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UNTY Unity Bancorp

Filed: 5 May 21, 2:49pm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2021

OR

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

For the transition period from ____ to ____.

Commission File Number 1-12431

Graphic

Unity Bancorp, Inc.

(Exact name of registrant as specified in its charter)

New Jersey

22-3282551

(State or other jurisdiction of incorporation or organization)

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

64 Old Highway 22, Clinton, NJ

08809

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code (908) 730-7630

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

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common stock

UNTY

NASDAQ

Securities registered pursuant to Section 12(g) of the Exchange Act: None

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

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

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

Large accelerated filer  

Accelerated filer  

Nonaccelerated filer  

Smaller reporting company  

Emerging Growth Company  

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

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

The number of shares outstanding of each of the registrant’s classes of common equity stock, as of April 30, 2021 common stock, no par value: 10,417,385 shares outstanding.

Table of Contents

    

Page #

PART I

CONSOLIDATED FINANCIAL INFORMATION

ITEM 1

Consolidated Financial Statements (Unaudited)

3

Consolidated Balance Sheets at March 31, 2021 and December 31, 2020

3

Consolidated Statements of Income for the three months ended March 31, 2021 and 2020

4

Consolidated Statements of Comprehensive Income for the three months ended March 31, 2021 and 2020

5

Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2021 and 2020

6

Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020

7

Notes to the Consolidated Financial Statements

8

ITEM 2

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

45

ITEM 3

Quantitative and Qualitative Disclosures about Market Risk

66

ITEM 4

Controls and Procedures

66

PART II

OTHER INFORMATION

66

ITEM 1

Legal Proceedings

66

ITEM 1A

Risk Factors

67

ITEM 2

Unregistered Sales of Equity Securities and Use of Proceeds

67

ITEM 3

Defaults upon Senior Securities

67

ITEM 4

Mine Safety Disclosures

67

ITEM 5

Other Information

67

ITEM 6

Exhibits

68

EXHIBIT INDEX

69

Exhibit 31.1

Exhibit 31.2

Exhibit 32.1

SIGNATURES

70

2

PART I        CONSOLIDATED FINANCIAL INFORMATION

ITEM 1        Consolidated Financial Statements (Unaudited)

Unity Bancorp, Inc.

Consolidated Balance Sheets

(Unaudited)

(In thousands)

    

March 31, 2021

    

December 31, 2020

ASSETS

Cash and due from banks

$

25,911

$

22,750

Federal funds sold and interest-bearing deposits

 

213,666

 

196,561

Cash and cash equivalents

 

239,577

 

219,311

Securities:

Debt securities available for sale (amortized cost of $32,549 in 2021 and $45,921 in 2020)

 

32,330

 

45,617

Equity securities with readily determinable fair values (amortized cost of $2,112 in 2021 and $2,112 in 2020)

 

2,221

 

1,954

Total securities

 

34,551

 

47,571

Loans:

 

  

 

  

SBA loans held for sale

 

8,809

 

9,335

SBA loans held for investment

 

38,296

 

39,587

SBA PPP loans

169,117

118,257

Commercial loans

 

853,078

 

839,788

Residential mortgage loans

 

448,149

 

467,586

Consumer loans

60,502

66,100

Consumer construction loans

 

90,497

 

87,164

Total loans

 

1,668,448

 

1,627,817

Allowance for loan losses

 

(22,965)

 

(23,105)

Net loans

 

1,645,483

 

1,604,712

Premises and equipment, net

 

20,043

 

20,226

Bank owned life insurance ("BOLI")

 

26,535

 

26,514

Deferred tax assets

 

9,116

 

9,183

Federal Home Loan Bank ("FHLB") stock

 

9,269

 

10,594

Accrued interest receivable

 

9,831

 

10,429

Goodwill

 

1,516

 

1,516

Prepaid expenses and other assets

 

8,897

 

8,858

Total assets

$

2,004,818

$

1,958,914

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

  

 

  

Liabilities:

 

  

 

  

Deposits:

 

  

 

  

Noninterest-bearing demand

$

465,511

$

459,677

Interest-bearing demand

 

217,714

 

204,236

Savings

 

502,300

 

455,449

Time, under $100,000

 

272,298

 

264,671

Time, $100,000 to $250,000

 

94,933

 

95,595

Time, $250,000 and over

 

75,637

 

78,331

Total deposits

 

1,628,393

 

1,557,959

Borrowed funds

 

170,000

 

200,000

Subordinated debentures

 

10,310

 

10,310

Accrued interest payable

 

255

 

248

Accrued expenses and other liabilities

 

14,674

 

16,486

Total liabilities

 

1,823,632

 

1,785,003

Shareholders’ equity:

 

  

 

  

Common stock

92,180

 

91,873

Retained earnings

 

98,331

 

90,669

Treasury stock

(8,791)

(7,442)

Accumulated other comprehensive loss

 

(534)

 

(1,189)

Total shareholders’ equity

 

181,186

 

173,911

Total liabilities and shareholders’ equity

$

2,004,818

$

1,958,914

Shares issued

10,996

10,961

Shares outstanding

10,422

10,456

Treasury shares

574

505

The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.

3

Unity Bancorp, Inc.

Consolidated Statements of Income

(Unaudited)

For the three months ended March 31, 

(In thousands, except per share amounts)

2021

    

2020

INTEREST INCOME

  

 

  

Federal funds sold and interest-bearing deposits

$

24

$

188

FHLB stock

 

63

 

109

Securities:

 

 

Taxable

 

292

 

511

Tax-exempt

 

10

 

22

Total securities

 

302

 

533

Loans:

 

  

 

  

SBA loans

 

783

 

985

SBA PPP loans

1,730

Commercial loans

 

10,474

 

9,933

Residential mortgage loans

 

5,128

 

5,770

Consumer loans

857

960

Consumer construction loans

 

1,215

 

1,107

Total loans

 

20,187

 

18,755

Total interest income

 

20,576

 

19,585

INTEREST EXPENSE

 

  

 

  

Interest-bearing demand deposits

 

309

 

378

Savings deposits

 

431

 

951

Time deposits

 

1,463

 

2,447

Borrowed funds and subordinated debentures

 

355

 

565

Total interest expense

 

2,558

 

4,341

Net interest income

 

18,018

 

15,244

Provision for loan losses

 

500

 

1,500

Net interest income after provision for loan losses

 

17,518

 

13,744

NONINTEREST INCOME

 

  

 

  

Branch fee income

 

295

 

317

Service and loan fee income

 

625

 

376

Gain on sale of SBA loans held for sale, net

 

245

 

473

Gain on sale of mortgage loans, net

 

1,750

 

1,051

BOLI income

 

129

 

173

Net security gains (losses)

 

310

 

(170)

Other income

 

372

 

325

Total noninterest income

 

3,726

 

2,545

NONINTEREST EXPENSE

 

  

 

  

Compensation and benefits

 

6,063

 

5,439

Processing and communications

 

807

 

708

Occupancy

 

706

 

624

Furniture and equipment

 

649

 

655

Professional services

 

380

 

269

Advertising

 

268

 

290

Deposit insurance

 

214

 

88

Director fees

 

208

 

200

BSA expenses

168

63

Other loan expenses

 

143

 

89

Loan collection and OREO (recoveries) expenses

 

(49)

 

186

Other expenses

 

245

 

712

Total noninterest expense

 

9,802

 

9,323

Income before provision for income taxes

 

11,442

 

6,966

Provision for income taxes

 

2,946

 

1,598

Net income

$

8,496

$

5,368

Net income per common share - Basic

$

0.81

$

0.49

Net income per common share - Diluted

$

0.80

$

0.49

Weighted average common shares outstanding – Basic

 

10,437

 

10,883

Weighted average common shares outstanding – Diluted

 

10,565

 

11,037

The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.

4

Unity Bancorp, Inc.

Consolidated Statements of Comprehensive Income

(Unaudited)

For the three months ended

March 31, 2021

March 31, 2020

    

    

    

    

Income tax

    

Before tax

Income tax

Net of tax

Before tax

expense

Net of tax

(In thousands)

amount

expense

amount

     

amount

(benefit)

amount

Net income

$

11,442

2,946

8,496

$

6,966

1,598

5,368

Other comprehensive income (loss) income

Debt securities available for sale:

 

Unrealized holding gains (losses) on securities arising during the period

 

395

89

306

(166)

(35)

(131)

Less: reclassification adjustment for gains (losses) on securities included in net income

 

310

65

245

(170)

(36)

(134)

Total unrealized gains on securities available for sale

 

85

 

24

 

61

 

4

 

1

 

3

Adjustments related to defined benefit plan:

 

  

 

  

 

  

 

  

 

  

 

  

Amortization of prior service cost

 

21

6

15

21

6

15

Total adjustments related to defined benefit plan

 

21

 

6

 

15

 

21

 

6

 

15

Net unrealized gains (losses) from cash flow hedges:

 

  

 

  

 

  

 

  

 

  

 

  

Unrealized holding gains (losses) on cash flow hedges arising during the period

 

807

228

579

(1,410)

(406)

(1,004)

Total unrealized gains (losses) on cash flow hedges

 

807

 

228

 

579

 

(1,410)

 

(406)

 

(1,004)

Total other comprehensive income (loss)

 

913

 

258

 

655

 

(1,385)

 

(399)

 

(986)

Total comprehensive income

$

12,355

$

3,204

$

9,151

$

5,581

$

1,199

$

4,382

The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.

5

Unity Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

For the three months ended March 31, 2021 and 2020

(Unaudited)

    

    

    

Accumulated

    

other

Total

Stock

Retained

comprehensive

Treasury

shareholders’

(In thousands)

Shares

Amount

earnings

(loss) income

aa

stock

equity

Balance, December 31, 2020

 

10,456

$

91,873

$

90,669

$

(1,189)

$

(7,442)

$

173,911

Net income

 

8,496

 

8,496

Other comprehensive income, net of tax

 

655

 

655

Dividends on common stock ($0.08 per share)

 

30

(834)

 

(804)

Common stock issued and related tax effects (1)

 

36

277

 

277

Treasury stock purchased, at cost

(70)

(1,349)

(1,349)

Balance, March 31, 2021

10,422

 

92,180

 

98,331

 

(534)

(8,791)

 

181,186

    

    

    

Accumulated

    

other

Total

Stock

Retained

comprehensive

Treasury

shareholders’

(In thousands)

Shares

Amount

earnings

income (loss)

stock

aa

equity

Balance, December 31, 2019

 

10,881

$

90,113

$

70,442

$

154

$

$

160,709

Net income

 

 

 

5,368

 

 

5,368

Other comprehensive loss, net of tax

 

 

 

 

(986)

 

(986)

Dividends on common stock ($0.08 per share)

 

 

30

 

(871)

 

 

(841)

Common stock issued and related tax effects (1)

 

13

 

227

 

 

 

227

Acquisition of treasury stock, at cost

(11)

(172)

(172)

Balance, March 31, 2020

10,883

 

90,370

 

74,939

 

(832)

 

(172)

 

164,305

(1)Includes the issuance of common stock under employee benefit plans, which includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised.

The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.

6

Unity Bancorp, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

For the three months ended March 31, 

(In thousands)

    

2021

    

2020

OPERATING ACTIVITIES:

 

  

 

  

Net income

$

8,496

$

5,368

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

 

  

 

Provision for loan losses

 

500

 

1,500

Net amortization of purchase premiums and discounts on securities

 

62

 

59

Depreciation and amortization

 

469

 

317

PPP deferred fees and costs

1,937

0

Deferred income tax benefit

 

(191)

 

(347)

Net security gains

 

(43)

 

(301)

Stock compensation expense

 

374

 

365

Valuation writedowns on OREO

 

0

 

200

Gain on sale of mortgage loans, net

 

(2,001)

 

(622)

Gain on sale of SBA loans held for sale, net

 

(245)

 

(473)

Origination of mortgage loans sold

 

(101,869)

 

(38,562)

Origination of SBA loans held for sale

 

(1,312)

 

(2,595)

Proceeds from sale of mortgage loans, net

 

103,870

 

39,184

Proceeds from sale of SBA loans held for sale, net

 

2,416

 

5,850

BOLI income

 

(129)

 

(173)

Net change in other assets and liabilities

 

(685)

 

1,714

Net cash provided by operating activities

 

11,649

 

11,484

INVESTING ACTIVITIES

 

  

 

  

Purchases of FHLB stock, at cost

 

(16,450)

 

(22,275)

Maturities and principal payments on debt securities available for sale

 

6,305

 

2,198

Proceeds from sales of debt securities available for sale

 

7,048

 

6,029

Proceeds from sales of equity securities

 

0

 

111

Proceeds from redemption of FHLB stock

 

17,775

 

27,405

Net increase in SBA PPP loans

(52,492)

0

Net decrease (increase) in loans

 

8,364

 

(17,277)

Proceeds from BOLI

 

107

 

117

Purchases of premises and equipment

 

(224)

 

(166)

Net cash used in investing activities

 

(29,567)

 

(3,858)

FINANCING ACTIVITIES

 

  

 

  

Net increase in deposits

 

70,434

 

128,504

Proceeds from new borrowings

 

130,000

 

109,000

Repayments of borrowings

 

(160,000)

 

(223,000)

Proceeds from exercise of stock options

 

80

 

34

Fair market value of shares withheld to cover employee tax liability

 

(177)

 

(172)

Dividends on common stock

 

(804)

 

(841)

Purchase of treasury stock

(1,349)

(172)

Net cash provided by financing activities

 

38,184

 

13,353

Increase in cash and cash equivalents

 

20,266

 

20,979

Cash and cash equivalents, beginning of period

 

219,311

 

158,016

Cash and cash equivalents, end of period

$

239,577

$

178,995

SUPPLEMENTAL DISCLOSURES

 

  

 

  

Cash:

 

  

 

  

Interest paid

$

2,550

$

4,559

Income taxes paid

3,320

1,782

Noncash investing activities:

  

  

Transfer of SBA loans held for sale to held to maturity

0

1,024

Capitalization of servicing rights

$

19

$

486

The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.

