interest rates can increase or decrease our net interest income, because different types of assets and liabilities may react differently, and at different times, to market interest rate changes. When interest bearing liabilities mature or reprice more quickly than interest earning assets in a period, an increase in interest rates could reduce net interest income. Similarly, when interest earning assets mature or reprice more quickly than interest bearing liabilities, falling interest rates could reduce net interest income. Additionally, an increase in interest rates may, among other things, reduce loan demand and our ability to originate loans (which would also decrease our ability to generate noninterest income through the sale of loans into the secondary market), and make it more difficult for borrowers to repay adjustable-rate loans or otherwise decrease loan repayment rates. A decrease in the general level of interest rates may affect us through, among other things, increased prepayments on our loan and mortgage-backed securities portfolios and increased competition for deposits. Accordingly, changes in the level of market interest rates affect our net yield on interest earning assets, loan origination volume, loan and mortgage-backed securities portfolios, and our overall results. Fluctuations in interest rates are highly sensitive to many factors that are not predictable or controllable. Therefore, while we attempt to manage our risk from changes in market interest rates by adjusting the rates, maturity, repricing, and balances of the different types of interest-earning assets and interest bearing liabilities, we might not be able to maintain a consistent positive spread between the interest that we receive and the interest that we pay. As a result, a rapid increase or decrease in interest rates could have an adverse effect on our net interest margin and results of operations.
In addition, as market interest rates rise, we will have competitive pressures to increase the rates we pay on deposits. Because interest rates we pay on our deposits could be expected to increase more quickly than the increase in the yields we earn on our interest-earning assets, our net interest income would be adversely affected.
Furthermore,Governmental economic and monetary policy will influence our results of operations. The rates of interest payable on deposits and chargeable on loans are affected by monetary policy as determined by various governmental and regulatory authorities, in particular the FRB, as well as by national, state and local economic conditions. The FRB, in an attempt to help the overall economy, has among other things kept interest rates low through its targeted federal funds rate and the purchase of Treasury and mortgage-backed securities. If the FRB continues to increaseincreases the federal funds rate in the near term, as is expected, overall interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic growth. If rates remain relatively low it could create deflationary pressures, which while possibly lowering our operating costs, could have a negative impact on our borrowers, especially our commercial borrowers, and the values of collateral securing our loans, which could negatively affect our financial performance.
We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the interest rates on existing loans and securities.
RequirementsReforms to hold more capitaland uncertainty of the London Inter-bank Offered Rate, or LIBOR, calculation process and potential phasing out of LIBOR may adversely affect us.
In 2017, the United Kingdom’s Financial Conduct Authority announced that after 2021 it would no longer compel banks to submit the rates required to calculate the LIBOR. This announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. Consequently, at this time, it is not possible to predict whether and to what extent banks will continue to provide submissions for the calculation of LIBOR. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes in views or alternatives may be on the markets for LIBOR-indexed financial instruments. The FRB in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing the U.S. dollar LIBOR with a new index calculated by short-term repurchase agreements, backed by Treasury securities (“SOFR”). SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains traction as a LIBOR replacement tool remains in question, although some transactions using SOFR have been completed in 2019, and the future of LIBOR remains uncertain as this time. Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and securities in our portfolio. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may experience significant expenses in effecting the transition, and may be subject to disputes or litigation with customers and creditors over the appropriateness or comparability to LIBOR of the substitute indices, which could have aan adverse effect on our results of operations.
We may be subject to more stringent capital requirements in the future.
We are subject to regulatory requirements specifying minimum amounts and types of capital that we must maintain. From time to time, the regulators change these regulatory capital adequacy guidelines. If we fail to meet these minimum capital guidelines and other regulatory requirements, we may be restricted in the types of activities we may conduct and we may be prohibited from taking certain capital actions, such as paying dividends and repurchasing or redeeming capital securities.
In particular, the capital requirements applicable to the Bank under the Basel III rules become fully phased-in on January 1, 2019. The Bank is now required to satisfy additional, more stringent, capital adequacy standards than it had in the past. While we expect to meet the requirements of the Basel III rules, we may fail to do so. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material adverse effect on our financial condition and results of operations.
In July 2013, the bank regulators adopted a final rule for the Basel III capital framework. These rules apply to all depository institutions, top-tier bank holding companies with total consolidated assets of $1 billion or more and top-tier savings and loan holding companies and substantially amend the regulatory risk-based capital rules applicable to us. The rules apply to Howard Bank and Howard Bancorp. The rules include a capital conservation buffer that phases in over a period of years that began in 2016 and will become fully effective in 2019. Failure to satisfy any of the capitaladdition, these requirements including with the applicable “buffer” amount, will result in limits on paying dividends, engaging in share repurchases and paying discretionary bonuses. The rules establish a maximum percentage of eligible retained income that could be utilized for such actions if the capital requirements of the buffer are not fully satisfied. Beginning January 1, 2018, Howard Bancorp and the Bank’s risk-based capital requirements, with the applicable buffer, are (i) a common equity Tier 1 ratio of 6.375%, (ii) a Tier 1 capital (common Tier 1 capital plus Additional Tier 1 capital) ratio of 7.875% and (iii) a total capital ratio of 9.875%. The capital conservation buffer does not apply to our leverage ratio requirement, which will remain at 4.0%. Once the capital conservation buffer is fully phased in on January 1, 2019, the resulting requirements will be a common equity Tier 1 ratio of 7.0%, a Tier 1 ratio of 8.5%, and a total capital ratio of 10.5%. These increased capital requirements may have a material adversenegative impact on our liquidity and resultsability to lend, grow deposit balances, make acquisitions or make capital distributions in the form of operations,dividends or the failure to satisfy such requirements may result in our inability to pay dividends on or repurchase shares of our common stock, whichshare repurchases. Higher capital levels could also negatively impact the market price oflower our stock, and may negatively impact our ability to retain personnel if our ability to pay retention bonuses is compromised.return on equity.
Our business may be adversely affected by increasing prevalence of fraud and other financial crimes.
As a financial institution, we are subject to risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes have increased. We believe we have controls in place to detect and prevent such losses, but in some cases multi-party collusion or other sophisticated methods of hiding fraud may not be readily detected or detectable, and could result in losses that affect our financial condition and results of operations.
Financial crime is not limited to the financial services industry. Our customers could experience fraud in their businesses, which could materially impact their ability to repay their loans, and deposit customers in all financial institutions are constantly and unwittingly solicited by others in fraud schemes that vary from easily detectable and obvious attempts to high-level and very complex international schemes that could drain an account of millions of dollars and require detailed financial forensics to unravel. While we have controls in place, contractual agreements with our customers partitioning liability, and insurance to help mitigate the risk, none of these are guarantees that we will not experience a loss, potentially a loss that could have a material adverse effect on our financial condition, reputation and results of operations.
Monetary policy and general economic conditions will influence our results of operations.
Governmental economic and monetary policy will influence our results of operations. The rates of interest payable on deposits and chargeable on loans are affected by fiscal policy as determined by various governmental and regulatory authorities, in particular the FRB, as well as by national, state and local economic conditions. In addition, adverse general economic conditions may impair the ability of our borrowers to repay loans.
Because the Bank serves a limited market area, we are susceptible to economic downturns in our market area.
Our lending and deposit operations are concentrated in the Greater Baltimore Metropolitan Area. Broad geographic diversification is not currently part of our community bank focus. As a result, our success depends in part on economic conditions in our markets. Adverse changes in economic conditions in our primary market area could reduce our deposit base and demand for our services and products and negatively impact growth in our loans and deposits, impair our ability to collect on our outstanding loans, increase credit losses, problem loans and charge-offs, and otherwise negatively affect our performance and financial condition. Declines in real estate values could cause some of our residential and commercial real estate loans to be inadequately collateralized, which would expose us to a greater risk of loss in the event that the recovery on amounts due on defaulted loans is resolved by selling the real estate collateral. In addition, adverse changes in economic conditions in and around our market area may more severely impact our business and financial condition than are our larger, more geographically diverse competitors. Our larger bank competitors, for example, serve more geographically diverse market areas, parts of which may not be affected by the same economic conditions that may exist in our market areas.
Further, unexpected changes in the national and local economy may adversely affect our ability to attract deposits and to make loans. In particular, due to the proximity of our primary and secondary market areas to Washington, D.C., decreases in spending by the Federal government or cuts to Federal government employment could impact us to a greater degree than banks that serve a larger or a different geographical area. Such risks are beyond our control and may have a material adverse effect on our financial condition and results of operations and, in turn, the value of our common stock.
The small toand medium-sized businesses that the Bank lendswe lend to may have fewer resources to weather a downturn in the economy, which may impair a borrower’s ability to repay a loan to the Bank that could materially harm our operating results.
The Bank targets itsWe target our business development and marketing strategy primarily to serve the banking and financial services needs of small toand medium-sized businesses. These small toand medium-sized businesses frequently have a smaller market share than their competition, may be more vulnerable to economic downturns, oftenmay need substantial additional capital to expand or compete and may experience significant volatility in operating results. Any one or more of these factors may impair their ability to repay a loan. In addition, the success of a small toand medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on its business and its ability to repay a loan. As a result, economic downturns and other events that negatively impact our market areas and the businesses we serve could cause the Bankus to incur substantial credit losses that could negatively affect our results of operations and financial condition.
Changes in tax laws may negatively impact our financial performance.
Changes in tax laws contained in the Tax Cuts and Jobs Act, which was enacted in December 2017, contain a number of provisions that could have an impact on the banking industry, borrowers and the market for single family residential and multifamily residential real estate. Among the changes are: lower limits on the deductibility of mortgage interest on single family residential mortgages; limitations on deductibility of business interest expense; and limitations on the deductibility of property taxes and state and local income taxes. Such changes may have an adverse effect on the market for and valuation of single family residential properties and multifamily residential properties, as well as on the demand for such loans in the future. If home ownership or multifamily residential property ownership become less attractive, demand for mortgage loans would decrease, which could have a material adverse effect on our mortgage banking operations and as a result on our revenues, net income, operating results and financial condition. In addition, the value of the properties securing loans in our portfolio may be adversely impacted as a result of the changing economics of home ownership and multifamily residential ownership, which could require an increase in our provision for credit losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations. Additionally, certain borrowers could become less able to service their debts as a result of higher tax obligations. These changes could adversely affect our business, financial condition and results of operations.
We are subject to liquidity risks.
Market conditions could negatively affect the level or cost of available liquidity, which would affect our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner, and without adverse consequences. Core deposits are our primary source of funding, but this is supplemented by overnight unsecured master notes, customer repurchase agreements, FHLB advances, the FRB Discount Window, subordinated debentures and other purchased funds. A significant decrease in our core deposits, an inability to renew FHLB advances or access the Discount Window, an inability to obtain alternative funding to core deposits or our other traditional sources of funds, or a substantial, unexpected, or prolonged change in the level or cost of liquidity could have a negative effect on our business, financial condition and results of operations.
We depend heavily on six key employees, Mary Ann Scully and Robert A. Altieri, George C. Coffman, Steven M. Poynot, Charles E. Schwabe and James D. Witty,Kunisch, Jr., to continue the implementation of our long-term business strategy and the loss of their services could disrupt our operations and result in reduced earnings.
Ms. Scully is our PresidentChairman and Chief Executive Officer, Mr. Altieri is an Executive Vice President, President of our Mortgage Banking Division and our Chief Specialty Lending Officer, Mr. Coffman is an Executive Vice President and our Chief Financial Officer, Mr. Poynot is an Executive Vice President and Chief Administrative Officer, Mr. Schwabe is an Executive Vice President, our Secretary and our Chief Risk Officer, and Mr. WittyKunisch is an Executive Vice President and our Chief Lending Officer.President. We believe that our continued growth and future success will depend in large part on the skills of our senior management team. We believe our senior management team possessesthese two executive officers possess valuable knowledge about and experience in the banking industry and that their knowledge and relationships would be difficult to replicate. We have entered into an employment agreement with each of Ms. Scully Mr. Altieri, Mr. Coffman, Mr. Poynot, Mr. Schwabe and Mr. WittyKunisch and acquired key-person life insurance on each, such executive officer, but the existence of such agreements and insurance does not assure that we will be able to retain their services or recover losses associated with the loss of their services. The unexpected loss of the services of Ms. Scully Mr. Altieri, Mr. Coffman, Mr. Poynot, Mr. Schwabe or Mr. WittyKunisch could have a material adverse effect on our business, operations, financial condition and operating results, as well as the value of our common stock.
Federal and state banking agencies periodically conduct examinations of our business, including compliance with laws and regulations, and our failure to comply with any supervisory actions to which we are or become subject as a result of such examinations may adversely affect us.
State and federal banking agencies, including the FRB, the FDIC and the Commissioner, periodically conduct examinations of our business, including compliance with laws and regulations. If, as a result of an examination, a state or federal banking agency were to determine that our financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of any of our operations had become unsatisfactory, or that we or our management was in violation of any law or regulation, it may take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to assess civil monetary penalties against our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate the Bank’s deposit insurance. If we become subject to such regulatory actions, our business, results of operations and reputation may be negatively impacted.
Our expansion plans will require regulatory approvals, and failure to obtain them may restrict our growth.
We intend to complement and expand our business by continuing to pursue strategic acquisitions of banks and other financial institutions. We must generally receive regulatory approval before we can acquire an institution or business. Such regulatory approvals may not be granted on terms that are acceptable to us, or at all. We may also be required to sell branches as a condition to receiving regulatory approval, which condition may not be acceptable to us or, if acceptable to us, may reduce the benefit of any acquisition.
In addition to the acquisition of existing financial institutions, as opportunities arise, we plan to continue de novo branching as a part of our internal growth strategy and possibly enter into new markets through de novo branching. De novo branching and any acquisition carries with it numerous risks, including the inability to obtain all required regulatory approvals. The failure to obtain these regulatory approvals for potential future strategic acquisitions and de novo branches may impact our business plans and restrict our growth.
We may be required to raise additional capital in the future, but that capital may not be available when it is needed on attractive terms, or at all.
We are required by regulatory authorities to maintain adequate levels of capital to support our operations. Our capital requirements for the foreseeable future are currently satisfied. We may at some point, however, need to raise additional capital to support our continued growth or if our liquidity is adversely affected by external factors such as worsening economica return of recessionary conditions and/or continued slow economic growth.other negative developments in the domestic or international credit markets. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations could be materially impaired, or the failure to raise additional capital could have a material adverse effect on our liquidity, financial condition or results of operations. In addition, if we decide to raise additional equity capital, your interest in Howard Bancorpthe Company could be diluted. Furthermore, if we raise additional capital through the issuance of debt securities, there can be no assurance that sufficient revenues or cash flow will exist to service such debt.
Our investment securities portfolio is subject to credit risk, market risk, and liquidity risk.
Our investment securities portfolio is subject to risks beyond our control that may significantly influence its fair value. These include, but are not limited to, rating agency downgrades of the securities, defaults of the issuers of the securities, lack of market pricing of the securities, and instability in the credit markets. Lack of market activity with respect to some securities has, in certain circumstances, required us to base their fair market valuation on unobservable inputs. Any changes in these risk factors, in current accounting principles or interpretations of these principles could impact our assessment of fair value and thus the determination of other-than-temporary impairment of the securities in the investment securities portfolio. Investment securities that previously were determined to be other-than-temporarily impaired could require further write-downs due to continued erosion of the creditworthiness of the issuer. Write-downs of investment securities would negatively affect our earnings and regulatory capital ratios.
Further, most of our securities investment portfolio as of December 31, 20172019 has been designated as available for sale pursuant to Statement of Financial Accounting Standards, Accounting Standards Codification (“ASC”) Topic 320 – “Investments.” ASC Topic 320 requires that unrealized gains and losses in the estimated value of the available for sale portfolio be “marked to market” and reflected as a separate item in stockholders’ equity, net of tax. If the market value of the investment portfolio declines, this could cause a corresponding decline in stockholders’ equity.
Our lending limit may limit our growth.
We are limited in the amount we can loan to a single borrower by the amount of our capital. Generally, under current law, we may lend up to 15% of our unimpaired capital and surplus to any one borrower. Based upon our current capital levels, such amount is significantly less than that of many of our competitors and may discourage potential borrowers who have credit needs in excess of our lending limit from doing business with us. We accommodate larger loans by selling participations in those loans to other financial institutions, but this strategy may not always be available.
The failure to maintain our reputation may materially adversely affect our ability to grow and generate revenue.
Our reputation is one of the most valuable components of our business. Damage to our reputation could undermines the confidence of clients and prospects in our ability to serve them and therefore could negatively affect our earnings. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, mergers and acquisitions and cybersecurity incidents, and from actions taken by government regulators and community organizations in response to those activities. Damage to our reputation also could affect the confidence of rating agencies, regulators, stockholders and other parties in a wide range of transactions that are important to our business. Failure to maintain our reputation ultimately would have an adverse effect on our ability to maintain and grow our business. Actions by the financial services industry generally or by other members of or individuals in the financial services industry also could impact our reputation negatively. The considerable expansion in the use of social media over recent years has increased the risk that our reputation could be negatively impacted in a short amount of time. If we are unable to quickly and effectively respond to any incidents negatively impacting our reputation, it could have a material and long-term negative impact on our business and, therefore, our operating results.
We are party to various claims and lawsuits incidental to our business. Litigation is subject to many uncertainties such that the expenses and ultimate exposure with respect to many of these matters cannot be ascertained.
From time to time, we are the subject of various claims and legal actions by customers, employees, stockholders and others. Whether such claims and legal actions are legitimate or unfounded, if such claims and legal actions are not resolved in our favor, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact customer demand for those products and services. In light of the potential cost and uncertainty involved in litigation, we have in the past and may in the future settle matters even when we believe we have a meritorious defense. Certain claims may seek injunctive relief, which could disrupt the ordinary conduct of our business and operations or increase our cost of doing business. Our insurance or indemnities may not cover all claims that may be asserted against us. Any judgments or settlements in any pending litigation or future claims, litigation or investigation could have a material adverse effect on our business, reputation, financial condition and results of operations.
From time to time we are, or may become, involved in suits, legal proceedings, information-gatherings, investigations and proceedings by governmental and self-regulatory agencies that may lead to adverse consequences.
Many aspects of the banking business involve a substantial risk of legal liability. From time to time, we are, or may become, the subject of information-gathering requests, reviews, investigations and proceedings, and other forms of regulatory inquiry, including by bank regulatory agencies, self-regulatory agencies, the SEC and law enforcement authorities. The results of such proceedings could lead to significant civil or criminal penalties, including monetary penalties, damages, adverse judgements, settlements, fines, injunctions, restrictions on the way we conduct our business or reputational harm.
Risks Related to an Investment in Our Common Stock
Anti-takeover provisions in our corporate documents and in federal and state law may make it difficult and expensive to remove current management.
Anti-takeover provisions in our articles of incorporation and bylaws and federal and state banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire Howard Bancorp,us, even if doing so would be perceived to be beneficial to our stockholders. For example, we have a classified board of directors with three-year staggered terms, which may delay the ability of stockholders to change the membership of a majority of our board. In addition, directors may only be removed from office by the affirmative vote of at least 80% of all of the votes of our stockholders entitled to be cast. Our articles of incorporation also authorize our board to classify or reclassify shares of our stock in one or more classes or series, to cause the issuance of additional shares of our stock, and to amend our articles without stockholder approval to increase or decrease the number of shares of stock that we have authority to issue. The combination of these provisions effectively inhibitsmay inhibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock. These provisions could also discourage proxy contests and make it more difficult and expensive for holders of our common stock to elect directors other than the candidates nominated by our board of directors or otherwise remove existing directors and management, even if current management is not performing adequately.
OurMaryland law and our articles of incorporation limit the liability of our directors and officers and the rights of us and our stockholders to take action against our directors and officers.
OurMaryland law provides that a director will not have any liability as a director as long as he or she performs his or her duties in accordance with the applicable standard of conduct. In addition, our articles of incorporation eliminateseliminate our directors’ and officers’ liability to us and our stockholders for money damages to the fullest extent permitted by Maryland law. Our articles of incorporation and bylaws also require us to indemnify our directors and officers for liability resulting from actions taken by them in those capacities to the maximum extent permitted by Maryland law. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law. In addition, we may be obligated to fund the defense costs incurred by our directors and officers.
The market price for our common stock may be volatile.
The market price of our common stock could be subject to significant fluctuations due to changes in sentiment in the market regarding our operations or business prospects. Factors that may affect market sentiment include:
| · | operating results that vary from the expectations of our management or of securities analysts and investors; |
| · | developments in our business or in the financial service sector generally; |
| · | regulatory or legislative changes affecting our industry generally or our business and operations in particular; |
| · | operating and securities price performance of companies that investors consider to be comparable to us; |
| · | changes in estimates or recommendations by securities analysts; |
| · | announcements of strategic developments, acquisitions, dispositions, financings and other material events by us or our competitors; and |
| · | changes in financial markets and national and local economies and general market conditions, such as interest rates and stock, commodity, credit or asset valuations or volatility. |
While the U.S. and other governments continue efforts to restore confidence in financial markets and promote economic growth, market and economic turmoil could still occur in the near- or long-term, negatively affecting our business, financial condition and results of operations, as well as the price, trading volume and volatility of our common stock.
We may be unable to, or may continue to choose not to, pay dividends on our common stock.
We cannot assure youhave never paid cash dividends to holders of our common stock. Although we may pay cash dividends in the future, we currently intend to retain a large majority of any earnings to help fund our growth. Our ability to pay dividends. Ourcash dividends may be limited by regulatory restrictions, by our Bank’s ability to pay cash dividends to the Company and by our need to maintain sufficient capital to support our operations. The FRB has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. The FRB’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. Under the prompt corrective action regulations, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.
Since the Company is a legal entity separate and distinct from the Bank and does not conduct stand-alone operations, its ability to pay dividends depends on the following factors, among others:ability of the Bank to pay dividends to it. As a Maryland-chartered trust company, the Bank is subject to limitations on the amount of dividends that it is permitted to pay. The federal banking agencies have also issued policy statements which provide that bank holding companies and insured banks should generally only pay dividends out of current earnings.
If our Bank is not permitted to pay cash dividends to the Company, it is unlikely that we would be able to pay cash dividends on our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, and if declared by our board of directors. If we fail to pay dividends in the future, capital appreciation, if any, of our common stock may be the sole opportunity for gains on an investment in our common stock. In addition, in the event the Bank becomes unable to pay dividends to Howard Bancorp,the Company, we may not be able to service our debt or pay our other obligations or pay dividends on our common stock.obligations. Accordingly, Howard Bancorp’sthe Company’s inability to receive dividends from Howardthe Bank could also have a material adverse effect on our business, financial condition and results of operations and the value of your investment in our common stock.operations.
We can sell additional shares of common stock without consulting stockholders and without offering shares to existing stockholders, which would result in dilution of our stockholders’ interests in Howard Bancorp and could depress our stock price.
Our articles of incorporation currently authorize an aggregate of 20 million20,000,000 shares of common stock, 9,827,07218,714,844 of which are outstanding as of February 28, 2018. Our27, 2020. As permitted by Maryland law, our articles of incorporation provide that our board of directors has the authority tocan amend our articles of incorporation, without stockholder approval, to increase or decrease the aggregate number of shares of stock or the number of shares of any class of stock that we have the authority to issue. TheOur board of directors is further authorized to issue additional shares of common stock and preferred stock, at such times and for such consideration as it may determine, without stockholder action. The ability of the board of directors to increase our authorized shares of capital stock, and the existence of authorized but unissued shares of common stock and preferred stock, could have the effect of rendering more difficult or discouraging hostile takeover attempts, or of facilitating a negotiated acquisition and could affect the market for and price of our common stock. Because our common stockholders do not have preemptive rights to purchase shares of our capital stock (that is, the right to purchase a stockholder’s pro rata share of any securities issued by Howard Bancorp)us), any future offering of capital stock could have a dilutive effect on holders of our common stock.
Item 1B. Unresolved Staff Comments
None
Our headquarters are located at 3301 Boston Street, Baltimore, Maryland in Ellicott City, Maryland. As ofa building that we own, which also includes a full-service branch office. Including the headquarters building, at December 31, 2017, the Bank owns eight2019, we owned ten of our sixteen full-service branches and leased itsthe remaining branches.six branches, all of which are located in our Greater Baltimore Metropolitan market area. In addition, we lease five regional mortgage banking or commercial lending offices (four in Maryland and one in Delaware) and lease one former branch location. We also own two former branch facilities that are classified as long-lived assets within “Interest receivable and other assets” on our Consolidated Balance Sheet. See Note 9Notes to the Consolidated Financial Statements, “Premises and Equipment,” and “Leases” for additional information.
At December 31, 2017, we ownedinformation with respect to the following properties,amount at which had a book value of $15.2 million:our premises and equipment are recorded and commitments under long-term leases.
We leased the following branches at December 31, 2017:
We lease the following facilities unless otherwise noted:
From time to time, we may be involved in litigation relating to claims arising out of our normal course of business. As of the date of this report, we are not aware of any material pending litigation matters.
Item 4. Mine Safety Disclosures
Not applicable
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities
Our common stock is listed on The Nasdaq Stock Market under the symbol “HBMD.”
The following table reflects the high and low sale prices for the periods presented. Quotations are based on Nasdaq listings and reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
| 2017 | 2016 | |||||||||||||||
| Stock price range | Stock price range | |||||||||||||||
| Quarter | High | Low | High | Low | ||||||||||||
| First | $ | 19.00 | $ | 14.75 | $ | 13.33 | $ | 11.65 | ||||||||
| Second | 20.70 | 17.60 | 13.27 | 12.01 | ||||||||||||
| Third | 21.50 | 16.70 | 13.75 | 12.24 | ||||||||||||
| Fourth | 23.50 | 18.20 | 15.25 | 12.85 | ||||||||||||
At February 28, 2018,27, 2020, we had 428387 stockholders of record.
Dividends
We have not declared or paid any dividends on our common stock. We currently intend to retain all of our future earnings, if any, for use in our business and do not anticipate paying cash dividends on our common stock in the foreseeable future; however, our board of directors may decide to declare dividends in the future. Payments of future dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our business, operating results and financial condition, current and anticipated cash needs, plans for expansion, tax considerations, general economic conditions and any legal or contractual limitations onother factors deemed relevant to our ability to pay dividends.board. We are not obligated to pay dividends on our common stock.
As a Maryland corporation, we are subject to certain restrictions on dividends under the Maryland General Corporation Law. Generally, Maryland law limits cash dividends if the corporation would not be able to pay its debts in the usual course of business after giving effect to the cash dividend or if the corporation’s total assets would be less than the corporation’s total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of stockholders whose preferential rights on dissolution are superior to those receiving the distribution. We are also subject to certain restrictions on the payment of cash dividends as a result of banking laws, regulations and policies. See “Supervision and Regulation—Howard Bancorp, Inc.—Dividends.”
Because we are a bank holding company and do not engage directly in business activities of a material nature, our ability to declare and pay cash dividends to our stockholders depends, in large part, upon our receipt of dividends from the Bank, which is dependent upon, among other things, restrictions imposed by the reserve and capital requirements of Maryland and federal law and regulations, our income and financial condition, tax considerations and general business conditions. In addition, because we are a holding company, we are dependent uponalso subject to numerous limitations on the payment of dividends under federal and state banking laws, regulations and policies. See “Supervision and Regulation—Howard Bank—Dividends.”
Securities Authorized for Issuance Under Equity Compensation Plans
The information required by this section of this Item is incorporated by reference to the Bank to us as our principal source of funds to pay dividendsinformation included under the captions “Securities Authorized for Issuance Under Equity Compensation Plans” in the future, if any, and to make other payments.Proxy Statement.
Issuer Purchases of Equity Securities
The following table reflects information regarding our share repurchases for the three months ended December 31, 2019:
| Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs(1) | ||||||||||||
| October 1, 2019 - October 31, 2019 | - | $ | - | - | $ | 6,931,443 | ||||||||||
| November 1, 2019 - November 30, 2019 | - | - | - | 6,931,443 | ||||||||||||
| December 1, 2019 - December 31, 2019 | 14,864 | 17.11 | 14,864 | 6,677,138 | ||||||||||||
| Total | 14,864 | $ | 17.11 | 14,864 | ||||||||||||
(1) On April 24, 2019, our Board of Directors authorized a stock repurchase program under which we can, from time to time, purchase up to $7.0 million of our outstanding common shares, until the program expires on October 24, 2020. Under the stock repurchase program, shares of common stock may be repurchased by us in open market transactions or in privately negotiated transactions as permitted under applicable rules and regulations or through a 10b5-1 trading plan under the Exchange Act, which would permit shares to be repurchased when we might otherwise be precluded from doing so because of self-imposed trading blackout periods or other regulatory restrictions. Repurchases may be conducted, suspended, or terminated at any time without notice. The extent to which we repurchase any shares and the timing of such repurchases will depend upon market conditions and other considerations as may be considered in our sole discretion. A total of 19,764 shares at an average price paid per share of $16.34 were repurchased under this program as of December 31, 2019. As of February 24, 2020, we had repurchased all remaining shares under the stock repurchase program, resulting in a total of 392,565 shares repurchased at an average price paid per share of $17.83.
27
Item 6. Selected Financial Data
| Year ended December 31, | Year ended December 31, | |||||||||||||||||||||||||||||||||||||||
| (in thousands, except per share data.) | 2017 | 2016 | 2015 | 2014 | 2013 | 2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||||||||||||||||||
| Statements of operations data: | ||||||||||||||||||||||||||||||||||||||||
| Interest income | $ | 43,026 | $ | 38,741 | $ | 33,349 | $ | 23,360 | $ | 17,711 | $ | 91,434 | $ | 80,389 | $ | 43,026 | $ | 38,741 | $ | 33,349 | ||||||||||||||||||||
| Interest expense | 5,167 | 4,562 | 3,072 | 2,402 | 1,901 | 22,124 | 13,771 | 5,167 | 4,562 | 3,072 | ||||||||||||||||||||||||||||||
| Provision for credit losses | 1,831 | 2,037 | 1,836 | 3,255 | 950 | 4,193 | 6,091 | 1,831 | 2,037 | 1,836 | ||||||||||||||||||||||||||||||
| Noninterest income | 19,524 | 14,796 | 11,935 | 23,256 | 1,324 | 21,034 | 17,860 | 19,524 | 14,796 | 11,935 | ||||||||||||||||||||||||||||||
| Noninterest expense | 45,200 | 38,699 | 38,261 | 23,694 | 13,239 | 64,078 | 83,112 | 45,200 | 38,699 | 38,261 | ||||||||||||||||||||||||||||||
| Federal and state income tax expense | 3,152 | 2,936 | 973 | 6,853 | 984 | 5,192 | (897 | ) | 3,152 | 2,936 | 973 | |||||||||||||||||||||||||||||
| Net income | 7,200 | 5,303 | 1,142 | 10,412 | 1,961 | |||||||||||||||||||||||||||||||||||
| Dividends | - | 166 | 126 | 126 | 165 | |||||||||||||||||||||||||||||||||||
| Net income (loss) | 16,881 | (3,828 | ) | 7,200 | 5,303 | 1,142 | ||||||||||||||||||||||||||||||||||
| Preferred stock dividends | - | - | - | 166 | 126 | |||||||||||||||||||||||||||||||||||
| Net income available to common shareholders | 7,200 | 5,137 | 1,016 | 10,286 | 1,796 | 16,881 | (3,828 | ) | 7,200 | 5,137 | 1,016 | |||||||||||||||||||||||||||||
| Per share data and shares outstanding: | ||||||||||||||||||||||||||||||||||||||||
| Net income per common share, basic | $ | 0.75 | $ | 0.74 | $ | 0.16 | $ | 2.53 | $ | 0.44 | ||||||||||||||||||||||||||||||
| Net income per common share, diluted | $ | 0.75 | $ | 0.73 | $ | 0.16 | $ | 2.48 | $ | 0.44 | ||||||||||||||||||||||||||||||
| Net income (loss) per common share, basic | $ | 0.89 | $ | (0.22 | ) | $ | 0.75 | $ | 0.74 | $ | 0.16 | |||||||||||||||||||||||||||||
| Net income (loss) per common share, diluted | $ | 0.89 | $ | (0.22 | ) | $ | 0.75 | $ | 0.73 | $ | 0.16 | |||||||||||||||||||||||||||||
| Book value per common share at period end | $ | 13.47 | $ | 12.27 | $ | 11.54 | $ | 11.36 | $ | 8.80 | $ | 16.48 | $ | 15.48 | $ | 13.47 | $ | 12.27 | $ | 11.54 | ||||||||||||||||||||
| Average common shares outstanding | 9,555,952 | 6,975,662 | 6,160,005 | 4,073,077 | 4,036,291 | 19,068,246 | 17,556,554 | 9,555,952 | 6,975,662 | 6,160,005 | ||||||||||||||||||||||||||||||
| Diluted average common shares outstanding | 9,596,804 | 6,998,982 | 6,223,496 | 4,143,101 | 4,076,470 | 19,071,077 | 17,556,554 | 9,596,804 | 6,998,982 | 6,223,496 | ||||||||||||||||||||||||||||||
| Shares outstanding at period end | 9,820,592 | 6,991,072 | 6,962,139 | 4,145,547 | 4,095,650 | 19,066,913 | 19,039,347 | 9,820,592 | 6,991,072 | 6,962,139 | ||||||||||||||||||||||||||||||
| Financial Condition data: | ||||||||||||||||||||||||||||||||||||||||
| Total assets | $ | 1,149,950 | $ | 1,026,957 | $ | 946,759 | $ | 691,416 | $ | 499,918 | $ | 2,374,619 | $ | 2,266,514 | $ | 1,149,950 | $ | 1,026,957 | $ | 946,759 | ||||||||||||||||||||
| Loans receivable (gross) | 936,608 | 821,524 | 757,002 | 552,917 | 403,875 | 1,745,513 | 1,649,751 | 936,608 | 821,524 | 757,002 | ||||||||||||||||||||||||||||||
| Allowance for credit losses | 6,159 | 6,428 | 4,869 | 3,602 | 2,506 | 10,401 | 9,873 | 6,159 | 6,428 | 4,869 | ||||||||||||||||||||||||||||||
| Other interest-earning assets | 152,343 | 152,075 | 138,137 | 99,261 | 60,481 | 363,320 | 351,917 | 152,343 | 152,075 | 138,137 | ||||||||||||||||||||||||||||||
| Total deposits | 863,908 | 808,734 | 747,408 | 554,039 | 388,949 | 1,714,365 | 1,685,806 | 863,908 | 808,734 | 747,408 | ||||||||||||||||||||||||||||||
| Borrowings | 148,920 | 127,574 | 98,828 | 67,628 | 61,658 | 319,368 | 276,653 | 148,920 | 127,574 | 98,828 | ||||||||||||||||||||||||||||||
| Total stockholders’ equity | 132,253 | 85,790 | 92,899 | 59,643 | 48,624 | 314,148 | 294,683 | 132,253 | 85,790 | 92,899 | ||||||||||||||||||||||||||||||
| Common equity | 132,253 | 85,790 | 80,337 | 47,081 | 36,062 | 314,148 | 294,683 | 132,253 | 85,790 | 80,337 | ||||||||||||||||||||||||||||||
| Average assets | 1,072,943 | 970,710 | 782,441 | 557,602 | 428,961 | 2,250,334 | 1,997,474 | 1,072,943 | 970,710 | 782,441 | ||||||||||||||||||||||||||||||
| Average stockholders' equity | 123,763 | 86,221 | 76,143 | 50,674 | 47,717 | 304,925 | 266,075 | 123,763 | 86,221 | 76,143 | ||||||||||||||||||||||||||||||
| Average common stockholders' equity | 123,763 | 81,896 | 63,581 | 38,112 | 35,155 | 304,925 | 266,075 | 123,763 | 81,896 | 63,581 | ||||||||||||||||||||||||||||||
| Selected performance ratios: | ||||||||||||||||||||||||||||||||||||||||
| Return on average assets | 0.67 | % | 0.55 | % | 0.15 | % | 1.87 | % | 0.46 | % | 0.75 | % | (0.19 | )% | 0.67 | % | 0.55 | % | 0.15 | % | ||||||||||||||||||||
| Return on average common equity | 5.82 | % | 6.48 | % | 1.80 | % | 27.32 | % | 5.58 | % | 5.54 | % | (1.44 | )% | 5.82 | % | 6.48 | % | 1.80 | % | ||||||||||||||||||||
| Net interest margin(1) | 3.73 | % | 3.73 | % | 4.08 | % | 3.97 | % | 3.93 | % | 3.50 | % | 3.78 | % | 3.73 | % | 3.73 | % | 4.08 | % | ||||||||||||||||||||
| Efficiency ratio(2) | 78.77 | % | 79.01 | % | 90.64 | % | 53.59 | % | 77.27 | % | 70.93 | % | 98.38 | % | 78.77 | % | 79.01 | % | 90.64 | % | ||||||||||||||||||||
| Asset quality ratios: | ||||||||||||||||||||||||||||||||||||||||
| Nonperforming loans to gross loans | 1.41 | % | 1.17 | % | 1.37 | % | 0.77 | % | 0.79 | % | 1.10 | % | 1.50 | % | 1.41 | % | 1.17 | % | 1.37 | % | ||||||||||||||||||||
| Allowance for credit losses to loans | 0.66 | % | 0.78 | % | 0.64 | % | 0.65 | % | 0.62 | % | 0.60 | % | 0.60 | % | 0.66 | % | 0.78 | % | 0.64 | % | ||||||||||||||||||||
| Allowance for credit losses to nonperforming loans | 46.70 | % | 69.24 | % | 46.95 | % | 84.69 | % | 78.76 | % | 54.33 | % | 39.94 | % | 46.70 | % | 69.24 | % | 46.95 | % | ||||||||||||||||||||
| Nonperforming assets to loans and other real estate | 1.57 | % | 1.41 | % | 1.68 | % | 1.21 | % | 1.37 | % | 1.27 | % | 1.76 | % | 1.57 | % | 1.41 | % | 1.68 | % | ||||||||||||||||||||
| Nonperforming assets to total assets | 1.28 | % | 1.16 | % | 1.35 | % | 0.97 | % | 1.11 | % | 0.94 | % | 1.28 | % | 1.28 | % | 1.16 | % | 1.35 | % | ||||||||||||||||||||
| Capital ratios: | ||||||||||||||||||||||||||||||||||||||||
| Leverage ratio | 11.70 | % | 8.36 | % | 9.90 | % | 8.60 | % | 9.93 | % | 9.55 | % | 8.77 | % | 11.70 | % | 8.36 | % | 9.90 | % | ||||||||||||||||||||
| Common equity tier 1 capital ratio | 11.09 | % | 10.00 | % | 12.77 | % | 9.71 | % | 11.47 | % | ||||||||||||||||||||||||||||||
| Tier I risk-based capital ratio | 12.77 | % | 9.71 | % | 11.47 | % | 10.11 | % | 11.45 | % | 11.09 | % | 10.00 | % | 12.77 | % | 9.71 | % | 11.47 | % | ||||||||||||||||||||
| Total risk-based capital ratio | 13.72 | % | 10.83 | % | 12.09 | % | 10.73 | % | 12.05 | % | 13.14 | % | 12.14 | % | 13.72 | % | 10.83 | % | 12.09 | % | ||||||||||||||||||||
| Average equity to average assets | 11.53 | % | 8.88 | % | 9.73 | % | 9.09 | % | 11.12 | % | 13.55 | % | 13.32 | % | 11.53 | % | 8.88 | % | 9.73 | % | ||||||||||||||||||||
| (1) | Net interest margin is net interest income divided by average earning assets. |
| (2) | Efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income. |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This section is intended to help currentThe following discussion provides additional information regarding our operations for the twelve-month periods ending December 31, 2019, 2018 and potential investors understand our financial performance through a discussion of the factors affecting our consolidated2017, and financial condition at December 31, 20172019 and 20162018, and our consolidated results of operations for the years ended December 31, 2017, 2016 and 2015. This section should be read in conjunction with theour Consolidated Financial Statements and related notes to the consolidated financial statements that appear elsewhere in this report. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods.
