1ST CONSTITUTION BANCORP When used in this Quarterly Report on Form 10-Q for the three and nine months endedSeptember 30, 2021 (this "Form 10-Q"), the words "the Company," "we," "our," and "us" refer to1ST Constitution Bancorp and, as the context requires, its wholly-owned subsidiary,1ST Constitution Bank (the "Bank"), the Bank's wholly-owned subsidiaries, 1STConstitution Investment Company of New Jersey, Inc. andFCB Assets Holdings, Inc. , and 1STConstitution Real Estate Investment Corporation , which is indirectly owned by the Bank. 1ST Constitution Capital Trust II ("Trust II"), a subsidiary of the Company, is not included in the Company's consolidated financial statements as it is a variable interest entity and the Company is not the primary beneficiary. Trust II, a subsidiary of the Company, was created inMay 2006 to issue trust preferred securities to assist the Company in raising additional capital. This discussion and analysis of the operating results for the three and nine months endedSeptember 30, 2021 and financial condition atSeptember 30, 2021 is intended to help readers analyze the accompanying financial statements, notes and other supplemental information contained in this Form 10-Q. Results of operations for the three- and six-month periods endedSeptember 30, 2021 are not necessarily indicative of results to be attained for any other period. This discussion and analysis should be read in conjunction with the consolidated financial statements, notes and tables included elsewhere in this Form 10-Q and Part II, Item 7 of the Company's Form 10-K (Management's Discussion and Analysis of Financial Condition and Results of Operation) for the year endedDecember 31, 2020 , as filed with theSecurities and Exchange Commission (the "SEC") onMarch 15, 2021 (the "2020 Form 10-K").
Forward-Looking Statements
This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act").The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. When used in this and in future filings by the Company with theSEC , and in the Company's written and oral statements made with the approval of an authorized executive officer of the Company, the words or phrases "will," "will likely result," "could," "should," "may," "anticipates," "believes," "continues," "expects," "intends," "plans," "will continue," "is anticipated," "estimated," "project" or "outlook" or similar expressions (including confirmations by an authorized executive officer of the Company of any such expressions made by a third party with respect to the Company) are intended to identify forward-looking statements. The Company cautions readers not to place undue reliance on any such forward-looking statements, each of which speaks only as of the date made. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. These forward-looking statements are based upon our opinions and estimates as of the date they are made and are not guarantees of future performance. Although we believe that the expectations reflected in these forward-looking statements are reasonable, such forward-looking statements are subject to known and unknown risks and uncertainties that may be beyond our control, which could cause actual results, performance and achievements to differ materially from results, performance and achievements projected, expected, expressed or implied by the forward-looking statements. Examples of factors or events that could cause actual results to differ materially from historical results or those anticipated, expressed or implied include, without limitation, changes in the overall economy and interest rate changes; inflation, market and monetary fluctuations; the ability of our customers to repay their obligations; the accuracy of our financial statement estimates and assumptions, including the adequacy of the estimates made in connection with determining the adequacy of the allowance for loan losses; increased competition and its effect on the availability and pricing of deposits and loans; significant changes in accounting, tax or regulatory practices and requirements; changes in deposit flows, loan demand or real estate values; the enactment of legislation or regulatory changes; changes in monetary and fiscal policies of theU.S. government; changes to the method that LIBOR rates are determined and to the phasing out of LIBOR after 2021; changes in loan delinquency rates or in our levels of nonperforming assets; our ability to declare and pay dividends; changes in the economic climate in the market areas in which we operate; the frequency and magnitude of foreclosure of our loans; changes in consumer spending and saving habits; the effects of the health and soundness of other financial institutions, including the need of theFDIC to increase theDeposit Insurance Fund assessments; technological changes; the effects of climate change and harsh weather conditions, including hurricanes and man-made disasters; the economic impact of any future terrorist threats and attacks, acts of war or threats thereof and the response ofthe United States to any such threats and attacks; failure to consummate the merger of1st Constitution Bancorp with and into Lakeland Bancorp, Inc. ("Lakeland"), with Lakeland as the surviving entity (the "Merger"), for any reason, including the failure to obtain all necessary regulatory approvals (and the risk that such approvals may result in the imposition of conditions that could adversely affect the combined company), failure to obtain shareholder approvals or failure to satisfy any of the other closing conditions in a timely basis or at all; the diversion of management's time from ongoing business operations due to issues relating to the Merger; the 33 -------------------------------------------------------------------------------- occurrence of any event, change or other circumstances that could give rise to the right of one or both of the parties to terminate the Agreement and Plan of Merger, dated as ofJuly 11, 2021 , by and between Lakeland and1st Constitution Bancorp (the "Merger Agreement"); the outcome of legal proceedings that have been, or may in the future, be instituted against Lakeland and/or the Company related to the Merger; potential adverse reactions or changes to business or employee relationships, including those resulting from the announcement or completion of the transaction; other risks described from time to time in our filings with theSEC ; and our ability to manage the risks involved in the foregoing. Further, the foregoing factors may be exacerbated by the ultimate impact of the Novel Coronavirus ("COVID-19") pandemic, which is unknown at this time. In addition, statements about the COVID-19 pandemic and the potential effects and impacts of the COVID-19 pandemic on the Company's business, financial condition, liquidity and results of operations may constitute forward-looking statements and are subject to the risk that actual results may differ, possibly materially, from what is reflected in such forward-looking statements due to factors and future developments that are uncertain, unpredictable and, in many cases, beyond our control, including the scope, duration and extent of the pandemic, actions taken by governmental authorities in response to the pandemic and the direct and indirect impact of the pandemic on our employees, customers, business and third-parties with which we conduct business. Although management has taken certain steps to mitigate any negative effect of the aforementioned factors and the COVID-19 pandemic, significant unfavorable changes could severely impact the assumptions used and have an adverse effect on profitability. Additional information concerning the factors that could cause actual results to differ materially from those in the forward-looking statements is contained in Item 1. "Business," Item 1A. "Risk Factors," Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," elsewhere in the 2020 Form 10-K and in our other filings with theSEC , and in Part II, Item 1A of this Form 10-Q. However, other factors besides those listed in Item 1A. "Risk Factors" or discussed in the 2020 Form 10-K or this Form 10-Q also could adversely affect our results and you should not consider any such list of factors to be a complete list of all potential risks or uncertainties. Any forward-looking statements made by us or on our behalf speak only as of the date they are made. We undertake no obligation to publicly revise any forward-looking statements or cautionary factors, except as required by law. OVERVIEW The Company is a bank holding company registered under theBank Holding Company Act of 1956, as amended. The Company was organized under the laws of theState of New Jersey inFebruary 1999 for the purpose of acquiring all of the issued and outstanding stock of the Bank, a full-service commercial bank that began operations inAugust 1989 , thereby enabling the Bank to operate within a bank holding company structure. The Company became an active bank holding company onJuly 1, 1999 . Other than its ownership interest in the Bank, the Company currently conducts no other significant business activities. The Bank operates 25 branches and manages its investment portfolio through its subsidiary, 1STConstitution Investment Company of New Jersey, Inc. FCB Assets Holdings, Inc. , a subsidiary of the Bank, is used by the Bank to manage and dispose of repossessed real estate. OnJuly 11, 2021 , the Company and Lakeland (NASDAQ: LBAI), the holding company forLakeland Bank , entered into the Merger Agreement, providing for the Merger of the Company with and into Lakeland, with Lakeland continuing as the surviving entity. The Merger Agreement provides that, immediately following the consummation of the Merger, the Bank will merge with and intoLakeland Bank (the "Bank Merger"). OnNovember 5, 2021 , the Company and Lakeland issued a joint press release announcing the receipt of approval of the proposed Merger from both theFederal Deposit Insurance Corporation and theNew Jersey Department of Banking and Insurance . For additional discussion of the Merger and the Bank Merger, see Note 13 to the financial statements contained in Part I, Item 1 of this Form 10-Q. COVID-19 Impact and Response
As the Company conducts its daily operations, the health and safety of our employees and customers remains our primary concern and we continue to maintain the same measures and protective procedures that we implemented in 2020.