7

Unity Bancorp, Inc.

Notes to the Consolidated Financial Statements (Unaudited)

March 31, 2021

NOTE 1. Significant Accounting Policies

The accompanying Consolidated Financial Statements include the accounts of Unity Bancorp, Inc. (the "Parent Company") and its wholly-owned subsidiary, Unity Bank (the "Bank" or when consolidated with the Parent Company, the "Company"), and reflect all adjustments and disclosures which are generally routine and recurring in nature, and in the opinion of management, necessary for a fair presentation of interim results. The Bank has multiple subsidiaries used to hold part of its investment and loan portfolios and OREO properties. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior period amounts to conform to the current year presentation, with no impact on current earnings or shareholders’ equity. The financial information has been prepared in accordance with U.S. generally accepted accounting principles and has not been audited. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenues and expenses during the reporting periods. Actual results could differ from those estimates. Amounts requiring the use of significant estimates include the allowance for loan losses, valuation of deferred tax and servicing assets, the carrying value of loans held for sale and other real estate owned, the valuation of securities and the determination of other-than-temporary impairment for securities and fair value disclosures. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. The markets served by the Company have been significantly impacted by the COVID-19 pandemic, which started during the first quarter of 2020. The Company continues to assess the financial impact of the COVID-19 pandemic.

The interim unaudited Consolidated Financial Statements included herein have been prepared in accordance with instructions for Form 10-Q and the rules and regulations of the Securities and Exchange Commission (“SEC”) and consist of normal recurring adjustments necessary for the fair presentation of interim results. The results of operations for the three months ended March 31, 2021 are not necessarily indicative of the results which may be expected for the entire year. As used in this Form 10-Q, “we” and “us” and “our” refer to Unity Bancorp, Inc., and its consolidated subsidiary, Unity Bank, depending on the context. Certain information and financial disclosures required by U.S. generally accepted accounting principles have been condensed or omitted from interim reporting pursuant to SEC rules. Interim financial statements should be read in conjunction with the Company’s Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.

Risks and Uncertainties

On March 11, 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic. The COVID-19 pandemic has adversely affected local, national and global economic activity. Actions taken to help mitigate the spread of COVID-19 include restrictions on travel, localized quarantines, and government-mandated closures of certain businesses. The spread of the outbreak has caused significant disruptions to the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates.

On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00 percent to 1.25 percent. This range was further reduced to 0 percent to 0.25 percent on March 16, 2020. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted to, among other provisions, provide emergency assistance for individuals, families and businesses affected by the COVID-19 pandemic. These reductions in interest rates and other effects of the COVID-19 pandemic may materially and adversely affect the Company’s financial condition and results of operations in future periods. It is unknown how long the adverse conditions associated with the COVID-19 pandemic will last and what the complete financial effect will be to the Company. It is possible that estimates made in the financial statements could be materially and adversely impacted as a result of these conditions.

8

On July 27, 2017, the U.K. Financial Conduct Authority, which regulates LIBOR, announced that it will no longer persuade or compel banks to submit rates for the calculation of LIBOR to the LIBOR administrator after 2021. The announcement also 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 LIBOR submissions to the LIBOR administrator or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable benchmark for certain loans and liabilities including our subordinated notes, what rate or rates may become accepted alternatives to LIBOR or the effect of any such changes in views or alternatives on the values of the loans and liabilities, whose interest rates are tied to LIBOR. Uncertainty as to the nature of such potential changes, alternative reference rates, the elimination or replacement of LIBOR, or other reforms may adversely affect the value of, and the return on our loans and our investment securities.

Other-Than-Temporary Impairment

The Company has a process in place to identify securities that could potentially incur credit impairment that is other-than-temporary. This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation. This evaluation considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, the intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, our ability and intent to hold the security for a forecasted period of time that allows for the recovery in value.

Management assesses its intent to sell or whether it is more likely than not that it will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired with no intent to sell and no requirement to sell prior to recovery of its amortized cost basis, the amount of the impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income. For debt securities where management has the intent to sell, the amount of the impairment is reflected in earnings as realized losses.

The present value of expected future cash flows is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best estimate cash flows vary depending on the type of security. The asset-backed securities cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees. The corporate bond cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond specific facts and circumstances including timing, security interests and loss severity.

Transfers 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.

9

Loans

Loans Held for Sale

Loans held for sale represent the guaranteed portion of Small Business Administration (“SBA”) loans, excluding loans originated under the Paycheck Protection Program, and are reflected at the lower of aggregate cost or market value. The Company originates loans to customers under an SBA program that historically has provided for SBA guarantees of up to 90 percent of each loan. The Company generally sells the guaranteed portion of its SBA loans to a third party and retains the servicing, holding the nonguaranteed portion in its portfolio. The net amount of loan origination fees on loans sold is included in the carrying value and in the gain or loss on the sale. When sales of SBA loans do occur, the premium received on the sale and the present value of future cash flows of the servicing assets are recognized in income. All criteria for sale accounting must be met in order for the loan sales to occur; see details under the “Transfers of Financial Assets” heading above.

Servicing assets represent the estimated fair value of retained servicing rights, net of servicing costs, at the time loans are sold. Servicing assets are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on stratifying the underlying financial assets by date of origination and term. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment, if temporary, would be reported as a valuation allowance.

Serviced loans sold to others are not included in the accompanying Consolidated Balance Sheets. Income and fees collected for loan servicing are credited to noninterest income when earned, net of amortization on the related servicing assets.

Loans Held for Investment

Loans held for investment are stated at the unpaid principal balance, net of unearned discounts and deferred loan origination fees and costs. In accordance with the level yield method, loan origination fees, net of direct loan origination costs, are deferred and recognized over the estimated life of the related loans as an adjustment to the loan yield. Interest is credited to operations primarily based upon the principal balance outstanding.

Loans are reported as past due when either interest or principal is unpaid in the following circumstances: fixed payment loans when the borrower is in arrears for two or more monthly payments; open end credit for two or more billing cycles; and single payment notes if interest or principal remains unpaid for 30 days or more.

Nonperforming loans consist of loans that are not accruing interest as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt (nonaccrual loans). When a loan is classified as nonaccrual, interest accruals are discontinued and all past due interest previously recognized as income is reversed and charged against current period earnings. Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income. Loans may be returned to an accrual status when the ability to collect is reasonably assured and when the loan is brought current as to principal and interest.

Loans are charged off when collection is sufficiently questionable and when the Company can no longer justify maintaining the loan as an asset on the balance sheet. Loans qualify for charge-off when, after thorough analysis, all possible sources of repayment are insufficient. These include: 1) potential future cash flows, 2) value of collateral, and/or 3) strength of co-makers and guarantors. All unsecured loans are charged off upon the establishment of the loan’s nonaccrual status. Additionally, all loans classified as a loss or that portion of the loan classified as a loss is charged off. All loan charge-offs are approved by the Board of Directors.

Troubled debt restructurings ("TDRs") occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. Interest income on

10

accruing TDRs is credited to operations primarily based upon the principal amount outstanding, as stated in the paragraphs above.

The Company evaluates its loans for impairment. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company has defined impaired loans to be all TDRs and nonperforming loans individually evaluated for impairment. Impairment is evaluated in total for smaller-balance loans of a similar nature (consumer and residential mortgage loans), and on an individual basis for all other loans. Impairment of a loan is measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or as a practical expedient, based on a loan’s observable market price or the fair value of collateral, net of estimated costs to sell, if the loan is collateral-dependent. If the value of the impaired loan is less than the recorded investment in the loan, the Company establishes a valuation allowance, or adjusts existing valuation allowances, with a corresponding charge to the provision for loan losses.

For additional information on loans, see Note 8 to the Consolidated Financial Statements and the section titled "Loan Portfolio" under Item 2. Management’s Discussion and Analysis.

Allowance for Loan Losses and Reserve for Unfunded Loan Commitments

The allowance for loan losses is maintained at a level management considers adequate to provide for probable loan losses as of the balance sheet date. The allowance is increased by provisions charged to expense and is reduced by net charge-offs.

The level of the allowance is based on management’s evaluation of probable losses in the loan portfolio, after consideration of prevailing economic conditions in the Company’s market area, the volume and composition of the loan portfolio, and historical loan loss experience. The allowance for loan losses consists of specific reserves for individually impaired credits and TDRs, reserves for nonimpaired loans based on historical loss factors and reserves based on general economic factors and other qualitative risk factors such as changes in delinquency trends, industry concentrations or local/national economic trends. This risk assessment process is performed at least quarterly, and, as adjustments become necessary, they are realized in the periods in which they become known.

Although management attempts to maintain the allowance at a level deemed adequate to provide for probable losses, future additions to the allowance may be necessary based upon certain factors including changes in market conditions and underlying collateral values. In addition, various regulatory agencies periodically review the adequacy of the Company’s allowance for loan losses. These agencies may require the Company to make additional provisions based on their judgments about information available to them at the time of their examination.

The Company maintains an allowance for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the allowance are made through other expenses and applied to the allowance which is maintained in other liabilities.

For additional information on the allowance for loan losses and unfunded loan commitments, see Note 9 to the Consolidated Financial Statements and the sections titled "Asset Quality" and "Allowance for Loan Losses and Reserve for Unfunded Loan Commitments" under Item 2. Management’s Discussion and Analysis.

Income Taxes

The Company accounts for income taxes according to the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates applicable to taxable income for the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

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Valuation reserves are established against certain deferred tax assets when it is more likely than not that the deferred tax assets will not be realized. Increases or decreases in the valuation reserve are charged or credited to the income tax provision. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that ultimately would be sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. The evaluation of a tax position taken is considered by itself and not offset or aggregated with other positions. Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest and penalties associated with unrecognized tax benefits would be recognized in income tax expense on the income statement.

NOTE 2. Litigation

The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. In the best judgment of management, based upon consultation with counsel, the consolidated financial position and results of operations of the Company will not be affected materially by the final outcome of any pending legal proceedings or other contingent liabilities and commitments.

NOTE 3. Net Income per Share

Basic net income per common share is calculated as net income divided by the weighted average common shares outstanding during the reporting period.

Diluted net income per common share is computed similarly to that of basic net income per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares, principally stock options, were issued during the reporting period utilizing the Treasury stock method. However, when a net loss rather than net income is recognized, diluted earnings per share equals basic earnings per share.

The following is a reconciliation of the calculation of basic and diluted income per share:

For the three months ended March 31, 

(In thousands, except per share amounts)

    

2021

    

2020

    

Net income

$

8,496

$

5,368

Weighted average common shares outstanding - Basic

 

10,437

 

10,883

Plus: Potential dilutive common stock equivalents

 

128

 

154

Weighted average common shares outstanding - Diluted

 

10,565

 

11,037

Net income per common share - Basic

$

0.81

$

0.49

Net income per common share - Diluted

 

0.80

 

0.49

Stock options and common stock excluded from the income per share calculation as their effect would have been anti-dilutive

 

154

 

363

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NOTE 4. Income Taxes

The Company follows FASB ASC Topic 740, “Income Taxes,” which prescribes a threshold for the financial statement recognition of income taxes and provides criteria for the measurement of tax positions taken or expected to be taken in a tax return. ASC 740 also includes guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition of income taxes.

On July 1, 2018, New Jersey’s Assembly Bill 4202 was signed into law. The bill, effective January 1, 2018, imposed a temporary surtax on corporations earning New Jersey allocated taxable income in excess of $1 million at a rate of 2.5 percent for tax years beginning on or after January 1, 2018, through December 31, 2019, and at 1.5 percent for tax years beginning on or after January 1, 2020, through December 31, 2021. In addition, New Jersey adopted mandatory unitary combined reporting for its Corporation Business Tax, which became effective for periods on or after January 1, 2019.