We have made, and will continue to make, various forward-looking statements with respect to financial, business and economic matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see the “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report.
Overview
Howard Bancorp, Inc. is the holding company for Howard Bank. Howard Bank was formed in 2004. Howard Bank’s business has consisted primarily of originating both commercial and real estate loans secured by property in our market area. Typically, commercial real estate and business loans involve a higher degree of risk and carry a higher yield than one-to four-family residential loans. Although we plan to continue to focus on commercial customers, we intend to continue our origination of one- to four-family residential mortgage loans, maintaining our portfolio of mortgage lending and also selling select loans into the secondary markets.
We are headquartered in Ellicott City, Maryland and weBaltimore, Maryland. We consider our primary market area to be the Greater Baltimore Metropolitan Area. We engage in a general commercial banking business, making various types of loans and accepting deposits. We market our financial services primarily to small to medium sizedsmall- and medium-sized businesses and their owners, professionals and executives, and high-net-worth individuals. Our loans are primarily funded by core deposits of customers in our market.
Our resultsOn December 18, 2019, we entered into an agreement to release certain management members of our mortgage division from their employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring our 91 remaining mortgage employees. We also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly created LLC. In consideration of the release of the employment agreements, the transfer of our mortgage employees, and the sale of the domain name, the LLC paid us $750 thousand. Under the agreement, there is a transition period of approximately 45 days, after which we have agreed to cease originating residential first lien mortgage loans and exit our mortgage banking activities. Accordingly, we expect to have the majority of the residential first lien mortgage pipeline processed by the end of the first quarter of 2020. In order to manage future loan run-off within our residential mortgage loan portfolio, we plan on buying first lien residential mortgage loans, on a servicing released basis, from both the LLC and other third-party originators.
While our mortgage banking activities were marginally profitable in two of the last three years and our decision to exit this activity will eliminate that source of income, we believe that the exit of these activities will have a negligible impact on our net income over the next twelve months and will improve our efficiency ratio. Most importantly, we believe that exiting these activities will allow us to focus resources on growing our more profitable and less volatile commercial banking business that represents our core competency. We expect that this renewed focus will more than replace the marginal levels of net income from our mortgage banking activities within the next twelve months. While we estimate that the after tax income from these activities in 2019 was $1.6 million, compared to an after tax loss of $1.4 million in 2018, the operating expenses we attributed to the mortgage banking activities represented only direct costs and did not include shared services expense for staff and support activities such as loan operations, depend mainlywire transfer operations, human resources, finance, internal audit, and compliance. If we had allocated these shared services expenses to our mortgage banking activities, the financial returns on our mortgage banking activities would have been even less.
We originally began our residential mortgage banking activities to provide increased diversification to our net interest income and noninterest income revenue. While we sold the majority of our residential first lien mortgage loan originations to investors, we held a portion of these originations in our loan portfolio to diversify our loan mix. We continued to grow our mortgage banking business until shortly after our merger with First Mariner in 2018, at which istime we determined to reduce our mortgage banking activities. This decision was shaped by our impressions of both the difference betweenevolution of the interest incomemortgage banking industry and the characteristics of the returns associated with our original diversification strategy. For instance, we earnsaw a growing need for both scale and technology investments as non-depository institutions began to dominate this space, which would require us to re-allocate our resources of both human and financial capital into a non-core business activity. In addition, despite management efforts to increase returns on mortgage originations through changes in mortgage banking management, processes and product array, we were not meeting our internal expectations. As a result, after also considering, among other factors, regulatory risks related to mortgage banking, the distraction of management from our core customer business, the need to allocate resources to a non-core business activity, and the adverse impact of our mortgage business on our loanefficiency ratio, we ultimately determined to exit our mortgage banking activities. After a ten-month period of negotiations with both internal and investment portfoliosexternal parties, in December 2019, we entered into an agreement to exit our mortgage banking activities which resulted in a positive return on the sale of the domain name (VAMortgage.com) and no severance or lease termination costs, other than $288 thousand of exit costs associated with change in control and retention agreements. The exit of our mortgage banking activities is discussed in Note 3 to the interest expense we pay on deposits and borrowings. Results of operations are also affected by provisions for credit losses, noninterest income and noninterest expense. Our noninterest expense consists primarily of compensation and employee benefits, as well as office occupancy, deposit insurance and general administrative and data processing expenses. Our operations are significantly affected by general economic and competitive conditions, particularly with respect to changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect our financial condition and results of operations.Consolidated Financial Statements.
In August 2015,On December 6, 2018, we acquired Patapsco Bancorp,entered into Subordinated Note Purchase Agreements with certaininstitutional accredited investors pursuant to which we sold and issued $25.0 million in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes due December 6, 2028 (the “Notes”). We used the parentnet proceeds from this offering for general corporate purposes, to provide for continued growth and to supplement our regulatory capital ratios.
On March 1, 2018, we completed our merger with First Mariner Bank, a Maryland chartered trust company (“First Mariner”). At the effective time of The Patapsco Bank, through the merger, of Patapsco Bancorp with and into Howard Bancorp, immediately followed by the merger of Patapsco BankFirst Mariner merged with and into the Bank.
In May 2016, we redeemed allBank, with the Bank continuing as the surviving bank. At the effective time of the 12,562merger, each outstanding share of First Mariner common stock and First Mariner Series A Non-Voting Non-Cumulative Perpetual Preferred Stock issued and outstanding was cancelled and converted into the right to receive 1.6624 shares of the Series AA Preferred Stock thatour common stock with cash paid in lieu of fractional shares. The aggregate merger consideration of $173.8 million included $9.2 million of cash and 9,143,222 shares of our common stock, which was valued at approximately $164.6 million. In our merger with First Mariner, we acquired 14 branches located in Baltimore City and Baltimore, Harford, Howard and Anne Arundel counties. First Mariner had previously issued to Treasury under its SBLF program for approximately $12.7total assets with a fair value of $1.01 billion as of March 1, 2018, including $664.3 million including dividends accrued but unpaid through the redemption date. The redemption of the Series AA Preferred Stock was funded with variable rate debtwith Raymond James Bank, N.A.loans, net of purchase accounting adjustments.
On February 1, 2017, we soldclosed an underwritten public offering of 2,760,000 shares of our common stock, resultingwhich included the exercise in aggregatefull of the underwriters’ over-allotment option, at a public offering price of $15.00 per share. The amount of gross proceeds raised in the offering was approximately $41.4 million, after underwriting discounts and estimated expenses, and the amount of net proceeds of approximatelyraised in this offering was $38.4 million. We used the proceeds of the offering to pay off thea $12.7 million loan to Raymond James Bank, N.A. and retained the remainder. This had a positive impact on our liquidity and capital position in 20172018 and provided funds that willallowed us to continue to allow us to grow our loans and investments.
On March 1, 2018, we acquired First Mariner throughRecent Market Conditions
Our financial performance generally, and in particular the merger of First Mariner with and into Howard Bank. The aggregate merger consideration of $173.8 million included $9.2 million of cash and 9,143,230 sharesability of our common stock,borrowers to repay their loans, the value of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly dependent on the business environment in our primary markets where we operate and in the United States as a whole. In early 2020, an outbreak of a novel strain of coronavirus was identified in Wuhan, China. The coronavirus has since spread within China and infections have been found in a number of countries around the world, including the United States. The coronavirus and its associated impacts on trade (including supply chains and export levels), travel, employee productivity and other economic activities has had, and may continue to have, a destabilizing effect on financial markets and economic activity. The extent of the impact of the coronavirus on our operational and financial performance is currently uncertain and cannot be predicted and will depend on certain developments, including, among others, the duration and spread of the outbreak, its impact on our customers, employees and vendors, and governmental, regulatory and private sector responses, which was valued at approximately $164.6 million.may be precautionary, to the coronavirus.
Financial Highlights
Financial highlights for the year ended December 31, 20172019 are as follows:
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| · | Our net interest margin decreased by 28 basis points to 3.50% in 2019, compared to 2018, due primarily to a 44 basis point increase in funding costs which more than offset the six basis point increase in the yield on our earning assets. |
| · | Loans and leases |
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| · | We recorded additional occupancy expenses related to our branch optimization initiative of $3.6 million in 2019. |
| · | Our nonperforming assets declined to 0.94% of total assets at year end compared to 1.28% at the prior year end. |
| · | We ended 2019 with a book value per common share |
Tax Cuts and Jobs Act.The Tax Cuts and Jobs Act was enacted on December 22, 2017. Among other things, the new law (i) establishes a reduced, flat corporate federal statutory income tax rate of 21%, (ii) eliminates the corporate alternative minimum tax and allows the use of any tax net operating loss carryforwards to offset regular tax liability for any taxable year, (iii) limits the deduction for net interest expense incurred by U.S. corporations, (iv) allows businesses to immediately expense, for tax purposes, the cost of new investments in certain qualified depreciable assets, (v) eliminates or reduces certain deductions related to meals and entertainment expenses, (vi) modifies the limitation on excessive employee remuneration to eliminate the exception for performance-based compensation and clarifies the definition of a covered employee and (vii) limits the deductibility of deposit insurance premiums. The Tax Cuts and Jobs Act also significantly changes U.S. tax law related to foreign operations, but such changes do not currently impact us.
| We remain “well capitalized” by all regulatory measures, with all year-end regulatory capital ratios above the prior year end levels. |
| · | In December 2019, we entered into an agreement to exit our mortgage banking activities, and we expect to have the majority of the residential first lien mortgage pipeline processed by the end of the first quarter of 2020. |
Critical Accounting Policies
Our accounting and financial reporting policies conform to the accounting principles generally accepted in the United States of America (“GAAP”) and general practice within the banking industry. Accordingly, preparationApplication of the financial statementsthese principles requires management to exercise significant judgment or discretion and make significantestimates, assumptions and complex judgements that affect the amounts reported in our Consolidated Financial Statements and accompanying notes. These estimates, assumptions and judgments are based on the information availablehistorical experience and various assumptions that have, or could have, a material impact on the carrying valuewe believe to be reasonable as of certain assets or on income. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statementsstatements; accordingly, as this information changes, our Consolidated Financial Statements could reflect different estimates, assumptions and judgments. Actual results could differ significantly from those estimates.
Certain accounting measurements inherently have a greater reliance on the reported amountsuse of incomeestimates, assumptions and expenses during the periods presented. In reviewingjudgments and, understanding financial information for us, you are encouraged to read and understand the significant accounting policies used in preparing our financial statements.as such, have a greater possibility of producing results that could be materially different than originally reported. The accounting policies we view as critical accounting policies are those relating to the allowance for credit losses, goodwill and other intangible assets, income taxes, and share based compensation.compensation and accounting for business combinations and loans acquired in business combinations.
In reviewing and understanding our financial information, we also encourage you to review our significant accounting policies used in preparing our financial statements. See Note 1 to our Consolidated Financial Statements for further discussion of our significant accounting policies.
Allowance for Credit Losses
TheOur allowance for credit losses is established through a provision for credit losses charged against income. Loans are charged against the allowance for credit losses when management believeswe believe that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that represents the amount of probable and reasonably estimable known and inherent losses in the loan portfolio, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the types and amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, estimated losses relating to specifically identified loans, and current economic conditions. This evaluation is inherently subjective as it requires material estimates including, among others, exposure at default, the amount and timing of expected future cash flows on impaired loans, value of collateral, estimated losses on our loan portfolios as well as consideration of general loss experience. Based on our estimate of the level of allowance for credit losses required, we record a provision for credit losses to maintain the allowance for credit losses at an appropriate level.
We cannot predict with certainty the amount of loan charge-offs that we will incur. We do not currently determine a range of loss with respect to the allowance for credit losses. In addition, our regulatory agencies, as an integral part of their examination processes, periodically review our allowance for credit losses. Such agencies may require that we recognize additions to the allowance for credit losses based on their judgments about information available to them at the time of their examination. To the extent that actual outcomes differ from management’s estimates, additional provisions to the allowance for credit losses may be required that would adversely impact earnings in future periods. Note 8 to our Consolidated Financial Statements describes the methodology used to determine the allowance for credit losses.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired in a business combination, less the estimated fair value of the liabilities assumed. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in a business combination. TheOur core deposit intangible is amortized over the estimated useful lives of the acquired long-term deposits, acquired, and the remaining amounts of theour core deposit intangible are periodically reviewed for reasonableness. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. We perform a qualitative assessment annually to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing updated qualitative factors, the Company determineswe determine that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it doeswe do not have to perform the two step impairment test. Determining the fair value under the first step of the goodwill impairment test and determining the fair value if individual assets and liabilities of a reporting unit under the second step of the goodwill impairment test are judgmental and often involve the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the fair value of other intangible assets. Estimates of fair value are primarily determined using discounted cash flows, market comparisons and recent transactions. Significant estimates and assumptions include projected future cash flows, discount rates, reflective market rate of return, projected growth rates and determination and evaluation of appropriate market comparables. Future events could cause the Companyus to conclude that goodwill or other intangible assets have become impaired, which would result in the Companyour recording of an impairment loss. Any resulting impairment loss could have a material impact on the Company’sour financial condition and results of operations. Based on the results of our qualitative assessment, the Companywe determined that there was not an impairment of the carrying value of either the goodwill or core deposit intangible at December 31, 2017.2019.
Income Taxes
We account for income taxes under the asset/liability method. We recognize deferred tax assets and liabilities for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carry-forwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on deferred tax assets and liabilities of a change in tax rates in income in the period indicated by the enactment date. We establish a valuation allowance for deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. The judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond our control. It is at least reasonably possible that management’s judgment about the need for a valuation allowance for deferred tax assets could change in the near term.
Share Based Compensation
We follow the provisions of ASC Topic 718 “Compensation – Stock Compensation,” which requires the expense recognition over the respective service period for the fair value of share based compensation awards, such as stock options, restricted stock, and performance based shares. This standard allows management to establish modeling assumptions as to expected stock price volatility, option terms, forfeiture rates and dividend rates which directly impact estimated fair value. The accounting standard also allows for the use of alternative option pricing models which may impact fair value as determined. Our practice is to utilize reasonable and supportable assumptions that are reviewed with the appropriate board committee.
Accounting for Business Combinations
We account for transactions that meet the definition of a purchase business combination by recording the assets acquired and liabilities assumed at their fair value on the acquisition date. Determining the fair value of assets acquired, including identified intangible assets, and liabilities assumed often involves estimates based on third-party valuations, such as appraisals, or internal valuations based on discounted cash flow analysis or other valuation techniques that may include estimates of attrition, inflation, asset growth rates, discount rates, multiples of earnings or other relevant factors. In addition, the determination of the useful lives over which an intangible asset will be amortized is subjective. If the fair value of the assets acquired exceeds the purchase price plus the fair value of the liabilities assumed, a bargain purchase gain is recognized. Conversely, if the purchase price plus the fair value of the liabilities assumed exceeds the fair value of the assets acquired, goodwill is recognized.
Loans Acquired in Business Combinations
We record acquired loans at fair value at the date of acquisition based on a discounted cash flow methodology that considers various factors, including the type of loan and related collateral, classification status, whether the loan has a fixed or variable interest rate, its term and whether or not the loan was amortizing, and our assessment of risk inherent in the cash flow estimates. These cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change. Acquired loans are segregated into two categories upon purchase: (1) loans purchased without evidence of deteriorated credit quality since origination, referred to in this report as “acquired performing loans,” and (2) loans purchased with evidence of deteriorated credit quality since origination for which it is probable that all contractually required payments will not be collected, referred to in this report as “acquired credit impaired loans.”
We account for and evaluate acquired credit impaired loans for impairment in accordance with the provisions of ASC 310-30. We estimate the cash flows expected to be collected on purchased loans based upon the expected remaining life of the loans, which includes the effects of estimated prepayments. Cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change. Subsequent to the acquisition date, we continue to monitor cash flows on a quarterly basis, to determine the performance of each acquired credit impaired loan in comparison to management’s initial performance expectations. Subsequent decreases in the present value of expected cash flows are recorded as an increase in the allowance for credit losses through a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.
Acquired performing loans outside the scope of ASC 310-30 are accounted for under ASC 310-20. For acquired performing loans, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and the discount is accreted to interest income over the life of the loan. Subsequent to the purchase date, the method used to evaluate the sufficiency of the credit discount is similar to organic loans, and if necessary, additional reserves are recognized in the allowance for loan and lease losses.
Balance Sheet Analysis and Comparison of Financial Condition
A comparison between December 31, 20172019 and December 31, 20162018 balance sheets is presented below.
General
Total assets increased $123.0$108.1 million, or 12.0%4.8%, to $1.1$2.37 billion at December 31, 20172019 compared to assets of $1.0$2.27 billion at December 31, 2016. This2018. Our asset growth consisted primarily of increases in our portfolio loans of $115.1$95.8 million, loans held for sale of $9.4 million, cash and cash equivalents of $8.5 million and investment securitiesother assets of $38.5$11.5 million, partially offset by declinesa decline of $19.5$9.9 million in interest bearing deposits in banks, $10.4 million in cash and cash equivalents, and $8.9 million in loans held for sale.investment securities. The primary sourcesources of funding for the asset growth was an increasewere increases in deposit levels.balances and FHLB borrowings. Customer deposits increased from $808.7 million at December 31, 2016 to $863.9 million at December 31, 2017, an increase of $55.2$28.6 million, or 6.8%. Supplementing this deposit growth, our1.7%, in 2019 over 2018, while total borrowings increased $21.3$42.7 million, or 15.4%. Within total borrowings, FHLB borrowings increased $55.0 million. Total stockholders’ equity increased $19.5 million during 2017. Primarily2019 primarily as a result of the proceeds from our 2017 capital offering, total stockholders’ equity increased $46.5 million or 54.2% during 2017. As anticipated, all of our regulatory capital ratios increased dramatically as a result of the capital raised in the offering.retained earnings.
Investment Securities
Available for sale
Available
Our available for sale securities are reported at fair value. We currently holdAt December 31, 2019, we held U.S. agency and treasury securities,debentures, mortgage backed securities, and mutual fund investments in our securitiescorporate debentures. This portfolio which are categorized as available for sale. The investment in mutual funds is a supplement to our community reinvestment program activities. We use our securities portfolioused primarily to provide the requiredsufficient liquidity to fund our loans and provide funds for withdrawals of deposits. In addition, this portfolio is used as collateral for funding via commercial customer overnight securities sold under agreement to repurchase (“repurchase agreements”) and as well as to provide sufficient liquidity to fund our loans and provide funds for withdrawalsa source of deposits.earnings.
Held to maturity
Held to maturity securities are reported at amortized cost. The only investments that we have classified as held to maturity are certain corporate debentures. These investments are intended to be held until maturity.
In addition to our available for sale and held to maturity securities, at December 31, 2017 and December 31, 2016 we held an investment in stock of the Federal Home Loan Bank of $6.5 million and $5.1 million, respectively. This investment is required for continued Federal Home Loan Bank membership and is based partially upon the amount of borrowings outstanding from the FHLB. This Federal Home Loan Bank stock is carried at cost.
The following table sets forth the composition of our investment securities portfolio at the dates indicated.
| December 31, | December 31, | |||||||||||||||||||||||||||||||||||||||||||||||
| (in thousands) | 2017 | 2016 | 2015 | 2019 | 2018 | 2017 | ||||||||||||||||||||||||||||||||||||||||||
| Amortized | Estimated | Amortized | Estimated | Amortized | Estimated | Amortized | Estimated | Amortized | Estimated | Amortized | Estimated | |||||||||||||||||||||||||||||||||||||
| Cost | Fair Value | Cost | Fair Value | Cost | Fair Value | Cost | Fair Value | Cost | Fair Value | Cost | Fair Value | |||||||||||||||||||||||||||||||||||||
| Available for sale | ||||||||||||||||||||||||||||||||||||||||||||||||
| U.S. Government | ||||||||||||||||||||||||||||||||||||||||||||||||
| Agencies | $ | 68,082 | $ | 67,740 | $ | 34,584 | $ | 34,463 | $ | 48,467 | $ | 48,422 | $ | 66,428 | $ | 67,312 | $ | 130,088 | $ | 130,397 | $ | 68,082 | $ | 67,740 | ||||||||||||||||||||||||
| Treasuries | 1,505 | 1,494 | 1,512 | 1,504 | - | - | - | - | - | - | 1,505 | 1,494 | ||||||||||||||||||||||||||||||||||||
| Mortgage-backed | 2,541 | 2,479 | 1,366 | 1,298 | 54 | 57 | 139,918 | 142,699 | 90,242 | 90,460 | 2,541 | 2,479 | ||||||||||||||||||||||||||||||||||||
| Other investments | 2,579 | 2,543 | 1,500 | 1,463 | 1,100 | 1,094 | 5,510 | 5,494 | 3,011 | 3,001 | 2,579 | 2,543 | ||||||||||||||||||||||||||||||||||||
| $ | 74,707 | $ | 74,256 | $ | 38,962 | $ | 38,728 | $ | 49,621 | $ | 49,573 | $ | 211,856 | $ | 215,505 | $ | 223,341 | $ | 223,858 | $ | 74,707 | $ | 74,256 | |||||||||||||||||||||||||
| Held to maturity Corporate debentures | $ | 9,250 | $ | 9,421 | $ | 6,250 | $ | 6,584 | $ | 3,000 | $ | 3,328 | ||||||||||||||||||||||||||||||||||||
| Held to maturity | ||||||||||||||||||||||||||||||||||||||||||||||||
| Corporate debentures | $ | 7,750 | $ | 7,897 | $ | 9,250 | $ | 9,253 | $ | 9,250 | $ | 9,421 | ||||||||||||||||||||||||||||||||||||
We had available for sale securities of $74.3 million and $38.7$215.5 million at December 31, 2017 and2019, a decrease of $8.4 million, compared to $223.9 million at December 31, 2016, respectively, which were recorded at fair value.2018. As part of our overall interest rate risk strategy, we sold $35.4 million of available for sale investment securities in 2019, recording a gain on the sale of $645 thousand. This represents an increasegain was offset by prepayment penalties of $35.5$692 thousand related to the early redemption of $114.0 million or 91.7%,of FHLB borrowings. The sale of the securities and early repayment of the FHLB borrowings was primarily for asset/liability management purposes. In 2018, we repositioned a portion of our pre-acquisition portfolio through the sale of primarily shorter duration agency debenture bonds with maturities over one year, endedrecording a loss on the sale of $364 thousand. We did not sell any securities during 2017. At December 31, 2017 from the prior year end. The increase in the size of the portfolio was intended to provide additional collateral for certain funding sources, and to provide additional liquidity for the Bank. Nearly $35.02019, $1.5 million of our securities portfolio matures in one year or less givingcompared to $38.9 million at December 31, 2018. Available for sale securities give us the capacity to fund future loan growth while maintaining an appropriate amount of securities to provide the required collateral under our repurchase agreements. We did not record any gains or losses on sales or calls of securities in 2017. In 2016 we sold an equity security with a carrying value of $100 thousand issued by a local small financial institution that resulted in a gain upon sale of $96 thousand.
We had securitiesOur held to maturity of $9.3 million and $6.3securities balances were $7.8 million at December 31, 20172019 and $9.3 million at December 31, 2016, respectively, which were recorded at amortized cost. This represents an increase of $3.0 million during 2017,2018., consisting of additional investments in corporate debentures. The $1.5 million decrease year over year was the result of a bond call initiated by the underlying issuer.
With respect to our portfolio of securitiesOur available for sale thesecurities portfolio contained 3816 securities with unrealized losses of $451$166 thousand at December 31, 2019, and 1231 securities with unrealized losses of $240$275 thousand at December 31, 2017 and 2016, respectively.2018. Changes in the fair value of these securities resulted primarily from interest rate fluctuations. We do not intend to sell these securities nor is it more likely than not that we would be required to sell these securities before their anticipated recovery, and we believe the collection of the investment and related interest is probable. Based on this analysis, we do not consider any of the unrealized losses to be other than temporary impairment losses. Oneimpairment. There were no held to maturity securities was in a loss position at December 31, 2017 while none were in a loss position2019, and one at December 31, 2016.2018. Note 5 to our Consolidated Financial Statements provides more detail concerning the composition of our portfolio and our process for evaluating the portfolio for other-than-temporary impairment.
Portfolio Maturities and Yields
The composition and maturities of the investment securities portfolio (with respect to those securities that have a fixed maturity date) at December 31, 20172019 is summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur.
| As of December 31, 2019 | ||||||||||||||||||||||||||||||||||
| After one | After five | |||||||||||||||||||||||||||||||||
| (in thousands) | One year or less | through five years | through ten years | After ten years | Total | |||||||||||||||||||||||||||||
| Weighted | Weighted | Weighted | Weighted | Weighted | ||||||||||||||||||||||||||||||
| Amortized | Average | Amortized | Average | Amortized | Average | Amortized | Average | Amortized | Average | |||||||||||||||||||||||||
| Cost | Yield | Cost | Yield | Cost | Yield | Cost | Yield | Cost | Yield | |||||||||||||||||||||||||
| U.S. Government | ||||||||||||||||||||||||||||||||||
| Agencies | $ | 1,497 | 1.96 | % | $ | 49,162 | 3.01 | % | $ | 15,769 | 2.50 | % | $ | - | - | % | $ | 66,428 | 2.87 | % | ||||||||||||||
| Mortgage-backed | - | - | 4 | 4.74 | 4,547 | 3.13 | 135,367 | 2.95 | 139,918 | 2.96 | ||||||||||||||||||||||||
| Other investments | - | - | - | - | 5,510 | 6.70 | - | - | 5,510 | 6.70 | ||||||||||||||||||||||||
| $ | 1,497 | 1.96 | % | $ | 49,166 | 3.01 | % | $ | 25,826 | 3.51 | % | $ | 135,367 | 2.95 | % | $ | 211,856 | 3.02 | % | |||||||||||||||
| Held to maturity | ||||||||||||||||||||||||||||||||||
| Corporate debentures | $ | - | - | $ | - | - | $ | 7,750 | 5.79 | $ | - | - | $7,750 | 5.79 | % | |||||||||||||||||||
Nonmarketable Equity Securities
| As of December 31, 2017 | ||||||||||||||||||||||||||||||||||||||||
| After one | After five | |||||||||||||||||||||||||||||||||||||||
| (in thousands) | One year or less | through five years | through ten years | After ten years | Total | |||||||||||||||||||||||||||||||||||
| Weighted | Weighted | Weighted | Weighted | Weighted | ||||||||||||||||||||||||||||||||||||
| Amortized | Average | Amortized | Average | Amortized | Average | Amortized | Average | Amortized | Average | |||||||||||||||||||||||||||||||
| Cost | Yield | Cost | Yield | Cost | Yield | Cost | Yield | Cost | Yield | |||||||||||||||||||||||||||||||
| Available for sale | ||||||||||||||||||||||||||||||||||||||||
| U.S. Government | ||||||||||||||||||||||||||||||||||||||||
| Agencies | $ | 33,600 | 1.18 | % | $ | 34,482 | 1.48 | % | $ | - | - | % | $ | - | - | % | $ | 68,082 | 1.33 | % | ||||||||||||||||||||
| Treasury | 1,505 | 0.83 | - | - | - | - | - | - | 1,505 | 0.83 | ||||||||||||||||||||||||||||||
| Mortgage-backed | - | - | 8 | 4.55 | 7 | 4.98 | 2,526 | 2.68 | 2,541 | 2.69 | ||||||||||||||||||||||||||||||
| $ | 35,105 | 1.16 | % | $ | 34,490 | 1.48 | % | $ | 7 | 4.98 | % | $ | 2,526 | 2.68 | % | $ | 72,128 | 1.37 | % | |||||||||||||||||||||
| Held to maturity Corporate debentures | $ | - | - | $ | - | - | $ | 9,250 | 6.16 | $ | - | - | $ | 9,250 | % | |||||||||||||||||||||||||
At December 31, 2019 and 2018, we held an investment in stock of the Federal Home Loan Bank (“FHLB”) of $14.2 million and $11.8 million, respectively. This investment is required for continued FHLB membership and is based partially upon the amount of borrowings outstanding from the FHLB. This FHLB stock is carried at cost.
Loan and Lease Portfolio
Total loans and leases increased $115.1$95.8 million, or 14.0%5.8%, to $936.6 million$1.74 billion at December 31, 20172019 from $821.5 million$1.65 billion at December 31, 2016. This2018, primarily as a result of organic growth during 2017 was primarily due to growth ingrowth. Overall, residential real estate loans increased $38.9 million, commercial loans and leases increased $36.0 million, and commercial real estate loans (including constructionincreased $24.0 million in 2019, from 2018, as we continued to focus on the needs of small- and land development), which increased $81.6 million or 19.3% from 2016 levels. Additionally, commercial and industrial loans grew $26.0 million andmedium-sized businesses in our market area. Within residential junior lien loans increased $8.0 million. Residential real estate, loans and the consumer loan portfolio declined $609 thousand or less than 1% during 2017first lien mortgages increased $54.4 million, including $27.4 million purchased from their year-end 2016 levels.a non-affiliated mortgage banking entity, which was partially offset by a $15.5 million decrease in residential-junior lien mortgages.