During the first nine months of 2021, the Company continued working with customers impacted by the economic disruption resulting from the COVID-19 pandemic. To support our loan and deposit customers and the communities we serve, we continue to provide access to additional credit and forbearance on loan interest and or principal payments for up to 90 days where management has determined that it is warranted. •All loans except for two that had previously received deferrals were no longer deferred atSeptember 30, 2021 . The two loans consisted of one hotel loan for$3.1 million that was placed on non-accrual in the third quarter of 2020 and one residential mortgage loan for$871,000 that was placed on non-accrual in the first quarter of 2021. •As a long-standingSmall Business Administration ("SBA") preferred lender, we actively participated in the SBA's Paycheck Protection Program ("PPP") lending program established under the Coronavirus Aid, Relief and Economic 34 -------------------------------------------------------------------------------- Security Act (the "CARES Act"). In 2020, we funded 467 SBA PPP loans totaling$75.6 million ,$75.2 million of which had been forgiven by the SBA and paid off through the end of the third quarter of 2021. •The Economic Aid to Hard-Hit Small Business, Not for Profits and Venues Act ("Economic Aid Act") was enacted inDecember 2020 in further response to the COVID-19 pandemic. Among other things, the Economic Aid Act provided relief to borrowers to access additional credit through a second round of the SBA's PPP. We actively participated in the second round PPP and funded loans totaling$35.3 million ,$12.7 million of which had been forgiven by the SBA and paid off through the end of the third quarter of 2021. 35 -------------------------------------------------------------------------------- RESULTS OF OPERATIONS Three and Nine Months EndedSeptember 30, 2021 Compared to Three and Nine Months EndedSeptember 30, 2020 Summary The Company reported net income of$5.4 million and diluted earnings per share of$0.53 for the three months endedSeptember 30, 2021 compared to net income of$4.9 million and diluted earnings per share of$0.48 for the three months endedSeptember 30, 2020 . Net income increased 10.6% and diluted earnings per share increased 10.4% for the third quarter of 2021 compared to the third quarter of 2020. For the nine months endedSeptember 30, 2021 , net income was$15.5 million , or$1.51 per diluted share, compared to net income of$12.0 million , or$1.17 per diluted share, for the nine months endedSeptember 30, 2020 . Net income increased 29.0% and diluted earnings per share increased 29.1% for the first nine months of 2021 compared to the first nine months of 2020. Return on average total assets and return on average shareholders' equity were 1.16% and 10.94%, respectively, for the three months endedSeptember 30, 2021 compared to return on average total assets and return on average shareholders' equity of 1.08% and 10.92%, respectively, for the three months endedSeptember 30, 2020 . Return on average total assets and return on average shareholders' equity were 1.14% and 10.76%, respectively, for the nine months endedSeptember 30, 2021 compared to return on average total assets and return on average shareholders' equity of 0.96% and 9.17%, respectively, for the nine months endedSeptember 30, 2020 . Book value per share was$19.37 atSeptember 30, 2021 compared to$18.32 atDecember 31, 2020 . OnJuly 11, 2021 , the Company entered into the Merger Agreement with Lakeland pursuant to which the Company will merge with and into Lakeland and the Bank will merge with and intoLakeland Bank . Expenses of$737,000 and$1.2 million related to the pending Merger were incurred for the three and nine months endedSeptember 30, 2021 , respectively. No merger-related expenses were incurred for the three months endedSeptember 30, 2020 and$64,000 of merger-related expenses were incurred for the nine months endedSeptember 30, 2020 . Adjusted net income increased 24.5% to$6.1 million , for the third quarter of 2021 compared to adjusted net income of$4.9 million for the third quarter of 2020. Adjusted net income per diluted share increased 22.9% to$0.59 for the third quarter of 2021 compared to adjusted net income per diluted share of$0.48 for the third quarter of 2020. For the nine months endedSeptember 30, 2021 , adjusted net income was$16.5 million , or$1.61 per diluted share, compared to adjusted net income of$12.1 million , or$1.18 per diluted share, for the nine months endedSeptember 30, 2020 . Adjusted net income, adjusted net income per diluted share, adjusted return on average total assets and adjusted return on average shareholders' equity are non-GAAP financial measures that exclude the after-tax effect of merger-related expenses from the comparable GAAP financial measures. These and other non-GAAP financial measures should be considered in addition to, but not as a substitute for, the Company's GAAP financial results. A reconciliation of these non-GAAP financial measures to the GAAP financial results is included in the following table. 36
-------------------------------------------------------------------------------- The following table reflects the reconciliation of non-GAAP financial measures(1) for the three and nine months endedSeptember 30, 2021 and 2020. Three Months Ended Nine Months Ended September 30, September 30, 2021 2020 2021 2020 Adjusted net income Net income$ 5,430 $ 4,910 $ 15,511 $ 12.021 Adjustments: Merger-related expenses 737 - 1,184 64 Income tax effect of adjustments (52) - (150) (19) Adjusted net income$ 6,115
Adjusted net income per diluted share
Adjusted net income$ 6,115
Diluted shares outstanding 10,319,637 10,268,951 10,299,029 10,260,477 Adjusted net income per diluted share$ 0.59
Adjusted return on average total assets
Adjusted net income$ 6,115
Average assets 1,854,273 1,804,198 1,826,235 1,675,200 Adjusted return on average total assets 1.31 % 1.08 % 1.21 % 0.96 % Adjusted return on average shareholders' equity Adjusted net income$ 6,115 $ 4,910 $ 16,545 $ 12,066 Average equity 196,838 178,946 192,763 175,141 Adjusted return on average shareholders' equity 12.33 % 10.92 % 11.48 % 9.20 % Adjusted efficiency ratio Adjusted non-interest expenses(2)$ 10,104
18,832 20,222 56,612 52,811
Adjusted efficiency ratio 53.65 % 54.21 % 55.27 % 57.81 %
Book value and tangible book value per common
share
Shareholders' equity $ 199,923 $ 182,007
Less: goodwill and intangible assets 35,765 36,471
Tangible shareholders' equity 164,158 145,536
Shares outstanding 10,318,907 10,237,520
Book value per common share $ 19.37 $ 17.78
Tangible book value per common share $ 15.91 $ 14.22
(1) We use the non-GAAP financial measures of adjusted net income, adjusted net
income per diluted share, adjusted return on average total assets, adjusted
return on average shareholders' equity, tangible book value per common share,
adjusted non-interest expenses and adjusted efficiency ratio because management
believes that it is helpful to readers in understanding the Company's financial
performance and the effect of the expenses related to the pending Merger on its
financial statements. These non-GAAP financial measures improve the
comparability of the current period results with the results of the prior
periods. The Company cautions that the non-GAAP financial measures should be
considered in addition to, but not as a substitute for, the Company's GAAP
financial results.