On September 29, 2020, New Jersey’s Assembly Bill 4721 was signed into law. The bill, retroactively effective January 1, 2020, extends the 2.5% corporate income surtax until December 31, 2023. The Division of Taxation will waive any underpayment penalties on 2020 estimated tax payments related to the retroactive increase. In addition, if the federal corporate tax rate is increased to a rate of at least 35% of taxable income, the surtax will be suspended.

For the quarter ended March 31, 2021, the Company reported income tax expense of $2.9 million for an effective tax rate of 25.7 percent, compared to an income tax expense of $1.6 million and an effective tax rate of 22.9 percent for the prior year’s quarter. The Company did 0t recognize or accrue any interest or penalties related to income taxes during the three months ended March 31, 2021 or 2020. The Company did 0t have an accrual for uncertain tax positions as of March 31, 2021 or December 31, 2020, as deductions taken and benefits accrued are based on widely understood administrative practices and procedures and are based on clear and unambiguous tax law. Tax returns for all years 2016 and thereafter are subject to future examination by tax authorities.

NOTE 5. Other Comprehensive (Loss) Income

The following tables show the changes in other comprehensive (loss) income for the three months ended March 31, 2021 and 2020, net of tax:

For the three months ended March 31, 2021

 

 

Adjustments

 

Net unrealized

 

Accumulated

 

Net unrealized

 

related to

 

(losses) gains

 

other

 

(losses) gains on

 

defined benefit

 

from cash flow

 

comprehensive

(In thousands)

securities

 

plan

 

hedges

 

(loss) income

Balance, beginning of period (1)

    

$

(179)

$

(238)

$

(737)

    

$

(1,154)

Other comprehensive income before reclassifications

 

306

579

 

885

Less amounts reclassified from accumulated other comprehensive income (loss)

 

245

(15)

 

230

Period change

 

61

 

15

 

579

 

655

Balance, end of period (1)

$

(118)

$

(223)

$

(158)

$

(499)

13

For the three months ended March 31, 2020

 

 

Adjustments

 

Net unrealized

 

Accumulated

 

Net unrealized

 

related to

 

gains (losses)

 

other

 

gains (losses) on

 

defined benefit

 

from cash flow

 

comprehensive

(In thousands)

securities

 

plan

 

hedges

 

income (loss)

Balance, beginning of period (1)

    

$

316

$

(295)

$

168

    

$

189

Other comprehensive loss before reclassifications

 

(131)

(1,004)

 

(1,135)

Less amounts reclassified from accumulated other comprehensive loss

 

(134)

(15)

 

(149)

Period change

 

3

 

15

 

(1,004)

 

(986)

Balance, end of period (1)

$

320

$

(280)

$

(836)

$

(797)

(1)AOCI does not reflect the net reclassification of $35 thousand to Retained Earnings as a result of ASU 2016-01, "Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" & ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income".

NOTE 6. Fair Value

Fair Value Measurement

The Company follows FASB ASC Topic 820, “Fair Value Measurement and Disclosures,” which requires additional disclosures about the Company’s assets and liabilities that are measured at fair value. Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed as follows:

Level 1 Inputs

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Generally, this includes debt and equity securities and derivative contracts that are traded in an active exchange market (i.e. New York Stock Exchange), as well as certain U.S. Treasury, U.S. Government and sponsored entity agency mortgage-backed securities that are highly liquid and are actively traded in over-the-counter markets.

Level 2 Inputs

Quoted prices for similar assets or liabilities in active markets.
Quoted prices for identical or similar assets or liabilities in inactive markets.
Inputs other than quoted prices that are observable, either directly or indirectly, for the term of the asset or liability (i.e., interest rates, yield curves, credit risks, prepayment speeds or volatilities) or “market corroborated inputs.”
Generally, this includes U.S. Government and sponsored entity mortgage-backed securities, corporate debt securities and derivative contracts

14

Level 3 Inputs

Prices or valuation techniques that require inputs that are both unobservable (i.e. supported by little or no market activity) and that are significant to the fair value of the assets or liabilities.
These assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

Fair Value on a Recurring Basis

The following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis:

Debt Securities Available for Sale

The fair value of available for sale ("AFS") debt securities is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).

As of March 31, 2021, the fair value of the Company’s AFS debt securities portfolio was $32.3 million. Approximately 46 percent of the portfolio was made up of residential mortgage-backed securities, which had a fair value of $15.0 million at March 31, 2021. Approximately $14.8 million of the residential mortgage-backed securities are guaranteed by the Government National Mortgage Association ("GNMA"), the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC"). The underlying loans for these securities are residential mortgages that are geographically dispersed throughout the United States.

Most of the Company’s AFS debt securities were classified as Level 2 assets at March 31, 2021. The valuation of AFS debt securities using Level 2 inputs was primarily determined using the market approach, which uses quoted prices for similar assets or liabilities in active markets and all other relevant information. It includes model pricing, defined as valuing securities based upon their relationship with other benchmark securities.

Included in the Company’s AFS debt securities are two corporate bonds which are classified as Level 3 assets at March 31, 2021, which were previously classified as Level 2 assets.  The valuation of these corporate bonds is determined using broker quotes, third-party vendor prices, or other valuation techniques, such as discounted cash flow techniques.  Market inputs used in the other valuation techniques or underlying third-party vendor prices or broker quotes include benchmark and government bond yield curves, credit spreads, and trade execution data. 

The following table presents a reconciliation of the Level 3 available for sale debt securities measured at fair value on a recurring basis for the three months ended March 31, 2021 and 2020:

For the three months ended March 31, 

(In thousands)

    

2021

    

2020

Balance at beginning of period (1)

 

$

4,400

 

$

Purchases/additions

Sales/reductions

 

 

Realized gains (losses)

 

 

Unrealized gains

 

138

 

Balance at end of period

$

4,538

$

(1) Includes AFS debt securities classified as Level 2 at December 31, 2019, which were transferred to Level 3 during the year ended 2020.

15

Equity Securities with Readily Determinable Fair Values

The fair value of equity securities is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).

As of March 31, 2021, the fair value of the Company’s equity securities portfolio was $2.2 million.

All of the Company’s equity securities were classified as Level 2 assets at March 31, 2021. The valuation of equity securities using Level 2 inputs was primarily determined using the market approach, which uses quoted prices for similar assets or liabilities in active markets and all other relevant information.

There were no changes in the inputs or methodologies used to determine fair value during the period ended March 31, 2021, as compared to the periods ended December 31, 2020 and March 31, 2020.

Loans Held for Sale

Fair Value for loans held for sale is derived from quoted market prices for similar loans, in which case they are characterized as Level 2 assets in the fair value hierarchy.

Interest Rate Swap Agreements

The fair value of interest rate swap agreements is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).

The Company’s derivative instruments are classified as Level 2 assets, as the readily observable market inputs to these models are validated to external sources, such as industry pricing services, or are corroborated through recent trades, dealer quotes, yield curves, implied volatility or other market-related data.

16

The tables below present the balances of assets and liabilities measured at fair value on a recurring basis as of March 31, 2021 and December 31, 2020:

Fair Value Measurements at March 31, 2021 Using

Quoted Prices in

Assets/Liabilities

Active Markets

Significant Other

Significant

Measured at Fair

for Identical

Observable

Unobservable

(In thousands)

    

Value

    

Assets (Level 1)

    

Inputs (Level 2)

    

Inputs (Level 3)

Measured on a recurring basis:

 

  

 

  

 

  

 

  

Assets:

 

  

 

  

 

  

 

  

Debt securities available for sale:

 

  

 

  

 

  

 

  

State and political subdivisions

$

2,375

$

$

2,375

$

Residential mortgage-backed securities

 

15,013

 

 

15,013

 

Corporate and other securities

 

14,942

 

 

10,404

 

4,538

Total debt securities available for sale

$

32,330

$

$

27,792

$

4,538

Equity securities with readily determinable fair values

 

2,221

 

 

2,221

 

Total equity securities

$

2,221

$

$

2,221

$

Loans held for sale

 

10,392

 

 

10,392

 

Total loans held for sale

$

10,392

$

$

10,392

$

Interest rate swap agreements

 

(219)

 

 

(219)

 

Total swap agreements

$

(219)

$

$

(219)

$

Fair value Measurements at December 31, 2020 Using

Quoted Prices in

Assets/Liabilities

Active Markets

Significant Other

Significant

Measured at Fair

for Identical

Observable

Unobservable

(In thousands)

    

Value

    

Assets (Level 1)

    

Inputs (Level 2)

    

Inputs (Level 3)

Measured on a recurring basis:

 

  

 

  

 

  

 

  

Assets:

 

  

 

  

 

  

 

  

Debt securities available for sale:

 

  

 

  

 

  

 

  

U.S. Government sponsored entities

$

2,003

$

$

2,003

$

State and political subdivisions

 

2,969

 

 

2,969

 

Residential mortgage-backed securities

 

17,410

 

 

17,410

 

Corporate and other securities

 

23,235

 

 

18,835

 

4,400

Total debt securities available for sale

$

45,617

$

$

41,217

$

4,400

Equity securities with readily determinable fair values

 

1,954

 

 

1,954

 

Total equity securities

$

1,954

$

$

1,954

$

Loans held for sale

 

10,712

 

 

10,712

 

Total loans held for sale

$

10,712

$

$

10,712

$

Interest rate swap agreements

 

(1,026)

 

 

(1,026)

 

Total swap agreements

$

(1,026)

$

$

(1,026)

$

17

Fair Value on a Nonrecurring Basis

The following tables present the assets and liabilities subject to fair value adjustments (impairment) on a non-recurring basis carried on the balance sheet by caption and by level within the hierarchy (as described above):

Fair Value Measurements at March 31, 2021 Using

Quoted Prices

Significant

in Active

Other

Significant

Assets/Liabilities

Markets for

Observable

Unobservable

Net Credit

Measured at Fair

Identical Assets

Inputs

Inputs

During

(In thousands)

    

Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

    

Period

Measured on a non-recurring basis:

 

  

 

  

 

  

 

  

 

  

Financial assets:

 

  

 

  

 

  

 

  

 

  

Impaired collateral-dependent loans

$

12,591

$

$

$

12,591

$

(556)

Fair Value Measurements at December 31, 2020 Using

Quoted Prices

Significant

in Active

Other

Significant

Net (Credit)

Assets/Liabilities

Markets for

Observable

Unobservable

Provision

Measured at Fair

Identical Assets

Inputs

Inputs

During

(In thousands)

    

Value

    

(Level 1)

    

(Level 2)

    

(Level 3)

    

Period

Financial assets:

 

  

 

  

 

  

 

  

 

  

OREO

$

$

$

$

$

(225)

Impaired collateral-dependent loans

 

11,959

 

 

 

11,959

 

3,693

Certain assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following is a description of the valuation methodologies used for instruments measured at fair value on a nonrecurring basis:

Appraisal Policy

All appraisals must be performed in accordance with the Uniform Standards of Professional Appraisal Practice ("USPAP"). Appraisals are certified to the Company and performed by appraisers on the Company’s approved list of appraisers. Evaluations are completed by a person independent of Company management. The content of the appraisal depends on the complexity of the property. Appraisals are completed on a “retail value” and an “as is value.”

OREO

The fair value of OREO is determined using third party appraisals, which may be discounted based on management’s review and changes in market conditions (Level 3 Inputs).

Impaired Collateral-Dependent Loans

The fair value of impaired collateral-dependent loans is derived in accordance with FASB ASC Topic 310, “Receivables.” Fair value is determined based on the loan’s observable market price or the fair value of the collateral. Partially charged-off loans are measured for impairment based upon a third party appraisal for collateral-dependent loans. When an updated appraisal is received for a nonperforming loan, the value on the appraisal may be discounted in the manner discussed above. If there is a deficiency in the value after the Company applies these discounts, management applies a specific reserve and the loan remains in nonaccrual status. The receipt of an updated appraisal would not qualify as a reason to put a loan back into accruing status. The Company removes loans from nonaccrual status generally when the borrower makes three months of contractual payments and demonstrates the ability to service the debt going forward. Charge-offs are determined based upon the loss that management believes the Company will incur after evaluating collateral for impairment based upon the valuation methods described above and the ability of the borrower to pay any deficiency.

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The valuation allowance for impaired loans is included in the allowance for loan losses in the consolidated balance sheets. At March 31, 2021, the valuation allowance for impaired loans was $3.6 million, a decrease of $556 thousand from $4.1 million at December 31, 2020.