The following table sets forth the composition of our loan portfolio at the dates indicated.
| December 31, | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| December 31, | 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | 2017 | 2016 | 2015 | 2014 | 2013 | Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Real Estate | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Construction and land | $ | 74,398 | 7.9 | % | $ | 72,973 | 8.9 | % | $ | 69,385 | 9.1 | % | $ | 64,158 | 11.6 | % | $ | 50,884 | 12.6 | % | $ | 128,285 | 7.3 | % | $ | 123,671 | 7.5 | % | $ | 74,398 | 7.9 | % | $ | 72,973 | 8.9 | % | $ | 69,385 | 9.1 | % | ||||||||||||||||||||||||||||||||||||||||
| Residential - first lien | 194,896 | 20.8 | 195,032 | 23.7 | 182,988 | 24.1 | 88,293 | 16.0 | 39,249 | 9.7 | 437,409 | 25.1 | 383,044 | 23.2 | 194,896 | 20.8 | 195,032 | 23.7 | 182,988 | 24.1 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Residential - junior lien | 43,047 | 4.6 | 35,009 | 4.3 | 27,477 | 3.6 | 19,301 | 3.5 | 8,266 | 2.0 | 74,164 | 4.2 | 89,645 | 5.4 | 43,047 | 4.6 | 35,009 | 4.3 | 27,477 | 3.6 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total residential real estate | 237,943 | 25.4 | 230,041 | 28.0 | 210,465 | 27.7 | 107,594 | 19.5 | 47,515 | 11.7 | 511,573 | 29.3 | 472,689 | 28.6 | 237,943 | 25.4 | 230,041 | 28.0 | 210,465 | 27.7 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial - owner occupied | 170,408 | 18.2 | 134,213 | 16.3 | 131,114 | 17.3 | 112,826 | 20.4 | 90,333 | 22.4 | 241,795 | 13.9 | 234,102 | 14.2 | 170,408 | 18.2 | 134,213 | 16.3 | 131,114 | 17.3 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial - non-owner occupied | 260,802 | 27.8 | 216,781 | 26.4 | 181,361 | 23.9 | 123,958 | 22.4 | 113,559 | 28.1 | 444,052 | 25.4 | 427,747 | 25.9 | 260,802 | 27.8 | 216,781 | 26.4 | 181,361 | 23.9 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total commercial real estate | 431,210 | 46.0 | 350,994 | 42.7 | 312,475 | 41.2 | 236,784 | 42.8 | 203,892 | 50.5 | 685,847 | 39.3 | 661,849 | 40.1 | 431,210 | 46.0 | 350,994 | 42.7 | 312,475 | 41.2 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total real estate loans | 743,551 | 79.3 | 654,008 | 79.6 | 592,325 | 78.0 | 408,536 | 73.9 | 302,291 | 74.8 | 1,325,705 | 75.9 | 1,258,209 | 76.2 | 743,551 | 79.3 | 654,008 | 79.6 | 592,325 | 78.0 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial loans and leases | 188,729 | 20.2 | 162,715 | 19.8 | 160,424 | 21.4 | 139,669 | 25.2 | 100,410 | 24.9 | 372,872 | 21.4 | 336,876 | 20.5 | 188,729 | 20.2 | 162,715 | 19.8 | 160,424 | 21.4 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Consumer loans | 4,328 | 0.5 | 4,801 | 0.6 | 4,253 | 0.6 | 4,712 | 0.9 | 1,174 | 0.3 | 46,936 | 2.7 | 54,666 | 3.3 | 4,328 | 0.5 | 4,801 | 0.6 | 4,253 | 0.6 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total loans and leases | $ | 936,608 | 100.0 | % | $ | 821,524 | 100.0 | % | $ | 757,002 | 100.0 | % | $ | 552,917 | 100.0 | % | $ | 403,875 | 100.0 | % | $ | 1,745,513 | 100.0 | % | $ | 1,649,751 | 100.0 | % | $ | 936,608 | 100.0 | % | $ | 821,524 | 100.0 | % | $ | 757,002 | 100.0 | % | ||||||||||||||||||||||||||||||||||||||||
Loan Portfolio Maturities
The following table summarizes the scheduled repayments of our loan portfolio and sets forth the scheduled repayments of fixed and adjustable rate loans in our portfolio at December 31, 2017.2019.
| At December 31, 2017 | At December 31, 2019 | |||||||||||||||||||||||||||||||
| After one | After one | |||||||||||||||||||||||||||||||
| (dollars in thousands) | One year or less | through five years | After five years | Total | One year or less | through five years | After five years | Total | ||||||||||||||||||||||||
| Real Estate | ||||||||||||||||||||||||||||||||
| Construction and land | $ | 38,571 | $ | 30,023 | $ | 5,804 | $ | 74,398 | $ | 51,305 | $ | 31,994 | $ | 44,986 | $ | 128,285 | ||||||||||||||||
| Residential - first lien | 42 | 3,608 | 191,246 | 194,896 | 880 | 4,996 | 431,533 | 437,409 | ||||||||||||||||||||||||
| Residential - junior lien | 247 | 848 | 41,952 | 43,047 | 697 | 3,763 | 69,704 | 74,164 | ||||||||||||||||||||||||
| Total residential real estate | 289 | 4,456 | 233,198 | 237,943 | 1,577 | 8,759 | 501,237 | 511,573 | ||||||||||||||||||||||||
| Commercial - owner occupied | 14,685 | 61,354 | 94,369 | 170,408 | 15,665 | 91,403 | 134,727 | 241,795 | ||||||||||||||||||||||||
| Commercial - non-owner occupied | 34,163 | 62,802 | 163,837 | 260,802 | 18,021 | 220,219 | 205,812 | 444,052 | ||||||||||||||||||||||||
| Total commercial real estate | 48,848 | 124,156 | 258,206 | 431,210 | 33,686 | 311,622 | 340,539 | 685,847 | ||||||||||||||||||||||||
| Total real estate loans | 87,708 | 158,635 | 497,208 | 743,551 | 86,568 | 352,375 | 886,762 | 1,325,705 | ||||||||||||||||||||||||
| Commercial loans and leases | 24,614 | 60,897 | 103,218 | 188,729 | 49,224 | 121,251 | 202,397 | 372,872 | ||||||||||||||||||||||||
| Consumer loans | 100 | 593 | 3,635 | 4,328 | 645 | 15,138 | 31,153 | 46,936 | ||||||||||||||||||||||||
| Total | $ | 112,422 | $ | 220,125 | $ | 604,061 | $ | 936,608 | $ | 136,437 | $ | 488,764 | $ | 1,120,312 | $ | 1,745,513 | ||||||||||||||||
| Rate terms: | ||||||||||||||||||||||||||||||||
| Fixed rate | $ | 69,415 | $ | 162,303 | $ | 323,326 | $ | 555,044 | $ | 59,496 | $ | 364,779 | $ | 519,678 | $ | 943,953 | ||||||||||||||||
| Adjustable rate | 43,007 | 57,822 | 280,735 | 381,564 | 76,941 | 123,985 | 600,634 | 801,560 | ||||||||||||||||||||||||
| Total | $ | 112,422 | $ | 220,125 | $ | 604,061 | $ | 936,608 | $ | 136,437 | $ | 488,764 | $ | 1,120,312 | $ | 1,745,513 | ||||||||||||||||
Loans Held for Sale
We sell the majority of the residential mortgage loans originated bythat we originate. Outstanding balances for the Bank. Loansloans held for sale decreased $8.9portfolio increased $9.4 million to $42.2$30.7 million at December 31, 20172019, from $51.1$21.3 million at December 31, 2016. Mortgage2018. Our mortgage loan origination volumes continue to be strong, with $673.4for sale volume was $573.3 million in loans originated in 20172019 compared to $599.3$586.4 million in 2016. The decrease2018. As previously mentioned, in December 2019, we entered into an agreement to exit our mortgage banking activities, and we expect to have the majority of the residential first lien mortgage pipeline processed by the end of the first quarter of 2020.
Goodwill and Other Intangible Assets
Goodwill represents the consideration paid in excess of the fair value of net assets acquired (including identifiable intangibles) in a business combination. We initially recorded $70.1 million of goodwill associated with the First Mariner merger in 2018. Based upon updated information the goodwill was adjusted downward in the levelfirst quarter of loans held for sale2019 by $4.7 million to reflect adjustments to net deferred tax assets as detailed in Note 2 of our Consolidated Financial Statements, resulting in a decrease of our total goodwill at December 31, 20172019 to $65.9 million.
Our core deposit intangible represents the estimated value of long-term deposit relationships acquired in a business combination and is amortized over the estimated useful lives of the long-term deposits acquired. The unamortized balance of our core deposit intangible was $8.5 million at December 31, 2019, compared to $11.5 million at December 31, 2018. Amortization expense reflected in noninterest expense totaled $3.0 million, $2.9 million and $0.5 million for the prior year was largely theyears ended December 31, 2019, 2018 and 2017, respectively.
Leases
As a result of us adopting Accounting Standards Update (“ASU”) 2016-02,Leases(Topic 842), we recognized $14.1 million in right-of-use assets and $14.5 million of lease liabilities for operating leases. These amounts are reflected in other assets and other liabilities on our Consolidated Balance Sheet at December 31, 2019, and primarily account for the purchasers ofnet changes in interest receivable and other assets and accrued expenses and other liabilities from the loans executing on the salesamounts reported at a faster pace, so that we held the loans for a shorter period of time.December 31, 2018.
Deposits
We accept deposits primarily from the areas in which our branches and offices are located. We have consistently focused on building broader customer relationships and targeting small business customers to increase our core deposits. We also rely on our customer service to attract and retain deposits. We offer a variety of deposit accounts with a range of interest rates and terms. Customer deposits have historically provided us with a sizeable source of relatively stable and low-cost funds to support asset growth. Our deposit accounts consist of commercial and retail checking accounts, savings accounts, certificates of deposit, money market accounts, and individual retirement accounts. We do not currently accept brokered deposits other than those obtained under Promontory Interfinancial Network’s certificate of deposit account registry service program.
We review and update interest rates paid, maturity terms, service fees and withdrawal penalties on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market interest rates, liquidity requirements, anticipated short term loan demand and our deposit growth goals.
Our depositsDeposits increased from $808.7 million$1.69 billion at December 31, 20162018 to $863.9 million$1.71 billion at December 31, 2017,2019, an increase of $55.2$28.6 million. Noteworthy increases included growth of $39.8 million or 6.8% for 2017, all of which is attributable to organic activities. Total demand deposits, the largest individual category of deposits growth, increased $44.4 million or 18.1%, comprised ofin noninterest-bearing demand depositsaccounts and $32.8 million in certificates of deposit. Offsetting this growth was a decline of $35.3$43.9 million andin interest-bearing demand deposits growthaccounts. This decline was a result of $9.1 million. Money market accounts increased $4.6our largest deposit relationship reducing their interest-bearing demand balances by $61.6 million or 1.9%, certificatesduring the second quarter of 2019 to fund new opportunities and investments. Other interesting-bearing deposit increased $4.6 million or 1.8%, and savings accounts increased $1.6 million or 3.1%, comparing year-end 2017 levels to year-end 2016 levels.balances remained relatively flat year over year.
The following table sets forth the distribution of total deposit accounts,deposits, by account type, at the dates indicated.indicated:
| December 31, | December 31, | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | 2017 | 2016 | 2015 | 2019 | 2018 | 2017 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Weighted | Weighted | Weighted | Weighted | Weighted | Weighted | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| % of | Average | % of | Average | % of | Average | % of | Average | % of | Average | % of | Average | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Amount | Total | Rate | Amount | Total | Rate | Amount | Total | Rate | Amount | Total | Rate | Amount | Total | Rate | Amount | Total | Rate | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Noninterest-bearing demand | $ | 218,139 | 26 | % | - | % | $ | 182,880 | 23 | % | - | % | $ | 173,689 | 23 | % | - | % | $ | 468,975 | 27 | % | - | % | $ | 429,200 | 26 | % | - | % | $ | 218,139 | 26 | % | - | % | ||||||||||||||||||||||||||||||||||||
| Interest-bearing checking | 71,642 | 8 | 0.25 | 62,538 | 8 | 0.23 | 54,014 | 7 | 0.21 | 183,447 | 11 | 0.46 | 227,322 | 13 | 0.35 | 71,642 | 8 | 0.25 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Money market accounts | 252,453 | 29 | 0.43 | 247,858 | 31 | 0.46 | 230,661 | 31 | 0.47 | 360,711 | 21 | 0.79 | 356,130 | 21 | 0.61 | 252,453 | 29 | 0.43 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Savings | 52,078 | 6 | 0.14 | 50,495 | 6 | 0.14 | 51,989 | 7 | 0.18 | 130,141 | 7 | 0.18 | 134,893 | 8 | 0.15 | 52,078 | 6 | 0.14 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Certificates of deposit | 269,596 | 31 | 1.05 | 264,963 | 32 | 0.87 | 237,055 | 32 | 0.75 | 571,091 | 34 | 2.06 | 538,261 | 32 | 1.31 | 269,596 | 31 | 1.05 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total deposits | $ | 863,908 | 100 | % | 0.63 | % | $ | 808,734 | 100 | % | 0.57 | % | $ | 747,408 | 100 | % | 0.56 | % | $ | 1,714,365 | 100 | % | 1.24 | % | $ | 1,685,806 | 100 | % | 0.79 | % | $ | 863,908 | 100 | % | 0.63 | % | ||||||||||||||||||||||||||||||||||||
The following table sets forth the maturity of certificates of deposit of $100,000 and overor more at December 31, 2017.2019.
| (in thousands) | ||||||||
| Three months or less | $ | 57,471 | $ | 226,443 | ||||
| Over three to six months | 55,658 | 39,211 | ||||||
| Over six to twelve months | 44,144 | 64,069 | ||||||
| Over twelve months | 40,488 | 54,993 | ||||||
| $ | 197,761 | $ | 384,716 | |||||
Borrowings
Customer deposits remain the primary source of funds that we utilizeuse to meet funding needs,loan growth, but we supplement this with short-termshort and long-term borrowings. BorrowingsOur borrowings consist of overnight unsecured master notes, customer repurchase agreements, FHLB advances and a junior subordinated debenture assumed in the Patapsco Bancorp acquisition.debentures. Repurchase agreementsconsist of overnight electronic sweep products that move customer excess funds from noninterest-bearing deposit accounts to an interest-bearing repurchase agreement, which is classified as a borrowing. Master notes similarly sweep funds from the Bank’s customer accounts to Howard Bancorpthe Company but do not require pledged collateral. Repurchase agreements sweep funds within the Bank and are secured primarily by pledges ofpledged U.S. Government Agency securities, based upon their fair value, as collateral for 100% of the principal and accrued interest of itsour repurchase agreements. Total borrowings were $319.4 million at December 31, 2019 and $276.7 million at December 31, 2018.
Subordinated Debt
On December 6, 2018, the Company entered into Subordinated Note Purchase Agreements with certain Purchasers pursuant to which the Company sold and issued $25.0 million in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes due December 6, 2028. The Company used the net proceeds of this offering for general corporate purposes, to provide for continued growth and to supplement its regulatory capital ratios.
The Notes were structured to qualify initially as Tier 2 capital for regulatory capital purposes and bear an initial interest rate of 6.00% per annum from and including December 6, 2018, to but excluding December 6, 2023, with interest during this period payable semi-annually in arrears. From and including December 6, 2023, to but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an annual floating rate equal to three-month LIBOR, plus 302 basis points, with interest during this period payable quarterly in arrears. The Notes are redeemable by the Company at its option, in whole or in part, on or after December 6, 2023.
Patapsco Statutory Trust I, a Connecticut statutory business trust and an unconsolidated wholly-owned subsidiary of Howard Bancorp,the Company (the “Trust”), issued $5$5.0 million of capital trust pass-through securities to investors. The interest rate currently adjusts on a quarterly basis at the rate of the three monththree-month LIBOR plus 1.48%. Patapsco StatutoryThe Trust I purchased $5,155,000 of junior subordinated deferrable interest debentures from Patapsco Bancorp.Bancorp, a bank holding company that we acquired in 2015. The debentures are the sole asset of the Trust.Trust and, in our acquisition of Patapsco Bancorp, alsowe assumed its obligation to fully and unconditionally guaranteed the obligations of the Trust under the capital securities, which guarantee became an obligation of Howard Bancorp upon our acquisition of Patapsco Bancorp.securities. The capital securities are redeemable by the Companyus at par. The capital securities must be redeemed upon final maturity of the subordinated debentures on December 31, 2035.
OurShort-term borrowings totaled $148.9 million at December 31, 2016 and $127.6 million at December 31, 2016.
Short-term borrowings are summarized in the following table:
| December 31, | ||||||||||||||||||||||||
| 2017 | 2016 | 2015 | ||||||||||||||||||||||
| (dollars in thousands) | Amount | Rate | Amount | Rate | Amount | Rate | ||||||||||||||||||
| Securities Sold Under Agreement to Repurchase & Master Notes | ||||||||||||||||||||||||
| At period end | $ | 14,356 | 0.12 | % | $ | 11,390 | 0.13 | % | $ | 16,621 | 0.12 | % | ||||||||||||
| Average for the year | 13,460 | 0.13 | 13,626 | 0.13 | 19,434 | 0.12 | ||||||||||||||||||
| Maximum month-end balance | 16,563 | 21,764 | 23,694 | |||||||||||||||||||||
| Federal Funds Purchased and Short-term Borrowed Funds | ||||||||||||||||||||||||
| At period end | $ | 116,029 | 1.50 | % | $ | 95,666 | 1.26 | % | $ | 52,500 | 0.55 | % | ||||||||||||
| Average for the year | 75,053 | 1.14 | 49,831 | 1.16 | 27,459 | 0.47 | ||||||||||||||||||
| Maximum month-end balance | 116,029 | 95,666 | 52,500 | |||||||||||||||||||||
| December 31, | ||||||||||||||||||||||||
| 2019 | 2018 | 2017 | ||||||||||||||||||||||
| (dollars in thousands) | Amount | Rate | Amount | Rate | Amount | Rate | ||||||||||||||||||
| Period-end balance: | ||||||||||||||||||||||||
| FHLB advances | $ | 230,000 | 1.70 | % | $ | 118,000 | 2.34 | % | $ | 14,356 | 0.12 | % | ||||||||||||
| Repurchase agreements 1 | 6,127 | 0.19 | 16,576 | 0.21 | 116,029 | 1.50 | ||||||||||||||||||
| Federal funds purchased | - | - | - | - | - | - | ||||||||||||||||||
| Total | $ | 236,127 | 1.66 | % | $ | 134,576 | 2.08 | % | $ | 130,385 | 1.35 | % | ||||||||||||
| Average balance for the year: | ||||||||||||||||||||||||
| FHLB advances | $ | 148,460 | 2.30 | % | $ | 125,108 | 1.80 | % | $ | 13,460 | 0.13 | % | ||||||||||||
| Repurchase agreements 1 | 7,122 | 0.19 | 18,927 | 0.19 | 74,763 | 1.14 | ||||||||||||||||||
| Federal funds purchased | 625 | 2.30 | 2,015 | 2.04 | 290 | 1.22 | ||||||||||||||||||
| Total | $ | 156,207 | 2.20 | % | $ | 146,050 | 1.59 | % | $ | 88,513 | 0.99 | % | ||||||||||||
| Maximum month-end balance: | ||||||||||||||||||||||||
| FHLB advances | $ | 273,000 | $ | 310,023 | $ | 16,563 | ||||||||||||||||||
| Repurchase agreements 1 | 15,293 | 25,291 | 116,029 | |||||||||||||||||||||
| Federal funds purchased | - | 30,000 | - | |||||||||||||||||||||
1 Includes overnight unsecured master notes
Short-term borrowingborrowings totaled $130.4$236.1 million at December 31, 20172019 and $107.1$134.6 million at December 31, 2016.2018, an increase of $101.5 million. Short-term borrowings at December 31, 2017, reflect an increase of $23.3 million or 21.8%. Short-term borrowings at December 31, 20172019 consisted of repurchase agreements of $13.5$6.0 million, master notes totaling $817$101 thousand, and 15seven short-term FHLB advances totaling $116.0$230.0 million.
Long-term borrowingborrowings totaled $18.5$83.2 million at December 31, 2017,2019, consisting of onefour long-term FHLB advances totaling $55.0 million and subordinated debt of $28.2 million, discussed above, compared to long term borrowings of $142.1 million at December 31, 2018, consisting of five long-term fixed rate FHLB advance of $15.0advances totaling $114.0 million and junior subordinated debt of $3.5$28.1 million. The December 31, 2019 long-term borrowings included three ten-year term, three-month Bermudan convertible borrowings. In each of these borrowings, the Bank has sold the option for call, and each borrowing’s first call occurs in the first quarter of 2020. In 2019, we repaid $114 million of long-term FHLB borrowings prior to their maturity, incurring prepayment penalties of $692 thousand which are included in our other operating expenses. The early repayment of these advances was primarily for asset/liability management purposes.
Stockholders’ Equity
Total stockholders’ equity increased $46.5$19.5 million, or 54.2%6.6%, from $85.8to $314.1 million at December 31, 2016 to $132.32019, from $294.7 million at December 31, 2017. As previously disclosed, the2018. Our increase in stockholders’ equity iswas primarily the result of the $38.4 million ofour net proceeds fromincome for 2019 as well as an increase in unrealized gains in our sale of 2,760,000 shares of common stock in an underwritten public offering that closed in the first quarter of 2017.
Asinvestment portfolio as a result of this offering,lower market interest rates. On April 24, 2019, we announced a share buyback program to purchase up to $7.0 million of our capital position increased dramatically.common shares. We repurchased a total of 19,764 of our common shares in 2019, reducing our equity by $322 thousand. The extent to which we repurchase any additional shares and the timing of such repurchases will depend upon market conditions and other considerations as may be considered in our sole discretion. Total stockholders’ equity at December 31, 20172019 represents a capitalan equity to assetassets ratio of 11.53%13.2%, compared to 8.36%13.0% at December 31, 2016. Book2018. Our book value per share was $13.47$16.48 at December 31, 2017 compared to $12.272019 and $15.48 at December 31, 2016. Leverage ratio, Tier1 risk-based capital ratio2018.
Comparison of Results of Operations
General
Our results of operations depend mainly on our net interest income, which is the difference between the interest income we earn on our loan and total risk-based capital ratio were 11.70%, 12.77%investment portfolios, as well as accretion income on acquired loans, and 13.72%, respectively,the interest expense we pay on deposits and borrowings. Our net interest income can be significantly influenced by a variety of factors, including overall loan demand, economic conditions, credit risk, the amount of nonearning assets including nonperforming loans and acquired credit impaired loans, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities, early withdrawal of deposits, exercise of call options on borrowings or securities, a general rise or decline in interest rates, changes in the slope of the yield-curve, and balance sheet growth or contraction.
Our results of operations are also affected by provisions for credit losses, noninterest income and noninterest expense. Our noninterest expense consists primarily of compensation and employee benefits, as well as office occupancy, data processing, deposit insurance, and general administrative expenses.
A discussion of our results of operations for the years ended December 31, 2017.2019, 2018 and 2017 follows.
Average Balance and Yields
The following tables set forth average balances, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, and have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
| December 31, | December 31, | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2017 | 2016 | 2015 | 2019 | 2018 | 2017 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Average | Income | Yield | Average | Income | Yield | Average | Income | Yield | Average | Income | Yield | Average | Income | Yield | Average | Income | Yield | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Balance | / Expense | / Rate | Balance | / Expense | / Rate | Balance | / Expense | / Rate | Balance | / Expense | / Rate | Balance | / Expense | / Rate | Balance | / Expense | / Rate | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Earning assets | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loans and leases:1 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial loans and leases | $ | 177,167 | $ | 8,113 | 4.58 | % | $ | 159,230 | $ | 7,738 | 4.86 | % | $ | 142,697 | $ | 6,948 | 4.89 | % | $ | 357,129 | $ | 17,880 | 5.01 | % | $ | 320,435 | $ | 16,017 | 5.00 | % | $ | 177,167 | $ | 8,113 | 4.58 | % | ||||||||||||||||||||||||||||||||||
| Commercial real estate | 373,972 | 17,584 | 4.70 | 323,868 | 15,506 | 4.79 | 269,412 | 14,422 | 5.35 | 667,557 | 33,424 | 5.01 | 610,111 | 30,328 | 4.97 | 373,972 | 17,584 | 4.70 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Construction and land | 79,177 | 3,813 | 4.82 | 72,061 | 3,369 | 4.68 | 65,508 | 3,121 | 4.76 | 121,156 | 6,782 | 5.60 | 107,962 | 5,917 | 5.48 | 79,177 | 3,813 | 4.82 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Residential real estate | 234,429 | 10,151 | 4.33 | 225,054 | 9,536 | 4.24 | 144,743 | 6,382 | 4.41 | 487,586 | 21,803 | 4.47 | 429,986 | 18,891 | 4.39 | 234,429 | 10,151 | 4.33 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Consumer | 4,475 | 252 | 5.64 | 4,561 | 249 | 5.45 | 4,257 | 258 | 6.07 | 50,017 | 2,471 | 4.94 | 44,361 | 2,289 | 5.16 | 4,475 | 252 | 5.64 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total loans and leases | 869,220 | 39,913 | 4.59 | 784,774 | 36,398 | 4.64 | 626,617 | 31,131 | 4.97 | 1,683,445 | 82,360 | 4.89 | 1,512,855 | 73,442 | 4.85 | 869,220 | 39,913 | 4.59 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loans held for sale | 35,065 | 1,300 | 3.71 | 43,206 | 1,467 | 3.40 | 47,691 | 1,706 | 3.58 | 30,276 | 1,195 | 3.95 | 38,261 | 1,567 | 4.09 | 35,065 | 1,300 | 3.71 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other earning assets2 | 41,953 | 397 | 0.95 | 36,918 | 185 | 0.50 | 24,365 | 63 | 0.26 | 63,806 | 1,094 | 1.71 | 69,103 | 1,083 | 1.57 | 41,953 | 397 | 0.95 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Securities:3 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| U.S. Treasury | 1,494 | 12 | 0.84 | 851 | 7 | 0.83 | 2,071 | 12 | 0.58 | - | - | 1,241 | 10 | 0.83 | 1,494 | 12 | 0.84 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| U.S Gov agencies | 50,002 | 581 | 1.16 | 41,899 | 194 | 0.46 | 33,989 | 117 | 0.34 | 85,421 | 2,376 | 2.78 | 72,659 | 1,507 | 2.07 | 50,002 | 581 | 1.16 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Mortgage-backed | 1,439 | 38 | 2.63 | 213 | 6 | 2.86 | 1,275 | 3 | 0.26 | 93,566 | 2,889 | 3.09 | 44,748 | 1,369 | 3.06 | 1,439 | 38 | 2.63 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Corporate debentures | 8,750 | 541 | 6.18 | 4,386 | 288 | 6.57 | 3,000 | 180 | 6.00 | 9,503 | 583 | 6.13 | 9,277 | 571 | 6.15 | 8,750 | 541 | 6.18 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other investments | 6,306 | 244 | 3.88 | 5,162 | 196 | 3.79 | 3,534 | 137 | 3.89 | 14,258 | 937 | 6.57 | 15,682 | 840 | 5.36 | 6,306 | 244 | 3.88 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total securities | 67,991 | 1,416 | 2.08 | 52,511 | 691 | 1.32 | 43,869 | 449 | 1.02 | 202,748 | 6,785 | 3.35 | 143,607 | 4,297 | 2.99 | 67,991 | 1,416 | 2.08 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total earning assets | 1,014,229 | 43,026 | 4.24 | 917,409 | 38,741 | 4.22 | 742,542 | 33,349 | 4.49 | 1,980,275 | 91,434 | 4.62 | 1,763,826 | 80,389 | 4.56 | 1,014,229 | 43,026 | 4.24 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Cash and due from banks | 8,903 | 7,529 | 7,342 | 13,970 | 16,928 | 8,903 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Bank premises and equipment, net | 19,673 | 20,569 | 16,145 | 43,823 | 45,830 | 19,673 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other assets | 35,815 | 30,704 | 20,329 | 221,764 | 177,056 | 35,815 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Less: allowance for credit losses | (5,677 | ) | (5,501 | ) | (3,917 | ) | (9,498 | ) | (6,166 | ) | (5,677 | ) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total assets | $ | 1,072,943 | $ | 970,710 | $ | 782,441 | $ | 2,250,334 | $ | 1,997,474 | $ | 1,072,943 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-bearing liabilities | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Deposits: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-bearing demand accounts | $ | 68,097 | 168 | 0.25 | % | $ | 57,846 | $ | 132 | 0.23 | % | $ | 48,465 | $ | 101 | 0.21 | % | $ | 199,091 | 912 | 0.46 | % | $ | 157,523 | $ | 554 | 0.35 | % | $ | 68,097 | $ | 168 | 0.25 | % | ||||||||||||||||||||||||||||||||||||
| Money market | 265,927 | 1,143 | 0.43 | 250,118 | 1,149 | 0.46 | 172,492 | 807 | 0.47 | 356,955 | 2,814 | 0.79 | 361,101 | 2,197 | 0.61 | 265,927 | 1,143 | 0.43 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Savings | 52,964 | 73 | 0.14 | 52,351 | 71 | 0.14 | 40,369 | 73 | 0.18 | 135,868 | 249 | 0.18 | 129,586 | 197 | 0.15 | 52,964 | 73 | 0.14 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Time deposits | 247,854 | 2,612 | 1.05 | 243,376 | 2,118 | 0.87 | 215,846 | 1,630 | 0.75 | 556,398 | 11,487 | 2.06 | 426,958 | 5,592 | 1.31 | 247,854 | 2,613 | 1.05 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total interest-bearing deposits | 634,842 | 3,997 | 0.63 | 603,691 | 3,470 | 0.57 | 477,172 | 2,611 | 0.55 | 1,248,312 | 15,462 | 1.24 | 1,075,168 | 8,540 | 0.79 | 634,842 | 3,997 | 0.63 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Short-term borrowings | 88,513 | 876 | 0.99 | 63,457 | 595 | 0.94 | 47,893 | 154 | 0.32 | 156,208 | 3,441 | 2.20 | 146,023 | 2,327 | 1.59 | 88,513 | 876 | 0.99 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Long-term borrowings | 8,967 | 294 | 3.28 | 28,285 | 497 | 1.76 | 22,881 | 307 | 1.34 | 86,367 | 3,221 | 3.73 | 101,488 | 2,904 | 2.86 | 8,967 | 294 | 3.28 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total interest-bearing funds | 732,322 | 5,167 | 0.71 | 695,433 | 4,562 | 0.66 | 547,946 | 3,072 | 0.56 | 1,490,887 | 22,124 | 1.48 | 1,322,679 | 13,771 | 1.04 | 732,322 | 5,167 | 0.71 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Noninterest-bearing deposits | 212,261 | 182,909 | 150,848 | 431,557 | 403,656 | 212,261 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other liabilities and accrued expenses | 4,597 | 6,147 | 7,505 | 22,965 | 5,064 | 4,597 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total liabilities | 949,180 | 884,489 | 706,299 | 1,945,409 | 1,731,399 | 949,180 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shareholders' equity | 123,763 | 86,221 | 76,142 | 304,925 | 266,075 | 123,763 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total liabilities & shareholders' equity | $ | 1,072,943 | $ | 970,710 | $ | 782,441 | $ | 2,250,334 | $ | 1,997,474 | $ | 1,072,943 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Net interest rate spread4 | $ | 37,859 | 3.54 | % | $ | 34,179 | 3.57 | % | $ | 30,277 | 3.93 | % | $ | 69,310 | 3.13 | % | $ | 66,618 | 3.52 | % | $ | 37,859 | 3.53 | % | ||||||||||||||||||||||||||||||||||||||||||||||
| Effect of noninterest-bearing funds | 0.20 | 0.16 | 0.15 | 0.37 | 0.26 | 0.20 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Net interest margin on earning assets5 | 3.73 | % | 3.73 | % | 4.08 | % | 3.50 | % | 3.78 | % | 3.73 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (1) | Loan fee income is included in the interest income calculation, and non-accrual loans are included in the average loan base upon which the interest rate earned on loans is calculated. |
| (2) | Includes Federal funds sold and interest-bearing deposits with banks. |
| (3) | Available for sale securities are presented at fair value, held to maturity securities are presented at amortized cost. |
| (4) | Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities. |
| (5) | Net interest margin represents net interest income divided by average total interest-earning assets. |
Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total of the changes set forth in the rate and volume columns are presented in the total column.
| For the year ended December 31, | For the year ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||||
| 2017 vs. 2016 | 2016 vs. 2015 | 2019 vs. 2018 | 2018 vs. 2017 | ||||||||||||||||||||||||||||||||||||||||||||
| Due to variances in | Due to variances in | Due to variances in | Due to variances in | ||||||||||||||||||||||||||||||||||||||||||||
| (in thousands) | Total | Rates | Volumes1 | Total | Rates | Volumes 1 | Total | Rates | Volumes1 | Total | Rates | Volumes1 | |||||||||||||||||||||||||||||||||||
| Interest earned on: | |||||||||||||||||||||||||||||||||||||||||||||||
| Loans and leases: | |||||||||||||||||||||||||||||||||||||||||||||||
| Commercial loans and leases | $ | 375 | $ | (334 | ) | $ | 709 | $ | 790 | $ | (47 | ) | $ | 837 | $ | 1,863 | $ | 21 | $ | 1,842 | $ | 7,904 | $ | 741 | $ | 7,163 | |||||||||||||||||||||
| Commercial real estate | 2,078 | (208 | ) | 2,286 | 1,084 | (1,528 | ) | 2,612 | 3,096 | 225 | 2,871 | 12,744 | 1,013 | 11,731 | |||||||||||||||||||||||||||||||||
| Construction and land | 444 | 76 | 368 | 248 | (58 | ) | 306 | 865 | 127 | 738 | 2,104 | 523 | 1,581 | ||||||||||||||||||||||||||||||||||
| Residential real estate | 615 | 157 | 458 | 3,154 | (249 | ) | 3,403 | 2,912 | 351 | 2,561 | 8,740 | 148 | 8,592 | ||||||||||||||||||||||||||||||||||
| Consumer | 3 | 7 | (4 | ) | (9 | ) | (26 | ) | 17 | 182 | (97 | ) | 279 | 2,037 | (21 | ) | 2,058 | ||||||||||||||||||||||||||||||
| Loans held for sale | (167 | ) | 101 | (268 | ) | (239 | ) | (87 | ) | (152 | ) | (372 | ) | (55 | ) | (317 | ) | 267 | 135 | 132 | |||||||||||||||||||||||||||
| Securities | 725 | 301 | 424 | 242 | 129 | 113 | 2,488 | 512 | 1,976 | 2,881 | 620 | 2,261 | |||||||||||||||||||||||||||||||||||
| Other earning assets | 212 | 123 | 89 | 122 | 59 | 63 | 11 | 100 | (89 | ) | 686 | 259 | 427 | ||||||||||||||||||||||||||||||||||
| Total interest income | 4,285 | 223 | 4,062 | 5,392 | (1,807 | ) | 7,199 | 11,045 | 1,184 | 9,861 | 37,363 | 3,418 | 33,945 | ||||||||||||||||||||||||||||||||||
| Interest paid on: | |||||||||||||||||||||||||||||||||||||||||||||||
| Savings deposits | 2 | 1 | 1 | (2 | ) | (18 | ) | 16 | |||||||||||||||||||||||||||||||||||||||
| Interest bearing checking | 37 | 8 | 29 | 31 | 10 | 21 | 358 | 170 | 188 | 386 | 69 | 317 | |||||||||||||||||||||||||||||||||||
| Money market accounts | (6 | ) | (55 | ) | 49 | 342 | (15 | ) | 357 | 617 | 644 | (27 | ) | 1,054 | 475 | 579 | |||||||||||||||||||||||||||||||
| Savings deposits | 52 | 43 | 9 | 124 | 6 | 118 | |||||||||||||||||||||||||||||||||||||||||
| Time deposits | 494 | 334 | 160 | 488 | 249 | 239 | 5,895 | 3,222 | 2,673 | 2,979 | 644 | 2,335 | |||||||||||||||||||||||||||||||||||
| Short-term borrowings | 281 | 25 | 256 | 441 | 296 | 145 | 1,114 | 895 | 219 | 1,451 | 534 | 917 | |||||||||||||||||||||||||||||||||||
| Long-term borrowings | (203 | ) | 323 | (526 | ) | 190 | 95 | 95 | 317 | 881 | (564 | ) | 2,610 | (38 | ) | 2,648 | |||||||||||||||||||||||||||||||
| Total interest expense | 605 | 636 | (31 | ) | 1,490 | 617 | 873 | 8,353 | 5,855 | 2,498 | 8,604 | 1,690 | 6,914 | ||||||||||||||||||||||||||||||||||
| Net interest earned | $ | 3,680 | $ | (413 | ) | $ | 4,093 | $ | 3,902 | $ | (2,424 | ) | $ | 6,326 | $ | 2,692 | $ | (4,672 | ) | $ | 7,363 | $ | 28,759 | $ | 1,728 | $ | 27,031 | ||||||||||||||||||||
(1) Change attributed to mix (rate and volume) are included in volume variance.
| (1) | Change attributed to mix (rate and volume) is included in volume variance. |
Comparison of Results of Operations
A comparison of the results of operations for the years ended December 31, 20172019 and December 31, 2016 is presented below.2018
General
NetOur net income availableincreased $20.7 million to common stockholders increased $2.1$16.9 million or 40%, to $7.2 million for the year ended December 31, 2017in 2019, compared to $5.1a net loss of $3.8 million for the year ended December 31, 2016.in 2018. The net loss in 2018 was primarily driven by $15.5 million of merger and restructuring expenses related to our March 1, 2018 merger with First Mariner, which were not repeated in 2019. The increase in net income available to common stockholdersin 2019 was also driven by increases of $3.7a $11.0 million increase in net interest income, compared to 2018, primarily from an increase in interest and $4.7 million in noninterest income,fees earned on loans and leases as a result of organic growth and a full-year impact of our merger with First Mariner, partially offset by increasesan $8.4 million increase in interest expense. In 2019, net income was also partially offset by $3.6 million of $6.5 millionexpense, included within occupancy and equipment expense, related to our branch optimization initiative that resulted in noninterest expense, of which nearly $600 thousand were merger-related expenses. Much of this revenue growththree branch closures in 2019, and the increased expenses are attributable toexpected consolidation of two additional branches in the balance sheet growth resultingfirst quarter of 2020. Our results for 2019 also included the proceeds from our continued strategic and organic growth initiatives.agreement to exit our mortgage banking activities (net of expenses recorded) of $462 thousand.