(2) Adjusted non-interest expenses is calculated by subtracting merger-related
expenses from total non-interest expenses. Accordingly, adjusted non-interest
expenses for the three and nine months ended September 30, 2021 is calculated as
total non-interest expenses of $10.8 million and $32.5 million for the three-
and nine-month periods ended September 30, 2021 less $737,000 and $1.2 million
for the three and nine months ended September 30, 2021 , respectively, and
adjusted non-interest expenses for the three and nine months ended September 30,
2020 is calculated as total non-interest expenses of $11.0 million and $30.6
million for the three- and nine-month periods ended September 30, 2020 ,
respectively, less merger-related expenses of $64,000 for the nine months ended
September 30, 2020 .
37
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Third Quarter 2021 Highlights
•Return on average total assets and return on average shareholders' equity were
1.16% and 10.94%, respectively. Adjusted return on average total assets and
adjusted return on average shareholders' equity were 1.31% and 12.33%,
respectively.
•Net interest income was $14.8 million and the net interest margin was 3.42% on
a tax-equivalent basis.
•A provision for loan losses of $600,000 was recorded and net charge-offs were
$365,000 .
•Total loans were $1.2 billion at September 30, 2021 and decreased $37.0 million
from June 30, 2021 . During the third quarter of 2021, commercial business loans
decreased $20.4 million to $139.7 million due primarily to the forgiveness and
pay-off of the SBA PPP loans. Mortgage warehouse lines decreased $5.9 million
due to the lower volume of funding than in the second quarter of 2021.
Residential real estate loans held in the portfolio decreased $5.3 million due
to pay-offs of loans. All other components of the loan portfolio decreased a
combined $5.4 million .
•Non-interest income was $3.9 million for the third quarter of 2021, as
residential mortgage banking and SBA lending operations generated $1.5 million
and $1.1 million gain on sales of loans, respectively.
•Non-interest-bearing demand deposits increased $45.1 million , savings and
interest-bearing transaction accounts increased $62.4 million and certificates
of deposit declined $15.0 million during the third quarter of 2021.
•Non-performing loans were $9.5 million , or 0.80% of total loans at September
30, 2021 , representing a decrease of $2.5 million from June 30, 2021 . Other real
estate owned ("OREO") was $48,000 . One non-performing commercial real estate
loan for $3.1 million was transferred to loans held for sale and was charged
down $334,000 to its estimated fair value of $2.7 million .
Earnings Analysis
The Company's results of operations depend primarily on net interest income,
which is primarily affected by the market interest rate environment, the
monetary policy of the Board of Governors of the Federal Reserve System , the
shape of the U.S. Treasury yield curve and the difference between the yield on
interest-earning assets and the rate paid on interest-bearing liabilities. Other
factors that may affect the Company's operating results are general and local
economic and competitive conditions, government policies and actions of
regulatory authorities.
Net Interest Income
Net interest income, the Company's largest and most significant component of
operating income, is the difference between interest and fees earned on loans
and other earning assets and interest paid on deposits and borrowed funds. This
component represented 79.1% of the Company's net revenues (defined as net
interest income plus non-interest income) for the three months ended September
30, 2021 compared to 76.4% of net revenues for the three months ended September
30, 2020 . Net interest income also depends upon the relative amount of average
interest-earning assets, average interest-bearing liabilities and the interest
rate earned or paid on them, respectively.
38
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The following table sets forth the Company's consolidated average balances of
assets and liabilities and shareholders' equity, as well as interest income and
interest expense on related items, and the Company's average yield or rate for
the three months ended September 30, 2021 and 2020. The average rates are
derived by dividing interest income and interest expense by the average balance
of assets and liabilities, respectively.
Three months ended September 30, 2021 Three months ended September 30, 2020
(Dollars in thousands except Average Average Average Average
yield/cost information) Balance Interest Yield Balance Interest Yield
Assets
Interest-earning assets:
Federal funds sold/short-term
investments $ 270,231 $ 108 0.16 % $ 8,027 $ 2 0.10 %
Investment securities:
Taxable 145,979 545 1.49 % 155,242 725 1.87 %
Tax-exempt (1) 107,693 577 2.14 % 83,461 638 3.06 %
Total investment securities 253,672 1,122 1.77 % 238,703 1,363 2.28 %
Loans: (2)
Commercial real estate 612,067 8,008 5.12 % 609,917 7,789 5.00 %
Mortgage warehouse lines 229,034 2,398 4.10 % 333,461 3,383 4.06 %
Construction 127,567 1,837 5.63 % 136,252 1,794 5.24 %
Commercial business 122,796 1,228 3.97 % 138,073 1,445 4.16 %
SBA PPP loans 28,734 566 7.81 % 75,484 470 2.48 %
Residential real estate 65,587 730 4.45 % 89,755 1,137 4.96 %
Loans to individuals 17,895 175 3.88 % 27,284 293 4.20 %
Loans held for sale 5,927 47 3.17 % 23,914 155 2.59 %
All other loans 486 6 4.83 % 643 11 6.69 %
Deferred (fees) costs, net (1,034) - - % (1,736) - - %
Total loans 1,209,059 14,995 4.92 % 1,433,047 16,477 4.57 %
Total interest-earning assets 1,732,962 $ 16,225 3.71 % 1,679,777 $ 17,842 4.23 %
Non-interest-earning assets: Allowance for loan losses (17,302) (12,348) Cash and due from banks 20,243 11,460 Other assets 118,370 125,309 Total non-interest-earning assets 121,311 124,421 Total assets$ 1,854,273 $ 1,804,198 Liabilities and shareholders' equity Interest-bearing liabilities: Money market and NOW accounts$ 494,073 $ 414 0.33 %$ 425,401 $ 542 0.51 % Savings accounts 430,398 427 0.39 % 290,055 461 0.63 % Certificates of deposit 165,267 374 0.90 % 350,654 1,168 1.33 % Federal Reserve Bank PPPLF borrowings - - - % 35,296 33 0.37 % Short-term borrowings - - - % 63,175 62 0.39 % Redeemable subordinated debentures 18,557 81 1.71 % 18,557 90 1.90
%
Total interest-bearing liabilities 1,108,295
0.46 % 1,183,138$ 2,356 0.79
%
Non-interest-bearing liabilities: Demand deposits 516,527 413,350 Other liabilities 32,613 28,764 Total non-interest-bearing liabilities 549,140 442,114 Shareholders' equity 196,838 178,946 Total liabilities and shareholders' equity$ 1,854,273 $ 1,804,198 Net interest spread (3) 3.25 % 3.44 % Net interest income and margin (4)$ 14,929 3.42 %$ 15,486 3.67
%
(1) Tax equivalent basis, using federal tax rate of 21% in 2021 and 2020.