Fair Value of Financial Instruments

FASB ASC Topic 825, “Financial Instruments,” requires the disclosure of the estimated fair value of certain financial instruments, including those financial instruments for which the Company did not elect the fair value option. These estimated fair values as of March 31, 2021 and December 31, 2020 have been determined using available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data to develop estimates of fair value. The estimates presented are not necessarily indicative of amounts the Company could realize in a current market exchange. The use of alternative market assumptions and estimation methodologies could have had a material effect on these estimates of fair value. The methodology for estimating the fair value of financial assets and liabilities that are measured on a recurring or nonrecurring basis are discussed above.

The following methods and assumptions were used to estimate the fair value of other financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents

For these short-term instruments, the carrying value is a reasonable estimate of fair value.

Securities

The fair value of securities is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).

SBA Loans Held for Sale

The fair value of SBA loans held for sale is estimated by using a market approach that includes significant other observable inputs.

Loans

The fair value of loans is estimated by discounting the future cash flows using current market rates that reflect the interest rate risk inherent in the loan, except for previously discussed impaired loans.

FHLB Stock

Federal Home Loan Bank stock is carried at cost. Carrying value approximates fair value based on the redemption provisions of the issues.

Servicing Assets

Servicing assets do not trade in an active, open market with readily observable prices. The Company estimates the fair value of servicing assets using discounted cash flow models incorporating numerous assumptions from the perspective of a market participant including market discount rates and prepayment speeds.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

19

Deposit Liabilities

The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date (i.e. carrying value). The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using current market rates.

Borrowed Funds and Subordinated Debentures

The fair value of borrowings is estimated by discounting the projected future cash flows using current market rates.

Standby Letters of Credit

At March 31, 2021, the Bank had standby letters of credit outstanding of $4.4 million, compared to $4.5 million at December 31, 2020. The fair value of these commitments is nominal.

The table below presents the carrying amount and estimated fair values of the Company’s financial instruments presented as of March 31, 2021 and December 31, 2020:

March 31, 2021

December 31, 2020

Fair value

Carrying

Estimated

Carrying

Estimated

(In thousands)

    

level

    

amount

    

fair value

    

amount

    

fair value

Financial assets:

 

  

 

  

 

  

 

  

 

  

Cash and cash equivalents

 

Level 1

$

239,577

$

239,577

$

219,311

$

219,311

Securities (1)

 

Level 2

 

34,551

 

34,551

 

47,571

 

47,571

SBA loans held for sale

 

Level 2

 

8,809

 

10,392

 

9,335

 

10,712

Loans, net of allowance for loan losses (2)

 

Level 2

 

1,636,674

 

1,650,152

 

1,595,377

 

1,613,593

FHLB stock

 

Level 2

 

9,269

 

9,269

 

10,594

 

10,594

Servicing assets

 

Level 3

 

1,738

 

1,738

 

1,857

 

1,857

Accrued interest receivable

 

Level 2

 

9,831

 

9,831

 

10,429

 

10,429

Financial liabilities:

 

 

 

 

 

Deposits

 

Level 2

 

1,628,393

 

1,628,042

 

1,557,959

 

1,561,502

Borrowed funds and subordinated debentures

 

Level 2

 

180,310

 

181,727

 

210

 

212,358

Accrued interest payable

 

Level 2

 

255

 

255

 

248

 

248

(1)Includes corporate securities that are considered Level 3 and reported separately in the table under the “Fair Value on a Recurring Basis” heading. These securities had book values of $5.3 million and market values of $4.5 million.
(2)Includes collateral-dependent impaired loans that are considered Level 3 and reported separately in the tables under the “Fair Value on a Nonrecurring Basis” heading. Collateral-dependent impaired loans, net of specific reserves totaled $12.6 million and $12.0 million at March 31, 2021 and December 31, 2020, respectively.

Limitations

Fair value estimates are made at a point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

20

Fair value estimates are based on existing on- and off-statement of condition financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the effect of fair value estimates have not been considered in the above estimates.

NOTE 7. Securities

This table provides the major components of debt securities available for sale ("AFS") and equity securities with readily determinable fair values ("equity securities") at amortized cost and estimated fair value at March 31, 2021 and December 31, 2020:

March 31, 2021

December 31, 2020

    

    

Gross

    

Gross

    

    

    

Gross

    

Gross

    

Amortized

unrealized

unrealized

Estimated

Amortized

unrealized

unrealized

Estimated

(In thousands)

cost

gains

losses

fair value

cost

gains

losses

fair value

Available for sale:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

U.S. Government sponsored entities

$

0

$

0

$

0

$

0

$

2,000

$

3

$

0

$

2,003

State and political subdivisions

 

2,355

 

20

 

0

 

2,375

 

2,935

 

34

 

0

 

2,969

Residential mortgage-backed securities

 

14,498

 

515

 

0

 

15,013

 

16,765

 

645

 

0

 

17,410

Corporate and other securities

 

15,696

 

160

 

(914)

 

14,942

 

24,221

 

132

 

(1,118)

 

23,235

Total debt securities available for sale

$

32,549

$

695

$

(914)

$

32,330

$

45,921

$

814

$

(1,118)

$

45,617

Equity securities:

 

 

 

 

 

���

 

 

 

Total equity securities

$

2,112

$

184

$

(75)

$

2,221

$

2,112

$

0

$

(158)

$

1,954

This table provides the remaining contractual maturities and yields of securities within the investment portfolios. The carrying value of securities at March 31, 2021 is distributed by contractual maturity. Mortgage-backed securities and other securities, which may have principal prepayment provisions, are distributed based on contractual maturity. Expected maturities will differ materially from contractual maturities as a result of early prepayments and calls.

After one through

After five through

Total carrying

 

Within one year

five years

ten years

After ten years

value

 

(In thousands, except percentages)

    

Amount

    

Yield

    

Amount

    

Yield

    

Amount

    

Yield

    

Amount

    

Yield

    

Amount

    

Yield

 

Available for sale at fair value:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

U.S. Government sponsored entities

$

 

%  

$

 

%  

$

 

%  

$

 

%  

$

 

%

State and political subdivisions

 

1,149

 

1.50

 

681

 

3.12

 

 

 

545

 

2.74

 

2,375

 

2.25

Residential mortgage-backed securities

 

4

 

4.93

 

585

 

2.87

 

1,433

 

2.26

 

12,991

 

2.14

 

15,013

 

2.18

Corporate and other securities

 

 

 

 

 

10,404

 

4.69

 

4,538

 

3.15

 

14,942

 

4.22

Total debt securities available for sale

$

1,153

 

1.51

%  

$

1,266

 

3.01

%  

$

11,837

 

4.40

%  

$

18,074

 

2.41

%  

$

32,330

 

3.13

%

Equity Securities at fair value:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

 

Total equity securities

$

 

%  

$

 

%  

$

 

%  

$

2,221

 

2.34

%  

$

2,221

 

2.34

%

21

The fair value of securities with unrealized losses by length of time that the individual securities have been in a continuous unrealized loss position at March 31, 2021 and December 31, 2020 are as follows:

March 31, 2021

Less than 12 months

12 months and greater

Total

    

Total

    

    

    

    

    

    

number in a

Estimated

Unrealized

Estimated

Unrealized

Estimated

Unrealized

(In thousands, except number in a loss position)

loss position

fair value

loss

fair value

loss

fair value

loss

Available for sale:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Corporate and other securities

 

6

$

2,382

$

(118)

$

7,759

$

(796)

$

10,141

$

(914)

Total temporarily impaired securities

 

6

$

2,382

$

(118)

$

7,759

$

(796)

$

10,141

$

(914)

December 31, 2020

Less than 12 months

12 months and greater

Total

    

Total

    

    

    

    

    

    

number in a

Estimated

Unrealized

Estimated

Unrealized

Estimated

Unrealized

(In thousands, except number in a loss position)

loss position

fair value

loss

fair value

loss

fair value

loss

Available for sale:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

Corporate and other securities

 

9

$

4,793

$

(20)

$

9,157

$

(1,098)

$

13,950

$

(1,118)

Total temporarily impaired securities

 

9

$

4,793

$

(20)

$

9,157

$

(1,098)

$

13,950

$

(1,118)

Unrealized Losses

The unrealized losses in each of the categories presented in the tables above are discussed in the paragraphs that follow:

U.S. government sponsored entities and state and political subdivision securities: The unrealized losses on investments in these types of securities were caused by the increase in interest rate spreads or the increase in interest rates at the long end of the Treasury curve. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider these investments to be other-than temporarily impaired as of March 31, 2021 or December 31, 2020.

Residential and commercial mortgage-backed securities:  The unrealized losses on investments in mortgage-backed securities were caused by increases in interest rate spreads or the increase in interest rates at the long end of the Treasury curve. The majority of contractual cash flows of these securities are guaranteed by the Federal National Mortgage Association (FNMA), the Government National Mortgage Association (GNMA) or the Federal Home Loan Mortgage Corporation (FHLMC). It is expected that the securities would not be settled at a price significantly less than the par value of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider these investments to be other-than-temporarily impaired as of March 31, 2021 or December 31, 2020.

Corporate and other securities: Included in this category are corporate and other debt securities. The unrealized losses on corporate and other debt securities were due to widening credit spreads. The Company evaluated the prospects of the issuers and forecasted a recovery period; and as a result determined it did not consider these investments to be other-than-temporarily impaired as of March 31, 2021 or December 31, 2020. The contractual terms do not allow the securities to be settled at a price less than the par value. Because the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before recovery of its amortized cost basis, which may be at maturity, the Company did not consider these securities to be other-than-temporarily impaired as of March 31, 2021 or December 31, 2020.

22

Realized Gains and Losses

Gross realized gains and losses on securities for the three months ended March 31, 2021 and 2020 are detailed in the table below:

For the three months ended March 31, 

(In thousands)

2021

    

2020

Available for sale:

  

 

  

Realized gains

$

43

$

296

Realized losses

 

 

Total debt securities available for sale

 

43

 

296

Net gains on sales of securities

$

43

$

296

The net realized gains are included in noninterest income in the Consolidated Statements of Income as net security gains. There were $43 thousand of gross realized gains during the three months ended March 31, 2021, compared to $296 thousand during the same period a year ago. There were 0 gross realized losses for the three months ended March 31, 2021 or 2020.

For the three months ended March 31, 2021, the net gain is attributed to:

the sale of 6 corporate bonds with a total book value of $7.0 million and resulting gains of $39 thousand, and
the call of 1 taxable municipal security with a book value of $496 thousand and resulting gains of $4 thousand.

For the three months ended March 31, 2020, the net gain is attributed to:

the sale of 1 corporate bond with a book value of $2.2 million and resulting gains of $61 thousand,
3 mortage-backed securities with a total book value of $2.8 million and resulting gains of $57 thousand,
1 tax-exempt municipal security with a book value of $381 thousand and resulting gains of $27 thousand,
1 taxable municipal security with a book value of $456 thousand and resulting gains of $140 thousand, and
the call of 1 tax-exempt municipal security with a book value of $485 thousand and resulting gains of $11 thousand.

Equity Securities

Included in this category are Community Reinvestment Act ("CRA") investments and the Company’s current other equity holdings of financial institutions. Equity securities are defined to include (a) preferred, common and other ownership interests in entities including partnerships, joint ventures and limited liability companies and (b) rights to acquire or dispose of ownership interest in entities at fixed or determinable prices.

The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three months ended March 31, 2021 and 2020:

For the three months ended March 31, 

(In thousands)

    

2021

    

2020

Net gains (losses) recognized during the period on equity securities

$

267

$

(471)

Net gains recognized during the period on equity securities sold during the period

 

 

5

Unrealized gains (losses) recognized during the reporting period on equity securities still held at the reporting date

$

267

$

(466)

Pledged Securities

Securities with a carrying value of $1.5 million and $1.6 million at March 31, 2021 and December 31, 2020, respectively, were pledged to secure deposits, secure other borrowings and for other purposes required or permitted by law.

23

NOTE 8. Loans

The following table sets forth the classification of loans by class, including unearned fees, deferred costs and excluding the allowance for loan losses as of March 31, 2021 and December 31, 2020:

(In thousands)

    

March 31, 2021

    

December 31, 2020

SBA loans held for investment

$

38,296

$

39,587

SBA PPP loans

169,117

118,257

Commercial loans

 

  

 

  

SBA 504 loans

 

21,255

 

19,681

Commercial other

 

113,982

 

118,280

Commercial real estate

 

650,869

 

630,423

Commercial real estate construction

 

66,972

 

71,404

Residential mortgage loans

 

448,149

 

467,586

Consumer loans

 

 

Home equity

 

59,238

 

62,549

Consumer other

1,264

3,551

Consumer construction loans

90,497

87,164

Total loans held for investment

$

1,659,639

$

1,618,482

SBA loans held for sale

 

8,809

 

9,335

Total loans

$

1,668,448

$

1,627,817

Loans are made to individuals as well as commercial entities. Specific loan terms vary as to interest rate, repayment, and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Credit risk tends to be geographically concentrated in that a majority of the loan customers are located in the markets serviced by the Bank. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type. A description of the Company’s different loan segments follows:

SBA Loans: SBA 7(a) loans, on which the SBA has historically provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. The guaranteed portion of the Company’s SBA loans is generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment. SBA loans are for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans are guaranteed by the businesses’ major owners. SBA loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act includes a range of other provisions designed to support the U.S. economy and mitigate the impact of COVID-19 on financial institutions and their customers, including through the authorization of various relief programs and measures that the U.S. Department of the Treasury, the Small Business Administration, the Federal Reserve Board (“FRB”) and other federal banking agencies have implemented or may implement.