EarningsBoth our basic and diluted earnings per basic common share (“EPS”) for 2017 was $0.75were $0.89 in 2019, compared to $0.74 for 2016. Even though as noted above, net earnings for 2017 were 40.0% higher than for 2016, EPS only slightly increased primarily due to the larger numberboth a basic and diluted loss per common share of average shares outstanding$(0.22) in 2017 compared to 2016 resulting from our February 2017 stock offering. Average shares outstanding increased by over 2.6 million or 37% when comparing 2017 to 2016. Also impacting earnings per share for 2017 was approximately $567 thousand in merger-related expenses associated with the pending merger with First Mariner. We estimate that these merger costs, net of taxes, reduced earnings per share by approximately $0.04 for 2017.2018.
Interest Income
Interest income increased $4.3$11.0 million, or 11.1%13.7%, to $43.0$91.4 million for the year ended December 31, 2017in 2019, compared to $38.7$80.4 million during the year ended December 31, 2016. Thein 2018. $8.9 million of this increase was primarily dueattributable to a $3.5 million, or 10.0%, increase in interest and fees on loans and leases (excluding loans held for sale), and was primarily as a result of an $84.4 million or 10.8% increase in the average balance of portfolio loans, partially offset by a modest five basis point decrease in the average yield on our portfolio loans and leases, which resulted from decreases in the average rates earned on our commercial loans and leases and,attributable to a lesser extent, commercial real estate loans. Additionally, interest and dividends on investment securities increased $725 thousand and other interest income increased $212 thousand year over year as a result of increases in both the average balance and the average yield on these assets; the average yield on our securities portfolio increased 76 basis points and the average yield on our other interest earning assets increased 45 basis points year over year. Partially offsetting these increases was a decrease in income on loans held for sale of $167 thousand, or 11.4%, as a result of a decrease of $8.1 million inorganic loan growth with the average balance of our loans held for sale, partially offsetand leases up $170.6 million, or 11.3%, in 2019. Interest income was further aided by a 31 basisfour-basis point increase in the average yield on our loans held for sale. Overall,and leases, with increases in yields in all categories of loans other than consumer loans. The accretion of fair value adjustments in our loan portfolio added ten-basis points to the average yield on all interest earning assets during 2017 increased by 2 basis pointsloans in 2019, compared to 2016.15-basis points in 2018. Interest and dividends on investment securities increased $2.5 million in 2019 as a result of both an increase in average balances of $59.1 million and a 36-basis point increase in the average yield.
Interest Expense
Interest expense increased $605 thousand,$8.4 million, or 13.3%60.7%, to $5.2$22.1 million, during the year ended December 31, 2017 from $4.6in 2019, compared to $13.8 million during the prior year.in 2018. Interest expense on deposits increased by $527 thousand for 2017$6.9 million in 2019, compared to 2016,2018, with $288 thousand$3.9 million of the increase resulting from increases in the average volumes and $3.0 million resulting from increases in rates paid on interest-bearing deposits and $239 thousand of the increase resulting from the growth in the average balances of our interest-bearing deposits. These increaseincreases were driven primarilyinfluenced by the $4.5a $129.4 million increase in the average balance of time deposits and the 18 basisa corresponding 75-basis point increase in the rate paid on our time deposits; wesuch deposits. Average non-maturity interest bearing deposits increased $43.7 million with a 12-basis point increase in the average rate paid on such deposits. We increased the interest rates on our timeinterest-bearing deposits in response to the prevailing competitive rates in our market. The amortization of fair value adjustments in our interest-bearing liabilities, primarily in time deposits, reduced the market.rate on interest bearing liabilities by one-basis point in 2019, compared to six-basis points in 2018. Overall, the average interest rate paid on interest bearing deposits increased 45 basis points in 2019. In addition, interest expense on short- and long-term borrowings increased $78 thousandan aggregate of $1.4 million in 20172019, compared to 2016, primarily as2018, resulting from a result of increases in the average balance of our short-term borrowings and148-basis point increase in the average rate paid on our long-termsuch borrowings. The increase in average rates paid on borrowings partiallymore than offset by athe $4.9 million decrease in the average volume of our long-term borrowings. Average short-term borrowings increased by $25.1 million year over year while the average interest rate on these borrowings increased five basis points, and the average rate on long-term borrowings increased by 152 basis points as the average balance of our lower cost fixed rateshort- and long-term borrowings declined by $19.3 million, leaving only a small amount of higher cost long-term debt at the end of 2017.in 2019, compared to 2018.
Net Interest Income
Net interest income is our largest source of operating revenue. Net interest income is affected by various factors including changes in interest rates and the composition of interest-earning assets and interest-bearing liabilities and maturities. Net interest income is determined by the interest rate spread (i.e., the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income increased $3.7$2.7 million or 10.8%, duringin 2019, compared to 2018. The increase in net interest income, while up $7.3 million due to favorable volume variances, was offset by unfavorable rate variances of $4.6 million.
Our net interest margin was 3.50% in 2019, a decline of 28 basis points, compared to 3.78% in 2018. This decrease was primarily driven by a 44-basis point increase in the average rate paid on interest bearing liabilities, which more than offset the six-basis point increase in the average yield on interest earning assets. The net accretion of fair value adjustments added eight-basis points to our net interest margin in 2019, compared to 18-basis points in 2018.
Provision for Credit Losses
We recorded a provision for credit losses of $4.2 million for 2019, compared to $6.1 million for 2018, a decrease of $1.9 million. The decrease included the impact of a decrease in specific reserves from $2.4 million at December 31, 2018 to $500 thousand at December 31, 2019. The trend in our asset quality metrics indicate year over year improvement. Our nonperforming loans, as a percentage of gross loans, declined to 1.10% at 2019, from 1.50% at 2018, and nonperforming assets, as a percentage of total assets, declined to 0.94% at 2019 from 1.28% at 2018.
Notes 7 and 8 to our Consolidated Financial Statements as well as the Nonperforming and Problem Assets and Allowance for Credit Losses sections of this Management’s Discussion and Analysis provide additional information on our loan portfolio, asset quality, and the allowance for credit losses.
Noninterest Income
The following table presents the major categories of noninterest income for the years ended December 31, 20172019 and 2018:
| (in thousands) | 2019 | 2018 | $ Change | % Change | ||||||||||||
| Service charges on deposit accounts | $ | 2,747 | $ | 2,216 | $ | 531 | 24.0 | % | ||||||||
| Realized and unrealized gains on mortgage banking activity | 7,798 | 5,245 | 2,553 | 48.7 | ||||||||||||
| Gain (loss) on the sale of securities | 645 | (364 | ) | 1,009 | 277.2 | |||||||||||
| Loss on the disposal of bank premises & equipment | (70 | ) | (345 | ) | 275 | 79.7 | ||||||||||
| Income from bank owned life insurance | 1,858 | 1,614 | 244 | 15.1 | ||||||||||||
| Loan related fees and service charges | 3,934 | 5,624 | (1,690 | ) | (30.1 | ) | ||||||||||
| Other operating income | 4,122 | 3,870 | 252 | 6.5 | ||||||||||||
| Total noninterest income | $ | 21,034 | $ | 17,860 | $ | 3,174 | 17.8 | % | ||||||||
Noninterest income was $21.0 million for 2019, compared to $17.9 million for 2018. This increase was primarily driven by a $2.6 million increase in realized and unrealized gains on mortgage banking activity and the yearnet $1.0 million increase in gain (loss) on the sale of securities. While our mortgage loans originated for sale were down 2.2% in 2019, compared to 2018, our increase in realized and unrealized gains was up 48.7%. This represents an average gain on loans originated for sale of 1.36% in 2019, compared to 0.89% in 2018. The improvement in our average gain on loans originated for sale was the result of a stronger management focus on originating a more profitable product mix. The gain/(loss) on the sale of securities in 2019 and 2018, respectively, were both due to our interest rate positioning strategies at the time of the respective sales.
Service charges on deposit accounts, which consisted of account activity fees such as overdraft fees and other traditional banking fees, increased $531 thousand in 2019, compared to 2018, primarily as a result of increased overdraft activities resulting from deposit growth during 2019.
Other operating income, which consisted mainly of non-depository account fees such as wire, merchant card and ATM services, increased $252 thousand in 2019, compared to 2018. Reflected in 2019 other operating income was $750 thousand in revenue associated with the previously disclosed exit of our mortgage banking activities. In 2018, other operating income included a $750 thousand insurance refund.
Partially offsetting the above increases was a $1.7 million decrease in loan related fees and service charges. This decrease was primarily due to a $2.0 million reduction in underwriting and processing fees in 2019. Underwriting and processing fees from our mortgage banking activities decreased $2.3 million in 2019, compared to 2018. This reduction resulted from our decision to discontinue our national consumer direct origination channel in mid-2018. The loans originated from this channel generated substantially higher underwriting and processing fees per loan than comparable fees on loans originated from our retail origination channel.
Our mortgage banking activities generated total noninterest income of $10.6 million in 2019 and $10.2 million in 2018. The level of noninterest income generated by our mortgage banking activities will be substantially lower in 2020 as a result of our decision to exit all mortgage banking activities in early 2020.
Noninterest Expenses
The following table presents the major categories of noninterest expense for the years ended December 31, 2016.2019 and 2018:
| (in thousands) | 2019 | 2018 | $ Change | % Change | ||||||||||||
| Compensation and benefits | $ | 32,056 | $ | 33,674 | $ | (1,618 | ) | (4.8 | )% | |||||||
| Occupancy and equipment | 9,076 | 10,650 | (1,574 | ) | (14.8 | ) | ||||||||||
| Amortization of core deposit intangible | 3,013 | 2,856 | 157 | 5.5 | ||||||||||||
| Marketing and business development | 2,339 | 3,338 | (999 | ) | (29.9 | ) | ||||||||||
| Professional fees | 2,954 | 2,471 | 483 | 19.6 | ||||||||||||
| Data processing fees | 4,914 | 4,037 | 877 | 21.7 | ||||||||||||
| Merger and restructuring expense | - | 15,549 | (15,549 | ) | (100.0 | ) | ||||||||||
| FDIC assessment | 667 | 1,268 | (601 | ) | (47.4 | ) | ||||||||||
| Other real estate owned | 845 | 500 | 345 | 69.0 | ||||||||||||
| Loan production expense | 2,700 | 3,523 | (823 | ) | (23.3 | ) | ||||||||||
| Other operating expense | 5,514 | 5,246 | 268 | 5.1 | ||||||||||||
| Total noninterest expense | $ | 64,078 | $ | 83,112 | $ | (19,034 | ) | (22.9 | )% | |||||||
Noninterest expenses decreased $19.0 million, or 22.9%, to $64.1 million for 2019, compared to $83.1 million for 2018. This decrease was primarily driven by $15.5 million of merger and restructuring expenses related to our merger with First Mariner in 2018, which were not repeated in 2019.
Compensation and benefits expense are the largest component of our noninterest expenses, and decreased $1.6 million in 2019, compared to 2018. The primary driver of this decrease was decreases in staff related to our branch optimization initiative in 2019.
Occupancy and equipment expense decreased $1.6 million in 2019, compared to 2018. Following our merger with First Mariner in 2018, we evaluated our retail branch network, which resulted in the closing of several acquired and existing locations that we deemed to be redundant. In 2019, we continued to evaluate our branch delivery system and further optimized our branch locations. Because of our branch optimization efforts, we incurred $3.6 million and $2.7 million in lease termination and location closing costs in 2019 and 2018, respectively, partially offset by a reduction in lease liability expense on one branch location closed in 2019. These efficiencies also reduced general operating expenses (rent, janitorial, utilities, and depreciation) by $2.0 million in 2019, and equipment expenses (hardware and maintenance contracts and real estate taxes) by $281 thousand in 2019.
Marketing and business development expenses decreased by $1.0 million, or 29.9%, to $2.3 million in 2019. The 2018 expense level included $1.1 million of costs associated with mortgage lead generation from our former national leads-based consumer direct residential first lien mortgage origination channel that we discontinued in mid-2018.
Data processing fees consist of core system processors and banking network costs. These costs increased by $877 thousand to $4.9 million in 2019, from $4.0 million in 2018, resulting from the large growth in loan and deposit accounts primarily resulting from our merger with First Mariner, which increased our core processing cost, as well as improved technology to enhance product deliveries.
Our FDIC insurance expense was down $601 thousand in 2019. We received small bank assessment credits from the FDIC of $522 thousand in 2019, resulting from the Deposit Insurance Fund ratio exceeding 1.38%.
Other operating expenses consist mainly of a variety of general expenses such as telephone and data lines, supplies and postage, courier services, general insurance, and director fees. In aggregate, these expenses increased $268 thousand in 2019, compared to 2018, primarily as a result of a $700 thousand charge related to the settlement of a litigation claim related to mortgages originated by First Mariner before our acquisition of the bank and $692 thousand of prepayment penalties resulting from our early redemption of FHLB advances. Partially offsetting these increases was a $1.4 million reduction in various categories of other expense, due primarily to merger integration and branch optimization efficiencies.
Income Tax Expense
Income tax expense for 2019 was $5.2 million, compared to an income tax benefit in 2018 of $897 thousand. Our effective tax rate (income tax expense as a percentage of pretax income) was 23.5% in 2019 and 19.0% in 2018. The effective tax rate is influenced by sources of non-taxable income, such as the income from Bank Owned Life Insurance (“BOLI”) as well as certain non-deductible expense items. Certain merger and acquisition costs are deemed not deductible for income tax purposes, which impacted the effective tax rate for 2018. Income tax expense for 2019 was favorably impacted by a 2019 U.S. Treasury Department change in tax regulations that provided for retroactive application to the taxability of income from BOLI contracts that were acquired in certain tax-free merger transactions. As a result of the change in tax regulations, we recognized a $232 thousand net reduction of tax expense in 2019 pertained to BOLI income that was earned, and initially treated as subject to income tax, in 2018. Excluding the impact of the $232 thousand of BOLI income, the effective tax rate for 2019 would have been 24.5%.
Comparison of the years ended December 31, 2018 and December 31, 2017
General
We recorded a net loss for 2018 of $3.8 million, compared to net income of $7.2 million for 2017. The decrease in net income was primarily driven by $15.5 million of merger and restructuring expenses in 2018, compared to $567 thousand in 2017. Our basic and diluted loss per common share were both $(0.22) in 2018, compared to both basic and diluted income per common share of $0.75 in 2017. Average common shares outstanding increased 8.0 million in 2018, compared to 2017, as a result of the 9.1 million shares we issued on March 1, 2018 in connection with the First Mariner merger.
Interest Income
Interest income increased $37.4 million, or 86.8%, to $80.4 million for, 2018 compared to $43.0 million for 2017. $33.5 million of the increase was in interest and fees on loans and leases (excluding loans held for sale), due primarily to a $643.6 million, or 80.9%, increase in the average balance of our portfolio loans due primarily to the First Mariner merger. This asset growth was complimented by a 26-basis point increase in the average yield on our portfolio loans and leases, partially related to the 2018 increases in the prime lending rate. Interest and dividends on investment securities increased $2.9 million in 2018, compared to 2017, as a result of a 99-basis point increase in the average yield on our securities portfolio. Other interest income increased $686 thousand in 2018, compared to 2017, as a result of increases in both the average balance and the average yield on these assets. Overall, total average earning assets increased by $749.6 million, or 74%, in 2018, compared to 2017, and the average yield on all interest earning assets increased by 32 basis points.
Interest Expense
Interest expense increased $8.6 million, to $13.8 million, for 2018, from $5.2 million for 2017. Interest expense on deposits increased by $4.5 million in 2018, compared to 2017, with $3.3 million of the increase resulting from increases in average volumes and $1.2 million resulting from increase in rates paid on interest-bearing deposits. These increases were due largely to a $179.1 million increase in the average balance of time deposits and a corresponding 26-basis point increase in the rate paid on such deposits. In 2018, we increased the interest rates on our time deposits in response to the prevailing competitive rates in our market. In addition, interest expense on short- and long-term borrowings increased by an aggregate of $4.1 million in 2018, compared to 2017, primarily as a result of a $150.0 million increase in the average balance of such borrowings. The average rate paid on our short-term borrowings increased 60 basis points in 2018, compared to 2017, while the average rate paid on our long-term borrowings decreased 42 basis points. Because of the timing of the closing of our Notes offering in December 2018, the offering did not have a significant impact on interest expense in 2018.
Net Interest Income
Net interest income increased $28.8 million, or 76.0%, in 2018, compared to 2017. The increase in net interest income was primarily due to the increase in interest income driven by our continued balance sheet growth as discussed above, while successfully controllingrelated to the First Mariner merger, and our successful management of our interest expense even with the sizable growth in deposits and borrowings year over year.
Our net interest margin was 3.78% in 2018, an increase of five basis points, compared to 3.73% in 2017. This increase was primarily driven by a 34-basis point increase in the average rate paid on interest earnings assets, which more than offset the 33-basis point increase in the average yield on interest bearing liabilities.
Provision for Credit Losses
We establish a provision for credit losses, which is a charge to earnings, in order to maintain the allowance for credit losses at a level we consider adequate to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for credit losses, management considers past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of nonperforming loans. The amount of the allowance is based on estimates and actual losses may vary from such estimates as more information becomes available or economic conditions change. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as circumstances change or more information becomes available. The allowance for credit losses is assessed on at least a quarterly basis and provisions are made for credit losses as required in order to maintain the allowance.
Based on management’s evaluation of the above factors, we hadrecorded a provision for credit losses of $6.1 million in 2018, an increase of $4.3 million, compared to $1.8 million for 2017 compared to $2.0 million during 2016, a decrease of $206 thousand or 10.1%.in 2017. The provision level for 20162018 was impacted by an increased level of net charge-offs and a specific reserve of $2.4 million related to a long-term relationship.
Noninterest Income
The following table presents the migrationmajor categories of acquired loans into our allowance for credit losses measurement process, as well as some specific provisions on individual loans. Thus, even though we continued to experience organic loan growth, the mix of specific and general provisionsnoninterest income for the two years resulted in a provision for 2017 that was less than the provision in the prior year.ended December 31, 2018 and 2017:
Management analyzes the allowance for credit losses as described in the section entitled “Allowance for Credit Losses.” The provision that is recorded is sufficient, in management’s judgment, to bring the allowance for credit losses to a level that reflects the losses inherent in our loan portfolio relative to loan mix, economic conditions and historical loss experience. Management believes, to the best of its knowledge, that all known losses as of the balance sheet dates have been recorded. However, although management uses the best information available to make determinations with respect to the provisions for credit losses, additional provisions for credit losses may be required to be established in the future should economic or other conditions change substantially. In addition, as an integral part of their examination process, the Commissioner and the FDIC will periodically review the allowance for credit losses. The Commissioner and the FDIC may require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination.
Noninterest Income
| (in thousands) | 2018 | 2017 | $ Change | % Change | ||||||||||||
| Service charges on deposit accounts | $ | 2,216 | 923 | $ | 1,293 | 140.1 | % | |||||||||
| Realized and unrealized gains on mortgage banking activity | 5,245 | 11,035 | (5,790 | ) | (52.5 | ) | ||||||||||
| Gain (loss) on the sale of securities | (364 | ) | - | (364 | ) | N/M | ||||||||||
| Gain on the sale of portfolio loans | - | 86 | (86 | ) | (100.0 | ) | ||||||||||
| Loss on the disposal of bank premises & equipment | (345 | ) | (13 | ) | (332 | ) | (2,553.8 | ) | ||||||||
| Income from bank owned life insurance | 1,614 | 760 | 854 | 112.4 | ||||||||||||
| Loan related fees and service charges | 5,624 | 5,722 | (98 | ) | (1.7 | ) | ||||||||||
| Other operating income | 3,870 | 1,011 | 2,859 | 282.8 | ||||||||||||
| Total noninterest income | $ | 17,860 | $ | 19,524 | $ | (1,664 | ) | (8.5 | )% | |||||||
Noninterest income was $17.9 million for 2018, compared to $19.5 million for the year ended December 31, 2017 compared to $14.8 million for the year ended December 31, 2016.2017. The primary reason for the increasedecrease in noninterest income was primarily driven by reductions in our mortgage banking activities. As a resultSoon after the First Mariner merger, management announced the discontinuation of the national leads-based consumer direct unit of our mortgage division and a de-emphasis on mortgage operations to mitigate the inherent volatility of this business line, both of which resulted in a reduction of origination levels for 2018 and subsequent salesthe corresponding decrease in mortgage based noninterest income. We account for both our loans held for sale as well as our interest rate locks using the fair value approach, and under this methodology, revenues are negatively impacted when the levels of residential mortgageeither of these decline. Because of the overall reduction in the levels of originations and the fair value accounting for loans held for sale and interest rate locks our overall mortgage-based revenue declined by $5.8 million for 2018, compared to 2017, as reflected in the decrease in realized and unrealized gains on the sale of loans produced approximately $11.0 million in noninterest revenues during 2017 compared to $8.1 million in 2016. Complementing the realized and unrealized gains on sale of mortgage loans was loan fee income derived from mortgage banking processing and underwriting as well as other portfolio loan fees. Loan fees realized in 2017 were $5.7 million compared to $3.9 million during 2016 as a result of both an increase in the number of loans originated and a higher fee structure during 2017 compared to 2016.
Partially offsetting these increases was a reduction in gain on the sale of portfolio loans, which for 2016 consisted of the sale of an acquired impaired loan that resulted in a gain of approximately $675 thousand. The $86 thousand net gain recorded in 2017 is comprised of a $222 thousand gain related to the sale of the guaranteed portion of small business loans held in our portfolio, partially offset by a $136 thousand loss on the sale of residential mortgages held in our portfolio that were carried at fair value. The gain recorded in 2016 benefited from a $652 thousand gain on the sale of an acquired impaired loan during the second quarter of 2016, partially offset by a $120 thousand loss on residential loans sold in the fourth quarter of 2016 that were classified as held for investment.
In 2016 we sold stock in a small financial institution, resulting in a gain of $96 thousand; there were no such securities sales in 2017.activity.
Service charges on deposit accounts which consist of account activity fees such as overdraft fees and other traditional banking fees, increased $229 thousand period over period,$1.3 million, in 2018, compared to 2017, primarily as a result of increased overdraft feesactivities resulting from theboth acquired and organic deposit growth we continue to experiencegrowth.
Earnings on bank owned life insurance (“BOLI”)BOLI increased $137$854 thousand during 2017in 2018, compared to 20162017, as a result of our acquisition of $44.8 million of additional BOLI in the Bank purchasing an additional $6.5 million in BOLI early in 2017.First Mariner merger.
Other operating income, which consistsconsisted mainly of non-depository account fees such as wire, merchant card and ATM services, increased $91 thousand$2.6 million in 20172018, compared to 20162017, due to increased transaction volumes resultingprimarily from our larger customer base.the First Mariner merger.
Partially offsetting the above increases was a $332 thousand loss in 2018 on the disposal of certain fixed assets that were part of the exit cost associated with the First Mariner merger and reorganization strategies and a $364 thousand loss on the sale of securities in 2018.
Noninterest Expenses
The following table presents the major categories of noninterest expense for the years ended December 31, 2018 and 2017:
| (in thousands) | 2018 | 2017 | $ Change | % Change | ||||||||||||
| Compensation and benefits | $ | 33,674 | 23,573 | $ | 10,101 | 42.8 | % | |||||||||
| Occupancy and equipment | 10,650 | 4,154 | 6,496 | 156.4 | ||||||||||||
| Amortization of core deposit intangible | 2,856 | 505 | 2,351 | 465.5 | ||||||||||||
| Marketing and business development | 3,338 | 4,231 | (893 | ) | (21.1 | ) | ||||||||||
| Professional fees | 2,471 | 1,968 | 503 | 25.6 | ||||||||||||
| Data processing fees | 4,037 | 2,038 | 1,999 | 98.1 | ||||||||||||
| Merger and restructuring expense | 15,549 | 567 | 14,982 | 2,642.3 | ||||||||||||
| FDIC assessment | 1,268 | 650 | 618 | 95.1 | ||||||||||||
| Other real estate owned | 500 | 655 | (155 | ) | (23.7 | ) | ||||||||||
| Loan production expense | 3,523 | 3,743 | (220 | ) | (5.9 | ) | ||||||||||
| Other operating expense | 5,246 | 3,116 | 2,130 | 68.4 | ||||||||||||
| Total noninterest expense | $ | 83,112 | $ | 45,200 | $ | 37,912 | 83.9 | % | ||||||||
Noninterest Expenses
Controlling costs and maintaining operational efficiencies remains a primary focus for us. A key performance measure is the overall efficiency ratio. The efficiency ratio is calculated by dividing noninterest expenses by the sum of net interest income and noninterest income. The efficiency ratio was 78.77% for the year ended December 31, 2017 compared to 79.01% for the year ended December 31, 2016. Noninterest expenses increased $6.5$37.9 million, or 16.8%83.9%, to $83.1 million for 2018, compared to $45.2 million for 2017. The First Mariner merger had the year ended December 31, 2017most significant impact on noninterest expenses in 2018. Merger and restructuring expense were $15.5 million in 2018, compared to $38.7 million for the year ended December 31, 2016.$567 thousand in 2017.
Compensation and benefits expenses remainexpense are the largest component of noninterest expenses. Compensationexpenses, and benefits expenses grew by $4.5$10.1 million, or 23.9%42.9%, for 2017 versus 2016.2018, compared to 2017. The primary driver of thethis increase in compensation and benefits was the expanded size of our operational sales and branch staff in particular, in our mortgage division, and, to a lesser extent, increasedresulting from the First Mariner merger. In 2018, employee insurance cost, primarily health insurance. Insurance costcosts increased $462$563 thousand, or 25.0% comparing 2017 with 2016.employee related tax expense increased $654 thousand, and other employee benefits increased $356 thousand.
Occupancy and equipment related costs decreased slightly, by $468 thousand, during 2017expense increased $6.5 million in 2018, compared to 2016. The Bank reevaluated its2017. Following our First Mariner merger in 2018, we evaluated our retail branch network, and latewhich resulted in the second quarterclosing of 2016several acquired and existing locations that we deemed to be redundant. At the time of the First Mariner merger, we operated 14 branches and First Mariner operated 13 branches. At year-end 2018, we had closed three locations,as digital banking use continues to increasesix branches and bank branch transaction levels at these locations had been decreasing. Further, in early 2016, we incurred approximately $500 thousand in costs to exit lease agreements related to the three closed locations, which increased occupancy costs for 2016 and for which there was no comparable expense in 2017. In late 2017 we opened a new Remington branch location in Baltimore City, Maryland and plan to consolidate our Hampden location into Remingtonscheduled closing in the first quarter 2018. Additionally,of 2019. Because of these efforts, in early 2018, we plan to open our new Columbia branchincurred $2.7 million in Howard County, Maryland. As a result, we expect occupancylease termination and location closing costs. General operating expenses (rental, janitorial, maintenance, taxes and depreciation) increased $3.1 million in 2018, and equipment expenses to be slightly higher(hardware, maintenance contracts and depreciation) increased $704 thousand in 2018.
In the First Mariner merger, we recorded a $12.3 million core deposit intangible, which is amortized against noninterest expenses using an accelerated amortization schedule, which increased our core deposit intangible amortization expense by $2.4 million for 2018, than they were incompared to 2017.
As we have continuedData processing fees consist of core system processors and banking network costs. These costs increased $2.0 million, or 98.1%, in 2019 to grow, many of our noninterest expenses have increased to support our expanding infrastructure,$4.0 million, from $2.0 million in 2017, resulting from the large growth initiativesin loan and enhanced delivery strategies. Cost increases related to this expansion year over year include: marketing and business development - $856 thousand driven by mortgage-related marketing and business development expenses increases; data processing - $315 thousand relating to normal service provider increases; and merger related expense - $567 thousand as the result of activities related todeposit accounts staff resulting from the First Mariner acquisition.
Loan production expense, which includes costs related to originating,merger. 2018 data processing expenses were also inflated as we were running dual core processing systems from the closing and securitizing loans, including both loans placed in our portfolio and loans held for sale, increased $727 thousand to $3.7 million in 2017 from $3.0 million during 2016 as a result of the increased numberFirst Mariner merger in March 2018 until the conversion and integration of loans originated, both for sale and to retaineach business onto one consolidated platform, which occurred in our portfolio, during 2017 compared to 2016.
Other real estate owned (“OREO”) expenses increased $558 thousand, to $655 thousand during 2017 from $97 thousand in 2016. This increase was primarily driven by valuation adjustments of $581 thousand on OREO properties upon receipt of updated appraisals. We have contracts for the sale of two OREO properties that we expect, upon closing, to reduce our OREO by $1 million, which would represent a 68% reduction from 2017 OREO levels. We anticipate that these two sales will occur in the second quarter ofMay 2018.
Other operating expenses consistconsisted mainly of a variety of general expenses such as telephone and data lines, supplies and postage and courier services. In aggregate, these expenses decreased slightly, by $170 thousand, year over year. Supportingincreased $2.1 million, in 2018, compared to 2017, as a result of the increased costs to support our expanding infrastructure increasedinfrastructure. In 2018, compared to 2017, we saw increases in software licensing cost by $202 thousand. This increase was offset by decreases resulting from our eliminating redundanciesof $687 thousand, telephone and controlling costs during 2017, which resulted in year over year decreasesdate line cost of $26$243 thousand, in materials and supplies, $94 thousand in phone and data lines and $22 thousand in bankarmored carrier, security and armored carrier services. Additionally, as core deposit intangibles continue to amortize,postage expenses related to this amortization decreased $149of $203 thousand year over year.and general supplies and operating costs of $246 thousand.
Income Tax Expense
Taking into consideration the above-stated changes in net interestWe recorded an income the provisiontax benefit for credit losses, and our noninterest2018 of $897 thousand, compared to an income and noninterest expense levels, pretax income increased by $2.1 million from $8.2 million in 2016 to $10.4 million in 2017.
Income tax expense amounted toin 2017 of $3.2 million for year ended December 31, 2017million. Our effective tax rate (income tax expense as a percentage of pretax income) was 19.0% in 2018 and $2.9 million for year ended December 31, 2016.30.4% in 2017. The effective tax rate is influenced by sources of non-taxable income, such as the income from our BOLI program, and also byBank Owned Life Insurance (“BOLI”) as well as certain non-deductible expense items. Certain merger and acquisition costs are deemed not deductible for income tax purposes, which increasedimpacted the effective tax rate for 2017. Income2018. The lower effective tax expense for 2017rate in 2018 was impacted by the adjustment of our deferred tax assets and liabilities relateddue to the reduction in the U.S. federal statutorylower corporate income tax rate to 21% underrates enacted late in 2017 in conjunction with theTax Cuts and Jobs Act which was(“TCJA”).Among other things, the TCJA, enacted on December 22, 2017. As a result of2017, lowered the new law, which is more fully discussed below, we recognized net tax expense of $215 thousand. Income tax expense for 2017 was also impacted by a correction of an overstatement of taxes that resulted from incorrectly classifying certain acquired loan fair value adjustments on purchased credit impaired loans. As a result we recognized tax benefits totaling $622 thousand related to the 2015 through 2016 tax years, as detailed in the table in Note 13 to the Consolidated Financial Statements, “Income Taxes.” As a result of these effects, our effective tax rate decreased to 30.4% for 2017 from 35.6% for 2016.
Tax Cuts and Jobs Act.The Tax Cuts and Jobs Act was enacted on December 22, 2017. Among other things, the new law (i) establishes a reduced, flat corporate federal statutory income tax rate of 21%, (ii) eliminates from the prior maximum corporate alternative minimum tax and allows the userate of any tax net operating loss carryforwards to offset regular tax liability35%; for any taxable year, (iii) limits the deduction for net interest expense incurred by U.S. corporations, (iv) allows businesses to immediately expense, for tax purposes, the cost of new investments in certain qualified depreciable assets, (v) eliminates or reduces certain deductions related to meals and entertainment expenses, (vi) modifies the limitation on excessive employee remuneration to eliminate the exception for performance-based compensation and clarifies the definition of a covered employee and (vii) limits the deductibility of deposit insurance premiums. The Tax Cuts and Jobs Act also significantly changes U.S. tax law related to foreign operations, however, such changes do not currently impact us.
A comparison of the results of operations for the years ended December 31, 2016 and December 31, 2015 is presented below.
General
Net income available to common stockholders increased $4.1 million, to $5.1 millionus, this change was effective for the year ended December 31, 2016 compared to $1.0 million for the year ended December 31, 2015. The increase in net income available to common stockholders was driven by increases of $5.3 million in interest income and $2.9 million in noninterest income, partially offset by increases of $1.5 million in interest expense, $201 thousand in the provision for credit losses and $432 thousand in noninterest expense. Much of this revenue growth and the increased expenses are attributable to the balance sheet growth resulting from our continued strategic and organic growth initiatives. For 2016, the dividends paid on preferred stock totaled $166 thousand compared to $126 thousand for 2015.
Interest Income
Interest income increased $5.4 million, or 16.2%, to $38.7 million for the year ended December 31, 2016 compared to $33.3 million during the year ended December 31, 2015. The increase was almost entirely due to a $5.0 million, or 15.3%, increase in interest and fees on loans and leases (including loans held for sale). The increase in interest and fees on loans and leases was a result of an increase of $158.2 million in average loans outstanding for 2016 versus 2015, largely attributable to the loans we acquired in the Patapsco Bancorp acquisition, partially offset by a decrease in the average yield on such loans. The average yield on loans and leases decreased to 4.64% from 4.97% year over year and the average yield on loans held for sale decreased to 3.40% from 3.58%, reflective of competitive conditions with respect to loan pricing that required us to lower our interest rates on loans. Commercial real estate loans reflected the largest decline in yield and was impacted by our large growth in this category with much of the growth recorded at reduced interest rates given the highly competitive pricing in our marketplace. In addition, interest income earned on investment securities increased $242 thousand as the average yield on investment securities increased to 1.32% from 1.02%, primarily as a result of changes in the portfolio mix. In addition, other interest income increased $122 thousand to $185 thousand during the year ended December 31, 2016 compared to $63 thousand during the prior year. This increase was a result of increases in both the average balance and average yield on other earning assets, which increased $12.6 million and 24 basis points, respectively, year over year. The average balance increase was a result of the Bank’s $19.5 million investment in interest bearing certificates of deposit at other financial institutions.