(2) Loan origination fees are considered an adjustment to interest income. For
the purpose of calculating loan yields, average loan balances include
non-accrual
loans with no related interest income and the average balance of loans held for
sale.
(3) The net interest spread is the difference between the average yield on
interest-earning assets and the average rate paid on interest-bearing
liabilities.
(4) The net interest margin is equal to net interest income divided by average
interest-earning assets.
39
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The following table sets forth the Company's consolidated average balances of
assets and liabilities and shareholders' equity, as well as interest income and
interest expense on related items, and the Company's average yield or rate for
the nine months ended September 30, 2021 and 2020. The average rates are derived
by dividing interest income and interest expense by the average balance of
assets and liabilities, respectively.
Nine months ended September 30, 2021 Nine months ended September 30, 2020
(Dollars in thousands except Average Average Average Average
yield/cost information) Balance Interest Yield Balance Interest Yield
Assets
Interest-earning assets:
Federal funds sold/short-term
investments $ 210,127 $ 203 0.13 % $ 16,433 $ 95 0.77 %
Investment securities:
Taxable 135,665 1,569 1.54 % 163,979 2,633 2.14 %
Tax-exempt (1) 96,173 1,762 2.44 % 77,145 1,821 3.15 %
Total investment securities 231,838 3,331 1.92 % 241,124 4,454 2.46 %
Loans: (2)
Commercial real estate 613,930 23,487 5.04 % 588,145 22,935 5.12 %
Mortgage warehouse lines 243,168 7,486 4.06 % 244,470 7,702 4.20 %
Construction 131,001 5,488 5.52 % 141,428 5,965 5.63 %
Commercial business 126,508 3,726 3.94 % 142,010 4,815 4.53 %
SBA PPP loans 48,062 2,292 6.38 % 43,374 818 2.52 %
Residential real estate 72,525 2,412 4.43 % 89,333 3,085 4.54 %
Loans to individuals 18,625 574 4.12 % 28,857 1,001 4.56 %
Loans held for sale 11,750 282 3.20 % 14,160 304 2.86 %
All other loans 632 18 3.76 % 872 31 4.67 %
Deferred (fees) costs, net (1,252) - - % (345) - - %
Total loans 1,264,949 45,765 4.84 % 1,292,304 46,656 4.82 %
Total interest-earning assets 1,706,914 $ 49,299 3.86 % 1,549,861 $ 51,205 4.41 %
Non-interest-earning assets: Allowance for loan losses (16,826) (10,684) Cash and due from banks 17,216 12,182 Other assets 118,931 123,841 Total non-interest-earning assets 119,321 125,339 Total assets$ 1,826,235 $ 1,675,200 Liabilities and shareholders' equity Interest-bearing liabilities: Money market and NOW accounts$ 475,929 $ 1,299 0.36 %$ 417,557 $ 1,913 0.61 % Savings accounts 393,733 1,263 0.43 % 275,679 1,612 0.78 % Certificates of deposit 234,331 1,593 0.91 % 354,551 4,608 1.74 % Federal Reserve Bank PPPLF borrowings - - - % 13,169 36 0.37 % Short-term borrowings 108 - - % 39,344 169 0.58 % Redeemable subordinated debentures 18,557 248 1.76 % 18,557 348 2.46
%
Total interest-bearing liabilities 1,122,658
0.52 % 1,118,857$ 8,686 1.04
%
Non-interest-bearing liabilities: Demand deposits 479,204 351,291 Other liabilities 31,610 29,911 Total non-interest-bearing liabilities 510,814 381,202 Shareholders' equity 192,763 175,141 Total liabilities and shareholders' equity$ 1,826,235 $ 1,675,200 Net interest spread (3) 3.34 % 3.37 % Net interest income and margin (4)$ 44,896 3.52 %$ 42,519 3.66 % (1) Tax equivalent basis, using federal tax rate of 21% in 2021 and 2020. (2) Loan origination fees are considered an adjustment to interest income. For the purpose of calculating loan yields, average loan balances include non-accrual loans with no related interest income and the average balance of loans held for sale. (3) The net interest spread is the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities. (4) The net interest margin is equal to net interest income divided by average interest-earning assets. 40 -------------------------------------------------------------------------------- Three months endedSeptember 30, 2021 compared to three months endedSeptember 30, 2020 Net interest income was$14.8 million for the third quarter of 2021 and decreased$544,000 compared to net interest income of$15.4 million for the third quarter of 2020. Total interest income was$16.1 million for the three months endedSeptember 30, 2021 compared to$17.7 million for the three months endedSeptember 30, 2020 . The decrease in total interest income was due primarily to a significant decline in the average balance of total loans that resulted in a lower yield on average interest-earning assets for the third quarter of 2021 compared to the third quarter of 2020. Average interest-earning assets were$1.7 billion , with a tax-equivalent yield of 3.71%, for the third quarter of 2021 compared to average interest-earning assets of$1.7 billion , with a tax-equivalent yield of 4.23%, for the third quarter of 2020. The decline in the tax-equivalent yield is due primarily to a significant change in the mix of average interest-earning assets in 2021 compared to 2020. Total average loans were 69.8% of total average earning assets for the third quarter of 2021 compared to 85.3% for the third quarter of 2020. The tax-equivalent yield on average interest-earning assets for the third quarter of 2021 declined 52 basis points to 3.71% due primarily to the lower percentage of average loans to average earning assets, the decline in market interest rates during 2020 to a low level that continued through the third quarter of 2021 and the significant increase in the average balance of federal funds sold/short-term investments with a yield of 0.16%. TheFederal Reserve reduced the targeted federal funds rate 150 basis points inMarch 2020 in response to the economic uncertainty resulting from the COVID-19 pandemic. As a result of the reductions in the targeted federal funds rate, the prime rate declined to 3.25% inMarch 2020 and was unchanged through the third quarter of 2021. As a result of the continued economic disruption and uncertainty, the low interest rate environment continued throughSeptember 30, 2021 . The Bank had approximately$421.3 million of loans with an interest rate tied to the prime rate and approximately$45.2 million of loans with an interest rate tied to either 1- or 3-month LIBOR atSeptember 30, 2021 . Unearned fees, net of deferred costs, related to the SBA PPP loans were$736,000 atSeptember 30, 2021 . Interest expense on average interest-bearing liabilities was$1.3 million , with an interest cost of 0.46%, for the third quarter of 2021, compared to$1.4 million , with an interest cost of 0.52%, for the second quarter of 2021 and$2.4 million , with an interest cost of 0.79%, for the third quarter of 2020. Interest expense declined$1.1 million for the third quarter of 2021 compared to the third quarter of 2020 due primarily to the decline in interest rates paid on deposits as a direct result of the low interest rate environment. The average cost of interest-bearing deposits was 0.44% for the third quarter of 2021, 0.50% for the second quarter of 2021 and 0.81% for the third quarter of 2020. The interest rates paid on deposits generally do not adjust quickly to rapid changes in market interest rates and decline over time in a falling interest rate environment. Management will continue to monitor and adjust the interest rates paid on deposits to reflect the then current interest rate environment and competitive factors. The net interest margin on a tax-equivalent basis was 3.42% for the third quarter of 2021 compared to 3.67% for the third quarter of 2020. The net interest margin for the third quarter