The CARES Act provides assistance to small businesses through the establishment of the SBA Paycheck Protection Program ("PPP"). The PPP generally provides small businesses with funds to pay up to 24 weeks of payroll costs, including certain benefits. The funds are provided in the form of loans that may be fully or partially forgiven when used for payroll costs, interest on mortgages, rent, and utilities. The payments on these loans will be deferred for up to six months. Loans made after June 5, 2020, mature in five years, and loans made prior to June 5, 2020, mature in two years but can be extended to five years if the lender agrees. Forgiveness of the PPP loans is based on the borrower maintaining or quickly rehiring employees and maintaining salary levels. Most small businesses with 500 or fewer employees are eligible. Applications for the PPP loans started on April 3, 2020 and the application period was extended through August 8, 2020. As an existing SBA 7(a) lender, the Company opted to participate in the program. In December

24

2020, legislation was adopted providing additional funding for the PPP program and reopening applications on January 13, 2021 through March 31, 2021.

Commercial Loans: Commercial credit is extended primarily to middle market and small business customers. Commercial loans are generally made in the Company’s market place for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. Loans will generally be guaranteed in full or for a meaningful amount by the businesses’ major owners. Commercial loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided. Generally, the Company has a 50 percent loan to value ratio on SBA 504 program loans at origination.

Residential Mortgage, Consumer and Consumer Construction Loans: The Company originates mortgage and consumer loans including principally residential real estate and home equity lines and loans and consumer construction lines. The Company originates qualified mortgages which are generally sold in the secondary market and nonqualified mortgages which are generally held for investment. Each loan type is evaluated on debt to income, type of collateral and loan to collateral value, credit history and the Company’s relationship with the borrower.

Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to credit administration policies and procedures. Due diligence on loans begins when we initiate contact regarding a loan with a borrower. Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval. The loan portfolio is then subject to on-going internal reviews for credit quality which in part is derived from ongoing collection and review of borrowers’ financial information, as well as independent credit reviews by an outside firm.

The Company’s extension of credit is governed by the Credit Risk Policy which was established to control the quality of the Company’s loans. This policy and the underlying procedures are reviewed and approved by the Board of Directors on a regular basis.

Credit Ratings

For SBA 7(a), SBA 504 and commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality. A loan’s internal risk rating is updated at least annually and more frequently if circumstances warrant a change in risk rating. The Company uses a 1 through 10 loan grading system that follows regulatory accepted definitions.

Pass: Risk ratings of 1 through 6 are used for loans that are performing, as they meet, and are expected to continue to meet, all of the terms and conditions set forth in the original loan documentation, and are generally current on principal and interest payments. These performing loans are termed “Pass”.

Special Mention: Criticized loans are assigned a risk rating of 7 and termed “Special Mention”, as the borrowers exhibit potential credit weaknesses or downward trends deserving management’s close attention. If not checked or corrected, these trends will weaken the Bank’s collateral and position. While potentially weak, these borrowers are currently marginally acceptable and no loss of interest or principal is anticipated. As a result, special mention assets do not expose an institution to sufficient risk to warrant adverse classification. Included in “Special Mention” could be turnaround situations, such as borrowers with deteriorating trends beyond one year, borrowers in startup or deteriorating industries, or borrowers with a poor market share in an average industry. "Special Mention" loans may include an element of asset quality, financial flexibility, or below average management. Management and ownership may have limited depth or experience. Regulatory agencies have agreed on a consistent definition of “Special Mention” as an asset with potential weaknesses which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. This definition is intended to ensure that the “Special Mention” category is

25

not used to identify assets that have as their sole weakness credit data exceptions or collateral documentation exceptions that are not material to the repayment of the asset.

Substandard: Classified loans are assigned a risk rating of an 8 or 9, depending upon the prospect for collection, and deemed “Substandard”. A risk rating of 8 is used for borrowers with well-defined weaknesses that jeopardize the orderly liquidation of debt. The loan is inadequately protected by the current paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified “Substandard”.

A risk rating of 9 is used for borrowers that have all the weaknesses inherent in a loan with a risk rating of 8, with the added characteristic that the weaknesses make collection of debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Serious problems exist to the point where partial loss of principal is likely. The possibility of loss is extremely high, but because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans’ classification as estimated losses is deferred until a more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures; capital injection; perfecting liens on additional collateral; and refinancing plans. Partial charge-offs are likely.

Loss: Once a borrower is deemed incapable of repayment of unsecured debt, the risk rating becomes a 10, the loan is termed a “Loss”, and charged-off immediately. Loans to such borrowers are considered uncollectible and of such little value that continuance as active assets of the Bank is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these basically worthless assets even though partial recovery may be affected in the future.

For residential mortgage, consumer and consumer construction loans, management uses performing versus nonperforming as the best indicator of credit quality. Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. These credit quality indicators are updated on an ongoing basis, as a loan is placed on nonaccrual status as soon as management believes there is sufficient doubt as to the ultimate ability to collect interest on a loan.

At March 31, 2021, there were $2.5 million of residential consumer loans in the process of foreclosure, compared to $4.8 million at December 31, 2020.

26

The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of March 31, 2021:

March 31, 2021

SBA & Commercial loans - Internal risk ratings

(In thousands)

    

Pass

    

Special mention

    

Substandard

    

Total

SBA loans held for investment

$

35,932

$

532

$

1,832

$

38,296

SBA PPP loans

169,117

169,117

Commercial loans

 

  

 

  

 

  

 

  

SBA 504 loans

 

21,255

 

 

 

21,255

Commercial other

 

105,509

 

5,413

 

3,060

 

113,982

Commercial real estate

 

623,270

 

22,519

 

5,080

 

650,869

Commercial real estate construction

 

66,972

 

 

 

66,972

Total commercial loans

 

817,006

 

27,932

 

8,140

 

853,078

Total SBA and commercial loans

$

1,022,055

$

28,464

$

9,972

$

1,060,491

    

    

Residential mortgage & Consumer loans - Performing/Nonperforming

(In thousands)

    

    

Performing

    

Nonperforming

    

Total

Residential mortgage loans

$

441,438

$

6,711

$

448,149

Consumer loans

 

  

 

 

  

Home equity

 

59,238

 

 

59,238

Consumer other

1,264

1,264

Total consumer loans

60,502

60,502

Consumer construction loans

87,932

2,565

90,497

Total residential mortgage, consumer and consumer construction loans

$

589,872

$

9,276

$

599,148

The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of December 31, 2020:

    

December 31, 2020

SBA & Commercial loans - Internal risk ratings

(In thousands)

    

Pass

    

Special mention

    

Substandard

    

Total

SBA loans held for investment

$

36,991

$

525

$

2,071

$

39,587

SBA PPP loans

118,257

118,257

Commercial loans

 

  

 

  

 

  

 

  

SBA 504 loans

 

19,681

 

 

 

19,681

Commercial other

 

109,672

 

5,533

 

3,075

 

118,280

Commercial real estate

 

603,482

 

25,206

 

1,735

 

630,423

Commercial real estate construction

 

71,404

 

 

 

71,404

Total commercial loans

 

804,239

 

30,739

 

4,810

 

839,788

Total SBA and commercial loans

$

959,487

$

31,264

$

6,881

$

997,632

Residential mortgage & Consumer loans - Performing/Nonperforming

(In thousands)

 

  

Performing

Nonperforming

Total

Residential mortgage loans

 

  

$

462,369

$

5,217

$

467,586

Consumer loans

 

  

 

  

 

  

 

  

Home equity

 

  

 

61,254

 

1,295

 

62,549

Consumer other

3,551

3,551

Total consumer loans

64,805

1,295

66,100

Consumer construction loans

85,414

1,750

87,164

Total residential mortgage, consumer and consumer construction loans

 

  

$

612,588

$

8,262

$

620,850

27

Nonperforming and Past Due Loans

Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans and generally represent loans that are well collateralized and in the process of collection. The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.

The following tables set forth an aging analysis of past due and nonaccrual loans as of March 31, 2021 and December 31, 2020:

March 31, 2021

    

    

    

90+ days

    

    

    

    

3059 days

6089 days

and still

Nonaccrual

Total past

(In thousands)

past due

past due

accruing

(1)

due

Current

Total loans

SBA loans held for investment

$

6,341

$

$

$

1,560

$

7,901

$

30,395

$

38,296

SBA PPP loans

169,117

169,117

Commercial loans

 

  

 

  

 

  

 

  

 

  

 

 

  

SBA 504 loans

 

 

 

 

 

 

21,255

 

21,255

Commercial other

 

43

 

60

 

 

340

 

443

 

113,539

 

113,982

Commercial real estate

 

889

 

787

 

 

612

 

2,288

 

648,581

 

650,869

Commercial real estate construction

 

 

 

 

 

 

66,972

 

66,972

Residential mortgage loans

 

4,728

 

1,224

 

2,145

 

6,711

 

14,808

 

433,341

 

448,149

Consumer loans

 

 

 

 

 

  

 

 

Home equity

 

49

 

 

183

 

 

232

 

59,006

 

59,238

Consumer other

7

7

1,257

1,264

Consumer construction loans

854

416

212

2,565

4,047

86,450

90,497

Total loans held for investment

12,911

2,487

2,540

11,788

29,726

1,629,913

1,659,639

SBA loans held for sale

 

2,664

 

 

 

 

2,664

 

6,145

 

8,809

Total loans

$

15,575

$

2,487

$

2,540

$

11,788

$

32,390

$

1,636,058

$

1,668,448

(1)At March 31, 2021, nonaccrual loans included $139 thousand of loans guaranteed by the SBA.

28

December 31, 2020

    

    

    

90+ days

    

    

    

    

3059 days

6089 days

and still

Nonaccrual

Total past

(In thousands)

past due

past due

accruing

(1)

due

Current

Total loans

SBA loans held for investment

$

792

$

1,280

$

$

2,473

$

4,545

$

35,042

$

39,587

SBA PPP loans

118,257

118,257

Commercial loans

 

  

 

  

 

  

 

  

 

  

 

  

 

  

SBA 504 loans

 

 

 

 

 

 

19,681

 

19,681

Commercial other

 

186

 

201

 

 

266

 

653

 

117,627

 

118,280

Commercial real estate

 

3,109

 

1,971

 

 

1,059

 

6,139

 

624,284

 

630,423

Commercial real estate construction

 

1,047

 

 

 

 

1,047

 

70,357

 

71,404

Residential mortgage loans

 

3,232

 

2,933

 

262

 

5,217

 

11,644

 

455,942

 

467,586

Consumer loans

 

 

 

 

 

 

 

  

Home equity

 

393

 

 

187

 

1,295

 

1,875

 

60,674

 

62,549

Consumer other

3

1

4

3,547

3,551

Consumer construction loans

120

796

1,750

2,666

84,498

87,164

Total loans held for investment

8,882

7,182

449

12,060

28,573

1,589,909

1,618,482

SBA loans held for sale

 

448

 

 

 

 

448

 

8,887

 

9,335

Total loans

$

9,330

$

7,182

$

449

$

12,060

$

29,021

$

1,598,796

$

1,627,817

(1)At December 31, 2020, nonaccrual loans included $371 thousand of loans guaranteed by the SBA.

Impaired Loans

The Company has defined impaired loans to be all nonperforming loans individually evaluated for impairment and TDRs. Management considers a loan impaired when, based on current information and events, it is determined that the Company will not be able to collect all amounts due according to the loan contract. Impairment is evaluated on an individual basis for SBA and commercial loans.