Interest Expense
Interest expense increased $1.5 million, or 48.5%, to $4.6 million during the year ended December 31, 2016 from $3.1 million during the prior year. Interest expense on deposits increased $859 thousand or 32.9% as a result of the $126.5 million or 26.5% increase in average interest-bearing deposits we experienced, largely attributable to the deposits we acquired in the Patapsco Bancorp acquisition. Overall, the average rate paid on our interest-bearing deposits remained relatively unchanged year over year. Average money market balances grew 45.0%, while the average rate on these deposits decreased slightly in 2016.
Interest expense on borrowings increased $631 thousand comparing 2016 to 2015, as a result of increases in both the average volume of and average rate on our borrowings. There were two main reasons for these increases. The first was an increase in the average balance of and average rate on our long-term borrowings resulting from the $3.4 million of debt we assumed in the Patapsco Bancorp acquisition and increases in FHLB advances. The second was the increase in the average balance of and the average rate paid on our short-term borrowings resulting from the $12.6 million variable rate debt we incurred to fund the redemption of our outstanding preferred stock as discussed above. It is important to note that while our Series AA Preferred Stock was outstanding we were paying a dividend on the stock, which was not a component of interest expense, while the additional $12.6 million in borrowings used to redeem the preferred stock has associated interest payments, and therefore was a component of interest expense during 2016.
Net Interest Income
Net interest income increased $3.9 million, or 12.9%, during the year ended December 31, 2016 compared to the year ended December 31, 2015. The increase in net interest income was primarily due to an increase in interest income driven by our continued balance sheet growth, while controlling interest expense even with the sizable growth in deposits and borrowings.
Provision for Credit Losses
Based on management’s evaluation of the relevant factors, as discussed above, we had a provision for credit losses of $2.0 million for 2016 compared to $1.8 million during 2015, an increase of $201 thousand or 11%. The increased provision for credit losses during 2016 resulted primarily from the 9% growth of our loan portfolio and also included the migration of acquired loans from previous years into our allowance for credit loss measurements. The provision for 2016 reflects general provisions on loans that are collectively evaluated given the continued growth in the size of our loan portfolio, as well as any specific provisions required on loans that are individually evaluated and deemed to be impaired.
Noninterest Income
Noninterest income was $14.8 million for the year ended December 31, 2016 compared to $11.9 million for the year ended December 31, 2015. The primary reason for the increase in noninterest income was our mortgage banking activity. As a result of the origination and subsequent sales of residential mortgage loans, realized and unrealized gains on the sale of loans produced approximately $8.1 million in noninterest revenues for 2016 compared to $7.0 million in 2015. Complementing the realized and unrealized gains on sale of mortgage loans was loan fee income derived from mortgage banking processing and underwriting as well as other portfolio loan fees. The loan fees realized in 2016 were $3.9 million compared to $2.9 million for 2015 given both the increase in the number of loans originated and a higher fee structure for 2016 versus 2015.
In addition, the Bank benefited from a $652 thousand gain on the sale of an acquired impaired loan during the second quarter of 2016, partially offset by a $120 thousand loss on residential loans sold in the fourth quarter of 2016 that were classified as held for investment. Howard Bancorp had held stock in a small financial institution that we sold, resulting in a gain of $96 thousand, in 2016. In the second quarter the Bank closed three branch locations, two of which were previously acquired in acquisitions. Related to these closings the Bank recorded a $70 thousand loss on the disposal of furniture and equipment. In the fourth quarter of 2016 the Bank recorded a loss of $14 thousand on the sale of one property that was held in OREO compared to a loss of $8 thousand in 2015. Net gain on sales of loans other than loans held for sale totaled $623 thousand in 2016; there were no sales of loans other than loans held for sale in 2015.
Service charges on deposit accounts decreased $79 thousand during 2016. This decrease was partially a result of lower overdraft fee income.
Further, earnings on BOLI increased $215 thousand during 2016 compared to 2015 as a result of the Bank purchasing an additional $2.2 million in BOLI in January 2016 and the full year of earnings on the BOLI acquired in the Patapsco Bancorp acquisition.
Other operating income increased $116 thousand in 2016 compared to the same period of 2015 due to increased transaction volumes resulting from our larger customer base.
Noninterest Expenses
The efficiency ratio was 79.01% for the year ended December 31, 2016 compared with 90.64% for the year ended December 31, 2015, which decrease was primarily the result of the 2015 figure including costs related to the Patapsco Bancorp acquisition. Noninterest expenses remained relatively stable, increasing $432 thousand, or 1.1%, to $38.7 million for the year ended December 31, 2016 compared to $38.3 million for the year ended December 31, 2015. While the Patapsco Bancorp merger costs accounted for $ 4.3 million of 2015 expenses, the integration and operation of the acquired business was the primary driver of increased operating expenses for 2016.
Compensation and benefits expenses remain the largest component of noninterest expenses. Compensation and benefits expenses grew by $1.8 million or 10.7% for 2016 versus 2015. The increased compensation and benefit costs are attributed to a full year of operation with the branches and staff acquired in the Patapsco Bancorp acquisition, compared to four months of 2015, signing incentives and onboarding costs related to our successfully attracting a sizable commercial loan origination team, as well as a higher level of expenses associated with our mortgage banking activities throughout 2016.
Occupancy and equipment related costs increased by $806 thousand during 2016 compared to 2015, primarily as a result of the $500,000 in costs to exit lease agreements related to our closure of three branch locations in the second quarter of 2016.
Continued growth initiatives and the implementation of new products continued to result in increases in many of our noninterest expenses during 2016. Cost increases related to this expansion year over year include: marketing and business development - $514 thousand; professional fees - $633 thousand; data processing - $370 thousand; and FDIC assessment - $327 thousand.
Loan production expense increased $793 thousand to $3.0 million during 2016 as a result of the increased number of loans originated during 2016 compared to 2015.
We recorded a valuation write-down of $83 thousand on one OREO property in 2016 while in 2015 we had $736 thousand in similar write-downs related to three OREO properties.
Other operating expenses in aggregate, these expenses decreased slightly, by $45 thousand, year over year. Supporting our expanding infrastructure increased insurance cost by $135 thousand, customer service expenses by $191 thousand and other operating expenses by $13 thousand. These increases were offset by decreases in other operating expenses resulting from our eliminating redundancies and controlling costs during 2016, which reduced materials and supplies by $169 thousand, postage by $48 thousand, phone and data lines by $8 thousand, bank security and armored carrier by $43 thousand and software licenses and maintenance by $56 thousand.2018.
Nonperforming and Problem Assets
Management performsWe perform reviews of all delinquent loans and our loan officers contact customers to attempt to resolve potential credit issues in a timely manner. When in the best interests of Howard Bank and the customer, we will enter into a troubled debt restructuring with respect to a particular loan. When not possible, we seek to aggressively move loans through the legal and foreclosure process within applicable legal constraints.
Loans are placed on non-accrual status when payment of principal or interest is 90 days or more past due and the value of the collateral securing the loan, if any, is less than the outstanding balance of the loan. Loans are also placed on non-accrual status if management haswe have serious doubt about further collectability of principal or interest on the loan, even though the loan is currently performing. When loans are placed on a non-accrual status, unpaid accrued interest is fully reversed, and furthersubsequent income, if any, is recognized only to the extent received. The loan may be returned to accrual status if the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time and ultimate collectability of the total contractual principal and interest is no longer in doubt.
Under GAAP we are required to account for certain loan modifications or restructurings as troubled debt restructurings (“TDRs”). In general, the modification or restructuring of a debt constitutes a TDR if we, for economic or legal reasons related to the borrower’s financial difficulties, grant a concession, such as a reduction in the effective interest rate, to the borrower that we would not otherwise consider. However, all debt restructurings or loan modifications for a borrower do not necessarily constitute troubled debt restructurings. We believe loan modifications will potentially result in a lower level of loan losses and loan collection costs than if we proceeded immediately through the foreclosure process with these borrowers.
The table below sets forth the amounts and categories of our nonperforming assets, which consist of non-accrual loans, troubled debt restructurings and OREO (which includes real estate acquired through, or in lieu of, foreclosure), at the dates indicated.
| December 31, | ||||||||||||||||||||
| (in thousands) | 2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
| Non-accrual loans: | ||||||||||||||||||||
| Real estate loans: | ||||||||||||||||||||
| Construction and land | $ | 637 | $ | - | $ | - | $ | 1,144 | $ | - | ||||||||||
| Residential - first lien | 1,722 | 491 | 693 | 719 | 331 | |||||||||||||||
| Residential - junior lien | 396 | 37 | 63 | 57 | - | |||||||||||||||
| Commercial | 6,375 | 1,584 | 1,148 | - | 258 | |||||||||||||||
| Commercial and leases | 3,438 | 4,624 | 5,935 | 2,015 | 2,593 | |||||||||||||||
| Consumer | - | 167 | 150 | 92 | - | |||||||||||||||
| Total non-accrual loans | 12,568 | 6,903 | 7,989 | 4,027 | 3,182 | |||||||||||||||
| Accruing troubled debt restructured loans: | ||||||||||||||||||||
| Real estate loans: | ||||||||||||||||||||
| Construction and land | 125 | 125 | - | - | - | |||||||||||||||
| Residential - first lien | 287 | 294 | 301 | - | - | |||||||||||||||
| Commercial | - | 2,073 | 2,073 | 226 | - | |||||||||||||||
| Commercial and leases | 208 | 183 | 7 | - | - | |||||||||||||||
| Total accruing troubled debt restructured loans | 620 | 2,675 | 2,381 | 226 | - | |||||||||||||||
| Total non-performing loans | 13,188 | 9,578 | 10,370 | 4,253 | 3,182 | |||||||||||||||
| Other real estate owned: | ||||||||||||||||||||
| Land | 956 | 1,220 | 964 | 595 | 595 | |||||||||||||||
| Commercial | 593 | 1,130 | 1,405 | 1,877 | 1,782 | |||||||||||||||
| Total other real estate owned | 1,549 | 2,350 | 2,369 | 2,472 | 2,377 | |||||||||||||||
| Total non-performing assets | $ | 14,737 | $ | 11,928 | $ | 12,739 | $ | 6,725 | $ | 5,559 | ||||||||||
| Ratios: | ||||||||||||||||||||
| Non-performing loans to total gross loans | 1.41 | % | 1.17 | % | 1.37 | % | 0.77 | % | 0.79 | % | ||||||||||
| Non-performing assets to total assets | 1.28 | % | 1.16 | % | 1.35 | % | 0.97 | % | 1.11 | % | ||||||||||
| Loans past due 90 days still accruing: | ||||||||||||||||||||
| Real estate loans: | ||||||||||||||||||||
| Construction and land | $ | - | $ | 1 | $ | 15 | $ | 278 | $ | - | ||||||||||
| Residential - first lien | 328 | 298 | 941 | 158 | - | |||||||||||||||
| Residential - junior lien | 50 | - | 30 | - | - | |||||||||||||||
| Commercial | 3,094 | 2,703 | 681 | 150 | 159 | |||||||||||||||
| Commercial and leases | - | - | 147 | 571 | 296 | |||||||||||||||
| Consumer | - | 1 | 2 | - | - | |||||||||||||||
| $ | 3,472 | $ | 3,003 | $ | 1,816 | $ | 1,157 | $ | 455 | |||||||||||
| December 31, | ||||||||||||||||||||
| (in thousands) | 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
| Non-accrual loans: | ||||||||||||||||||||
| Real estate loans: | ||||||||||||||||||||
| Construction and land | $ | 481 | $ | 1,323 | $ | 637 | $ | - | $ | - | ||||||||||
| Residential - first lien | 12,162 | 12,278 | 1,722 | 491 | 693 | |||||||||||||||
| Residential - junior lien | 786 | 1,137 | 396 | 37 | 63 | |||||||||||||||
| Commercial owner occupied | 566 | 1,268 | 508 | 509 | 232 | |||||||||||||||
| Commercial non-owner occupied | 1,725 | 5,018 | 5,867 | 1,075 | 916 | |||||||||||||||
| Commercial and leases | 1,960 | 2,417 | 3,438 | 4,624 | 5,935 | |||||||||||||||
| Consumer | 127 | 174 | - | 167 | 150 | |||||||||||||||
| Total non-accrual loans | 17,807 | 23,615 | 12,568 | 6,903 | 7,989 | |||||||||||||||
| Accruing troubled debt restructured loans: | ||||||||||||||||||||
| Real estate loans: | ||||||||||||||||||||
| Construction and land | - | 125 | 125 | 125 | - | |||||||||||||||
| Residential - first lien | 968 | 982 | 287 | 294 | 301 | |||||||||||||||
| Commercial non-owner occupied | - | - | - | 2,073 | 2,073 | |||||||||||||||
| Commercial and leases | 367 | - | 208 | 183 | 7 | |||||||||||||||
| Total accruing troubled debt restructured loans | 1,335 | 1,107 | 620 | 2,675 | 2,381 | |||||||||||||||
| Total non-performing loans | 19,142 | 24,722 | 13,188 | 9,578 | 10,370 | |||||||||||||||
| Other real estate owned: | ||||||||||||||||||||
| Land | 1,559 | 1,772 | 956 | 1,220 | 964 | |||||||||||||||
| Residential - first lien | 1,344 | 1,062 | - | - | - | |||||||||||||||
| Commercial non-owner occupied | 195 | 1,558 | 593 | 1,130 | 1,405 | |||||||||||||||
| Total other real estate owned | 3,098 | 4,392 | 1,549 | 2,350 | 2,369 | |||||||||||||||
| Total non-performing assets | $ | 22,240 | $ | 29,114 | $ | 14,737 | $ | 11,928 | $ | 12,739 | ||||||||||
| Ratios: | ||||||||||||||||||||
| Non-performing loans to total gross loans | 1.10 | % | 1.50 | % | 1.41 | % | 1.17 | % | 1.37 | % | ||||||||||
| Non-performing assets to total assets | 0.94 | % | 1.28 | % | 1.28 | % | 1.16 | % | 1.35 | % | ||||||||||
| Loans past due 90 days still accruing: | ||||||||||||||||||||
| Real estate loans: | ||||||||||||||||||||
| Construction and land | $ | - | $ | 351 | $ | - | $ | 1 | $ | 15 | ||||||||||
| Residential - first lien | 47 | 570 | 328 | 298 | 941 | |||||||||||||||
| Residential - junior lien | - | - | 50 | - | 30 | |||||||||||||||
| Commercial owner occupied | - | - | 131 | - | 236 | |||||||||||||||
| Commercial non-owner occupied | - | - | 2,963 | 2,703 | 445 | |||||||||||||||
| Commercial and leases | - | - | - | - | 147 | |||||||||||||||
| Consumer | - | - | - | 1 | 2 | |||||||||||||||
| $ | 47 | $ | 921 | $ | 3,472 | $ | 3,003 | $ | 1,816 | |||||||||||
Included in total non-accrual loans at December 31, 2017 shown above2019 are seven troubled debt restructured loans (“TDRs”)five TDRs with a net carrying balance totaling $4.7 million$813 thousand that were not performing in accordance with their modified terms, and the accrual of interest has ceased. Four of these loans were added to the non-accruing TDRs in 2017 - three residential real estate loans, two first lien loans totaling $886 thousand and a junior lien loan in the amount of $398 thousand, and aThere was one new commercial loan in the amountwith its term extended and its payment restructured during 2019 of $85$17 thousand. WeAdditionally, we had one commercial real estate credit for $2.2 millionland development loan that was restructured in 2016 of $125 thousand that had been performing in accordance with its modified terms in 2018 that was downgraded fromto not performing to non-performing in the second quarter of 2017. Further, there were three TDRs totaling $620 thousand performing subject to their modified terms at December 31, 2017, two of which were restructured as TDRs in 2017.2019.
Under GAAP we are required to account for certain loan modifications or restructurings as TDRs. In general, the modification or restructuring of a debt constitutes a TDR if Howard Bank, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession, such as a reduction in the effective interest rate, to the borrower that we would not otherwise consider. However, all debt restructurings or loan modifications for a borrower do not necessarily constitute troubled debt restructurings.
Interest income that would have been recorded during the years ended December 31,2019, 2018 and 2017 2016 and 2015 if the non-accrual loans had been current and in accordance with their original terms was $461 thousand, $317 thousand and $198 thousand, respectively. No interest income was recorded on such loans during these periods.
NonperformingOur nonperforming assets amountedwere $22.2 million, or 0.94% of total assets, at December 31, 2019 compared to $29.1 million, or 1.28% of total assets, at December 31, 2018, and $14.7 million, or 1.28% of total assets, at December 31, 2017 compared to $11.9 million or 1.16% of total assets at December 31, 2016 and $12.7 million or 1.35% of total assets at December 31, 2015.2017. Total nonperforming assets increased $2.8decreased $6.9 million during 2017.2019.
The composition of our nonperforming loans at December 31, 2019 is further described below:
Non-Accrual Loans:Loans
| · |
| · |
| · |
| · |
| · |
| · | 15 commercial loans |
Accruing Troubled Debt Restructured Loans:
| · |
Accruing Troubled Debt Restructured Loans
| · | Two residential real estate |
| · |
Other Real Estate Owned
Real estate we acquire as a result of foreclosure is classified as OREO.Other Real Estate Owned (“OREO”). When a property is acquired as a result of foreclosure, it is recorded at fair value less the anticipated cost to sell at the date of foreclosure. If there is a subsequent declinechange in the value of OREO, we record a valuation allowance to adjust the carrying value of the real estate owned, we provide an additional allowance to reduce real estate acquired through foreclosure to its current fair value less estimated disposal costs. Costs relating to holding such real estate are charged against incomeexpensed in the current period while costs relating to improving such real estate are capitalized until a saleable condition is reached up to the property’s net realizable value then such costsuntil a saleable condition is reached. Costs in excess of the property’s net realizable value would be charged against incomeexpensed in the current period.
OREO at December 31, 2017 consisted of:
We had OREO of $1.5$3.1 million at December 31, 2017 and $2.42019, $4.4 million at December 31, 20162018, and 2015.$1.5 million at 2017. Included in noninterest expenses were $473 thousand, $352 thousand and $581 thousand $83 thousandfor 2019, 2018 and $736 thousand2017, respectively, attributable to net increases in valuation allowances recorded for 2017, 2016 and 2015, respectively, as the current appraised value of OREO properties, less estimated cost to sell, was insufficient to cover the recorded OREO amount.
Additionally, cost relating towe sold two parcels of land, one commercial real estate property and seven residential real estate properties recording a net loss of $28 thousand in 2019. OREO recordedadditions in noninterest expenses were $87 thousand, $94 thousand and $75 thousand for 2017, 2016 and 2015, respectively.2019 consisted of two residential real estate properties with a net carrying balance of $1.2 million.
OREO at December 31, 2019 consisted of:
| · | Several parcels of unimproved land. |
| · | One commercial real estate property. |
| · | Four residential 1-4 family properties. |
Classification of Loans
Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality as Substandard, Doubtful, or Loss assets. An asset is considered Substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Substandard assets include those assets characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all of the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable or improbable. Assets (or portions of assets) classified as Loss are those considered uncollectible and of such little value that their continuance as assets is not warranted. Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve our close attention, are required to be designated as Special Mention.
We maintain an allowance for credit losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Our determination as to the classification of our assets is subject to review by the Commissioner and the FDIC. We regularly review our asset portfolio to determine whether any assets require classification in accordance with applicable regulations.
The following table sets forth our amounts of classified loans and criticized loans (classified loans and loans designated as Special Mention) at the dates indicated.
| December 31, | December 31, | |||||||||||||||||||||||
| (in thousands) | 2017 | 2016 | 2015 | 2019 | 2018 | 2017 | ||||||||||||||||||
| Classified loans: | ||||||||||||||||||||||||
| Substandard | $ | 6,779 | $ | 3,734 | $ | 3,009 | $ | 17,882 | $ | 24,610 | $ | 6,779 | ||||||||||||
| Doubtful | 6,310 | 6,903 | 6,496 | - | - | 6,310 | ||||||||||||||||||
| Total classified loans | 13,089 | 10,637 | 9,505 | 17,882 | 24,610 | 13,089 | ||||||||||||||||||
| Special mention | 1,592 | 524 | 614 | - | 3,955 | 1,592 | ||||||||||||||||||
| Total criticized loans | $ | 14,681 | $ | 11,161 | $ | 10,119 | $ | 17,882 | $ | 28,565 | $ | 14,681 | ||||||||||||
Allowance for Credit Losses
We provide for credit losses based upon the consistent application of our documented allowance for credit loss methodology. All credit losses are charged to the allowance for credit losses and all recoveries are credited to it. Additions to the allowance for credit losses are provided by charges to income based on various factors that, in our judgment, deserve current recognition in estimating probable losses. We regularly review the loan portfolio and make provisions for credit losses in order to maintain the allowance for credit losses in accordance with GAAP.
In accordance with accounting guidance for business combinations, there was no allowance for credit losses brought forward on any acquired loans in our acquisitions. For acquired performing loans, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and the discount is accreted to interest income over the life of the loan. Subsequent to the purchase date, the method used to evaluate the sufficiency of the credit discount is similar to originated loans, and if necessary, additional reserves are recognized in the allowance for credit losses.
We recorded acquired credit impaired loans in our acquisitions net of purchase accounting adjustments. Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each acquired credit impaired loan in comparison to management’s initial performance expectations. Subsequent decreases in the present value of expected cash flows will be recorded as an increase in the allowance for credit losses through a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.
The allowance for credit losses consists primarily of two components:
| 1) | Specific allowances are established for loans classified as impaired. For loans classified as impaired, the allowance is established when the net realizable value (collateral value less costs to sell) of the impaired loan is lower than the carrying amount of the loan. The amount of impairment provided for as a specific allowance is represented by the deficiency, if any, between the underlying collateral value and the carrying value of the loan. Impaired loans for which the estimated fair value of the loan, or the loan’s observable market price or the fair value of the underlying collateral, if the loan is collateral dependent, exceeds the carrying value of the loan are not considered in establishing specific allowances for credit losses; and |
| 2) | General allowances established for credit losses on a portfolio basis for loans that do not meet the definition of impaired loans. The portfolio is grouped into similar risk characteristics, primarily loan type and regulatory classification. We apply an estimated loss rate to each loan group. The loss rates applied are based upon our loss experience adjusted, as appropriate, for the qualitative factors discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions. |
The allowance for credit losses is maintained at a level to provide for losses that are probable and can be reasonably estimated. Management’sOur periodic evaluation of the adequacy of the allowance is based on Howard Bank’s past credit loss experience, known and inherent losses in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans.
A loan is considered past due or delinquent when a contractual payment is not paid on the day it is due. A loan is considered impaired when, based on current information and events, it is probable that Howard Bankwe will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determinesWe determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. The impairment of a loan may be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, Howard Bank’sour impairment on such loans is measured by reference to the fair value of the collateral. Interest income on impaired loans is recognized on the cash basis.
Our loan policies state that after all collection efforts have been exhausted, and the loan is deemed to be a loss, then the remaining loan balance will be charged to the established allowance for credit losses. All loans are evaluated for loss potential once it has been determined by our Watch Committee that the likelihood of repayment is in doubt. When a loan is past due for at least 90 days or a deterioration in debt service coverage ratio, guarantor liquidity, or loan-to-value ratio has occurred that would cause concern regarding the likelihood of the full repayment of principal and interest, and the loan is deemed not to be well secured, the loan should be moved to non-accrual status and a specific reserve is established if the net realizable value is less than the principal value of the loan balance(s). Once the actual loss value has been determined a charge-off against the allowance for credit losses for the amount of the loss is taken. Each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss.
The adjustments to historical loss experience are based on our evaluation of several qualitative factors, including:
| · | changes in lending policies, procedures, practices or personnel; |
| · | changes in the level and composition of construction portfolio and related risks; |
| · | changes and migration of classified assets; |
| · | changes in exposure to subordinate collateral lien positions; |
| · | levels and composition of existing guarantees on loans by SBA or other agencies; |
| · | changes in national, state and local economic trends and business conditions; |
| · | changes and trends in levels of loan payment delinquencies; and |
| · | any other factors that management considers relevant to the quality or performance of the loan portfolio. |
We evaluate the allowance for credit losses based upon the combined total of the specific and general components. Generally, when the loan portfolio increases, absent other factors, the allowance for credit loss methodology results in a higher dollar amount of estimated probable losses than would be the case without the increase. Generally, when the loan portfolio decreases, absent other factors, the allowance for credit loss methodology results in a lower dollar amount of estimated probable losses than would be the case without the decrease.
Commercial and commercial real estate loans generally have greater credit risks compared to the one- to four-family residential mortgage loans we originate, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related business and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. Actual credit losses may be significantly more than the allowance for credit losses we have established, which could have a material negative effect on our financial results.
Generally, we underwrite commercial loans based on cash flow and business history and receive personal guarantees from the borrowers where appropriate. We generally underwrite commercial real estate loans and residential real estate loans at a loan-to-value ratio of 85% or less at origination. Accordingly, in the event that a loan becomes past due and, randomly with respect to performing loans, we will conduct visual inspections of collateral properties and/or review publicly available information, such as online databases, to ascertain property values. We will also obtain formal appraisals on a regular basis even if we are not considering liquidation of the property to repay a loan. It is our practice to obtain updated appraisals if there is a material change in market conditions or if we become aware of new or additional facts that indicate a potential material reduction in the value of any individual property collateral.
For impaired loans, we utilize the appraised value or present value of expected cash flows in determining the appropriate specific allowance for credit losses attributable to a loan. In addition, changes in the appraised value of multiple properties securing our loans may result in an increase or decrease in our general allowance for credit losses as an adjustment to our historical loss experience due to qualitative and environmental factors, as described above.
As of December 31, 20172019 and 2016,2018, nonperforming loans amounted to $13.2were $19.1 million and $9.6$24.7 million, respectively. The amount of nonperforming loans requiring specific reserves totaled $6.4 million$554 thousand and $3.8$3.0 million, respectively, and the amount of nonperforming loans with no specific valuation allowance totaled $6.8$18.5 million and $5.8$21.7 million, respectively, at December 31, 20172019 and December 31, 2016.2018.
Nonperforming loans are evaluated and valued at the time the loan is identified as impaired on a case by case basis, at the lower of cost or market value. Market value is measured based on the value of the collateral securing the loan. The value of real estate collateral is determined based on an appraisal by qualified licensed appraisers hired by us. Appraised values may be discounted based on management’s historical experience, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business. The difference between the appraised value and the principal balance of the loan will determine the specific allowance valuation required for the loan, if any. Nonperforming loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.
We evaluate the loan portfolio on at least a quarterly basis, more frequently if conditions warrant, and the allowance is adjusted accordingly. While we use the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Commissioner and the FDIC will periodically review the allowance for credit losses. The Commissioner and the FDIC may require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination.
The following table sets forth activity in our allowance for credit losses for the twelve monthsyear ended:
| December 31, | December 31, | |||||||||||||||||||||||||||||||||||||||
| (in thousands) | 2017 | 2016 | 2015 | 2014 | 2013 | 2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||||||||||||||||||
| Balance at beginning of year | $ | 6,428 | $ | 4,869 | $ | 3,602 | $ | 2,506 | $ | 2,764 | $ | 9,873 | $ | 6,159 | $ | 6,428 | $ | 4,869 | $ | 3,602 | ||||||||||||||||||||
| Charge-offs: | ||||||||||||||||||||||||||||||||||||||||
| Real estate | ||||||||||||||||||||||||||||||||||||||||
| Construction and land loans | (155 | ) | (216 | ) | - | - | - | (282 | ) | (202 | ) | (155 | ) | (216 | ) | - | ||||||||||||||||||||||||
| Residential first lien loans | (133 | ) | - | (23 | ) | - | (183 | ) | (518 | ) | (142 | ) | (133 | ) | - | (23 | ) | |||||||||||||||||||||||
| Residential junior lien loans | (31 | ) | - | (12 | ) | - | - | (532 | ) | (195 | ) | (31 | ) | - | (12 | ) | ||||||||||||||||||||||||
| Commercial owner occupied loans | (235 | ) | (191 | ) | - | - | - | (46 | ) | (28 | ) | (235 | ) | (191 | ) | - | ||||||||||||||||||||||||
| Commercial non-owner occupied loans | - | - | (82 | ) | (160 | ) | (375 | ) | (2,026 | ) | (797 | ) | - | - | (82 | ) | ||||||||||||||||||||||||
| Commercial loans and leases | (1,605 | ) | (234 | ) | (825 | ) | (2,054 | ) | (759 | ) | (622 | ) | (1,092 | ) | (1,605 | ) | (234 | ) | (825 | ) | ||||||||||||||||||||
| Consumer loans | (108 | ) | (20 | ) | (5 | ) | (5 | ) | - | (210 | ) | (63 | ) | (108 | ) | (20 | ) | (5 | ) | |||||||||||||||||||||
| (2,267 | ) | (661 | ) | (947 | ) | (2,219 | ) | (1,317 | ) | (4,236 | ) | (2,519 | ) | (2,267 | ) | (661 | ) | (947 | ) | |||||||||||||||||||||
| Recoveries: | ||||||||||||||||||||||||||||||||||||||||
| Real estate | ||||||||||||||||||||||||||||||||||||||||
| Construction and land loans | 6 | - | - | - | - | 80 | - | 6 | - | - | ||||||||||||||||||||||||||||||
| Residential first lien loans | - | - | 3 | 1 | - | - | 8 | - | - | 3 | ||||||||||||||||||||||||||||||
| Residential junior lien loans | 1 | - | 1 | - | - | 115 | 10 | 1 | - | 1 | ||||||||||||||||||||||||||||||
| Commercial owner occupied loans | 6 | 40 | - | - | - | - | - | 6 | 40 | - | ||||||||||||||||||||||||||||||
| Commercial non-owner occupied loans | 6 | 5 | 318 | 4 | 29 | 17 | 32 | 6 | 5 | 318 | ||||||||||||||||||||||||||||||
| Commercial loans and leases | 113 | 101 | 52 | 55 | 80 | 357 | 88 | 113 | 101 | 52 | ||||||||||||||||||||||||||||||
| Consumer loans | 35 | 37 | 4 | - | - | 2 | 4 | 35 | 37 | 4 | ||||||||||||||||||||||||||||||
| 167 | 183 | 378 | 60 | 109 | 571 | 142 | 167 | 183 | 378 | |||||||||||||||||||||||||||||||
| Net charge-offs | (2,100 | ) | (478 | ) | (569 | ) | (2,159 | ) | (1,208 | ) | (3,665 | ) | (2,377 | ) | (2,100 | ) | (478 | ) | (569 | ) | ||||||||||||||||||||
| Provision for credit losses | 1,831 | 2,037 | 1,836 | 3,255 | 950 | 4,193 | 6,091 | 1,831 | 2,037 | 1,836 | ||||||||||||||||||||||||||||||
| Balance at end of year | $ | 6,159 | $ | 6,428 | $ | 4,869 | $ | 3,602 | $ | 2,506 | $ | 10,401 | $ | 9,873 | $ | 6,159 | $ | 6,428 | $ | 4,869 | ||||||||||||||||||||
| Net charge-offs to average loans and leases | 0.24 | % | 0.06 | % | 0.09 | % | 0.48 | % | 0.34 | % | 0.22 | % | 0.16 | % | 0.24 | % | 0.06 | % | 0.09 | % | ||||||||||||||||||||
Allocation of Allowance for Credit Losses
The following tables set forth the allowance for credit losses allocated by loan category and the percent of loans in each category to total loans at the dates indicated. The allowance for credit losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
| December 31, | December 31, | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2017 | 2016 | 2015 | 2014 | 2013 | 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Amount | Percent1 | Amount | Percent1 | Amount | Percent1 | Amount | Percent1 | Amount | Percent1 | Amount | Percent1 | Amount | Percent 1 | Amount | Percent 1 | Amount | Percent 1 | Amount | Percent 1 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Real estate | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Construction and land loans | $ | 735 | 7.9 | % | $ | 511 | 8.9 | % | $ | 265 | 9.1 | % | $ | 174 | 11.6 | % | $ | 122 | 12.6 | % | $ | 1,256 | 7.3 | % | $ | 741 | 7.5 | % | $ | 735 | 7.9 | % | $ | 511 | 8.9 | % | $ | 265 | 9.1 | % | ||||||||||||||||||||||||||||||||||||||||
| Residential first lien loans | 668 | 20.8 | 454 | 23.7 | 300 | 24.1 | 272 | 16.0 | 200 | 9.7 | 2,256 | 25.1 | 1,170 | 23.2 | 668 | 20.8 | 454 | 23.7 | 300 | 24.1 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Residential junior lien loans | 177 | 4.6 | 89 | 4.3 | 47 | 3.6 | 55 | 3.5 | 34 | 2.0 | 478 | 4.2 | 292 | 5.4 | 177 | 4.6 | 89 | 4.3 | 47 | 3.6 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial owner occupied loans | 617 | 18.2 | 327 | 16.3 | 309 | 17.3 | 160 | 20.4 | 131 | 22.4 | 788 | 13.9 | 735 | 14.2 | 617 | 18.2 | 327 | 16.3 | 309 | 17.3 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial non-owner occupied loans | 1,410 | 27.8 | 1,120 | 26.4 | 728 | 23.9 | 562 | 22.4 | 541 | 28.1 | 2,968 | 25.4 | 4,057 | 25.9 | 1,410 | 27.8 | 1,120 | 26.4 | 728 | 23.8 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial loans and leases | 2,529 | 20.2 | 3,800 | 19.8 | 3,094 | 21.5 | 2,366 | 25.2 | 1,464 | 24.9 | 2,103 | 21.4 | 2,644 | 20.5 | 2,529 | 20.2 | 3,800 | 19.8 | 3,094 | 21.5 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Consumer loans | 23 | 0.5 | 127 | 0.6 | 126 | 0.6 | 13 | 0.9 | 14 | 0.3 | 552 | 2.7 | 234 | 3.3 | 23 | 0.5 | 127 | 0.6 | 126 | 0.6 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 6,159 | 100.0 | % | $ | 6,428 | 100.0 | % | $ | 4,869 | 100.0 | % | $ | 3,602 | 100.0 | % | $ | 2,506 | 100.0 | % | $ | 10,401 | 100.0 | % | $ | 9,873 | 100.0 | % | $ | 6,159 | 100.0 | % | $ | 6,428 | 100.0 | % | $ | 4,869 | 100.0 | % | ||||||||||||||||||||||||||||||||||||||||
(1) Represents the percent of loans in each category to total loans.
| (1) | Represents the percent of loans in each category to total loans. |
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, and the sale of securities available for sale. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Committee (“ALCO”) is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we havehad enough sources of liquidity to satisfy our short- and long-term liquidity needs as of December 31, 20172019 and December 31, 2016.2018.
We regularly monitor and adjust our investments in liquid assets based upon our assessment of:
| · | Expected loan demand; |
| · | Expected deposit flows and borrowing maturities; |
| · | Yields available on interest-earning deposits and securities; and |
| · | The objectives of our asset/liability management program. |
Excess liquid assets are invested generally in interest-earninginterest-bearing deposits in banks (primarily the Federal Reserve Bank) and short-term investment securities.