of 2021 was negatively impacted by the$262.2 million increase in the average balance of federal funds sold/short-term investments, which was driven in part by the$224.0 million decrease in average total loans which had a significant impact on net interest income and the yield of average earning assets. The reinvestment of proceeds from maturing and called investment securities and the purchase of new investment securities at the current lower interest rates also contributed to the decline in net interest income. Interest income for the third quarter of 2021 included$451,000 of fee income related to PPP loans that were forgiven and paid off by the SBA. Excluding the effect of the higher average balance of federal funds sold/short-term investments due to the increase in average deposits, the net interest margin was approximately 3.62% for the third quarter of 2021. Nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 For the nine months endedSeptember 30, 2021 , net interest income increased$2.4 million , or 5.7%, to$44.5 million compared to$42.1 million for the nine months endedSeptember 30, 2020 . Total interest income was$48.9 million for the nine months endedSeptember 30, 2021 compared to$50.8 million for the nine months endedSeptember 30, 2020 . The decrease in total interest income year-over-year was due primarily to a decline in average total loans and the lower interest rate environment that resulted in the lower yield of average earning assets. Average interest-earning assets increased$157.1 million to$1.71 billion for the nine months endedSeptember 30, 2021 compared to$1.55 billion for the same period in 2020. This increase was due primarily to a$184.1 million increase in average deposits partially offset by a$52.4 million decrease in average borrowings. The tax-equivalent yield on average interest earnings assets was 3.86% for the nine months endedSeptember 30, 2021 compared to 4.41% for the same period in the prior year. The decline of 55 basis points in tax-equivalent yield year-over-year was due primarily to the lower interest rate environment and the significant increase in federal funds sold/short-term investments, which had a low yield. Interest expense on average interest-bearing liabilities was$4.4 million , with an interest cost of 0.52%, for the nine months endedSeptember 30, 2021 compared to$8.7 million , with an interest cost of 1.04%, for the same period in the prior year. Interest expense 41 -------------------------------------------------------------------------------- declined$4.3 million for the nine months endedSeptember 30, 2021 compared to the prior year period due primarily to the decline in interest rates paid on deposits as a direct result of the low interest rate environment. The interest cost of interest-bearing liabilities declined 52 basis points atSeptember 30, 2021 compared toSeptember 30, 2020 due primarily to lower market interest rates. Average total interest-bearing liabilities were relatively unchanged year-over-year, however, there was a significant change within the components of interest-bearing liabilities. Money market and NOW accounts increased$58.4 million and savings accounts increased$118.1 million , while certificates of deposit decreased$120.2 million , Federal Reserve Bank PPPLF borrowings decreased$13.2 million and short-term borrowings decreased$39.2 million . Management will continue to monitor the interest rates paid on deposits and adjust them based on then current market conditions. The net interest margin on a tax-equivalent basis was 3.52% for the nine months endedSeptember 30, 2021 compared to 3.66% for the nine months endedSeptember 30, 2020 . The decline in the net interest margin year-over-year was due primarily to the significant increase in low yielding federal funds sold/short-term investments and the decline in yield of investment securities.
Provision for Loan Losses
Management considers a complete review of the following specific factors in determining the provisions for loan losses: historical losses by loan category, the level of non-accrual loans and problem loans as identified through internal review and classification, collateral values and the growth, size and risk elements of the loan portfolio. In addition to these factors, management takes into consideration current economic conditions and local real estate market conditions. As a result of the continuing economic and social disruption caused by the COVID-19 pandemic, in the third quarter of 2021 management reviewed construction, commercial business and commercial real estate loans that had been modified to defer interest and or principal for up to 90 days with a special emphasis on the hotel and restaurant-food service industries that have been adversely impacted by the economic disruption caused by the pandemic. Prior toMarch 2020 , when the impacts of the COVID-19 pandemic began to be realized, the general economic environment inNew Jersey and theNew York City metropolitan area had been positive with stable and expanding economic activity, and the Company had generally experienced stable loan credit quality over the past five years.
Three months ended
The Company recorded a provision for loan losses of$600,000 for the third quarter of 2021 compared to a provision for loan losses of$2.3 million for the third quarter of 2020 which included a specific reserve of$1.5 million for impaired loans. The provision for loan losses for the third quarter of 2021 reflected the decline in the size of the loan portfolio, net charge-offs of$365,000 and changes in risk elements and mix of the loan portfolio atSeptember 30, 2021 . AtSeptember 30, 2021 , total loans were$1.2 billion and the allowance for loan losses was$17.2 million , or 1.43% of total loans, compared to total loans of$1.5 billion and an allowance for loan losses of$14.5 million , or 0.99% of total loans, atSeptember 30, 2020 . The increase in the allowance for loan losses year-over-year is due primarily to the$1.7 million increase in specific reserves for impaired loans, higher charge-offs in 2021 compared to 2020 and the concomitant increase in the historical loss factors, an increase in the allowance due to changes in loan credit risk ratings in 2021, changes in the mix of loans in the loan portfolio and risk factors related to the economic uncertainty due to the COVID-19 pandemic continuing to adversely impact borrowers' business operations and financial results. The allowance for loan losses, excluding the allocated reserve for mortgage warehouse lines, was$16.1 million , or 1.67% of total loans excluding mortgage warehouse lines atSeptember 30, 2021 . In addition, atSeptember 30, 2021 , there were$23.1 million of SBA PPP loans, which are 100% guaranteed by the SBA and, accordingly, no allowance was provided. Nine months endedSeptember 30, 2021 compared to nine months endedSeptember 30, 2020 During the first nine months of 2021, the Company recorded a provision for loan losses of$2.6 million compared to a provision for loan losses of$5.3 million for the first nine months of 2020. The provision for loan losses for the 2020 period included an increase of$2.3 million in the allowance for the estimated increase in incurred loan losses due primarily to the economic and social disruption caused by the COVID-19 pandemic, an increase in specific reserves of$1.5 million , and the effect of net charge-offs of$161,000 . The provision for loan losses for the first nine months of 2021 reflected primarily a$1.0 million increase in specific reserves on impaired loans and net charge-offs of$1.1 million .