29

The following table provides detail on the Company’s impaired loans that are individually evaluated for impairment with the associated allowance amount, if applicable, as of March 31, 2021:

    

March 31, 2021

    

Unpaid

    

    

principal

Recorded

Specific

(In thousands)

balance

investment

reserves

With no related allowance:

  

 

  

 

  

SBA loans held for investment (1)

$

1,138

$

1,037

$

Commercial loans

 

  

 

  

 

  

Commercial real estate

 

1,920

 

1,920

 

Total commercial loans

 

1,920

 

1,920

 

Residential mortgage loans

6,090

5,985

Consumer loans

Home equity

427

427

Consumer construction loans

1,780

1,780

Total impaired loans with no related allowance

 

11,355

 

11,149

 

With an allowance:

 

  

 

  

 

  

SBA loans held for investment (1)

 

691

 

384

 

319

Commercial loans

 

  

 

  

 

  

Commercial other

 

3,203

 

3,078

 

2,979

Commercial real estate

 

140

 

20

 

20

Total commercial loans

 

3,343

 

3,098

 

2,999

Residential mortgage loans

726

726

44

Consumer construction loans

785

785

189

Total impaired loans with a related allowance

 

5,545

 

4,993

 

3,551

Total individually evaluated impaired loans:

 

  

 

  

 

  

SBA loans held for investment (1)

 

1,829

 

1,421

 

319

Commercial loans

 

  

 

  

 

  

Commercial other

 

3,203

 

3,078

 

2,979

Commercial real estate

 

2,060

 

1,940

 

20

Total commercial loans

 

5,263

 

5,018

 

2,999

Residential mortgage loans

6,816

6,711

44

Consumer loans

Home equity

427

427

Consumer construction loans

2,565

2,565

189

Total individually evaluated impaired loans

$

16,900

$

16,142

$

3,551

(1)Balances are reduced by amount guaranteed by the SBA of $139 thousand at March 31, 2021.

30

The following table provides detail on the Company’s impaired loans that are individually evaluated for impairment with the associated allowance amount, if applicable, as of December 31, 2020:

    

December 31, 2020

    

Unpaid

    

    

principal

Recorded

Specific

(In thousands)

balance

investment

reserves

With no related allowance:

  

 

  

 

  

SBA loans held for investment (1)

$

1,799

$

1,698

$

Commercial loans

 

  

 

  

 

  

Commercial real estate

 

1,462

 

1,462

 

Total commercial loans

 

1,462

 

1,462

 

Residential mortgage loans

4,080

3,975

Consumer loans

Home equity

1,295

1,295

Consumer construction loans

1,750

1,750

Total impaired loans with no related allowance

 

10,386

 

6,205

 

With an allowance:

 

  

 

  

 

  

SBA loans held for investment (1)

 

434

 

404

 

324

Commercial loans

 

  

 

  

 

  

Commercial other

 

3,160

 

3,160

 

3,106

Commercial real estate

 

1,730

 

1,080

 

576

Total commercial loans

 

4,890

 

4,240

 

3,682

Residential mortgage loans

1,242

1,242

101

Total impaired loans with a related allowance

 

6,566

 

5,886

 

4,107

Total individually evaluated impaired loans:

 

  

 

  

 

  

SBA loans held for investment (1)

 

2,233

 

2,102

 

324

Commercial loans

 

 

 

Commercial other

 

3,160

 

3,160

 

3,106

Commercial real estate

 

3,192

 

2,542

 

576

Total commercial loans

 

6,352

 

5,702

 

3,682

Residential mortgage loans

5,322

5,217

101

Consumer loans

Home equity

1,295

1,295

Consumer construction loans

1,750

1,750

Total individually evaluated impaired loans

$

16,952

$

16,066

$

4,107

(1)Balances are reduced by amount guaranteed by the SBA of $371 thousand at December 31, 2020.

31

The following table presents the average recorded investments in impaired loans and the related amount of interest recognized during the time period in which the loans were impaired for the three months ended March 31, 2021 and 2020. The average balances are calculated based on the month-end balances of impaired loans. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal under the cost recovery method, and therefore no interest income is recognized. The interest income recognized on impaired loans noted below represents primarily accruing TDRs and nominal amounts of income recognized on a cash basis for well-collateralized impaired loans.

    

For the three months ended March 31, 

2021

2020

    

    

Interest

    

    

Interest

income

income

Average

recognized

Average

recognized

recorded

on impaired

recorded

on impaired

(In thousands)

investment

loans

investment

loans

SBA loans held for investment (1)

$

1,901

$

16

$

1,128

$

3

Commercial loans

 

  

 

  

 

  

 

  

SBA 504 loans

 

 

 

600

 

32

Commercial other

 

374

 

3

 

5

 

10

Commercial real estate

 

2,237

 

56

 

1,047

 

12

Consumer loans

Home equity

844

18

Consumer construction loans

2,610

10

Total

$

7,966

$

103

$

2,780

$

57

(1)Balances are reduced by the average amount guaranteed by the SBA of $293 thousand and $182 thousand for the three months ended March 31, 2021 and 2020, respectively.

TDRs

The Company’s loan portfolio also includes certain loans that have been modified as TDRs. TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider, unless it results in a delay in payment that is insignificant. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. Under the CARES Act and regulatory guidance issued in regards to the COVID-19 pandemic, loan payment deferrals for periods of up to 180 days granted to borrowers adversely effected by the pandemic are not considered TDR’s if the borrower was current on its loan payments at year end 2019 or until the deferral was granted. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs if the loan is collateral-dependent. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.

TDRs of $1.1 million and $663 thousand are included in the impaired loan numbers as of March 31, 2021 and December 31, 2020, respectively. The increase in TDRs was due to the addition of 2 loans, partially offset by principal pay downs. At March 31, 2021 and December 31, 2020, there were 0 specific reserves on the TDRs. The TDRs are in accrual status since they are performing in accordance with the restructured terms. There are no commitments to lend additional funds on these loans.

32

There were 2 loans modified as TDRs during the three months ended March 31, 2021. There were 0 loans modified during the three months ended March 31, 2020 that were deemed to be TDRs. The following table details loans modified during the three months ended March 31, 2021, including the number of modifications and the recorded investment at the time of the modification:

For the three months ended March 31, 2021

Number of

Recorded investment

(In thousands, except number of contracts)

contracts

at time of modification

Home equity

2

$

427

Total

2

$

427

To date, the Company’s TDRs consisted of principal reduction, interest only periods and maturity extensions. There were 0 loans modified as a TDR within the previous 12 months that subsequently defaulted at some point during the three months ended March 31, 2021. In this case, the subsequent default is defined as 90 days past due or transferred to nonaccrual status.

NOTE 9. Allowance for Loan Losses and Reserve for Unfunded Loan Commitments

Allowance for Loan Losses

The Company has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. At a minimum, the adequacy of the allowance for loan losses is reviewed by management on a quarterly basis. For purposes of determining the allowance for loan losses, the Company has segmented the loans in its portfolio by loan type. Loans are segmented into the following pools: SBA 7(a), commercial, residential mortgages, consumer, and consumer construction loans. Certain portfolio segments are further broken down into classes based on the associated risks within those segments and the type of collateral underlying each loan. Commercial loans are divided into the following five classes: commercial real estate, commercial real estate construction, unsecured business line of credit, commercial other, and SBA 504. Consumer loans are divided into two classes as follows:  home equity and other.

The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. The same standard methodology is used, regardless of loan type. Specific reserves are made to individual impaired loans and TDRs (see Note 1 for additional information on this term). The general reserve is set based upon a representative average historical net charge-off rate adjusted for the following environmental factors: delinquency and impairment trends, charge-off and recovery trends, volume and loan term trends, changes in risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes. Within the five-year historical net charge-off rate, the Company weights the past three years more heavily as it believes it is more indicative of future charge-offs. All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate and high risk. Each environmental factor is evaluated separately for each class of loans and risk weighted based on its individual characteristics.

For SBA 7(a) and commercial loans, the estimate of loss based on pools of loans with similar characteristics is made through the use of a standardized loan grading system that is applied on an individual loan level and updated on a continuous basis. The loan grading system incorporates reviews of the financial performance of the borrower, including cash flow, debt-service coverage ratio, earnings power, debt level and equity position, in conjunction with an assessment of the borrower’s industry and future prospects. It also incorporates analysis of the type of collateral and the relative loan to value ratio.
For residential mortgage, consumer, and consumer construction loans, the estimate of loss is based on pools of loans with similar characteristics. Factors such as credit score, delinquency status and type of collateral are evaluated. Factors are updated frequently to capture the recent behavioral characteristics of the subject portfolios, as well as any changes in loss mitigation or credit origination strategies, and adjustments to the reserve factors are made as needed.

33

According to the Company’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable. All credits which are 90 days past due must be analyzed for the Company’s ability to collect on the credit. Once a loss is known to exist, the charge-off approval process is immediately expedited. This charge-off policy is followed for all loan types.

The allocated allowance is the total of identified specific and general reserves by loan category. The allocation is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of the portfolio.

The following tables detail the activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2021 and 2020:

For the three months ended March 31, 2021

    

SBA held

    

    

    

    

    

for

Consumer

(In thousands)

investment

Commercial

Residential

Consumer

construction

Total

Balance, beginning of period

$

1,301

$

14,992

$

5,318

$

681

$

813

$

23,105

Charge-offs

 

(282)

 

(373)

 

 

(1)

 

 

(656)

Recoveries

 

15

 

1

 

 

 

 

16

Net charge-offs

 

(267)

 

(372)

 

 

(1)

 

 

(640)

Provision for (credit to) loan losses charged to expense

 

620

 

107

 

(309)

 

(131)

 

213

 

500

Balance, end of period

$

1,654

$

14,727

$

5,009

$

549

$

1,026

$

22,965

For the three months ended March 31, 2020

    

SBA held

    

    

    

    

    

for

Consumer

(In thousands)

investment

Commercial

Residential

Consumer

construction

Total

Balance, beginning of period

$

1,079

$

9,722

$

4,254

$

625

$

715

$

16,395

Charge-offs

 

(25)

 

(300)

 

(200)

 

 

 

(525)

Recoveries

 

5

 

1

 

 

 

 

6

Net charge-offs

 

(20)

 

(299)

 

(200)

 

 

 

(519)

Provision for (credit to) loan losses charged to expense

 

(54)

 

706

 

709

 

46

 

93

 

1,500

Balance, end of period

$

1,005

$

10,129

$

4,763

$

671

$

808

$

17,376

The following tables present loans and their related allowance for loan losses, by portfolio segment, as of March 31, 2021 and December 31, 2020:

March 31, 2021

    

SBA held

    

    

    

    

for

Consumer

(In thousands)

investment

Commercial

Residential

Consumer

construction

Total

Allowance for loan losses ending balance:

 

  

 

  

 

  

 

  

 

  

Individually evaluated for impairment

$

319

$

2,999

$

44

$

$

189

$

3,551

Collectively evaluated for impairment

 

1,335

 

11,728

 

4,965

 

549

 

837

 

19,414

Total

$

1,654

$

14,727

$

5,009

$

549

$

1,026

$

22,965

Loan ending balances:

 

  

 

  

 

  

 

  

 

  

 

  

Individually evaluated for impairment

$

1,421

$

5,018

$

6,711

$

427

$

2,565

$

16,142

Collectively evaluated for impairment

 

205,992

 

848,060

 

441,438

 

60,075

 

87,932

 

1,643,497

Total

$

207,413

$

853,078

$

448,149

$

60,502

$

90,497

$

1,659,639

34

December 31, 2020

    

SBA held

    

    

    

    

for

Consumer

(In thousands)

investment

Commercial

Residential

Consumer

construction

Total

Allowance for loan losses ending balance:

 

  

 

  

 

  

 

  

 

  

Individually evaluated for impairment

$

324

$

3,682

$

101

$

$

$

4,107

Collectively evaluated for impairment

 

977

 

11,310

 

5,217

 

681

 

813

 

18,998

Total

$

1,301

$

14,992

$

5,318

$

681

$

813

$

23,105

Loan ending balances:

 

  

 

  

 

  

 

  

 

  

 

  

Individually evaluated for impairment

$

2,102

$

5,702

$

5,217

$

1,295

$

1,750

$

16,066

Collectively evaluated for impairment

 

155,742

 

834,086

 

462,369

 

64,805

 

85,414

 

1,602,416

Total

$

157,844

$

839,788

$

467,586

$

66,100

$

87,164

$

1,618,482

Changes in Methodology

The Company did not make any changes to its allowance for loan losses methodology in the current period.

Reserve for Unfunded Loan Commitments

In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the reserve are made through other expense and applied to the reserve which is classified as other liabilities. At March 31, 2021, a $310 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $288 thousand commitment reserve at December 31, 2020, due to a larger loan portfolio requiring a larger general reserve.

NOTE 10. New Accounting Pronouncements

ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 was issued to replace the incurred loss impairment methodology in current GAAP with an expected credit loss methodology and requires consideration of a broader range of information to determine credit loss estimates. Financial assets measured at amortized cost will be presented at the net amount expected to be collected by using an allowance for credit losses. Purchased credit impaired loans will receive an allowance account at the acquisition date that represents a component of the purchase price allocation. Credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses, with such allowance limited to the amount by which fair value is below amortized cost. For public business entities, ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019.