The most liquid of all assets are cash and cash equivalents. The level of these assets is dependent on our operating, financing, lending and investing activities during any given period. At December 31, 20172019 and 2016,2018, cash and cash equivalents totaled $29.0$110.0 million and $39.4$101.5 million, respectively. The decrease at December 31, 2017 from the prior year-end resulted from funding asset growth that outpaced the growth in our deposits and other funding sources. We used cash and cash equivalents to provide additional funds needed to fund these assets.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in our statements of cash flows included in our financial statements.
At December 31, 20172019 and 2016,2018, we had $219.6$386.8 million and $127.1$387.3 million, respectively, in loan commitments outstanding, includingconsisting of commitments issued to originate loans of $81.1$77.3 million and $46.2$104.5 million at December 31, 20172019 and 2016,2018, respectively, and $138.5$309.5 million and $80.9$382.8 million in unused lines of credit to borrowers at December 31, 20172019 and 2016,2018, respectively. In addition to commitments to originate loans and unused lines of credit, we had $10.8$13.9 million and $9.7$16.7 million in letters of credit at December 31, 20172019 and 2016,2018, respectively. Certificates of depositCDs due within one year totaled $195.5$458.9 million, or 22.6%26.8% of total deposits, and $178.3$325.5 million, or $22.0%$19.3% of total deposits, at December 31, 20172019 and 2016,2018, respectively. If we do not retain these deposits, we may be required to seek other sources of funds, including loan and securities sales and FHLB advances. Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on the certificates of depositCDs held in our portfolio as of December 31, 2017.2019. We believe, however, based on historical experience and current market interest rates that we will retain upon maturity a large portion of our certificates of depositCDs with maturities of one year or less as of December 31, 2017. 2019.
Our primary investing activity is originating loans. During the years ended December 31, 20172019 and December 31, 2016,2018, cash used to fund net loan growth was $120.3$99.2 million and $68.3$50.0 million, respectively. During these periods,2019, we purchased $62.3 million and $88.2$102.7 million of securities respectively.which partially offset $80.4 million of securities maturities / calls and $35.4 million of securities sales. In 2016 we invested $19.5 million in interest bearing deposits with banks, while during 2017 we have received $19.5 million in cash from the maturities of interest bearing deposits with banks. Additionally, in 2017 and 20162018, we purchased an additional $6.5 million and $2.2$193.8 million of BOLI, respectively.new securities while $169.3 million of securities either matured, were called, or sold.
Financing activities consist primarily of activity in deposit accounts and FHLB advances. We experienced a net increase in cash provided from deposits of $55.1$28.6 million and $61.3$115.5 million, respectively, during the years ended December 31, 20172019 and 2016.2018. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors.
Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB, which provide an additional source of funds. FHLB advances increased to $131$285.0 million at December 31, 20172019 compared to $100$232.0 million at December 31, 2016.2018. At December 31, 2017,2019, we had an available line of credit for $573.3 million at the ability to borrow upFHLB, with borrowings limited to a total of $254.7$435.4 million based upon ouron pledged collateral. At December 31, 2018, this available line of credit availability at the FHLB subjectwas $538.4 million, with borrowings limited to collateral requirements.a total of $345.9 million based on pledged collateral.
The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 20172019 and 2016, the Bank2018, we exceeded all regulatory capital requirements. The Bank isWe are considered “well capitalized” under regulatory guidelines. See “Item 1. Business—Supervision and Regulation—Howard Bank—Capital Requirements” and the Notes toNote 22 of our Consolidated Financial Statements.
Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements
We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our customers. These financial instruments are limited to commitments to originate loans and involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not represent unusual risks, and management does not anticipate any losses that would have a material effect on us.
Outstanding loan commitments and lines of credit at December 31, 20172019 and December 31, 20162018 are as follows:
| December 31, | ||||||||
| (in thousands) | 2017 | 2016 | ||||||
| Unfunded loan commitments | $ | 81,074 | $ | 46,194 | ||||
| Unused lines of credit | 138,526 | 80,876 | ||||||
| Letters of credit | 10,839 | 9,660 | ||||||
| December 31, | ||||||||
| (in thousands) | 2019 | 2018 | ||||||
| Unfunded loan commitments | $ | 77,314 | $ | 104,466 | ||||
| Unused lines of credit | 309,519 | 282,822 | ||||||
| Letters of credit | 13,853 | 16,661 | ||||||
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. We generally require collateral to support financial instruments with credit risk on the same basis as we do for balance sheet instruments. Management generally bases the collateral required on the credit evaluation of the counterparty. Commitments generally have interest rates at current market rates, expiration dates or other termination clauses and may require payment of a fee. Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no violation of any contractual condition. These lines generally have variable interest rates. Since we expect many of the commitments to expire without being drawn upon, and since it is unlikely that all customers will draw upon their lines of credit in full at any one time, the total commitment amount or line of credit amount does not necessarily represent future cash requirements. We evaluate each customer’s credit-worthiness on a case-by-case basis. Because we conservatively underwrite these facilities at inception, we have not had to withdraw any commitments. We are not aware of any loss that we would incur by funding our commitments lines of credit or letterslines of credit.
The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. No amount has been recognized in the statement of financial conditionconsolidated balance sheets at December 31, 2017, December 31, 20162019 or December 31, 20152018 as a liability for credit loss related to these commitments.
We have contractual obligations to make future payments on debt and lease agreements. In the normal course of business, we enter into contractual arrangements whereby we commit to future purchases of products or services from unaffiliated parties. These purchase obligations are legally binding agreements whereby we agree to purchase products or services with a specific minimum quantity at a fixed, minimum or variable price over a specified period of time. Purchase obligations may include vendor contracts, communication services, processing services and software contracts. ContractualWe also have contractual obligations under real property leases for thecertain facilities we utilize are also presented below.utilize.
Payments due by period for our contractual obligations at December 31, 20172019 are as follows:
| Within | One to | Three to | Over | |||||||||||||||||
| (in thousands) | one year | three years | five years | five years | Total | |||||||||||||||
| Certificates of deposit | $ | 195,511 | $ | 63,850 | $ | 10,235 | $ | - | $ | 269,596 | ||||||||||
| Long-term borrowings | - | 15,000 | - | 3,535 | 18,535 | |||||||||||||||
| Estimated interest due on certificate of deposit and long-term borrowings | 2,436 | 1,535 | 57 | 16 | 4,044 | |||||||||||||||
| Contractual service obligations | 1,843 | 3,517 | - | - | 5,360 | |||||||||||||||
| Operating leases | 2,105 | 3,910 | 2,641 | 2,742 | 11,398 | |||||||||||||||
| $ | 201,895 | $ | 87,812 | $ | 12,933 | $ | 6,293 | $ | 308,933 | |||||||||||
| Within | One to | Three to | Over | |||||||||||||||||
| (in thousands) | one year | three years | five years | five years | Total | |||||||||||||||
| Certificates of deposit | $ | 458,908 | $ | 108,120 | $ | 4,063 | $ | - | $ | 571,091 | ||||||||||
| Long-term borrowings | - | - | 5,000 | 50,000 | 55,000 | |||||||||||||||
| Estimated interest due on certificate of deposit and long-term borrowings | 4,937 | 1,440 | 1,117 | 1,383 | 8,877 | |||||||||||||||
| Contractual service obligations | 3,649 | 8,517 | 15,317 | - | 27,483 | |||||||||||||||
| Future lease payments | 1,636 | 2,950 | 2,312 | 11,341 | 18,239 | |||||||||||||||
| $ | 469,130 | $ | 121,027 | $ | 27,809 | $ | 62,724 | $ | 680,690 | |||||||||||
Impact of Inflation and Changing Prices
Our financial statements and related notes have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Liquidity and Funding
The objective of effective liquidity management is to ensure that the Companywe can meet customer loan requests, customer deposit maturities/withdrawals, and other cash commitments efficiently under both normal operating conditions as well as under unforeseen and unpredictable circumstances of industry or market stress. To achieve this objective, ALCO establishes and monitors liquidity guidelines requiring sufficient asset based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding markets. The Company managesWe manage liquidity at both the parent and subsidiary levels through active management of the balance sheet.
The additional information called for by this item is incorporated herein by reference to the “Liquidity and Capital Resources” section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Annual Report on Form 10-K.
Interest Rate Risk
Interest rate risk, one of the more prominent risks in terms of potential earnings impact, is an inevitable part of being a financial intermediary. It can occur for any one or more of the following reasons: (a) assets and liabilities may mature or reprice at different times (for example, if assets reprice faster than liabilities and interest rates are generally falling, the Company’sour earnings will initially decline); (b) assets and liabilities may re-price at the same time but by different amounts (when the general level of interest rates is falling, the Companywe may choose for customer management, competitive, or other reasons to reduce the rates paid on checking and savings deposit accounts by an amount that is less than the general decline in market interest rates); (c) short-term and long-term market interest rates may change by different amounts (i.e. the shape of the yield curve may impact new loan yields and funding costs differently); or (d) the remaining maturity of various assets or liabilities may shorten or lengthen as interest rates change (for example, mortgage-backed securities held in the securities available for sale portfolio may prepay significantly earlier than anticipated – with an associated reduction in portfolio yield and income – if long-term mortgage rates decline sharply). In addition to the direct impact of interest rate changes on net interest income through these categories, interest rates indirectly impact earnings through their effect on loan demand, credit losses, mortgage origination fees, and other sources of the Company’sour earnings.
In determining the appropriate level of interest rate risk, the Company considerswe consider the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. The Company uses a number of tools to measure interest rate risk including a model to simulate the impact of changes in interest rates on our net interest income, monitoring the sensitivity of the net present value of the balance sheet and monitoring the difference or gap between maturing or rate-sensitive assets and liabilities over various time periods.
Management believesWe believe that short term interest rate risk is best measured by simulation modeling. ThisWe prepare a current base case and standard alternative scenarios at least once quarterly and report the analysis calculates expectedboth internally to the Asset / Liability Committee and to the Board of Directors. More frequent or alternative scenarios are often prepared at our discretion.
The balance sheet is subject to quarterly testing for the standard alternative interest rate shock possibilities to indicate the inherent interest rate risk. Current and forward rates are shocked by +/- 100, +/- 200, +300, and +400 basis points (“bp”). Certain scenarios may be impractical under different economic circumstances. We seek to structure the balance sheet so that net interest income based upon historical trends, spreads to market rates, historical market relationships, prepayment behavior and current and expected product offerings using base market rates and usingat risk over a rising and a fallingtwelve month period does not exceed policy guidelines at the various interest rate scenario. For example, if rates were to rise 1.00% or 2.00% overshock levels.
Measures of the next 12 months, net interest income might decline respectively. Conversely, if rates were to decline overat risk produced by the next 12 months, net interest income might increase respectively.
These estimatessimulation analysis are highly assumption-dependent,indicators of an institution’s short-term performance in alternative rate environments. The measures are typically based upon a relatively brief period, usually one year, and may change regularly asdo not provide meaningful insight into the Company’s asset/liability structure and business evolves from one period to the next, results will vary as different interest rate scenarios are used and are measured relative to a base net interest income scenario that may change.
For the rising and falling interest rate scenarios, the base market interest rate forecast was increased and decreased over twelve months by 200 and 100 basis points, respectively. At December 31, 2017, ourinstitution’s long-term performance. Our net interest income exposure related to these hypothetical changesrate shocks at both December 31, 2019 and 2018 are presented in the following table. Due to relatively low current market interest rates, it was withinnot possible to calculate a decrease of 2% because many of the current guidelines establishedmarket interest rates would fall below zero in that scenario. All measures were in compliance with our governing policies.policy limits.
The following table presents interest sensitivity position at the dates indicated.Estimated Change in Net Interest Income
| Percentage Change in | ||||||||
| Net Interest Income | ||||||||
| 2017 | 2016 | |||||||
| Up 200 basis points | (1.44 | )% | (0.46 | )% | ||||
| Down 200 basis points | (2.20 | ) | (2.99 | ) | ||||
| Change in interest rates: | + 400 bp | + 300 bp | + 200 bp | + 100 bp | - 100 bp | - 200 bp | ||||||||||||||||||
| Policy limits | -15 | % | -12 | % | -12 | % | -10 | % | -10 | % | -12 | % | ||||||||||||
| December 31, 2019 | -13.1 | % | -9.7 | % | -6.3 | % | -3.0 | % | -0.6 | % | na | |||||||||||||
| December 31, 2018 | 5.9 | % | 4.5 | % | 3.2 | % | 2.0 | % | -3.6 | % | -10.7 | % | ||||||||||||
A summary of the repricing schedule of our interest-earning assets and interest-bearing liabilities as of December 31, 2017 is presented below.
| Interest Rate Sensitivity Period | ||||||||||||||||||||||||||||||||
| Less then | 30-90 | 91-180 | 181-365 | 1-2 | 2-5 | Over 5 | Total | |||||||||||||||||||||||||
| (Dollars in thousands) | 30 Days | Days | Days | Days | Years | Years | Years | Rate Sensitive | ||||||||||||||||||||||||
| Earning assets | ||||||||||||||||||||||||||||||||
| Other earning assets | $ | 993 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 993 | ||||||||||||||||
| Investment securities | 2,595 | 11,101 | 9,668 | 21,032 | 23,714 | 17,382 | 4,506 | 89,998 | ||||||||||||||||||||||||
| Loans and leases | 159,902 | 102,964 | 45,069 | 98,926 | 133,136 | 264,554 | 132,057 | 936,608 | ||||||||||||||||||||||||
| Loans held for sale | 42,153 | - | - | - | - | - | - | 42,153 | ||||||||||||||||||||||||
| Total earning assets | 205,643 | 114,065 | 54,737 | 119,958 | 156,850 | 281,936 | 136,563 | 1,069,752 | ||||||||||||||||||||||||
| Interest-bearing liabilities | ||||||||||||||||||||||||||||||||
| Interest-bearing checking | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 71,642 | $ | 71,642 | ||||||||||||||||
| Money market accounts | - | 252,453 | - | - | - | - | - | 252,453 | ||||||||||||||||||||||||
| Savings | - | - | - | - | - | - | 52,078 | 52,078 | ||||||||||||||||||||||||
| Certificate of deposits | 17,201 | 51,870 | 67,819 | 58,592 | 31,999 | 42,047 | 68 | 269,596 | ||||||||||||||||||||||||
| Short-term borrowings | 67,385 | 9,000 | 2,500 | 33,500 | 3,000 | 15,000 | - | 130,385 | ||||||||||||||||||||||||
| Long-term borrowings | - | - | - | - | 15,000 | - | 3,535 | 18,535 | ||||||||||||||||||||||||
| Total interest-bearing liabilities | 84,586 | 313,323 | 70,319 | 92,092 | 49,999 | 57,047 | 127,323 | 794,689 | ||||||||||||||||||||||||
| Interest rate sensitivity gap | $ | 121,057 | $ | (199,258 | ) | $ | (15,582 | ) | $ | 27,866 | $ | 106,851 | $ | 224,889 | $ | 9,240 | $ | 275,063 | ||||||||||||||
| Cumulative interest rate sensitivity gap | $ | 121,057 | $ | (78,201 | ) | $ | (93,783 | ) | $ | (65,917 | ) | $ | 40,934 | $ | 265,823 | $ | 275,063 | |||||||||||||||
| Cumulative sensitivity gap as percent of total assets | 10.53 | % | (6.80 | )% | (8.16 | )% | (5.73 | )% | 3.56 | % | 23.12 | % | 23.92 | % | ||||||||||||||||||
Item 8. Financial Statements and Supplementary Data
Report Of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors
Howard Bancorp, Inc.
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Howard Bancorp, Inc. and Subsidiary (the “Company”) as of December 31, 20172019 and 2016,2018, and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity, and cash flows for each of the twothree years in the period ended December 31, 2017,2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 20172019 and 2016,2018, and the results of their operations and their cash flows for each of the twothree years in the period ended December 31, 2017,2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ("PCAOB"), the Company's internal control over financial reporting as of December 31, 2017,2019, based on criteria established inInternal Control – Integrated Framework (2013)issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 15, 201816, 2020 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Dixon Hughes Goodman LLP
We have served as the Company’s auditor since 2016.
/s/ Dixon Hughes Goodman LLP
Baltimore, Maryland
March 15, 201816, 2020
55
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMReport Of Independent Registered Public Accounting Firm
To the ShareholdersStockholders and the Board of Directors
Howard Bancorp, Inc.
Ellicott City, Maryland
We have audited the accompanying consolidated statement of operations, comprehensive income, changes in shareholders’ equity, and cash flows of Howard Bancorp, Inc. (the “Company”) for the year ended December 31, 2015. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the Company’s results of operations and cash flows for the year ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.
/s/ Stegman & Company
Baltimore, Maryland
March 29, 2016
Report Of Independent Registered Public Accounting Firm
Stockholders and the Board of Directors of Howard Bancorp, Inc.
Opinion on Internal Control Over Financial Reporting
We have audited Howard Bancorp, Inc. and Subsidiary (the “Company”)’s internal control over financial reporting as of December 31, 2017,2019, based on criteria established inInternal Control – Integrated Framework (2013)issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, Howard Bancorp, Inc. and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017,2019, based on criteria established inInternal Control—Control – Integrated Framework (2013)issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”("PCAOB"), the consolidated financial statements of Howard Bancorp, Inc. and Subsidiary as of December 31, 20172019 and 2016, and2018, for each of the years in the twothree years ended December 31, 2017,2019, and our report dated March 15, 2018,16, 2020 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company'sCompany’s management is responsible for maintaining effective internal controlcontrols over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Effectiveness of Internal Control over Financial Reporting. Our responsibility is to express anand opinion on the Company'sCompany’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our auditaudits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company'scompany’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequatein adequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Dixon Hughes Goodman LLP
Baltimore, Maryland
March 15, 201816, 2020
Howard Bancorp, Inc. and Subsidiary
Consolidated Balance Sheets
| December 31, | December 31, | |||||||||||||||
| (in thousands, except share data) | 2017 | 2016 | 2019 | 2018 | ||||||||||||
| ASSETS | ||||||||||||||||
| Cash and due from banks | $ | 28,856 | $ | 29,675 | $ | 12,992 | $ | 14,860 | ||||||||
| Federal funds sold | 116 | 9,691 | ||||||||||||||
| Interest-bearing deposits with banks | 96,985 | 86,638 | ||||||||||||||
| Total cash and cash equivalents | 28,972 | 39,366 | 109,977 | 101,498 | ||||||||||||
| Interest bearing deposits with banks | - | 19,513 | ||||||||||||||
| Securities available for sale, at fair value | 74,256 | 38,728 | 215,505 | 223,858 | ||||||||||||
| Securities held to maturity, at amortized cost | 9,250 | 6,250 | 7,750 | 9,250 | ||||||||||||
| Nonmarketable equity securities | 6,492 | 5,103 | 14,152 | 11,786 | ||||||||||||
| Loans held for sale, at fair value | 42,153 | 51,054 | 30,710 | 21,261 | ||||||||||||
| Loans and leases, net of unearned income | 936,608 | 821,524 | 1,745,513 | 1,649,751 | ||||||||||||
| Allowance for credit losses | (6,159 | ) | (6,428 | ) | (10,401 | ) | (9,873 | ) | ||||||||
| Net loans and leases | 930,449 | 815,096 | 1,735,112 | 1,639,878 | ||||||||||||
| Bank premises and equipment, net | 19,189 | 20,080 | 42,724 | 45,137 | ||||||||||||
| Goodwill | 603 | 603 | 65,949 | 70,697 | ||||||||||||
| Core deposit intangible | 1,743 | 2,248 | 8,469 | 11,482 | ||||||||||||
| Bank owned life insurance | 28,631 | 21,371 | 75,830 | 74,153 | ||||||||||||
| Other real estate owned | 1,549 | 2,350 | 3,098 | 4,392 | ||||||||||||
| Deferred tax assets, net | 36,010 | 35,285 | ||||||||||||||
| Interest receivable and other assets | 6,663 | 5,195 | 29,333 | 17,837 | ||||||||||||
| Total assets | $ | 1,149,950 | $ | 1,026,957 | $ | 2,374,619 | $ | 2,266,514 | ||||||||
| LIABILITIES | ||||||||||||||||
| Noninterest-bearing deposits | $ | 218,139 | $ | 182,880 | $ | 468,975 | $ | 429,200 | ||||||||
| Interest-bearing deposits | 645,769 | 625,854 | 1,245,390 | 1,256,606 | ||||||||||||
| Total deposits | 863,908 | 808,734 | 1,714,365 | 1,685,806 | ||||||||||||
| Short-term borrowings | 130,385 | 107,056 | 236,127 | 134,576 | ||||||||||||
| Long-term borrowings | 18,535 | 20,517 | 83,241 | 142,077 | ||||||||||||
| Accrued expenses and other liabilities | 4,869 | 4,860 | 26,738 | 9,372 | ||||||||||||
| Total liabilities | 1,017,697 | 941,167 | 2,060,471 | 1,971,831 | ||||||||||||
| COMMITMENTS AND CONTINGENCIES | ||||||||||||||||
| STOCKHOLDERS' EQUITY | ||||||||||||||||
| Common stock - par value of $0.01 authorized 20,000,000 shares; issued and outstanding 9,820,592 shares at December 31, 2017 and 6,991,072 at December 31, 2016 | 98 | 70 | ||||||||||||||
| Common stock - par value of $0.01 authorized 20,000,000 shares; issued and outstanding 19,066,913 shares at December 31, 2019 and 19,039,347 at December 31, 2018 | 191 | 190 | ||||||||||||||
| Capital surplus | 110,387 | 71,021 | 276,156 | 275,843 | ||||||||||||
| Retained earnings | 22,105 | 14,849 | 35,158 | 18,277 | ||||||||||||
| Accumulated other comprehensive loss | (337 | ) | (150 | ) | ||||||||||||
| Accumulated other comprehensive income | 2,643 | 373 | ||||||||||||||
| Total stockholders’ equity | 132,253 | 85,790 | 314,148 | 294,683 | ||||||||||||
| Total liabilities and stockholders’ equity | $ | 1,149,950 | $ | 1,026,957 | $ | 2,374,619 | $ | 2,266,514 | ||||||||
The accompanying notes are an integral part of these consolidated financial statements.
| December 31, | Year Ended December 31, | |||||||||||||||||||||||
| (in thousands, except share data) | 2017 | 2016 | 2015 | 2019 | 2018 | 2017 | ||||||||||||||||||
| INTEREST INCOME | ||||||||||||||||||||||||
| Interest and fees on loans and leases | $ | 41,213 | $ | 37,865 | $ | 32,837 | $ | 83,555 | $ | 75,009 | $ | 41,213 | ||||||||||||
| Interest and dividends on securities | 1,416 | 691 | 449 | 6,785 | 4,297 | 1,416 | ||||||||||||||||||
| Other interest income | 397 | 185 | 63 | 1,094 | 1,083 | 397 | ||||||||||||||||||
| Total interest income | 43,026 | 38,741 | 33,349 | 91,434 | 80,389 | 43,026 | ||||||||||||||||||
| INTEREST EXPENSE | ||||||||||||||||||||||||
| Deposits | 3,997 | 3,470 | 2,611 | 15,462 | 8,540 | 3,997 | ||||||||||||||||||
| Short-term borrowings | 876 | 595 | 154 | 3,441 | 2,327 | 876 | ||||||||||||||||||
| Long-term borrowings | 294 | 497 | 307 | 3,221 | 2,904 | 294 | ||||||||||||||||||
| Total interest expense | 5,167 | 4,562 | 3,072 | 22,124 | 13,771 | 5,167 | ||||||||||||||||||
| NET INTEREST INCOME | 37,859 | 34,179 | 30,277 | 69,310 | 66,618 | 37,859 | ||||||||||||||||||
| Provision for credit losses | 1,831 | 2,037 | 1,836 | 4,193 | 6,091 | 1,831 | ||||||||||||||||||
| Net interest income after provision for credit losses | 36,028 | 32,142 | 28,441 | 65,117 | 60,527 | 36,028 | ||||||||||||||||||
| NONINTEREST INCOME | ||||||||||||||||||||||||
| Service charges on deposit accounts | 923 | 694 | 773 | 2,747 | 2,216 | 923 | ||||||||||||||||||
| Realized and unrealized gains on mortgage banking activity | 11,035 | 8,098 | 6,971 | 7,798 | 5,245 | 11,035 | ||||||||||||||||||
| Gain on the sale of securities | - | 96 | - | |||||||||||||||||||||
| Gain (loss) on the sale of securities | 645 | (364 | ) | - | ||||||||||||||||||||
| Gain on the sale of portfolio loans | 86 | 532 | - | - | - | 86 | ||||||||||||||||||
| Loss on the disposal of bank premises & equipment | (13 | ) | (70 | ) | - | (70 | ) | (345 | ) | (13 | ) | |||||||||||||
| Income from bank owned life insurance | 760 | 623 | 408 | 1,858 | 1,614 | 760 | ||||||||||||||||||
| Loan fee income | 5,722 | 3,903 | 2,979 | |||||||||||||||||||||
| Loan related fees and service charges | 3,934 | 5,624 | 5,722 | |||||||||||||||||||||
| Other operating income | 1,011 | 920 | 804 | 4,122 | 3,870 | 1,011 | ||||||||||||||||||
| Total noninterest income | 19,524 | 14,796 | 11,935 | �� | 21,034 | 17,860 | 19,524 | |||||||||||||||||
| NONINTEREST EXPENSE | ||||||||||||||||||||||||
| Compensation and benefits | 23,573 | 19,034 | 17,196 | 32,056 | 33,674 | 23,573 | ||||||||||||||||||
| Occupancy and equipment | 4,154 | 4,622 | 3,816 | 9,076 | 10,650 | 4,154 | ||||||||||||||||||
| Amortization of core deposit intangible | 505 | 655 | 462 | 3,013 | 2,856 | 505 | ||||||||||||||||||
| Marketing and business development | 4,231 | 3,375 | 2,861 | 2,339 | 3,338 | 4,231 | ||||||||||||||||||
| Professional fees | 1,968 | 2,111 | 1,478 | 2,954 | 2,471 | 1,968 | ||||||||||||||||||
| Data processing fees | 2,038 | 1,723 | 1,353 | 4,914 | 4,037 | 2,038 | ||||||||||||||||||
| Merger and restructuring expense | 567 | - | 4,344 | - | 15,549 | 567 | ||||||||||||||||||
| FDIC assessment | 650 | 780 | 453 | 667 | 1,268 | 650 | ||||||||||||||||||
| Other real estate owned expense | 655 | 97 | 744 | |||||||||||||||||||||
| Other real estate owned | 845 | 500 | 655 | |||||||||||||||||||||
| Loan production expense | 3,743 | 3,016 | 2,223 | 2,700 | 3,523 | 3,743 | ||||||||||||||||||
| Other operating expense | 3,116 | 3,286 | 3,331 | 5,514 | 5,246 | 3,116 | ||||||||||||||||||
| Total noninterest expense | 45,200 | 38,699 | 38,261 | 64,078 | 83,112 | 45,200 | ||||||||||||||||||
| INCOME BEFORE INCOME TAXES | 10,352 | 8,239 | 2,115 | |||||||||||||||||||||
| Income tax expense | 3,152 | 2,936 | 973 | |||||||||||||||||||||
| NET INCOME | $ | 7,200 | $ | 5,303 | $ | 1,142 | ||||||||||||||||||
| Preferred stock dividends | - | 166 | 126 | |||||||||||||||||||||
| Net income available to common stockholders | $ | 7,200 | $ | 5,137 | $ | 1,016 | ||||||||||||||||||
| NET INCOME PER COMMON SHARE | ||||||||||||||||||||||||
| INCOME (LOSS) BEFORE INCOME TAXES | 22,073 | (4,725 | ) | 10,352 | ||||||||||||||||||||
| Income tax expense (benefit) | 5,192 | (897 | ) | 3,152 | ||||||||||||||||||||
| NET INCOME (LOSS) | $ | 16,881 | $ | (3,828 | ) | $ | 7,200 | |||||||||||||||||
| NET INCOME (LOSS) PER COMMON SHARE | ||||||||||||||||||||||||
| Basic | $ | 0.75 | $ | 0.74 | $ | 0.16 | $ | 0.89 | $ | (0.22 | ) | $ | 0.75 | |||||||||||
| Diluted | $ | 0.75 | $ | 0.73 | $ | 0.16 | $ | 0.89 | $ | (0.22 | ) | $ | 0.75 | |||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Statements of Comprehensive Income
| December 31, | ||||||||||||
| (in thousands) | 2019 | 2018 | 2017 | |||||||||
| Net Income (Loss) | $ | 16,881 | $ | (3,828 | ) | $ | 7,200 | |||||
| Other comprehensive income (loss) | ||||||||||||
| Investments available-for-sale: | ||||||||||||
| Reclassification adjustment for (gain) loss | (645 | ) | 364 | - | ||||||||
| Related income tax | 177 | (100 | ) | - | ||||||||
| Unrealized holding gains (losses) | 3,778 | 602 | (217 | ) | ||||||||
| Related income tax (expense) benefit | (1,040 | ) | (156 | ) | 30 | |||||||
| Comprehensive income (loss) | $ | 19,151 | $ | (3,118 | ) | $ | 7,013 | |||||
Consolidated Statements of Changes in Stockholders’ Equity
| December 31, | ||||||||||||
| (in thousands) | 2017 | 2016 | 2015 | |||||||||
| Net Income | $ | 7,200 | $ | 5,303 | $ | 1,142 | ||||||
| Other comprehensive income | ||||||||||||
| Investments available-for-sale: | ||||||||||||
| Reclassification adjustment for gains | - | (96 | ) | - | ||||||||
| Related income tax expense | - | 38 | - | |||||||||
| Unrealized holding losses | (217 | ) | (90 | ) | (22 | ) | ||||||
| Related income tax benefit | 86 | 30 | 6 | |||||||||
| Comprehensive income | $ | 7,069 | $ | 5,185 | $ | 1,126 | ||||||
| Accumulated | ||||||||||||||||||||||||||||
| other | ||||||||||||||||||||||||||||
| Preferred | Number of | Common | Capital | Retained | comprehensive | |||||||||||||||||||||||
| (dollars in thousands, except share data) | stock | shares | stock | surplus | earnings | loss | Total | |||||||||||||||||||||
| Balances at January 1, 2015 | $ | 12,562 | 4,145,547 | $ | 41 | $ | 38,360 | $ | 8,696 | $ | (16 | ) | $ | 59,643 | ||||||||||||||
| Net income | - | - | - | - | 1,142 | - | 1,142 | |||||||||||||||||||||
| Net unrealized loss on securities | - | - | - | - | - | (16 | ) | (16 | ) | |||||||||||||||||||
| Dividends paid on preferred stock | - | - | - | - | (126 | ) | - | (126 | ) | |||||||||||||||||||
| Forfeited restricted shares | - | (6,664 | ) | - | (34 | ) | - | - | (34 | ) | ||||||||||||||||||
| Common stock offering | - | 2,173,913 | 22 | 23,096 | - | - | 23,118 | |||||||||||||||||||||
| Director stock awards | - | 7,163 | - | 95 | - | - | 95 | |||||||||||||||||||||
| Exercise of options | - | 62,287 | 1 | 652 | - | - | 653 | |||||||||||||||||||||
| Acquisition of Patapsco Bancorp | - | 560,891 | 6 | 8,043 | - | - | 8,049 | |||||||||||||||||||||
| Stock-based compensation | - | 19,002 | - | 375 | - | - | 375 | |||||||||||||||||||||
| Balances at December 31, 2015 | 12,562 | 6,962,139 | 70 | 70,587 | 9,712 | (32 | ) | 92,899 | ||||||||||||||||||||
| Net income | - | - | - | - | 5,303 | - | 5,303 | |||||||||||||||||||||
| Net unrealized loss on securities | - | - | - | - | - | (118 | ) | (118 | ) | |||||||||||||||||||
| Dividends paid on preferred stock | - | - | - | - | (166 | ) | - | (166 | ) | |||||||||||||||||||
| Redemption of preferred stock | (12,562 | ) | - | - | - | - | - | (12,562 | ) | |||||||||||||||||||
| Director stock awards | - | 7,241 | - | 160 | - | - | 160 | |||||||||||||||||||||
| Exercise of options | - | 3,020 | - | 35 | - | - | 35 | |||||||||||||||||||||
| Stock-based compensation | - | 18,672 | - | 239 | - | - | 239 | |||||||||||||||||||||
| Balances at December 31, 2016 | - | 6,991,072 | 70 | 71,021 | 14,849 | (150 | ) | 85,790 | ||||||||||||||||||||
| Net income | - | - | - | - | 7,200 | - | 7,200 | |||||||||||||||||||||
| Net unrealized loss on securities | - | - | - | - | - | (187 | ) | (187 | ) | |||||||||||||||||||
| Reclassification of tax effects resulting from the Tax Cuts and Jobs Act | 56 | 56 | ||||||||||||||||||||||||||
| Common stock offering | - | 2,760,000 | 28 | 38,355 | - | - | 38,383 | |||||||||||||||||||||
| Director stock awards | - | 11,404 | - | 205 | - | - | 205 | |||||||||||||||||||||
| Exercise of options | - | 27,113 | - | 316 | - | - | 316 | |||||||||||||||||||||
| Stock-based compensation | - | 31,003 | - | 490 | - | - | 490 | |||||||||||||||||||||
| Balances at December 31, 2017 | $ | - | 9,820,592 | $ | 98 | $ | 110,387 | $ | 22,105 | $ | (337 | ) | $ | 132,253 | ||||||||||||||
| Accumulated | ||||||||||||||||||||||||
| other | ||||||||||||||||||||||||
| Number of | Common | Capital | Retained | comprehensive | ||||||||||||||||||||
| (dollars in thousands, except share data) | shares | stock | surplus | earnings | income (loss) | Total | ||||||||||||||||||
| Balances at January 1, 2017 | 6,991,072 | $ | 70 | $ | 71,021 | $ | 14,849 | $ | (150 | ) | 85,790 | |||||||||||||
| Net income | - | - | - | 7,200 | - | 7,200 | ||||||||||||||||||
| Other comprehensive loss | - | - | - | - | (187 | ) | (187 | ) | ||||||||||||||||
| Reclassification of tax effects resulting from the Tax Cuts and Jobs Act | - | - | - | 56 | - | 56 | ||||||||||||||||||
| Common stock offering | 2,760,000 | 28 | 38,355 | - | - | 38,383 | ||||||||||||||||||
| Director stock awards | 11,404 | - | 205 | - | - | 205 | ||||||||||||||||||
| Exercise of options | 27,113 | - | 316 | - | - | 316 | ||||||||||||||||||
| Stock-based compensation | 31,003 | - | 490 | - | - | 490 | ||||||||||||||||||
| Balances at December 31, 2017 | 9,820,592 | 98 | 110,387 | 22,105 | (337 | ) | 132,253 | |||||||||||||||||
| Net loss | - | - | - | (3,828 | ) | - | (3,828 | ) | ||||||||||||||||
| Other comprehensive gain | - | - | - | - | 710 | 710 | ||||||||||||||||||
| Acquisition of First Mariner Bank | 9,143,222 | 92 | 164,486 | - | - | 164,578 | ||||||||||||||||||
| Director stock awards | 11,868 | - | 217 | - | - | 217 | ||||||||||||||||||
| Exercise of options | 9,123 | - | 97 | - | - | 97 | ||||||||||||||||||
| Stock-based compensation | 54,542 | - | 656 | - | - | 656 | ||||||||||||||||||
| Balances at December 31, 2018 | 19,039,347 | 190 | 275,843 | 18,277 | 373 | 294,683 | ||||||||||||||||||
| Net income | - | - | - | 16,881 | - | 16,881 | ||||||||||||||||||
| Other comprehensive gain | - | - | - | - | 2,270 | 2,270 | ||||||||||||||||||
| Director stock awards | 9,202 | - | 127 | - | - | 127 | ||||||||||||||||||
| Exercise of options | 13,418 | 1 | 115 | - | - | 116 | ||||||||||||||||||
| Employee stock purchase plan | 19,539 | - | 280 | - | - | 280 | ||||||||||||||||||
| Repurchased shares | (19,764 | ) | - | (322 | ) | - | - | (322 | ) | |||||||||||||||
| Stock-based compensation | 5,171 | - | 113 | - | - | 113 | ||||||||||||||||||
| Balances at December 31, 2019 | 19,066,913 | $ | 191 | $ | 276,156 | $ | 35,158 | $ | 2,643 | $ | 314,148 | |||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
| Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||||||
| (in thousands) | 2017 | 2016 | 2015 | 2019 | 2018 | 2017 | ||||||||||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||||||||||||||
| Net income | $ | 7,200 | $ | 5,303 | $ | 1,142 | ||||||||||||||||||
| Adjustments to reconcile net income to net cash from operating activities: | ||||||||||||||||||||||||
| Net income (loss) | $ | 16,881 | $ | (3,828 | ) | $ | 7,200 | |||||||||||||||||
| Adjustments to reconcile net income (loss) to net cash from operating activities: | ||||||||||||||||||||||||
| Provision for credit losses | 1,831 | 2,037 | 1,836 | 4,193 | 6,091 | 1,831 | ||||||||||||||||||
| Deferred income tax (benefit) | (1,132 | ) | (1,229 | ) | (3,019 | ) | 3,160 | (3,468 | ) | (1,132 | ) | |||||||||||||
| Provision for other real estate owned | 581 | 83 | 736 | 473 | 352 | 581 | ||||||||||||||||||
| Depreciation | 1,287 | 1,241 | 1,008 | |||||||||||||||||||||
| Depreciation and amortization | 2,348 | 2,188 | 1,287 | |||||||||||||||||||||
| Stock-based compensation | 695 | 399 | 436 | 240 | 873 | 695 | ||||||||||||||||||
| Net (accretion) amortization of investment securities | 81 | (3 | ) | (13 | ) | |||||||||||||||||||
| Net accretion of discount on purchased loans | (575 | ) | (714 | ) | (1,633 | ) | (1,640 | ) | (2,313 | ) | (575 | ) | ||||||||||||
| Gain on sales of securities | - | (96 | ) | - | ||||||||||||||||||||
| Loss on disposal of furniture, fixtures & equipment | 13 | 70 | - | |||||||||||||||||||||
| (Gain) loss on sale of securities | (645 | ) | 364 | - | ||||||||||||||||||||
| Loss on sale of premises and equipment | 70 | 345 | 13 | |||||||||||||||||||||
| Net amortization of intangible asset | 505 | 655 | 462 | 3,013 | 2,856 | 505 | ||||||||||||||||||
| Loans originated for sale | (673,448 | ) | (599,299 | ) | (591,422 | ) | (573,306 | ) | (586,385 | ) | (673,448 | ) | ||||||||||||
| Proceeds from sale of loans originated for sale | 693,384 | 606,020 | 591,597 | 571,656 | 640,710 | 693,384 | ||||||||||||||||||
| Realized and unrealized gains on mortgage banking activity | (11,035 | ) | (8,098 | ) | (6,971 | ) | (7,798 | ) | (5,245 | ) | (11,035 | ) | ||||||||||||
| (Gain) loss on sales of other real estate owned, net | (12 | ) | 14 | 8 | ||||||||||||||||||||
| Gain on sales of portfolio loans, net | (86 | ) | (532 | ) | - | |||||||||||||||||||
| Gain on sale of other real estate owned, net | (28 | ) | (64 | ) | (12 | ) | ||||||||||||||||||
| Cash surrender value of BOLI | (760 | ) | (623 | ) | (408 | ) | (1,858 | ) | (1,614 | ) | (760 | ) | ||||||||||||
| Increase in interest receivable | (672 | ) | (649 | ) | (356 | ) | ||||||||||||||||||
| Increase in interest payable | 124 | 5 | 90 | |||||||||||||||||||||
| Increase in other assets | (1,372 | ) | (817 | ) | (368 | ) | ||||||||||||||||||
| Decrease (increase) in other assets | 2,044 | 5,041 | (2,044 | ) | ||||||||||||||||||||
| Increase (decrease) in other liabilities | 293 | (1,460 | ) | (2,190 | ) | 1,618 | (1,091 | ) | 417 | |||||||||||||||
| Net cash provided by (used in) operating activities | 16,902 | 2,307 | (9,065 | ) | ||||||||||||||||||||
| Other - net | 140 | (1 | ) | (5 | ) | |||||||||||||||||||
| Net cash provided by operating activities | 20,561 | 54,811 | 16,902 | |||||||||||||||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||||||||||||||||||
| Purchase of interest bearing deposits with banks | - | (19,513 | ) | - | ||||||||||||||||||||
| Proceeds from maturities of interest bearing deposits with banks | 19,513 | - | - | - | - | 19,513 | ||||||||||||||||||
| Purchases of investment securities available-for-sale | (59,347 | ) | (84,969 | ) | (42,880 | ) | ||||||||||||||||||