Non-Interest Income
Three months ended
Non-interest income was$3.9 million for the third quarter of 2021, representing a decrease of$833,000 , or 17.6%, compared to$4.7 million for the third quarter of 2020. The decrease in non-interest income was driven primarily by a$764,000 decrease in gain on sales of loans. 42 -------------------------------------------------------------------------------- The Company originates and sells commercial loans guaranteed by the SBA and residential mortgage loans in the secondary market. In the third quarter of 2021,$8.3 million of SBA loans were sold and gain on sales of loans of$1.1 million was recorded compared to$5.1 million of SBA loans sold and gain on sales of loans of$463,000 recorded for the third quarter of 2020. In the third quarter of 2021, residential mortgage banking operations originated$51.0 million of residential mortgages, sold$54.0 million of residential mortgages and recorded a$1.5 million gain on sales of loans compared to approximately$118.0 million of residential mortgages originated,$97.5 million of residential mortgage loans sold and a$2.9 million gain on sales of loans recorded in the third quarter of 2020. Income from bank-owned life insurance ("BOLI") increased$191,000 for the third quarter of 2021 compared to the third quarter of 2020, due primarily to$200,000 of income from a death benefit. Other income decreased$173,000 in the third quarter of 2021 compared to the third quarter of 2020, which included an interest rate swap fee of$172,000 . Nine months endedSeptember 30, 2021 compared to nine months endedSeptember 30, 2020 Total non-interest income for the nine months endedSeptember 30, 2021 increased$1.4 million , or 13.8%, to$11.7 million compared to total non-interest income of$10.3 million for the nine months endedSeptember 30, 2020 due primarily to increases in gain on the sales of loans. For the nine months endedSeptember 30, 2021 ,$199.5 million of residential mortgages were originated and$226.3 million of residential mortgages were sold, which generated gain on sales of loans of$6.4 million , as compared to approximately$233.8 million of residential mortgages originated and$208.1 million of residential mortgage sold, which generated gain on sales of loans of$6.2 million , for the nine months endedSeptember 30, 2020 . Management believes that the increase in residential mortgage loans originated and sold was due primarily to increased residential mortgage financing activity as a result of lower mortgage interest rates. For the nine months endedSeptember 30, 2021 ,$16.4 million of SBA loans were sold and gain on sales of loans of$2.1 million was recorded compared to$7.8 million of SBA loans sold and gain on sales of loans of$688,000 recorded for the nine months endedSeptember 30, 2020 .
Service charges on deposit accounts decreased
For the nine months endedSeptember 30, 2021 , income on BOLI increased$89,000 to$721,000 compared to$632,000 for the nine months endedSeptember 30, 2020 due primarily to income from a death benefit. Gain on sales/calls of securities decreased$91,000 to$6,000 for the nine months endedSeptember 30, 2021 compared to$97,000 for the nine months endedSeptember 30, 2020 , which included a higher amount of investment securities called. Other income increased$51,000 to$2.2 million for the nine months endedSeptember 30, 2021 compared to$2.1 million for the nine months endedSeptember 30, 2020 , due primarily to general increases in other income components. In future periods, originations and sales of residential mortgages may decline due to a lower level of refinancing activity and or a lower level of residential home purchases resulting from the economic and social disruption caused by the COVID-19 pandemic. A decline in sales of residential mortgages would result in a lower gain on sales of loans and a decline of non-interest income. The future origination and sale of SBA loans may also be negatively affected by the pandemic. 43 -------------------------------------------------------------------------------- Non-Interest Expenses For the three months endedSeptember 30, 2021 , non-interest expenses were$10.8 million compared to$11.0 million for the three months endedSeptember 30, 2020 , representing a decrease of$121,000 . Adjusted non-interest expenses, which excludes the$737,000 of merger-related expenses incurred in the third quarter of 2021 in connection with the pending Merger, decreased$858,000 compared to the third quarter of 2020. Adjusted non-interest expenses is a non-GAAP measure that excludes merger-related expenses and should be considered in addition to, but not as a substitute for, the Company's GAAP financial results. A reconciliation of this non-GAAP financial measure to the GAAP financial results is included in the table on page 38 of this Form 10-Q.
The following table presents the major components of non-interest expenses for
the three and nine months ended
Three months ended September 30, Nine months ended September 30,
(Dollars in thousands) 2021 2020 2021 2020
Salaries and employee benefits $ 6,623
$ 20,034 $ 19,276
Occupancy expense 1,221 1,222 3,693 3,597
Data processing expenses 490 486 1,486 1,402
Equipment expense 378 388 1,198 1,211
Marketing 19 21 76 99
Telephone 117 124 367 378
Regulatory, professional and
consulting fees 431 575 1,476 1,536
Insurance 97 118 299 364
Supplies 49 67 160 275
FDIC insurance expense 108 225 533 484
Other real estate owned (recoveries)
expenses (22) 27 33 58
Merger-related expenses 737 - 1,184 64
Amortization of intangible assets 79 91 239 304
Other expenses 514 512 1,695 1,544
Total $ 10,841 $ 10,962 $ 32,473 $ 30,592 Three months ended
Salaries and employee benefits expense decreased$483,000 for the third quarter of 2021 compared to the third quarter of 2020 due primarily to a$855,000 decrease in mortgage commissions and a$68,000 decrease in overtime expense, partially offset by a$62,000 increase in temporary staffing costs and a$336,000 increase in incentive compensation.
Regulatory, professional and consulting fees declined
Merger-related expenses of$737,000 were incurred in the third quarter of 2021 for legal, financial advisory and other expenses incurred in connection with the pending Merger compared to no merger-related expenses in the third quarter of 2020. Non-interest expenses may increase, if there is a significant increase in non-performing loans, as a result of higher expenses incurred in connection with loan collection and recovery costs. In addition,FDIC insurance expense may increase if the Bank's financial condition is adversely impacted by a higher level of non-performing loans and assets.
Nine months ended
Non-interest expenses were$32.5 million for the nine months endedSeptember 30, 2021 compared to$30.6 million for the nine months endedSeptember 30, 2020 , representing an increase of$1.9 million , or 6.2%, due primarily to$1.2 million in merger-related expenses incurred in connection with the pending Merger and a$758,000 increase in salaries and employee benefits. 44 -------------------------------------------------------------------------------- Salaries and employee benefits increased$758,000 to$20.0 million for the nine months endedSeptember 30, 2021 compared to$19.3 million for the nine months endedSeptember 30, 2020 , due primarily to a$209,000 increase in temporary staffing costs, a$374,000 increase in incentive compensation, a$151,000 increase in share-based compensation expense, which were partially offset by a$100,000 decrease in the cost of employee benefits and a$49,000 decrease in overtime expense. Occupancy expense increased$96,000 to$3.7 million for the nine months endedSeptember 30, 2021 compared$3.6 million for the nine months endedSeptember 30, 2020 , due primarily to higher snow removal costs in the first quarter of 2021.