In May 2019, FASB issued ASU 2019-05, "Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief." ASU 2019-05 was issued to address concerns with the adoption of ASU 2016-13. ASU 2019-05 gives entities the ability to irrevocably elect the fair value option in Subtopic 825-10 for certain existing financial assets upon transition to ASU 2016-03. Financial assets that are eligible for this fair value election are those that qualify under Subtopic 825-10 and are within the scope of Subtopic 326-10, "Financial Instruments - Credit Losses - Measured at Amortized Costs." An exception to this is held-to-maturity debt securities, which do not qualify for this transition election. The effective date for the amendment is the same as the effective date in ASU 2016-03. In November 2019, FASB issued ASU 2019-10, "Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates." ASU 2019-10 was issued to defer the effective dates for certain guidance in its Accounting Standard Codification ("ASC") for certain entities. The amendments in this update amend the mandatory effective dates for ASC 326, "Financial Instruments - Credit Losses", for entities eligible to be smaller reporting companies as defined by the SEC for fiscal years beginning after December 15, 2022, including interim reporting periods within that reporting period. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its consolidated financial statements.

In November 2019, FASB issued ASU 2019-11, "Codification Improvements to Topic 326, Financial Instruments - Credit Losses." ASU 2019-11 was issued to address issues raised by stakeholders during the implementation of ASU

35

2016-13. ASU 2019-11 provides transition relief when adjusting the effective interest rate for troubled debt restructurings ("TDRs") that exist as of the adoption date, extends the disclosure relief in ASU 2019-04 to disclose accrued interest receivable balances separately from the amortized cost basis to additional disclosures involving amortized cost basis, and provides clarification regarding application of the guidance in paragraph 326-20-35-6 for financial assets secured by collateral maintenance provisions that provides a practical expedient to measure the estimate of expected credit losses by comparing the amortized cost basis of a financial asset and the fair value of collateral securing the financial asset as of the reporting date. The effective date and transition requirements for the amendment are the same as the effective date and transition requirements in ASU 2016-13.

ASU 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes." ASU 2019-12 removes the exception to the incremental approach for intraperiod tax allocation when there is a loss from continuing operations and income or a gain from other items and removes the exception to the interim period income tax accounting when a year-to-date loss exceeds the anticipated loss for the year. ASU 2019-12 also simplifies the accounting for income taxes by requiring that an entity recognize a franchise tax that is partially based on income as an income-based tax, that an entity evaluate when a step up in the tax basis of goodwill should be considered part of the business combination in which the book goodwill originally was recognized, and that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date. For public business entities, ASU 2019-12 is effective for interim and annual periods beginning after December 15, 2020. The Company adopted this standard as of January 1, 2021. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

ASU 2020-01, "Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 (a consensus of the Emerging Issues Task Force)." ASU 2020-01 clarifies that the observable price changes in orderly transactions that should be considered when applying the measurement alternative in accordance with ASC 321 include transactions that require it to either apply or discontinue the equity method of accounting under ASC 323. ASU 2020-01 also addresses questions about how to apply the guidance in Topic 815, “Derivatives and Hedging,” for certain forward contracts and purchased options to purchase securities that, upon settlement or exercise, would be accounted for under the equity method of accounting. The ASU clarifies that, for the purpose of applying ASC 815-10-15-141(a), an entity should not consider whether, upon the settlement of the forward contract or exercise of the purchased option, the underlying securities would be accounted for under the equity method in ASC 323 or the fair value option in accordance with the financial instruments guidance in Topic 825, “Financial Instruments.” For public business entities, ASU 2020-01 is effective for interim and annual periods beginning after December 15, 2020. The Company adopted this standard as of January 1, 2021. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

ASU 2020-03, "Codification Improvement to Financial Instruments." ASU 2020-03 clarifies that all entities are required to provide the fair value option disclosures in paragraphs 825-10-50-24 through 50-32 of the FASB’s Accounting Standards Codification (ASC). ASU 2020-03 also clarifies that the contractual term of a net investment in a lease determined in accordance with ASC 842, “Leases,” should be the contractual term used to measure expected credit losses under ASC 326, “Financial Instruments – Credit Losses.” ASU 2020-03 also addresses amendments to ASC 860-20, “Transfers and Servicing – Sales of Financial Assets,” clarify that when an entity regains control of financial assets sold, an allowance for credit losses should be recorded in accordance with ASC 326. The effective date and transition requirements for the amendment are the same as the effective date and transition requirements in ASU 2016-13. The Company is currently evaluating the impact of the adoption of ASU 2020-03 on its consolidated financial statements.

ASU 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting." ASU 2020-04 provides temporary optional guidance intended to ease the burden of reference rate reform on financial reporting. The guidance provides optional expedients and exceptions for applying existing guidance to contract modifications, hedging relationships and other transactions that are expected to be affected by reference rate reform and

36

meet certain scope guidance. ASU 2020-04 provides various optional expedients, including the following, for hedging relationships affected by reference rate reform, if certain criteria are met:

An entity can change certain critical terms of the hedging instrument or hedged item or transaction without having to dedesignate the relationship.
For fair value hedging relationships in which the designated interest rate is LIBOR or another rate that is expected to be discontinued, an entity may change the hedged risk to another permitted benchmark rate without dedesignating the relationship.
For cash flow hedging relationships in which the designated hedged risk is LIBOR or another rate that is expected to be discontinued, an entity may assert that the occurrence of the hedged forecasted transaction remains probable.
Certain qualifying conditions for the shortcut method and other methods that assume perfect effectiveness may be disregarded.

In addition, ASU 2020-04 permits an entity to make a one-time election to sell, transfer, or both sell and transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform and that were classified as held to maturity before January 1, 2020. ASU 2020-04 was effective upon its issuance on March 12, 2020. However, it cannot be applied to contract modifications that occur after December 31, 2022. With certain exceptions, the ASU also cannot be applied to hedging relationships entered into or evaluated after that date. The Company is currently evaluating the various optional expedients as well as impact of the adoption of ASU 2020-04 on its consolidated financial statements.

ASU 2020-06, “Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity's Own Equity.” ASU 2020-06 was issued to address the complexities of its guidance for certain financial instruments with characteristics of liabilities and equity, including:

Removing the accounting models that require beneficial conversion features or cash conversion features associated with convertible instruments to be recognized as a separate component of equity.
Adding certain disclosure requirements for convertible instruments.
Amending the guidance for the derivatives scope exception for contracts in an entity’s own equity.
Simplifying the diluted earning per share calculation for certain situations.

For public business entities, ASU 2020-06 is effective for interim and annual periods beginning after December 15, 2021. The Company is currently evaluating the impact of the adoption of ASU 2020-06 on its consolidated financial statements.

ASU 2021-01, “Reference Rate Reform (Topic 848): Scope.” ASU 2021-01 was issued to clarify certain optional expedients and exceptions in ASC 848 for contract modifications and hedge accounting applied to derivatives that are affected by the discounting transition. In addition, the ASU clarifies that a receive-variable-rate, pay-variable-rate cross-currency interest rate swap may be considered eligible as a hedging instrument in a net investment hedge if both legs of the swap do not have the same repricing intervals and dates as a result of the reference rate reform. ASU 2021-01 became effective January 7, 2021.

NOTE 11. Derivative Financial Instruments and Hedging Activities

Derivative Financial Instruments

The Company has derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments, and the value of the derivatives are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Such difference, which represents the fair value of the derivative instrument, is reflected on the Company’s balance sheet as other assets or other liabilities.

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to any derivative agreement. The Company controls the credit risk of its financial contracts through credit approvals, limits and

37

monitoring procedures, and does not expect any counterparties to fail their obligations. The Company deals only with primary dealers.

Derivative instruments are generally either negotiated OTC contracts or standardized contracts executed on a recognized exchange. Negotiated OTC derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise prices and maturity.

Risk Management Policies – Hedging Instruments

The primary focus of the Company’s asset/liability management program is to monitor the sensitivity of the Company’s net portfolio value and net income under varying interest rate scenarios to take steps to control its risks. On a quarterly basis, the Company evaluates the effectiveness of entering into any derivative agreement by measuring the cost of such an agreement in relation to the reduction in net portfolio value and net income volatility within an assumed range of interest rates.

Interest Rate Risk Management – Cash Flow Hedging Instruments

The Company has variable rate debt as a source of funds for use in the Company’s lending and investment activities and for other general business purposes. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases. Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore hedges its variable-rate interest payments. To meet this objective, management enters into interest rate swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments during the contract period.

At March 31, 2021, the Company had a total of 4 interest rate swaps designated as cash flow hedging instruments with a notional amount of $70.0 million, compared to 5 with a notional amount of $80.0 million at December 31, 2020. At March 31, 2021 and December 31, 2020, the Company had $1.5 million in cash collateral pledged for these derivatives which was included in federal funds sold and interest-bearing deposits. A summary of the Company’s outstanding interest rate swap agreements used to hedge variable rate debt at March 31, 2021 and December 31, 2020, respectively is as follows:

(In thousands, except percentages and years)

    

March 31, 2021

    

December 31, 2020

 

Notional amount

$

70,000

$

80,000

Fair value

$

(219)

$

(1,026)

Weighted average pay rate

 

1.05

%  

 

1.19

%

Weighted average receive rate

 

0.23

%  

 

0.89

%

Weighted average maturity in years

 

2.06

 

2.20

Number of contracts

 

4

 

5

During the three months ended March 31, 2021, the Company received variable rate London Interbank Offered Rate ("LIBOR") payments from and paid fixed rates in accordance with its interest rate swap agreements. At March 31, 2021, the unrealized loss relating to interest rate swaps was recorded as a derivative liability, whereas at December 31, 2020, the unrealized gain relating to interest rate swaps was recorded as a derivative asset. Changes in the fair value of the interest rate swaps designated as hedging instruments of the variability of cash flows associated with long-term debt are reported in other comprehensive income. The following table presents the net gains and losses recorded in other comprehensive income and the consolidated financial statements relating to the cash flow derivative instruments at March 31, 2021 and 2020, respectively:

For the three months ended March 31, 

(In thousands)

2021

 

2020

Gain (loss) recognized in OCI on derivatives

$

807

$

(1,410)

38

NOTE 12. Employee Benefit Plans

Stock Option Plans

The Company has incentive and nonqualified option plans, which allow for the grant of options to officers, employees and members of the Board of Directors. Grants under the Company’s incentive and nonqualified option plans generally vest over 3 years and must be exercised within 10 years of the date of grant. Transactions under the Company’s stock option plans for the three months ended March 31, 2021 are summarized in the following table:

    

    

    

Weighted

    

Weighted 

average

average 

remaining

Aggregate

exercise

contractual 

intrinsic

Shares

price

life in years

value

Outstanding at December 31, 2020

 

672,800

$

16.42

 

6.8

$

1,952,568

Options granted

 

89,000

 

19.21

 

 

Options exercised

 

(12,467)

 

6.43

 

 

Options forfeited

 

 

 

 

Options expired

 

 

 

 

Outstanding at March 31, 2021

 

749,333

$

16.91

 

7.1

$

3,858,402

Exercisable at March 31, 2021

471,179

$

15.18

 

5.9

$

3,228,220

On April 25, 2019, the Company adopted the 2019 Equity Compensation Plan providing for grants of up to 500,000 shares to be allocated between incentive and non-qualified stock options, restricted stock awards, performance units and deferred stock. The Plan replaced all previously approved and established equity plans then currently in effect. As of March 31, 2021, 281,500 options and 73,150 shares of restricted stock have been awarded from the plan leaving 145,350 shares available for future grants.

The fair values of the options granted during the three months ended March 31, 2021 and 2020 were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

For the three months ended March 31, 

    

2021

    

2020

Number of options granted

 

89,000

 

101,000

Weighted average exercise price

$

19.21

$

20.39

Weighted average fair value of options

$

7.72

$

5.54

Expected life in years (1)

 

8.38

 

8.66

Expected volatility (2)

 

43.69

%  

 

27.13

%

Risk-free interest rate (3)

 

1.14

%  

 

1.55

%

Dividend yield (4)

 

1.68

%  

 

1.61

%

(1)The expected life of the options was estimated based on historical employee behavior and represents the period of time that options granted are expected to be outstanding.
(2)The expected volatility of the Company’s stock price was based on the historical volatility over the period commensurate with the expected life of the options.
(3)The risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of the options on the date of grant.
(4)The expected dividend yield is the projected annual yield based on the grant date stock price.