| Purchases of investment securities held-to-maturity | (3,000 | ) | (3,250 | ) | (3,000 | ) | ||||||||||||||||||
| Proceeds from sale/maturities of investment securities available-for-sale | 23,520 | 95,731 | 61,043 | |||||||||||||||||||||
| Purchases of investment securities | (102,748 | ) | (193,805 | ) | (62,347 | ) | ||||||||||||||||||
| Proceeds from sale, maturities and calls of investment securities | 115,758 | 169,291 | 23,520 | |||||||||||||||||||||
| Net increase in loans and leases outstanding | (120,321 | ) | (68,273 | ) | (49,116 | ) | (99,177 | ) | (49,995 | ) | (120,321 | ) | ||||||||||||
| Purchase of bank owned life insurance | (6,500 | ) | (2,200 | ) | (1,800 | ) | - | - | (6,500 | ) | ||||||||||||||
| Proceeds from the sale of other real estate owned | 232 | 178 | 12 | 2,238 | 1,088 | 232 | ||||||||||||||||||
| Proceeds from the sale of portfolio loans | 3,798 | 4,263 | - | - | - | 3,798 | ||||||||||||||||||
| Purchase of premises and equipment | (409 | ) | (627 | ) | (5,273 | ) | (1,429 | ) | (1,943 | ) | (409 | ) | ||||||||||||
| Acquisition activity, net of cash received | - | - | 8,884 | |||||||||||||||||||||
| Proceeds from the sale of premises and equipment | 2,092 | 5,161 | - | |||||||||||||||||||||
| Cash acquired in acquisition | - | 38,889 | - | |||||||||||||||||||||
| Net cash used in investing activities | (142,514 | ) | (78,660 | ) | (32,130 | ) | (83,266 | ) | (31,314 | ) | (142,514 | ) | ||||||||||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||||||||||||||||||
| Net increase in deposits | 55,174 | 61,327 | 17,966 | 28,559 | 115,463 | 55,174 | ||||||||||||||||||
| Net increase in short-term borrowings | 23,329 | 37,935 | 15,493 | |||||||||||||||||||||
| Net increase (decrease) in short-term borrowings | 101,551 | (180,829 | ) | 23,329 | ||||||||||||||||||||
| Proceeds from issuance of long-term debt | 15,016 | 2,810 | 6,914 | 55,000 | 123,543 | 15,016 | ||||||||||||||||||
| Repayment of long-term debt | (17,000 | ) | (12,000 | ) | (9,000 | ) | (114,000 | ) | - | (17,000 | ) | |||||||||||||
| Net proceeds from issuance of common stock, net of cost | 38,699 | 35 | 23,771 | 396 | 97 | 38,699 | ||||||||||||||||||
| Redemption of preferred stock | - | (12,562 | ) | - | ||||||||||||||||||||
| Cash dividends on preferred stock | - | (166 | ) | (126 | ) | |||||||||||||||||||
| Cash consideration paid in acquisition | - | (9,245 | ) | - | ||||||||||||||||||||
| Repurchase of common stock | (322 | ) | - | - | ||||||||||||||||||||
| Net cash provided by financing activities | 115,218 | 77,379 | 55,018 | 71,184 | 49,029 | 115,218 | ||||||||||||||||||
| Net (decrease) increase in cash and cash equivalents | (10,394 | ) | 1,026 | 13,823 | ||||||||||||||||||||
| Net increase (decrease) in cash and cash equivalents | 8,479 | 72,526 | (10,394 | ) | ||||||||||||||||||||
| Cash and cash equivalents at beginning of period | 39,366 | 38,340 | 24,517 | 101,498 | 28,972 | 39,366 | ||||||||||||||||||
| Cash and cash equivalents at end of period | $ | 28,972 | $ | 39,366 | $ | 38,340 | $ | 109,977 | $ | 101,498 | $ | 28,972 | ||||||||||||
| SUPPLEMENTAL INFORMATION | ||||||||||||||||||||||||
| Cash payments for interest | $ | 5,044 | $ | 4,557 | $ | 2,982 | $ | 22,341 | $ | 13,123 | $ | 5,044 | ||||||||||||
| Cash payments for income taxes | 3,440 | 3,145 | 2,890 | 135 | - | 3,440 | ||||||||||||||||||
| Transferred from loans to other real estate owned | - | 256 | 625 | 1,389 | 917 | - | ||||||||||||||||||
| Cash payments for operating leases | 1,337 | 3,159 | 1,995 | |||||||||||||||||||||
| Assets acquired in business combination (net of cash received) | - | - | 194,828 | - | 971,431 | - | ||||||||||||||||||
| Liabilities assumed in business combination | - | - | 204,414 | - | 897,569 | - | ||||||||||||||||||
| Lease liabilities arising from obtaining right of use assets (see Note 11) | 18,009 | - | - | |||||||||||||||||||||
| Goodwill reduction for adjustments to acquired net deferred tax assets | 4,748 | - | - | |||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
Notes to Consolidated Financial Statements
Note 1: Summary of Significant Accounting Policies
| Note 1: | Summary of Significant Accounting Policies |
Nature of Operations
Howard Bancorp, Inc. (“Bancorp” or the “Company”) was incorporated in April 2005 under the laws of the State of Maryland. On December 15, 2005, Howard Bancorp Inc. (“Bancorp”) acquired all of the stock and became the holding company of Howard Bank (the “Bank”) pursuant to the Plan of Reorganization approved by the stockholders of the Bank and by federal and state regulatory agencies. Each share of the Bank’s common stock was converted into two shares of Bancorp common stock effected by the filing of Articles of Exchange on that date, and the stockholders of the Bank became the stockholders of Bancorp. The Bank has four subsidiaries, three of which hold foreclosed real estate and the other owns and manages real estate thatBancorp is used as a branch location and has office and retail space. The accompanying consolidated financial statements of Bancorp and its wholly-owned subsidiary bank (collectively the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).
Bancorp was incorporated in April of 2005 under the laws of the State of Maryland and isnow a bank holding company registered under the Bank Holding Company Act of 1956. Bancorp is1956, with a single bank holding company with one subsidiary, Howard Bank, which operates as a state trust company with commercial banking powers regulated by the Maryland Office of the Commissioner of Financial Regulation (the “Commissioner”).
On August 28, 2015, Bancorp completed its acquisition
The Bank has nine subsidiaries—six were formed to hold foreclosed real estate (three of Patapsco Bancorp, Inc. (“Patapsco Bancorp”)which are currently inactive), the parent company of The Patapsco Bank, through the merger of Patapsco Bancorp withtwo own and into Bancorp pursuant to the Agreementmanage real estate used for corporate purposes, and Plan of Merger dated as of March 2, 2015, as amended, by and between Bancorp and Patapsco Bancorp (the “Merger Agreement”). As a result of the merger, each share of common stock of Patapsco Bancorp was converted into the right to receive, at the holder’s election, $5.09 in cash or 0.3547 shares of Bancorp common stock, provided that (i) cash was paid in lieu of any fractional shares of Bancorp common stock and (ii) 20% of the shares of common stock of Patapsco Bancorp outstanding at the time of the merger were exchanged for cash in the merger, with the remaining shares of Patapsco Bancorp common stock exchanged for 560,891 shares of Bancorp common stock. The aggregate merger consideration was $10.064 million. In connection with the merger, immediately thereafter The Patapsco Bank was merged with and into the Bank, with the Bank the surviving bank.
On May 6, 2016, Bancorp redeemed all of the 12,562 shares of the Series AA Preferred Stock that it had previously issued to the U.S. Department of the Treasury (the “Treasury”) under its Small Business Lending Fund (“SBLF”) program. The aggregate redemption price of the Series AA Preferred Stock was approximately $12.7 million, including dividends accrued but unpaid through the redemption date. The redemption of the Series AA Preferred Stock was funded with variable rate debt with Raymond James Bank, N.A. This debt matured one year from commencement, with interest only payments based upon 30 day LIBOR plus 300 basis points.
On February 1, 2017, Bancorp closed an underwritten public offering, including the exercise in full by the underwriters of their option to purchase an additional 360,000 shares, at the public offering price of $15.00 per share. The exercise of the option to purchase additional shares brought the total number of shares of common stock sold by Bancorp to 2,760,000 shares and increased the amount of gross proceeds raised in the offering, before underwriting discounts and expenses of the offering, to approximately $41.4 million.
On March 1, 2018, we completed our acquisition of First Mariner Bank (“First Mariner”) through the merger of First Mariner with and into the Bank pursuant to the Agreement and Plan of Reorganization dated as August 14, 2017, as amended, by and between Bancorp, the Bank and First Mariner. As a result of the merger, each outstanding share of common stock of First Mariner was converted into the right to receive 1.6624 shares of Bancorp common stock, provided that cash was paid in lieu of any fractional shares. The aggregate merger consideration of $173.8 million included $9.2 million of cash and 9,143,230 shares of our common stock, which was valued at approximately $164.6 million based on Bancorp’s closing stock price of $18.00 on February 28, 2018.holds historic tax credit investments.
The Company is a diversified financial services company providing commercial banking, mortgage banking and consumer finance through banking branches, the internet and other distribution channels to businesses, business owners, professionals and other consumers located primarily in the Greater Baltimore Metropolitan Area.
Basis of Presentation
The following is a descriptionaccounting and reporting policies of the Company’s significantCompany conform to accounting policies.principles generally accepted in the United States of America (“GAAP”) and prevailing practices within the financial services industry for financial information.
Principles of Consolidation
The consolidated financial statements include the accounts of Bancorp, its subsidiary bankthe Bank and the Bank’s subsidiaries. All significant intercompany accounts and transactions have been eliminated. The parent company only financial statements report investments in the subsidiary bankBank under the equity method.
Use of 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. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the allowance for credit losses, goodwill, deferred tax assets, other-than-temporary impairment of investment securities and the fair value of loans held for sale.
Segment Information
The Company has one reportable segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, lending is dependent upon the ability of the Bank to fund itself with deposits and other borrowings and manage interest rate and credit risk. Accordingly, all significant operating decisions are based upon analysis of the Company as one segment or unit.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, cash items in the process of clearing, federal funds sold, and interest-bearing deposits with banks with original maturities of less than 90 days. Generally, federal funds are sold as overnight investments.
Investment Securities
Marketable equity securities and debtDebt securities not classified as held-to-maturity are classified as available-for-sale. Investments held-to-maturity represents securities that the Company has both the intent and ability to hold until maturity. Securities available-for-sale are acquired as part of the Bank's asset/liability management strategy and may be sold in response to changes in interest rates, loan demand, changes in prepayment risk and other factors. Securities available-for-sale are carried at estimated fair value, with unrealized gains or losses based on the difference between amortized cost and fair value reported as accumulated other comprehensive income (loss), net of deferred taxes, a separate component of stockholders’ equity, when appropriate. Realized gains and losses, using the specific identification method, are included as a separate component of noninterest income. Related interest and dividends are included in interest income. Held-to-maturity investments premiumsPremiums and discounts on held-to-maturity investments are amortized to interest income using the effective interest method. Declines in the fair value of individual securities below their amortized cost that are other than temporaryother-than-temporary result in write-downs of the individual securities to their fair value. Factors affecting the determination of whether an other-than-temporary impairment has occurred include a downgrading of the security by a rating agency, a significant deterioration in the financial condition of the issuer, or that management would not have thea change in management’s intent and ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value or that management would be required to sell the security before recovery in fair value.
Nonmarketable Equity Securities
Nonmarketable equity securities include equity securities that are not publicly traded or are held to meet regulatory requirements such as Federal Home Loan Bank of Atlanta (“FHLB”) stock. These securities are accounted for at cost. As of December 31, 2017cost and 2016 none of the non-marketable equity securities were considered impaired.evaluated for impairment each reporting period. Due to redemptive provisions of the Federal Home Loan Bank,FHLB, cost approximates fair value.
Loans Held For SaleMarketable Equity Securities
Marketable equity securities are carried at estimated fair value based on quoted prices. Changes in fair value of marketable equity securities are recognized in net income. At December 31, 2019 and 2018, marketable equity securities amounted to $4.0 million and $3.7 million, respectively, and are included in the interest receivable and other assets caption of the consolidated balance sheet.
Derivative Instruments and Hedging Activity
Interest Rate Swaps
The Company engagesexecutes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. These interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this activity do not meet the strict hedge accounting requirements, changes in salesfair value of residential mortgage loans originatedboth the customer swaps and the offsetting swaps are recognized directly in earnings.
By using derivative instruments, the Company is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the fair value gain in a derivative. When the fair value of a derivative contract is positive, this situation generally indicates that the counterparty is obligated to pay the Company, and, therefore, creates a repayment risk for the Company. When the fair value of a derivative contract is negative, the Company is obligated to pay the counterparty and therefore, has no repayment risk. The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Bank. Company.
The Company has elected to measure loans held for sale atrecognizes the fair value. Fair value is based on outstanding investor commitmentsof derivatives as assets or liabilities in the absencefinancial statements. The accounting for the changes in the fair value of such commitments,a derivative depends on current investor yield requirements based on third party models. Gains and losses on salesthe intended use of these loansthe derivative instrument at inception. The change in fair value of the effective portion of cash flow hedges is accounted for in other comprehensive income rather than net income. Changes in fair value of derivative instruments that are recordednot intended as a component of noninteresthedge are accounted for in the net income in the Consolidated Statementsperiod of Operations. The Company’s current practice is to sell residential mortgage loans on a servicing released basis,the change (see Derivatives and therefore, it has no intangible asset recordedHedging Activities footnote for the value of such servicing. Interest on loans held for sale is credited to income based on the principal amounts outstanding.
Upon sale and delivery, loans are legally isolated from the Company and the Company has no ability to restrict or constrain the ability of third party investors to pledge or exchange the mortgage loans. The Company does not have the entitlement or ability to repurchase the mortgage loans or unilaterally cause third party investors to put the mortgage loans back to the Company. Unrealized and realized gains on loan sales are determined using the specific identification method and are recognized through mortgage banking activity in the Consolidated Statements of Operations.further disclosure).
TheInterest Rate Lock Commitments
In connection with its mortgage banking activities, the Company enters into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitment). Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 15 to 60 days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at a premium at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan.
For purposes of calculating fair value of rate lock commitments, the Bank estimates loan closing and investor delivery rate based on historical experience. The measurement of the estimated fair value of the rate lock commitments is presented as realized and unrealized gains from mortgage banking activities with the corresponding balance sheet amount presented as part ofwithin other assets.
Loans Held For Sale
The Company engages in sales of residential mortgage loans originated by the Bank. Loans held for sale are carried at fair value. Fair value is based on outstanding investor commitments or, in the absence of such commitments, on current investor yield requirements based on third party models. The Company elected to measure loans held for sale atunder the fair value option to better align reported results with the underlying economic changes in value of the loans on the Company’s balance sheet. Changes in the fair value of these loans are recorded in earnings as a component of realized and unrealized gains from mortgage banking activities in noninterest income in the Consolidated Statements of Operations. The Company’s current practice is to sell residential mortgage loans on a servicing released basis, and, therefore, it has no intangible asset recorded for the value of such servicing. Interest on loans held for sale is credited to income based on the principal amounts outstanding.
Loans held for sale that were not ultimately sold, but instead were placed into the Bank’s portfolio, are reclassified to loans held for investment and continue to be recorded at fair value.
Loans and Leases
Loans and leases are stated at their principal balance outstanding, plus deferred origination costs, less unearned discounts and deferred origination fees. Interest on loans and leases is credited to income based on the principal amounts outstanding. Origination fees and costs are amortized to income over the contractual life of the related loans.loans and leases. Generally, accrual of interest on a loan or lease is discontinued when the loan or lease is delinquent more than 90 days unless the collateral securing the loan or lease is sufficient to liquidate the loan. All interest accrued but not collected for loans and leases that are placed on non-accrual or charged-off is reversed against interest income. Interest on these loans and leases is accounted for on the cash-basis or cost-recovery method,cash basis, until qualifying for return to accrual. Loans and leases are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Management considers loans and leases impaired when, based on current information, it is probable that the Company will not collect all principal and interest payments according to contractual terms. Loans and leases are tested for impairment no later than when principal or interest payments become 90 days or more past due and they are placed on non-accrual. Management also considers the financial condition of the borrower, cash flows of the loan or lease and the value of the related collateral. Impaired loans and leases do not include large groups of smaller balance homogeneous loans and leases such as residential real estate and consumer installment loans which are evaluated collectively for impairment. Loans and leases specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (90 days or less) provided eventual collection of all amounts due is expected. The impairment of a loan or lease may be measured based on the present value of expected future cash flows discounted at the loan’sloan or lease’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, the Company’s impairment on such loans and leases is measured by reference to the fair value of the collateral. Interest income on impaired loans and leases is recognized on the cash basis.
The segments of the Company’s loan and lease portfolio are disaggregated to a level that allows management to monitor risk and performance. The commercial real estate (“CRE”) loan segment is further disaggregated into two classes; owner occupied loans and non-owner occupied loans. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than owner occupied CRE loans. The residential mortgage loan segment is further disaggregated into two classes: first lien mortgages and second or junior lien mortgages.
Acquired Loans
Acquired loans are recorded at fair value at the date of acquisition, and accordingly, no allowance for loan losses is transferred to the acquiring entity under the acquisition method. The fair values of loans with evidence of credit deterioration (acquired credit impaired loans) are initially recorded at fair value, but thereafter accounted for differently than purchased, non-credit-impaired loans. For acquired credit impaired loans, the excess of all cash flows estimated to be collectable at the date of acquisition over the initial investment in the acquired credit impaired loan is recognized as interest income, using a level-yield basis over the life of the loan. This amount is referred to as the accretable yield. The acquired credit impaired loan’s contractually-required payments receivable estimated to be in excess of the amount of its future cash flows expected at the date of acquisition is referred to as the non-accretable difference, and is not reflected as an adjustment to the yield, but in the form of a loss accrual or a valuation allowance.
Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each acquired credit impaired loan in comparison to management’s initial performance expectations. Subsequent decreases in the present value of expected cash flows will be recorded as an increase in the allowance for credit losses through a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.
Allowance for Credit Losses
The allowance for credit losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan and lease portfolio and is based on the size and current risk characteristics of the loan and lease portfolio, an assessment of individual problem loans and leases, actual loss experience, current economic events in specific industries and geographic areas including unemployment levels and other pertinent factors including general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogenous loans and leases based on historical loss experience and consideration of economic trends, all of which may be susceptible to significant change. Credit losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for credit losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Evaluations are conducted at least quarterly and more often if deemed necessary.
The allowance for credit losses consists of a specific component and a nonspecific component. The components of the allowance for credit losses represent an estimation done pursuant to either the Financial Accounting Standards Board’s (the “FASB”) Accounting Standards Codification (“ASC”) Topic 450Contingenciesor ASC Topic 310Receivables. The specific component of the allowance for credit losses reflects expected losses resulting from analysis developed through credit allocations for individual loans.loans and leases. The credit allocations are based on a regular analysis of all loans and leases over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. The specific component of the allowance for credit losses also includes management’s determination of the amounts necessary given concentrations and changes in portfolio mix and volume.
The nonspecific portion of the allowance is determined based on management’s assessment of general economic conditions, as well as economic factors in the individual markets in which the Company operates including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle. This determination inherently involves a higher risk of uncertainty and considers current risk factors that may not have yet manifested themselves in the Bank’s historical loss factors used to determine the nonspecific component of the allowance, and it recognizes knowledge of the portfolio may be incomplete. The Bank’s historic loss factors are based upon actual losses incurred by portfolio segment over the preceding 24-month period. In portfolio segments where no actual losses have been incurred within the most recent 24-month period, industry loss data for that portfolio segment, as provided by the FDIC,Federal Deposit Insurance Corporation (“FDIC”), are utilized. In addition to historic loss factors, the Bank’s methodology for the allowance for credit losses also incorporates other risk factors that may be inherent within the portfolio segments. For each portfolio segment, in addition to the historic loss experience, the other factors that are measured and monitored in the overall determination of the allowance include:
| · | changes in lending policies, procedures, practices or personnel; |
| · | changes in the level and composition of construction portfolio and related risks; |
| · | changes and migration of classified assets; |
| · | changes in exposure to subordinate collateral lien positions; |
| · | levels and composition of existing guarantees on loans by |
| · | changes in national, state and local economic trends and business conditions; |
| · | changes and trends in levels of loan and lease payment delinquencies; and |
| · | any other factors that management considers relevant to the quality or performance of the loan and lease portfolio. |
Each of these qualitative risk factors is measured based upon data generated either internally, or in the case of economic conditions utilizing independently provided data on items such as unemployment rates, commercial real estate vacancy rates, or other market data deemed relevant to the business conditions within the markets served.
The Company’s loan and lease policies state that after all collection efforts have been exhausted, and the loan or lease is deemed to be a loss, then the remaining loan or lease balance will be charged to the Company’s established allowance for credit losses. All loans and leases are evaluated for loss potential once it has been determined by the Watch Committee that the likelihood of repayment is in doubt. When a loan is past due for at least 90 days or a deterioration in debt service coverage ratio, guarantor liquidity, or loan-to-value ratio has occurred that would cause concern regarding the likelihood of the full repayment of principal and interest, and the loan or lease is deemed not to be well secured, the loan shouldor lease would be moved to non-accrual status and a specific reserve is established if the net realizable value is less than the principal value of the loan balance(s). Once the actual loss value has been determined, a charge-off against the allowance for credit losses for the amount of the loss is taken. Each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss.
Goodwill, and Other Intangible Assets and Long-Lived Assets
Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in a business combination. The core deposit intangible is amortized over the estimated useful lives of the acquired long-term deposits acquired, and the remaining amounts of the core deposit intangible are periodically reviewed for reasonableness.impairment. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. Long-lived assets are those that provide the Company with a future economic benefit beyond the current year or operating period. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset is greater than the fair value of the asset. Assets to be disposed of are reported at the lower of the cost or the fair value, less costs to sell. An impairment analysis is performed annually as of October 31st each year.annually.
Management has determined that Bancorp has one reporting unit, and based upon the annual impairment analysis, it was determined that there was not an impairment of the carrying value of either the goodwill, or core deposit intangible or other long-lived assets for 2017.2019. The Company is not aware of any issues that have arisen since our last impairment analysis performed in the fourth quarter of 2019.
Business Combinations
GAAP requires that the acquisition method of accounting formerly referred to as the purchase method, be used for all business combinations and that an acquirer be identified for each business combination. Under GAAP, the acquirer is the entity that obtains control of one or more businesses in the business combination, and the acquisition date is the date the acquirer achieves control. GAAP requires that the acquirer recognize the fair value of assets acquired, liabilities assumed, and any non-controlling interest in the acquired entity at the acquisition date.
Other Real Estate Owned
Other real estate acquired through, or in lieu of, foreclosure is initially recorded at fair value less estimated cost to sell at the date of acquisition, establishing a new cost basis. Revenues and expenses from operationsGains or losses arising at the date of acquisition of such properties are included in noninterest income. Additions tocharged against the valuation allowance are included in noninterest expense.for credit losses. Subsequent to foreclosure, valuations are periodically performed by management and ana valuation allowance for losses is established, if necessary, by a charge to operationsnoninterest expense if the carrying value of a property exceeds its estimated fair value less estimated costs to sell. Gains and losses realized from the sale of OREO as well as expenses of operation are recorded in noninterest expense.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization computed using the straight-line method. Premises and equipment are depreciated over the useful lives of the assets, which generally range from 3three to 10 years for furniture, fixtures and equipment and 3three to 5five years for computer software and hardware. Bank owned premises are depreciated over a range of 20 to 30 years. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. The costs of major renewals and betterments are capitalized, while the costs of ordinary maintenance and repairs are included in noninterest expense.
Leases
The Company determines if an arrangement is a lease at inception. All of the Company’s leases are currently classified as operating leases and are included in other assets and other liabilities on the Company’s Consolidated Balance Sheet.
Right-of-use (“ROU”) assets represent the Company’s right to use an underlying asset for the lease term, and lease liabilities represent the Company’s obligation to make lease payments arising from the lease arrangements. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of the expected future lease payments over the remaining lease term. In determining the present value of future lease payments, the Company uses its incremental borrowing rate based on the information available at the lease commencement date. The operating ROU assets are adjusted for any lease payments made at or before lease commencement date, initial direct costs and any lease incentives received. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise such options. Lease expense is recognized on a straight line basis over the expected lease term. Lease agreements that include lease and non-lease components, such as common area maintenance charges, are accounted for separately.
Income Taxes
The Company uses the asset/liability method of accounting for income taxes. Under the asset/liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when these differences reverse.
As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. In addition, deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or the entire deferred tax asset will not be realized.
The Company does not have uncertain tax positions that are deemed material, and did not recognize any adjustments for unrecognized tax benefits. The Company’s policy is to recognize interest and penalties on income taxes in other non-interestnoninterest expenses. The Company remains subject to examination by federal and state taxing authorities for income tax returns for the years ending after December 31, 2014.
Net Income Perper Common Share
Basic net income per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the year. Diluted net income per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the year including any potential dilutive effects of common stock equivalents. Dilutive common stock equivalents such asconsist of stock options and warrants.restricted stock units, calculated under the treasury stock method.
Share-Based Compensation
Compensation cost is recognized for stock options issued to directors and employees. Compensation cost is measured as the fair value of these awards on their date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options. Compensation cost is recognized over the required service period, generally defined as the vesting period for stock option awards. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. When an award is granted to an employee who is retirement eligible, the compensation cost of these awards is recognized over the period up to when the director or employee first becomes eligible to retire.
Compensation expense for non-vested common stock awards is based on the fair value of the awards, which is generally the market price of the common stock on the measurement date, which, for the Company, is the date of grant, and is recognized ratably over the service period of the award.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit. Such financial instruments are recorded in the consolidated balance sheet when they are funded. Potential exposure to loss on commitments to extend credit, if deemed necessary, would be recorded in other liabilities.
As noted under Loans Held for Sale, the Company originates and sells residential mortgage loans to a variety of investors. Mortgage loans sold are subject to representations and warranties made to the third party purchasers regarding certain attributes. Subsequent to the sale, if a material underwriting deficiency or documentation defect is determined, the Company may be obligated to repurchase the mortgage loan or reimburse the investor for losses incurred if the deficiency or defect cannot be rectified within a specific period subsequent to discovery. The Company monitors the activity regarding the requirement to repurchase loans and the associated losses incurred. This information is applied to determine an estimated recourse reserve that is recorded in other liabilities.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on securities available for sale, are reported as a separate component of the equity section of the consolidated balance sheets, such items, along with net income, are components of comprehensive income. The Company’s sole component of accumulated other comprehensive income/loss is unrealized gains/losses on available for sale securities.
Transfer of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. In certain cases, the recourse to the Bank to repurchase assets may exist but is deemed immaterial based on the specific facts and circumstances.
Reclassifications
Certain reclassifications to 20162018 and 20152017 financial presentation were made to conform to the 20172019 presentation. These reclassifications did not affect previously reported net income or total stockholders’ equity.
NewRecent Accounting Pronouncements
The Financial Accounting Standards Board (the “FASB”(“FASB”) has issued Accounting Standards Update (“ASU”) 2018-02,2019-12,Income Statement—Reporting ComprehensiveTaxes (Topic 740) - Simplifying the Accounting for Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.TaxesOn December 22, 2017,. The guidance issued in this update simplifies the Tax Cuts and Jobs Act of 2017 (the “Act”) was signed into law making significant changesaccounting for income taxes by eliminating certain exceptions to the Internal Revenue Code. FASB financial reporting guidance requiresin ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition for deferred tax assetsliabilities for outside basis differences. This ASU also simplifies aspects of the accounting for franchise taxes and liabilities to be adjusted for the effect of a changeenacted changes in tax laws or rates withand clarifies the effect includedaccounting for transactions that result in income from continuing operationsa step-up in the reporting period that includes the enactment date inclusivetax basis of the income tax effects of items in accumulated other comprehensive income.goodwill. The amendments in this Update allow a reclassification from accumulated other comprehensive income to retained earningsASU are effective for standard tax effects resulting from the Act. The amendment better reflects the appropriate tax rate. ASU No. 2018-02 is effective forfiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted for public entities for reporting periods for which financial statements have not yet been issued. The Company early adopted this standard effective December 31, 2017 and reclassified $55 thousand that was recorded to income tax expense for 2017, due to re-measuring from 35% to 21% the federal deferred taxes on the accumulated other comprehensive income components related to available for sale securities.
The FASB has issued ASU 2017-12,Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This ASU’s objectives are to 1) improve the transparency and understanding of information conveyed to financial statements users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships2020, with those risk management activities; and 2) reduce the complexity of and simplify the application of hedge accounting by preparers. ASU 2017-12 is effective for fiscal years beginning after December 15, 2018; early adoption is permitted. The Company currently does not designate any derivative financial instruments as formal hedging relationships and therefore, does not utilize hedge accounting. However, the Company is currently evaluating this ASU to determine whether its provision will enhance the Company’s ability to employ risk management strategies, while improving the transparency and understanding of those strategies for financial statement users.
The FASB has issued ASU 2017-09,Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. This ASU clarifies when changes to the term or conditions of a share-based payment award must be accounted for as a modification. Under this ASU, an entity will not apply modification accounting to a share-based payment award if all of the following are the same immediately before and after the change: 1) The fair value: 2) the award’s vesting conditions; and 3) the award’s classification as an equity or liability instrument. ASU No. 2017-09 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years,permitted, and is not expected to have a material impact on the Company’s Consolidated Financial Statements.