Supplies expense decreased
Merger-related expenses were$1.2 million for the nine months endedSeptember 30, 2021 compared to$64,000 for the nine months endedSeptember 30, 2020 , reflecting the legal, financial advisory and other expenses incurred in connection with the pending Merger and the expenses incurred in 2020 related to the merger withShore Community Bank . Other expenses increased$151,000 to$1.7 million for the nine months endedSeptember 30, 2021 compared to$1.5 million for the nine months endedSeptember 30, 2020 , due primarily to general increases in various other operating expense categories year over year. Income Taxes
Three months ended
Income tax expense was$1.8 million for the third quarter of 2021, resulting in an effective tax rate of 25.3%, compared to income tax expense of$1.9 million , which resulted in an effective tax rate of 27.9% for the third quarter of 2020. The lower effective tax rate in the third quarter of 2021 reflected primarily the lower state tax rate that resulted from certain tax planning initiatives that reduced the effective tax rate and the tax benefit from higher deductions for share-based compensation in the third quarter of 2021, which was partially offset by non-deductible merger-related expenses, compared to the third quarter of 2020.
Nine months ended
Income tax expense was$5.7 million for the nine months endedSeptember 30, 2021 , resulting in an effective tax rate of 26.7%, compared to income tax expense of$4.5 million , which resulted in an effective tax rate of 27.1% for the nine months endedSeptember 30, 2020 . The increase in income tax expense was due primarily to a$4.7 million increase in pre-tax income in the first nine months of 2021 compared to the first nine months of 2020. The lower effective tax rate for the first nine months of 2021 reflected primarily the lower state tax rate that resulted from certain tax planning initiatives that reduced the effective tax rate and the tax benefit from higher deductions for share-based compensation, which was partially offset by non-deductible merger-related expenses, compared to the same period of 2020.
FINANCIAL CONDITION
Total consolidated assets were$1.91 billion atSeptember 30, 2021 compared to$1.81 billion atDecember 31, 2020 . Total cash and cash equivalents increased$252.0 million and total investment securities increased$111.4 million fromDecember 31, 2020 , which amounts were partially offset by decreases of$235.3 million in total portfolio loans and$23.0 million in loans held for sale.
Cash and Cash Equivalents
Cash and cash equivalents totaled$273.9 million atSeptember 30, 2021 compared to$22.0 million atDecember 31, 2020 , representing an increase of$252.0 million . The increase in cash and cash equivalents reflects an increase in deposits and the cash flows resulting from the decline in total portfolio loans, partially offset by the increase in total investment securities.
Loans Held for Sale
Loans held for sale were
45
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originations. The amount of loans held for sale varies from period to period due
to changes in the amount and timing of sales of residential mortgage loans and
SBA guaranteed commercial loans.
Investment securities represented approximately 17.2% of total assets atSeptember 30, 2021 and approximately 12.1% of total assets atDecember 31, 2020 . Total investment securities increased$111.4 million to$329.1 million atSeptember 30, 2021 from$217.7 million atDecember 31, 2020 . In response to the higher level of liquidity, purchases of investment securities totaled$171.6 million during the nine months endedSeptember 30, 2021 . During the same period proceeds from calls, maturities and payments totaled$58.1 million . Bonds with maturities between one and three years were the primary purchases. Securities available for sale are investments that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk and to take advantage of market conditions that create economically attractive returns. AtSeptember 30, 2021 , securities available for sale were$203.9 million , representing an increase of$78.7 million from securities available for sale of$125.2 million atDecember 31, 2020 . AtSeptember 30, 2021 , the securities available for sale portfolio had net unrealized gains of$1.5 million compared to net unrealized gains of$2.6 million atDecember 31, 2020 . These net unrealized gains were reflected, net of tax, in shareholders' equity as a component of accumulated other comprehensive income (loss). Securities held to maturity, which are carried at amortized historical cost, are investments for which there is the positive intent and ability to hold to maturity. AtSeptember 30, 2021 , securities held to maturity were$125.2 million , representing an increase of$32.6 million from$92.6 million atDecember 31, 2020 . The fair value of the held to maturity portfolio was$127.2 million and represented a net unrealized gain of$2.0 million atSeptember 30, 2021 . Loans The loan portfolio, which represents the Company's largest asset, is a significant source of both interest and fee income. Elements of the loan portfolio are subject to differing levels of credit and interest rate risk. The Company's primary lending focus continues to be the financing of mortgage warehouse lines, construction loans, commercial business loans, owner-occupied commercial mortgage loans and commercial real estate loans on income-producing assets.
The following table represents the components of the loan portfolio at
September 30, 2021 December 31, 2020
(Dollars in thousands) Amount % Amount %
Commercial real estate $ 612,827 51 % $ 618,978 43 %
Mortgage warehouse lines 235,897 20 388,366 27
Construction 129,636 11 129,245 9
Commercial business 139,654 12 188,728 13
Residential real estate 63,223 5 88,261 6
Loans to individuals 17,945 1 21,269 2
Other loans 93 - 113 -
Total loans 1,199,275 100 % 1,434,960 100 %
Deferred loan fees, net (820) (1,254)
Total loans, including deferred loan
fees, net $ 1,198,455 $ 1,433,706
Total portfolio loans at September 30, 2021 were $1.20 billion , compared to
$1.43 billion at December 31, 2020 . The $235.3 million decrease in portfolio
loans was due primarily to a decrease of $152.5 million in mortgage warehouse
lines as a result of lower funding volume in the third quarter of 2021 compared
to the fourth quarter of 2020, a decrease of $49.1 million in commercial
business loans as a result of forgiveness and pay-offs of SBA PPP loans, a
decrease of $25.0 million in residential real estate loans due to pay-offs and a
$6.2 million decrease in commercial real estate loans.
Commercial real estate loans totaled $612.8 million at September 30, 2021
compared to $619.0 million at December 31, 2020 . Commercial real estate loans
consist primarily of loans to businesses that are collateralized by real estate
assets employed in the operation of the business and loans to real estate
investors to finance the acquisition and/or improvement of income-producing
commercial properties.
46
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The Bank's mortgage warehouse funding group provides revolving lines of credit
that are available to licensed mortgage banking companies. The warehouse line of
credit is used by the mortgage banker to finance the origination of one-to-four
family residential mortgage loans that are pre-sold to the secondary mortgage
market, which includes state and national banks, national mortgage banking
firms, insurance companies and government-sponsored enterprises, including the
Federal National Mortgage Association, the Federal Home Loan Mortgage
Corporation and the Government National Mortgage Association . On average, an
advance under the warehouse line of credit remains outstanding for a period of
less than 30 days, with repayment coming directly from the sale of the loan into
the secondary mortgage market. The Bank collects interest and a transaction fee
at the time of repayment. Mortgage warehouse loans totaled $235.9 million at
September 30, 2021 compared to $388.4 million at December 31, 2020 . The decline
was due primarily to a lower mortgage funding volume in the third quarter of
2021 compared to the fourth quarter of 2020. In the first nine months of 2021,
$3.5 billion of residential mortgage loans were financed through the mortgage
warehouse funding group compared to $3.6 billion during the first nine months of
2020.
Construction loans totaled $129.6 million at September 30, 2021 relatively
unchanged from December 31, 2020 . Construction financing is provided to
businesses to expand their facilities and operations and to real estate
developers for the acquisition, development and construction of residential
properties and income-producing properties. First mortgage construction loans
are made to developers and builders for single family homes or multi-family
buildings that are pre-sold or are to be sold or leased on a speculative basis.