39

Upon exercise, the Company issues shares from its authorized but unissued common stock to satisfy the options. The following table presents information about options exercised during the three months ended March 31, 2021 and 2020:

For the three months ended March 31, 

    

2021

    

2020

Number of options exercised

 

12,467

 

5,500

Total intrinsic value of options exercised

$

170,023

$

86,241

Cash received from options exercised

$

80,113

$

34,265

Tax deduction realized from options

$

51,151

$

25,264

The following table summarizes information about stock options outstanding and exercisable at March 31, 2021:

Options outstanding

Options exercisable

    

Weighted average 

    

Weighted 

    

    

Weighted

Options

remaining contractual 

average 

Options

average

Range of exercise prices

outstanding

life (in years)

exercise price

exercisable

exercise price

$0.00 - $6.00

 

33,000

 

1.4

$

5.59

 

33,000

$

5.59

$6.01 - $12.00

 

146,800

 

4.2

 

8.95

 

146,800

 

8.95

$12.01 - $18.00

 

132,533

 

7.8

 

16.37

 

69,201

 

15.72

$18.01 - $24.00

 

437,000

 

8.3

 

20.61

 

222,178

 

20.56

Total

 

749,333

 

7.1

$

16.91

 

367,869

$

15.18

Financial Accounting Standards Board Accounting Standards Codification ("FASB ASC") Topic 718, “Compensation - Stock Compensation,” requires an entity to recognize the fair value of equity awards as compensation expense over the period during which an employee is required to provide service in exchange for such an award (vesting period). Compensation expense related to stock options and the related income tax benefit for the three months ended March 31, 2021 and 2020 are detailed in the following table:

For the three months ended March 31, 

    

2021

    

2020

Compensation expense

$

207,602

$

192,489

Income tax benefit

$

59,997

$

55,629

As of March 31, 2021, unrecognized compensation costs related to nonvested share-based compensation arrangements granted under the Company’s stock option plans totaled approximately $1.7 million. That cost is expected to be recognized over a weighted average period of 2.3 years.

Restricted Stock Awards

Restricted stock is issued under the 2019 Equity Compensation Plan to reward employees and directors and to retain them by distributing stock over a period of time. Restricted stock awards granted to date vest over a period of 4 years and are recognized as compensation to the recipient over the vesting period. The awards are recorded at fair market value at the time of grant and amortized into salary expense on a straight line basis over the vesting period. The following table summarizes nonvested restricted stock activity for the three months ended March 31, 2021:

    

    

Average grant

Shares

date fair value

Nonvested restricted stock at December 31, 2020

 

87,972

$

19.26

Granted

 

30,000

 

19.46

Cancelled

 

 

Vested

 

(26,633)

 

18.76

Nonvested restricted stock at March 31, 2021

 

91,339

$

19.47

40

Restricted stock awards granted during the three months ended March 31, 2021 and 2020 were as follows:

For the three months ended March 31, 

    

2021

    

2020

Number of shares granted

 

30,000

 

15,000

Average grant date fair value

$

19.46

$

16.63

Compensation expense related to restricted stock for the three months ended March 31, 2021 and 2020 is detailed in the following table:

For the three months ended March 31, 

2021

    

2020

Compensation expense

$

166,349

$

172,904

Income tax benefit

$

48,075

$

49,969

As of March 31, 2021, there was approximately $1.6 million of unrecognized compensation cost related to nonvested restricted stock awards granted under the Company’s stock incentive plans. That cost is expected to be recognized over a weighted average period of 2.9 years.

401(k) Savings Plan

The Bank has a 401(k) savings plan covering substantially all employees. Under the Plan, an employee can contribute up to 80 percent of their salary on a tax deferred basis. The Bank may also make discretionary contributions to the Plan. The Bank contributed $261 thousand and $185 thousand to the Plan during the three months ended March 31, 2021 and 2020, respectively.

Deferred Fee Plan

The Company has a deferred fee plan for Directors and eligible management. Directors of the Company have the option to elect to defer up to 100 percent of their respective retainer and Board of Director fees, and each eligible member of management has the option to elect to defer up to 100 percent of their total compensation. Director and officer deferred fees totaled $128 thousand and $491 thousand during the three months ended March 31, 2021 and 2020, respectively. The interest paid on the deferred balances totaled $28 thousand during the three months ended March 31, 2021 and 2020, respectively. The deferred balances distributed totaled $3 thousand during the three months ended March 31, 2021 and 2020, respectively.

Benefit Plans

In addition to the 401(k) savings plan which covers substantially all employees, in 2015 the Company established an unfunded supplemental defined benefit plan to provide additional retirement benefits for the President and Chief Executive Officer (“CEO”) and unfunded, non-qualified deferred retirement plans for certain other key executives.

On June 4, 2015, the Company approved the Supplemental Executive Retirement Plan (“SERP”) pursuant to which the President and CEO is entitled to receive certain supplemental nonqualified retirement benefits. The retirement benefit under the SERP is an amount equal to 60 percent (60%) of the average of the President and CEO’s base salary for the thirty-six (36) months immediately preceding the executive’s separation from service after age 66, adjusted annually thereafter by 2 percent (2%). The total benefit is to be made payable in 15 annual installments. The future payments are estimated to total $6.2 million. A discount rate of 4 percent (4%) was used to calculate the present value of the benefit obligation.

The President and CEO commenced vesting in this retirement benefit on January 1, 2014, and vests an additional three percent (3%) each year until fully vested on January 1, 2024. In the event that the President and CEO’s separation from service from the Company were to occur prior to full vesting, the President and CEO would be entitled to and shall be paid the vested portion of the retirement benefit calculated as of the date of separation from service. Notwithstanding

41

the foregoing, upon a Change in Control, and provided that within 6 months following the Change in Control the President and CEO is involuntarily terminated for reasons other than “cause” or the President and CEO resigns for “good reason,” as such is defined in the SERP, or the President and CEO voluntarily terminates his employment after being offered continued employment in a position that is not a “Comparable Position,” as such is also defined in the SERP, the President and CEO shall become one hundred percent (100%) vested in the full retirement benefit.

No contributions or payments have been made during the three months ended March 31, 2021. The following table summarizes the components of the net periodic pension cost of the defined benefit plan recognized during the three months ended March 31, 2021 and 2020:

For the three months ended March 31, 

(In thousands)

    

2021

    

2020

Service cost (1)

$

(34)

$

31

Interest cost

 

34

 

37

Amortization of prior service cost

 

21

 

21

Net periodic benefit cost

$

21

$

89

(1) Reduction in service cost totaling $137 thousand to be recognized over one year due to the recalculation of the President and CEO’s salary projection.

The following table summarizes the changes in benefit obligations of the defined benefit plan during the three months ended March 31, 2021 and 2020:

For the three months ended March 31, 

(In thousands)

    

2021

    

2020

Benefit obligation, beginning of year

$

3,845

$

3,571

Service cost (1)

 

(34)

 

31

Interest cost

 

34

 

37

Benefit obligation, end of period

$

3,845

$

3,639

(1) Reduction in service cost totaling $137 thousand to be recognized over one year due to the recalculation of the President and CEO’s salary projection.

On October 22, 2015, the Company entered into an Executive Incentive Retirement Plan (the “Plan”) with key executive officers. The Plan has an effective date of January 1, 2015.

The Plan is an unfunded, nonqualified deferred compensation plan. For any Plan Year, a guaranteed annual Deferral Award percentage of seven and one half percent (7.5%) of the participant’s annual base salary will be credited to each Participant’s Deferred Benefit Account. A discretionary annual Deferral Award equal to seven and one half percent (7.5%) of the participant’s annual base salary may be credited to the Participant’s account in addition to the guaranteed Deferral Award, if the Bank exceeds the benchmarks set forth in the Annual Executive Bonus Matrix. The total Deferral Award shall never exceed 15 percent (15%) of the participant’s base salary for any given Plan Year. Each Participant shall be one hundred percent (100%) vested in all Deferral Awards as of the date they are awarded.

As of March 31, 2021, the Company had total year to date expenses of $35 thousand related to the Plan. The Plan is reflected on the Company’s balance sheet as accrued expenses.

Certain members of management are also enrolled in a split-dollar life insurance plan with a post retirement death benefit of $250 thousand. Total expenses related to this plan were $1 thousand for the three months ended March 31, 2021 and 2020, respectively.

42

NOTE 13. Regulatory Capital

On September 17, 2019, the federal banking agencies issued a final rule providing simplified capital requirements for certain community banking organizations (banks and holding companies) with less than $10 billion in total consolidated assets, implementing provisions of The Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”). Under the proposal, a qualifying community banking organization would be eligible to elect the community bank leverage ratio framework, or continue to measure capital under the existing Basel III requirements. The new rule was effective beginning January 1, 2020, and qualifying community banking organizations may elect to opt into the new community bank leverage ratio (“CBLR”) in their call report beginning in the first quarter of 2020.

A qualifying community banking organization (“QCBO”) is defined as a bank, a savings association, a bank holding company or a savings and loan holding company with:

A leverage capital ratio of greater than 9.0%;
Total consolidated assets of less than $10.0 billion;
Total off-balance sheet exposures (excluding derivatives other than credit derivatives and unconditionally cancelable commitments) of 25% or less of total consolidated assets; and
Total trading assets and trading liabilities of 5% or less of total consolidated assets.

On April 6, 2020, the federal banking regulators, implemented the applicable provisions of the CARES Act, which modified the CBLR framework so that: (i) beginning in the second quarter 2020 and until the end of 2020, a banking organization that has a leverage ratio of 8% or greater and meets certain other criteria may elect to use the CBLR framework; and (ii) community banking organizations will have until January 1, 2022, before the CBLR requirement is re-established at greater than 9%. Under the interim rules, the minimum CBLR will be 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. The numerator of the CBLR is Tier 1 capital, as calculated under the Basel III rules. The denominator of the CBLR is the QCBO’s average assets, calculated in accordance with the QCBO’s Call Report instructions less assets deducted from Tier 1 capital.

The Bank has opted into the CBLR, and will therefore not be required to comply with the Basel III capital requirements.

The following table shows the CBLR ratio for the Company and the Bank for the period ended March 31, 2021 and December 31, 2020:

At March 31, 2021

At December 31, 2020

 

Company

    

Bank

 

 

Company

    

Bank

 

CBLR

 

10.19

%  

9.85

%  

 

10.09

%  

9.80

%  

NOTE 14. Leases

The Company follows ASU 2016-02, "Leases (Topic 842)," which revised certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. ASU 2016-02 requires that a lessee recognize the assets and liabilities on its balance sheet that arise from all leases with a term greater than 12 months. The core principle requires the lessee to recognize a liability to make lease payments and a "right-of-use" asset.

Operating leases in which the Bank is the lessee are recorded as right-of-use ("ROU") assets and lease liabilities and are included in Prepaid expenses and other assets and Accrued expenses and other liabilities, respectively, on the Bank’s Consolidated Balance Sheets. The Bank does not currently have any finance leases in which it is the lessee.

Operating lease ROU assets represent the Bank’s right to use an underlying asset during the lease term and operating lease liabilities represent its obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate. The incremental borrowing rate was calculated for each lease by taking a variable rate FHLB ARC product (based on Libor plus a spread) and then swapping it to a fixed rate borrowing by adding a fixed mid swap rate for the desired term. The borrowing rate for each lease is unique based on the lease term.

43

Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded in Occupancy expense in the Consolidated Statements of Income.

The Bank’s leases relate primarily to bank branches, office space and equipment with remaining lease terms of generally 1 to 10 years. Certain lease arrangements contain extension options which typically range from 1 to 5 years at the then fair market rental rates. As these extension options are not generally considered reasonably certain of exercise, they are not included in the lease term.

Certain real estate leases have lease payments that adjust based on annual changes in the Consumer Price Index ("CPI"). The leases that are dependent upon CPI are initially measured using the index or rate at the commencement date and are included in the measurement of the lease liability.

Operating lease ROU assets totaled $2.2 million at March 31, 2021, compared to $2.4 million at December 31, 2020. As of March 31, 2021, operating lease liabilities totaled $2.3 million, compared to $2.4 million at December 31, 2020.

The table below summarizes our net lease cost:

For the three months ended March 31, 

(In thousands)

2021

2020

Operating lease cost

$

149

$

148

Net lease cost

$

149

$

148

The table below summarizes the cash and non-cash activities associated with our leases:

For the three months ended March 31, 

(In thousands)

2021

2020

Cash paid for amounts included in the measurement of lease liabilities:

  

  

Operating cash flows from operating leases

$

145

$

141

ROU assets obtained in exchange for new operating lease liabilities

$

$

The table below summarizes other information related to our operating leases:

(In thousands, except percentages and years)

    

March 31, 2021

    

December 31, 2020

 

Weighted average remaining lease term in years

 

5.81

5.96

Weighted average discount rate

 

5.47

%  

5.45

%

Operating lease right-of-use assets

$

2,247

$

2,365

The table below summarizes the maturity of remaining lease liabilities:

(In thousands)

    

March 31, 2021

2021 (excluding the three months ended March 31, 2021)

$

411

2022

 

477

2023

 

410

2024

 

361

2025

 

371

2026 and thereafter

 

664

Total lease payments

$

2,694

Less: Interest

 

(392)

Present value of lease liabilities

$

2,302

As of March 31, 2021, the Company had not entered into any material leases that have not yet commenced.

44