The FASB has issued ASU 2017-08,2018-16,Receivables—Nonrefundable FeesDerivatives and Other Costs (Subtopic 310-20)Hedging (Topic 815): Premium AmortizationInclusion of the Secured Overnight Financing Rate (“SOFR”) Overnight Index Swap (“OIS”) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes.This ASU permits use of the OIS rate based on Purchased Callable Debt Securities.SOFR as a U.S. benchmark interest rate for hedge accounting purposes. Alternative Reference Rates Committee has proposed that the SOFR is the rate that represents best practice as the alternative to derivatives currently indexed to London Inter-Bank Offered Rate (“LIBOR”). The amendments in this Update shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The amendments in this UpdateASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.2019. The amendments should be adopted on a prospective basis for qualifying new or re-designated hedging relationships entered into on or after the date of adoption. The Company has non-designated hedge contracts that are indexed to LIBOR and is monitoring this activity and evaluating the related risks as they relate to derivatives.
The FASB has issued ASU 2019-10, Financial Instruments – Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This ASU amends the effective date of the credit loss standard (ASU 2016-13) for smaller reporting companies, as defined by the SEC. The one-time determination of whether an entity is eligible to be a smaller reporting company is based on an entity’s most recent determination as of November 15, 2019, in accordance with SEC regulations. The Company met this definition of smaller reporting company based on its most recent determination as of November 15, 2019. As a result, the effective date of this ASU for the Company has been amended from fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, to fiscal years beginning after December 31, 2022, and interim periods within those fiscal years. In addition, this ASU amended the mandatory effective date for the elimination of Step 2 from the goodwill impairment test (ASU 2017-04 discussed below). As a smaller reporting company, the effective date of the goodwill impairment standard for the Company has been amended from fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, to fiscal years beginning after December 31, 2022, and interim periods within those fiscal years.
The FASB has issued ASU 2018-13,Fair Value Measurement (Topic 820): Disclosure Framework— Changes to the Disclosure Requirements for Fair Value Measurement.This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will evaluateno longer be required to disclose the guidanceamount of and reason for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. The amendments in this update but doesASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019; early adoption is permitted. Entities are also allowed to elect early adoption of the eliminated or modified disclosure requirements and delay adoption of the new disclosure requirements until their effective date. ASU 2018-13 is not expect it toexpected have a significantmaterial impact on its financial position or result of operations.the Company’s Consolidated Financial Statements.
The FASB has issued ASU 2017-04,Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The amendments in this Update simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. Impairment changescharges should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. The amendments inAs discussed above, this Update areASU, as amended by ASU 2019-10, will be effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years.the Company on January 1, 2023. The Company will evaluate the guidance in this updateUpdate but does not expect it to have a significant impact on itsthe Company’s financial position or result of operations.
The FASB has issued ASU 2017-01,Business Combinations (Topic 805): Clarifying the Definition of a Business. The amendments in this Update provide clarification on the definition of a business and provides criteria to aid in the assessment of whether a transaction should be accounted for as an acquisition or a disposal of assets or business. The amendments in this Update are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company will evaluate the guidance in this update but does not expect it to have a significant impact on its financial position or resultresults of operations.
The FASB has issued ASU 2016-13,Financial Instruments—Credit Losses (Topic 326). The main objective of this update is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the guidance in this updateUpdate replaces 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 measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The guidance inAs discussed above, this update isASU, as amended by ASU 2019-10, will be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.the Company on January 1, 2023. The Company has engaged a third party vendor and is currently evaluating this guidancegathering historical data and reviewing the methodologies and assumptions utilized to determine the impact on its Consolidated Financial Statements.
The FASB has issued ASU 2016-09,Compensation—Stock Compensation (Topic 718). The purpose of this guidance is to simplify the accounting for share-based payment transactions, including the income tax consequences of these transactions. Under the provisions of the update the income tax consequences of excess tax benefits and deficiencies should be recognized in income tax expense in the reporting period in which the awards vest. Currently, excess tax benefits and deficiencies impact stockholders’ equity directly to the extent there is a cumulative excess tax benefit. In the event that a tax deficiency has occurred during the reporting period and a cumulative tax benefit does not exist, the tax deficiency is recognized in income tax expense under current GAAP. The update also provides that entities may continue to estimate forfeitures in accounting for stock based compensation or recognize them as they occur. This update became effective for interim and annual periods beginning after December 15, 2016. The Company adopted this standard effective January 1, 2017 and elected to apply this adoption prospectively. The recognition of excess tax benefits is in the provision for income taxes within the Consolidated Statements of Operations rather than paid-in capital where it had previously been recorded. Additionally, the Consolidated Statements of Cash Flows now present excess tax benefits in operating activity. The Company has elected to account for forfeitures when they occur. As allowed by the ASU the Company’s adoption was prospective, therefore, prior periods have not been adjusted.
The FASB has issued ASU 2016-02,Leases (Topic 842). The new guidance requires lessees to recognize lease assets and lease liabilities related to certain operating leases on their balance sheet and disclose key information about leasing arrangements. This guidance is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. The Company is currently evaluating this guidance to determine the impact on its consolidated financial statements. The Company leases certain properties under operating leases that will result in recognition on the Company’s balance sheet. At December 31, 2017, the Company had contractual operating lease commitments of approximately $11.4 million, before considering any renewal options.
The FASB has issued ASU No. 2016-01,Financial Instruments – Recognition and Measurement of Financial Assets and Liabilities. ASU No. 2016-01 requires equity investments to be measured at fair value with changes in fair value recognized in net income, excluding equity investments that are consolidated or accounted for under the equity method of accounting. The guidance allows equity investments without readily determinable fair values to be measured at cost minus impairment, with a qualitative assessment required to identify impairment. The guidance also: requires public companies to use exit prices to measure the fair value of financial instruments for disclosure purposes; requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; and eliminates the disclosure requirements related to measurement assumptions for the fair value of instruments measured at amortized cost. In addition, the guidance requires that for liabilities measured at fair value under the fair value option, changes in fair value due to changes in instrument-specific credit risk be presented in other comprehensive income. ASU No. 2016-01 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. Adoption of ASU No. 2016-01 is not expected to have a material impact on the Company’s Consolidated Financial Statements.
The FASB has issued ASU No. 2014-09,Revenue from Contracts with Customers (Topic 606). The guidance requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance in this update is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. As allowed by this ASU the Company is permitted to adopt using the full retrospective transition method for all periods presented, or modified retrospective method where the guidance would only be applied to existing contracts in effect at the adoption date and new contracts going forward. The Company’s revenue stream within the scope of ASU No. 2014-09 is primarily from service charges on deposit accounts. The Company is expected to use a modified retrospective approach to uncompleted contracts at the date of adoption. Periods prior to the date of adoption are not retrospectively revised, but a cumulative effect of adoption is recognized for the impact of the ASU on uncompleted contracts at the date of adoption. The impact of guidance in this update, including method of implementation, is not expected to have a material impact on the Company’s Consolidated Financial Statements.
Note 2: Business Combinations
| Note 2: | Business Combinations |
PatapscoFirst Mariner Acquisition
On August 28, 2015,March 1, 2018, Bancorp completed its acquisition of Patapsco Bancorp throughpreviously announced merger with First Mariner Bank (“First Mariner”). At the merger of Patapsco Bancorp, the parent company of The Patapsco Bank, with and into Bancorp pursuant to the Merger Agreement. As a result of the merger, each share of common stock of Patapsco Bancorp was converted into the right to receive, at the holder’s election, $5.09 in cash or 0.3547 shares of Bancorp common stock, provided that (i) cash was paid in lieu of any fractional shares of Bancorp common stock and (ii) 20% of the shares of common stock of Patapsco Bancorp outstanding at theeffective time of the merger, were exchanged for cash in the merger, with the remaining shares of Patapsco Bancorp common stock exchanged for 560,891 shares of Bancorp common stock. The aggregate merger consideration was $10.064 million. In connection with the merger, immediately thereafter The Patapsco Bank wasFirst Mariner merged with and into the Bank, with the Bank continuing as the surviving bank.bank in the merger. At the effective time of merger, under the terms of the merger agreement, each outstanding share of First Mariner common stock and First Mariner Series A Non-Voting Non-Cumulative Perpetual Preferred Stock issued and outstanding was cancelled and converted into the right to receive 1.6624 shares of Bancorp common stock, provided that cash was paid in lieu of any fractional shares. The aggregate merger consideration of $173.8 million included $9.2 million of cash and 9,143,222 shares of Bancorp’s common stock, which was valued at approximately $164.6 million based on Bancorp’s closing stock price of $18.00 on February 28, 2018.
The Company has accounted for the First Mariner merger under the acquisition method of accounting in accordance with FASB ASC Topic 805, “Business“Business Combinations,” whereby the acquired assets and assumed liabilities were recorded by Bancorpthe Company at their estimated fair values as of their acquisition date. Fair value estimates for loans and deposits were based on management’s acceptance of a fair market valuation analysis performed by an independent third party firm.
The acquired assets and assumed liabilities of Patapsco Bancorp were measured at estimated fair value. Management made significant estimates and exercised significant judgment in accounting for the acquisition of Patapsco Bancorp.First Mariner. Management judgmentally assigned risk ratings to loans based on appraisals and estimated collateral values, expected cash flows, prepayment speeds and estimated loss factors to measure fair values for loans. Deposits and borrowings were valued based upon interest rates, original and remaining terms and maturities, as well as current rates for similar funds in the same markets. Premises and equipment was valued based on recent appraised values. Management used quoted or current market prices to determine the fair value of investment securities.
The following table provides the purchase price as of the acquisition date, the current identifiable assets acquired and liabilities assumed at their estimated fair values, and the resulting goodwill of $603 thousand$65.3 million recorded from the acquisition:
(in thousands)
| (in thousands) | ||||
| Purchase Price Consideration | ||||
| Cash consideration | $ | 9,245 | ||
| Purchase price assigned to shares exchanged for stock | 164,578 | |||
| Total purchase price for First Mariner acquisition | $ | 173,823 | ||
| Assets acquired at fair value: | ||||
| Cash and cash equivalents | $ | 38,889 | ||
| Interest bearing deposits with banks | 3,920 | |||
| Investment securities available for sale | 130,302 | |||
| Loans held for sale | 28,189 | |||
| Loans | 664,338 | |||
| Accrued interest receivable | 3,023 | |||
| Other assets | 124,797 | |||
| Core deposit intangible | 12,588 | |||
| Total fair value of assets acquired | $ | 1,006,046 | ||
| Liabilities assumed at fair value: | ||||
| Deposits | 706,435 | |||
| Borrowings | 185,020 | |||
| Accrued expenses and other liabilities | 6,114 | |||
| Total fair value of liabilities assumed | $ | 897,569 | ||
| Purchase Price Consideration | ||||
| Cash consideration | $ | 2,015 | ||
| Purchase price assigned to shares exchanged for stock | 8,049 | |||
| Total purchase price for Patapsco acquisition | $ | 10,064 | ||
| Assets acquired at fair value: | ||||
| Cash and cash equivalents | $ | 19,047 | ||
| Investment securities available for sale | 26,255 | |||
| Loans | 156,907 | |||
| Accrued interest receivable | 602 | |||
| Other assets | 9,090 | |||
| Core deposit intangible | 1,974 | |||
| Total fair value of assets acquired | $ | 213,875 | ||
| Liabilities assumed at fair value: | ||||
| Deposits | 175,083 | |||
| Borrowings | 17,737 | |||
| Accrued expenses and other liabilities | 11,594 | |||
| Total fair value of liabilities assumed | $ | 204,414 |
| Net assets acquired at fair value: | $ | 108,477 | ||
| Transaction consideration paid to First Mariner | 173,823 | |||
| Amount of goodwill recorded from First Mariner Acquisition | $ | 65,346 |
| Net assets acquired at fair value: | $ | 9,461 | ||
| Transaction consideration paid to Patapsco Bancorp | 10,064 | |||
| Amount of goodwill recorded from Patapsco acquisition | $ | 603 |
The goodwill resulting from the First Mariner merger at December 31, 2019 of $65.3 million is lower than the $70.1 million reflected at December 31, 2018 due to a change in the acquired value of the net deferred tax asset included in other assets above. At the acquisition date, it was unclear under the Tax Cuts and Jobs Act (“TCJA”) whether appreciation in the cash value of acquired BOLI would be considered exempt from taxation. However, in the first quarter of 2019, the IRS issued new guidance which clarified the new law and made it more likely than not that the appreciated value of the BOLI acquired by the Company would be tax exempt. As a result, this eliminated the need for a deferred tax liability associated with acquired BOLI. The final regulation maintaining the tax exemption for acquired BOLI was issued in October 2019.
Acquired loans
The following table outlines the contractually required payments receivable, cash flows we expectthat the Company expects to receive, non-accretable credit adjustments and the accretable yield for all Patapsco BancorpFirst Mariner loans as of the acquisition date.
| Contractually | ||||||||||||||||||||
| Required | Non-Accretable | Cash Flows | Accretable | Carring Value | ||||||||||||||||
| Payments | Credit | Expected to be | FMV | of Loans | ||||||||||||||||
| Receivable | Adjustment | Collected | Adjustment | Receivable | ||||||||||||||||
| Performing loans acquired | $ | 156,393 | $ | - | $ | 156,393 | $ | 866 | $ | 155,527 | ||||||||||
| Impaired loans acquired | 3,465 | 1,713 | 1,752 | 372 | 1,380 | |||||||||||||||
| Total loans acquired | $ | 159,858 | $ | 1,713 | $ | 158,145 | $ | 1,238 | $ | 156,907 | ||||||||||
| (in thousands) | Contractually Required Payments Receivable | Non-Accretable Credit Adjustment | Cash Flows Expected to be Collected | Accretable FMV Adjustment | Carring Value of Loans Receivable | |||||||||||||||
| Performing loans acquired | $ | 654,621 | $ | - | $ | 654,621 | $ | 9,054 | $ | 645,567 | ||||||||||
| Credit impaired loans acquired | 29,470 | 9,644 | 19,826 | 1,055 | 18,771 | |||||||||||||||
| Total loans acquired | $ | 684,091 | $ | 9,644 | $ | 674,447 | $ | 10,109 | $ | 664,338 | ||||||||||
UponAs of the acquisitioneffective date of Patapsco Bancorp, the Company recordedmerger, all loans acquired were recorded at the estimated fair value on the purchase date with no carryover of the related allowance for creditloan losses. On the acquisitioneffective date of the Company segregatedmerger, the acquired loan portfolio was segregated into two loan pools, performing and non-performing loans to be retained in the Bank’sour portfolio.
The Company had an independent third party determinedetermined the net discounted value of cash flows on approximately 1,0002,700 performing loans totaling $156.4$654.6 million. The valuation took into consideration the loans’loans' underlying characteristics, including account types, remaining terms, annual interest rates, interest types such as fixed or variable rate, past delinquencies, timing of principal and interest payments, current market rates, loan-to-value ratios, loss exposures, and remaining balances. These performing loans were segregated into pools based on loan and payment type and in some cases, risk grade. The effect of this fair valuation process was a net accretable discount adjustment of $866 thousand at acquisition.$9.1 million on the effective date of the merger.
The Company also individually evaluated 1357 impaired loans totaling $3.5$29.5 million of contractually required payments, to determine the fair value as of the August 28, 2015March 1, 2018 measurement date. In determining the fair value for each individually evaluated impaired loan, the Company considered a number of factors including the remaining life of the acquired loan, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral and net present value of cash flows expectedthe Company expects to be recorded were considered,receive, among others.
The Company established a credit risk related non-accretable difference of $1.7$9.6 million relating to these acquired credit impaired loans, reflected in the recorded net fair value. The Company further estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount adjustment of $372 thousand$1.1 million at acquisition relating to these credit impaired loans.
The Company incurred no merger related costs in the year ended December 31, 2019 and $567 thousand of merger related costs in the year ended December 31, 2017. Merger related costs included in the Consolidated Statements of Operations for the year ended December 31, 2018 are summarized as follows:
| (in thousands) | ||||
| Compensation related | $ | 9,871 | ||
| Equipment disposition | 1,918 | |||
| Legal and consulting | 2,005 | |||
| Contract Terminations | 677 | |||
| Accounting & other | 1,078 | |||
| Total | $ | 15,549 |
Pro Forma Condensed Combined Financial Information:
The following table presents unaudited pro forma information as if the First Mariner merger had been completed on January 1, 2018 and January 1, 2017. The pro forma information does not necessarily reflect the results of operations that would have occurred had the First Mariner merger occurred at the beginning of 2018 or 2017. Supplemental pro forma earnings were adjusted to exclude merger related costs. The expected future amortizations of the various fair value adjustments were included beginning in each year presented. Cost savings are not reflected in the unaudited pro forma amounts for the periods presented. The pro forma financial information does not include the impact of possible business model changes, nor does it consider any potential impacts of current market conditions on revenues, expense efficiencies, or other factors.
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| December 31, | ||||||||
| (in thousands) | 2018 | 2017 | ||||||
| Net interest income after provision | $ | 66,873 | $ | 59,626 | ||||
| Noninterest income | 19,890 | 29,285 | ||||||
| Noninterest expense | 77,699 | 80,721 | ||||||
| Net income | 6,569 | 1,315 | ||||||
| Net income per share | $ | 0.35 | $ | 0.09 | ||||
| Note 3: | Exit of Mortgage Banking Activities |
On December 18, 2019, the Company entered into an agreement to release certain management members of the mortgage division from their employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring all remaining mortgage employees. The Company also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly created LLC. In consideration of the release of the employment agreements, the transfer of the mortgage employees, and the sale of the domain name, the LLC paid the Company $750 thousand. Under the agreement, there is a transition period of approximately 45 days, after which the Company has agreed to cease originating residential first lien mortgage loans and will exit all mortgage banking activities. Accordingly, the majority of the residential first lien mortgage pipeline is expected to be processed by the end of the first quarter of 2020. In order to manage loan run-off within the residential mortgage loan portfolio, the Company plans on buying first lien residential mortgage loans, on a servicing released basis, from both the LLC and other third-party originators.
The following table presents a rollforward of loans held for sale, showing loans originated for sale and loans sold into the secondary market, for the years ended December 31, 2019, 2018, and 2017. In addition, the volume of loans originated for the Company’s loan portfolio as well as a statement of operations for the mortgage banking activities for the years ended December 31, 2019, 2018, and 2017. Since the mortgage banking activities were conducted within a division of the Bank, formal financial statements were not prepared. The statement of operations presented below reflects only the direct costs associated with the Company’s mortgage banking activities and is thus representative of the incremental after tax impact of exiting this activity.
| Year Ended December 31, | ||||||||||||
| (dollars in thousands) | 2019 | 2018 | 2017 | |||||||||
| Loans held for sale, January 1 | $ | 21,261 | $ | 42,153 | $ | 51,054 | ||||||
| Loans originated for sale | 573,306 | 586,385 | 673,448 | |||||||||
| Loans held for sale acquired in First Mariner acquisition | - | 28,189 | - | |||||||||
| Loans sold into the secondary market | (563,857 | ) | (635,466 | ) | (682,349 | ) | ||||||
| Loans held for sale, December 31 | $ | 30,710 | $ | 21,261 | $ | 42,153 | ||||||
| Loans originated for the Bank's portfolio | $ | 114,561 | $ | 57,440 | $ | 52,905 | ||||||
| Statement of Operations: | ||||||||||||
| Net interest income | $ | 681 | $ | 1,403 | $ | 1,505 | ||||||
| Realized and unrealized gains on mortgage banking activity | 7,798 | 5,245 | 11,035 | |||||||||
| Loan related fees and service charges | 2,830 | 4,993 | 5,083 | |||||||||
| Total noninterest income | 10,628 | 10,238 | 16,118 | |||||||||
| Salaries and benefits | 6,394 | 7,083 | 7,673 | |||||||||
| Occupany | 354 | 1,710 | 661 | |||||||||
| All other operating expenses | 2,287 | 4,718 | 7,133 | |||||||||
| Total noninterest expense | 9,035 | 13,511 | 15,467 | |||||||||
| Pretax contribution | 2,274 | (1,870 | ) | 2,156 | ||||||||
| Income tax expense (benefit) | 626 | (515 | ) | 850 | ||||||||
| After tax contribution | $ | 1,648 | $ | (1,355 | ) | $ | 1,306 | |||||
70
Since the Bank’s 91 employees that were engaged in mortgage banking activities will be hired by the LLC under the terms of the agreement, no severance costs were recorded. However, the Company recorded $288 thousand of exit costs associated with change in control and retention agreements. Since the LLC will sublease the office space that was used by these employees, no exit costs associated with lease terminations were recorded.
Note 3: Cash and Due from Banks
| Note 4: | Cash and Due from Banks |
Regulation D of the Federal Reserve Act requires that banks maintain reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. During 20172019 and 2016,2018, the Company maintained balances at the Federal Reserve (in addition to vault cash) to meet the reserve requirements as well as balances to partially compensate for services. Additionally, the Company maintained balances with the Federal Home Loan Bank and other domestic correspondent financial institutions as partial compensation for services they provided to the Company.
Note 4: Investments Securities
| Note 5: | Investment Securities |
The Company holds securities classified as available for sale and held to maturity.
The amortized cost and estimated fair values of investments are as follows:
| December 31, | December 31, | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (in thousands) | 2017 | 2016 | 2019 | 2018 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Gross | Gross | Gross | Gross | Gross | Gross | Gross | Gross | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Amortized | Unrealized | Unrealized | Estimated | Amortized | Unrealized | Unrealized | Estimated | Amortized | Unrealized | Unrealized | Estimated | Amortized | Unrealized | Unrealized | Estimated | |||||||||||||||||||||||||||||||||||||||||||||||||
| Cost | Gains | Losses | Fair Value | Cost | Gains | Losses | Fair Value | Cost | Gains | Losses | Fair Value | Cost | Gains | Losses | Fair Value | |||||||||||||||||||||||||||||||||||||||||||||||||
| Available for sale | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| U.S. Government | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Agencies | $ | 68,082 | $ | - | $ | 342 | $ | 67,740 | $ | 34,584 | $ | 5 | $ | 126 | $ | 34,463 | $ | 66,428 | $ | 963 | $ | 79 | $ | 67,312 | $ | 130,088 | $ | 428 | $ | 119 | $ | 130,397 | ||||||||||||||||||||||||||||||||
| Treasuries | 1,505 | - | 11 | 1,494 | 1,512 | - | 8 | 1,504 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Mortgage-backed | 2,541 | - | 62 | 2,479 | 1,366 | 1 | 69 | 1,298 | 139,918 | 2,848 | 67 | 142,699 | 90,242 | 364 | 146 | 90,460 | ||||||||||||||||||||||||||||||||||||||||||||||||
| Other investments | 2,579 | - | 36 | 2,543 | 1,500 | - | 37 | 1,463 | 5,510 | 4 | 20 | 5,494 | 3,011 | - | 10 | 3,001 | ||||||||||||||||||||||||||||||||||||||||||||||||
| $ | 74,707 | $ | - | $ | 451 | $ | 74,256 | $ | 38,962 | $ | 6 | $ | 240 | $ | 38,728 | $ | 211,856 | $ | 3,815 | $ | 166 | $ | 215,505 | $ | 223,341 | $ | 792 | $ | 275 | $ | 223,858 | |||||||||||||||||||||||||||||||||
| Held to maturity | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Corporate debentures | $ | 9,250 | $ | 188 | $ | 17 | $ | 9,421 | $ | 6,250 | $ | 334 | $ | - | $ | 6,584 | $ | 7,750 | $ | 147 | $ | - | $ | 7,897 | $ | 9,250 | $ | 45 | $ | 42 | $ | 9,253 | ||||||||||||||||||||||||||||||||
The $1.5 million net decrease in held to maturity securities from December 31, 2018 to December 31, 2019 consisted of a $2.0 million call and a $0.5 million purchase.
Gross unrealized losses and fair value by investment category and length of time the individual securities have been in a continuous unrealized loss position at December 31, 20172019 and December 31, 20162018 are presented below:
| December 31, 2017 | ||||||||||||||||||||||||
| (in thousands) | Less than 12 months | 12 months or more | Total | |||||||||||||||||||||
| Gross | Gross | Gross | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
| Available for sale | ||||||||||||||||||||||||
| U.S. Government | ||||||||||||||||||||||||
| Agencies | $ | 54,303 | $ | 216 | $ | 13,437 | $ | 126 | $ | 67,740 | $ | 342 | ||||||||||||
| Treasuries | - | - | 1,494 | 11 | 1,494 | 11 | ||||||||||||||||||
| Mortgage-backed | 1,202 | 12 | 1,262 | 50 | 2,464 | 62 | ||||||||||||||||||
| Other investments | 2,500 | 36 | - | - | 2,500 | 36 | ||||||||||||||||||
| $ | 58,005 | $ | 264 | $ | 16,193 | $ | 187 | $ | 74,198 | $ | 451 | |||||||||||||
| Held to maturity | ||||||||||||||||||||||||
| Corporate debentures | $ | 9,250 | $ | 17 | $ | - | $ | - | $ | 9,250 | $ | 17 | ||||||||||||
| December 31, 2019 | |||||||||||||||||||||||
| (in thousands) | Less than 12 months | 12 months or more | Total | ||||||||||||||||||||
| Gross | Gross | Gross | |||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | ||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | ||||||||||||||||||
| Available for sale | |||||||||||||||||||||||
| U.S. Government | |||||||||||||||||||||||
| Agencies | $ | 10,689 | $ | 79 | $ | - | $ | - | $ | 10,689 | $ | 79 | |||||||||||
| Mortgage-backed | 35,512 | 60 | 975 | 7 | 36,487 | 67 | |||||||||||||||||
| Other investments | - | - | 2,990 | 20 | 2,990 | 20 | |||||||||||||||||
| $ | 46,201 | $ | 139 | $ | 3,965 | $ | 27 | $ | 50,166 | $ | 166 | ||||||||||||
| Held to maturity | |||||||||||||||||||||||
| Corporate debentures | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | |||||||||||
| December 31, 2018 | ||||||||||||||||||||||||
| (in thousands) | Less than 12 months | 12 months or more | Total | |||||||||||||||||||||
| Gross | Gross | Gross | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
| Available for sale | ||||||||||||||||||||||||
| U.S. Government | ||||||||||||||||||||||||
| Agencies | $ | 3,049 | $ | 3 | $ | 13,887 | $ | 116 | $ | 16,936 | $ | 119 | ||||||||||||
| Mortgage-backed | 26,197 | 54 | 2,107 | 92 | 28,304 | 146 | ||||||||||||||||||
| Other investments | 3,001 | 10 | - | - | 3,001 | 10 | ||||||||||||||||||
| $ | 32,247 | $ | 67 | $ | 15,994 | $ | 208 | $ | 48,241 | $ | 275 | |||||||||||||
| Held to maturity | ||||||||||||||||||||||||
| Corporate debentures | $ | 2,458 | $ | 42 | $ | - | $ | - | $ | 2,458 | $ | 42 | ||||||||||||
| December 31, 2016 | ||||||||||||||||||||||||
| (in thousands) | Less than 12 months | 12 months or more | Total | |||||||||||||||||||||
| Gross | Gross | Gross | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
| Available for sale | ||||||||||||||||||||||||
| U.S. Government | ||||||||||||||||||||||||
| Agencies | $ | 17,492 | $ | 126 | $ | - | $ | - | $ | 17,492 | $ | 126 | ||||||||||||
| Treasuries | 1,501 | 8 | - | - | 1,501 | 8 | ||||||||||||||||||
| Mortgage-backed | 1,273 | 69 | - | - | 1,273 | 69 | ||||||||||||||||||
| Other investments | 1,463 | 37 | - | - | 1,463 | 37 | ||||||||||||||||||
| $ | 21,729 | $ | 240 | $ | - | $ | - | $ | 21,729 | $ | 240 | |||||||||||||
The unrealized losses that existed were a result of market changes in interest rates since the original purchase. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) structure of the security. TheSecurities in the portfolio contained 38 securities with unrealized losses totaled 16 and 12 securities with unrealized losses31 at December 31, 20172019 and 2016,2018, respectively.
An impairment loss is recognized in earnings if any of the following are true: (1) the Company intends to sell the debt security; (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the Company does not expect to recover the entire amortized cost basis of the security. In situations where the Company intends to sell or when it is more likely than not that the Company will be required to sell the security, the entire impairment loss must be recognized in earnings. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in stockholders’ equity as a component of other comprehensive income, net of deferred tax.
The amortized cost and estimated fair values of investments by contractual maturity are shown below:
| December 31, | ||||||||||||||||
| (in thousands) | 2017 | 2016 | ||||||||||||||
| Amortized | Estimated Fair | Amortized | Estimated Fair | |||||||||||||
| Cost | Value | Cost | Value | |||||||||||||
| Amounts maturing: | ||||||||||||||||
| One year or less | $ | 35,105 | $ | 34,995 | $ | 16,988 | $ | 16,993 | ||||||||
| After one through five years | 34,489 | 34,248 | 19,120 | 18,985 | ||||||||||||
| After five through ten years | 9,257 | 9,428 | 6,262 | 6,596 | ||||||||||||
| After ten years | 2,526 | 2,464 | 2,842 | 2,738 | ||||||||||||
| $ | 81,377 | $ | 81,135 | $ | 45,212 | $ | 45,312 | |||||||||
| December 31, | ||||||||||||||||
| (in thousands) | 2019 | 2018 | ||||||||||||||
| Amortized | Estimated Fair | Amortized | Estimated Fair | |||||||||||||
| Cost | Value | Cost | Value | |||||||||||||
| Amounts maturing: | ||||||||||||||||
| One year or less | $ | 1,497 | $ | 1,500 | $ | 38,936 | $ | 38,892 | ||||||||
| After one through five years | 49,166 | 50,048 | 88,175 | 88,513 | ||||||||||||
| After five through ten years | 33,576 | 33,915 | 19,873 | 19,921 | ||||||||||||
| After ten years | 135,367 | 137,939 | 85,607 | 85,785 | ||||||||||||
| $ | 219,606 | $ | 223,402 | $ | 232,591 | $ | 233,111 | |||||||||
At December 31, 20172019 and December 31, 2016, $28.82018, $11.6 million and $26.8$42.3 million fair value of securities, respectively, were pledged as collateral for both repurchase agreements and deposits of local government entities that require pledged collateral as a condition of maintaining these deposit accounts. No single issuer of securities, except for Government agencygovernment agencies and mortgage backed securities, had outstanding balances that exceeded ten percent of stockholders’ equity at December 31, 2017.2019.
Note 5: Nonmarketable Equity Securities
| Note 6: | Nonmarketable Equity Securities |
At December 31, 20172019 and December 31, 2016,2018, the Company’s investment in nonmarketable equity securities consisted of Federal Home Loan BankFHLB stock, which is required for continued membership, of $6.5$14.2 million and $5.1$11.8 million, respectively. This investment is carried at cost.
Note 6:7: Loans and Leases
The Company makes loans and leases to customers primarily in the Greater Baltimore Maryland metropolitan area, and surrounding communities. A substantial portion of the Company’s loan portfolio consists of loans to businesses secured by real estate and/or other business assets.
The loan and lease portfolio segment balances at December 31, 20172019 and December 31, 20162018 are presented in the following table:
| December 31, | ||||||||||||||||||||||||||||||||
| December 31, | 2019 | 2018 | ||||||||||||||||||||||||||||||
| (in thousands) | 2017 | % of Total | 2016 | % of Total | Total | % of Total | Total | % of Total | ||||||||||||||||||||||||
| Real estate | ||||||||||||||||||||||||||||||||
| Construction and land | $ | 74,398 | 7.9 | % | $ | 72,973 | 8.9 | % | $ | 128,285 | 7.3 | % | $ | 123,671 | 7.5 | % | ||||||||||||||||
| Residential - first lien | 194,896 | 20.8 | 195,032 | 23.7 | 437,409 | 25.1 | 383,044 | 23.2 | ||||||||||||||||||||||||
| Residential - junior lien | 43,047 | 4.6 | 35,009 | 4.3 | 74,164 | 4.2 | 89,645 | 5.4 | ||||||||||||||||||||||||
| Total residential real estate | 237,943 | 25.4 | 230,041 | 28.0 | 511,573 | 29.3 | 472,689 | 28.6 | ||||||||||||||||||||||||
| Commercial - owner occupied | 170,408 | 18.2 | 134,213 | 16.3 | 241,795 | 13.9 | 234,102 | 14.2 | ||||||||||||||||||||||||
| Commercial - non-owner occupied | 260,802 | 27.8 | 216,781 | 26.4 | 444,052 | 25.4 | 427,747 | 25.9 | ||||||||||||||||||||||||
| Total commercial real estate | 431,210 | 46.0 | 350,994 | 42.7 | 685,847 | 39.3 | 661,849 | 40.1 | ||||||||||||||||||||||||
| Total real estate loans | 743,551 | 79.3 | 654,008 | 79.6 | 1,325,705 | 75.9 | 1,258,209 | 76.2 | ||||||||||||||||||||||||
| Commercial loans and leases | 188,729 | 20.2 | 162,715 | 19.8 | ||||||||||||||||||||||||||||
| Commercial loans and leases1 | 372,872 | 21.4 | 336,876 | 20.5 | ||||||||||||||||||||||||||||
| Consumer | 4,328 | 0.5 | 4,801 | 0.6 | 46,936 | 2.7 | 54,666 | 3.3 | ||||||||||||||||||||||||
| Total loans | $ | 936,608 | 100.0 | % | $ | 821,524 | 100.0 | % | ||||||||||||||||||||||||
| Total loans and leases | $ | 1,745,513 | 100.0 | % | $ | 1,649,751 | 100.0 | % | ||||||||||||||||||||||||
1Includes leases of $6,382 and $7,607 at December 31, 2019 and 2018, respectively.
Net loan and lease origination fees, which are included in the amounts above, totaled $54 thousand$1.3 million and $122$307 thousand at December 31, 20172019 and 2016,2018, respectively.
Portfolio Segments
The Company currently manages its credit products and the respective exposure to credit losses (credit risk) by the following specific portfolio segments (classes) which are levels at which the Company develops and documents its systematic methodology to determine the allowance for credit losses attributable to each respective portfolio segment. These segments are:
| · | Commercial business loans & leases– Commercial loans are made to provide funds for equipment and general corporate needs. Repayment of a loan primarily uses the funds obtained from the operation of the borrower’s business. Commercial loans also include lines of credit that are utilized to finance a borrower’s short-term credit needs and/or to finance a percentage of eligible receivables and inventory. The Company’s loan portfolio also includes a small portfolio of equipment leases, which consists of leases for essential commercial equipment used by |
| · | Construction and land loans – Commercial acquisition, development and construction loans are intended to finance the construction of commercial and residential properties and include loans for the acquisition and development of land. Construction loans represent a higher degree of risk than permanent real estate loans and may be affected by a variety of factors such as the borrower’s ability to control costs and adhere to time schedules and the risk that constructed units may not be absorbed by the market within the anticipated time frame or at the anticipated price. The loan commitment on these loans often includes an interest reserve that allows the lender to periodically advance loan funds to pay interest charges on the outstanding balance of the loan. |
| · | Commercial owner occupied real estate loans – Commercial owner-occupied real estate loans consist of commercial mortgage loans secured by owner occupied properties where an established banking relationship exists and involves a variety of property types to conduct the borrower’s operations. The primary source of repayment for this type of loan is the cash flow from the business and is based upon the borrower’s financial health and the ability of the borrower and the business to repay. |
| · | Commercial non-owner occupied real estate loans – Commercial non-owner occupied loans consist of properties where an established banking relationship exists and involves investment properties for warehouse, retail, and office space with a history of occupancy and cash flow. This commercial real estate category contains mortgage loans to the developers and owners of commercial real estate where the borrower intends to operate or sell the property at a profit and use the income stream or proceeds from the sale(s) to repay the loan. |