The Bank lends to developers and builders with established relationships,
successful operating histories and sound financial resources. In many cases the
Bank also provides the mortgage loan to the customer upon completion of the
project.
Commercial business loans totaled $139.6 million at September 30, 2021 compared
to $188.7 million at December 31, 2020 and declined $49.1 million primarily as a
result of the forgiveness and pay-offs of the SBA PPP loans. As a SBA preferred
lender, the Bank participated in both rounds of the SBA PPP loan program and had
$23.1 million in SBA PPP loans outstanding at September 30, 2021 . Commercial
business loans consist primarily of loans to small and middle market businesses
and are typically working capital loans used to finance inventory, receivables
or equipment needs. These loans are generally secured by business assets of the
commercial borrower.
Residential real estate loans totaled $63.2 million at September 30, 2021
compared to $88.3 million at December 31, 2020 and declined $25.0 million due
primarily to pay-offs. Loans to individuals, which are comprised primarily of
home equity loans, totaled $17.9 million at September 30, 2021 compared to $21.3
million at December 31, 2020 .
The ability of the Company to enter into larger loan relationships and
management's philosophy of relationship banking are key factors in the Company's
strategy for loan growth. The ultimate collectability of the loan portfolio and
recovery of the carrying amount of real estate are subject to changes in the
economic environment and real estate market in the Company's primary market area
of northern and central New Jersey , communities along the New Jersey shore and
the New York City metropolitan area.
If the economic disruption caused by the COVID-19 pandemic continues for an extended period of time, the Company may experience a decline in the origination of new loans and total loans could decline.
Non-Performing Assets
Non-performing assets consist of non-performing loans and other real estate owned. Non-performing loans are composed of (1) loans on non-accrual basis and (2) loans which are contractually past due 90 days or more as to interest and principal payments but which have not been classified as non-accrual. Included in non-accrual loans are loans, the terms of which have been restructured to provide a reduction or deferral of interest and/or principal because of deterioration in the financial position of the borrower and have not performed in accordance with the restructured terms. Loan payments that are deferred due to the COVID-19 pandemic continue to accrue interest and are not presented as past due in the table below. The Bank's policy with regard to non-accrual loans is that, generally, loans are placed on non-accrual status when they are 90 days past due, unless these loans are well secured and in process of collection or, regardless of the past due status of the loan, when management determines that the complete recovery of principal or interest is in doubt. Consumer loans are generally charged off after they become 120 days past due. Subsequent payments on loans in non-accrual status are credited to income only if collection of principal is not in doubt. AtSeptember 30, 2021 , non-accrual loans decreased by$7.7 million to$9.5 million from$16.4 million atDecember 31, 2020 , and the ratio of non-performing loans to total loans decreased to 0.80% atSeptember 30, 2021 compared to 1.20% atDecember 31, 2020 . During the nine months endedSeptember 30, 2021 ,$5.6 million of non-performing loans were resolved as a result of pay-downs, pay-offs and charge-offs, which included$833,000 of purchased credit impaired loans. One non-performing commercial real estate loan for$3.1 million was charged down$334,000 to its estimated fair value and transferred to loans held for sale. For the nine 47 --------------------------------------------------------------------------------
months ended
Non-accrual loans consist of construction, commercial business, commercial real estate and residential real estate loans, which are in the process of collection. The table below sets forth non-performing assets and risk elements in the Bank's portfolio at the dates indicated. (Dollars in thousands) September 30, 2021 December 31, 2020 Non-performing loans: Loans 90 days or more past due and still accruing $ - $ 871 Non-accrual loans 9,537 16,361 Total non-performing loans 9,537 17,232 Other real estate owned 48 92 Total non-performing assets 9,585 17,324 Performing troubled debt restructurings 5,080 5,768 Performing troubled debt restructurings and total non-performing assets $ 14,665 $ 23,092 Non-performing loans to total loans 0.80 % 1.20 %
Non-performing loans to total loans excluding mortgage warehouse lines
0.99 % 1.65 %
Non-performing assets to total assets 0.50 % 0.96 %
Non-performing assets to total assets excluding mortgage warehouse lines
0.57 % 1.22 %
Total non-performing assets and performing troubled debt 0.77 % 1.28 %
restructurings to total assets
Non-performing assets decreased by
AtSeptember 30, 2021 , the Bank had 8 loans totaling$5.2 million that were troubled debt restructurings. Two of these loans totaling$120,000 are included in the above table as non-accrual loans and the remaining six loans totaling approximately$5.1 million were performing atSeptember 30, 2021 . AtDecember 31, 2020 , the Bank had 10 loans totaling$5.9 million that were troubled debt restructurings. Two of these loans totaling$141,000 are included in the above table as non-accrual loans and the remaining eight loans totaling approximately$5.8 million were performingDecember 31, 2020 . In accordance withU.S. GAAP, the excess of cash flows expected at acquisition over the initial investment in the purchase of a credit impaired loan is recognized as interest income over the life of the loan. AtSeptember 30, 2021 , there were 3 loans acquired with evidence of deteriorated credit quality totaling$254,000 that were not classified as non-performing loans. AtDecember 31, 2020 , there were 5 loans acquired with evidence of deteriorated credit quality totaling$2.4 million that were not classified as non-performing loans. Management takes a proactive approach in addressing delinquent loans. The Company's President and Chief Executive Officer meets weekly with all loan officers to review the status of credits past due 10 days or more. An action plan is discussed for delinquent loans to determine the steps necessary to induce the borrower to cure the delinquency and restore the loan to a current status. In addition, delinquency notices are system-generated when loans are five days past due and again at 15 days past due. In most cases, the Company's collateral is real estate. If the collateral is foreclosed upon, the real estate is carried at fair market value less the estimated selling costs. The amount, if any, by which the recorded amount of the loan exceeds the fair market value of the collateral, less estimated selling costs, is a loss that is charged to the allowance for loan losses at the time of foreclosure or repossession. Resolution of a past-due loan through foreclosure can be delayed if the borrower files a bankruptcy petition because a collection action cannot be continued unless the Company first obtains relief from the automatic stay provided by the United States Bankruptcy Reform Act of 1978, as amended.
Allowance for Loan Losses and Related Provision
The allowance for loan losses is maintained at a level sufficient to absorb
estimated credit losses in the loan portfolio as of the date of the financial
statements. The allowance for loan losses is a valuation reserve available for
losses incurred or inherent in the loan
48
--------------------------------------------------------------------------------portfolio and other extensions of credit. The determination of the adequacy of the allowance for loan losses is a critical accounting policy of the Company.
The Company's primary lending emphasis is the origination of commercial business, construction and commercial real estate loans and mortgage warehouse lines of credit. Based on the composition of the loan portfolio, the inherent primary risks are deteriorating credit quality, a decline in the economy and a decline inNew Jersey andNew York City metropolitan area real estate market values. Any one, or a combination, of these events may adversely affect the loan portfolio and may result in increased delinquencies, loan losses and increased future provision levels. Due to the economic disruption and uncertainty caused by the COVID-19 pandemic, the allowance for loan losses may increase in future periods as borrowers are affected by the severe contraction of economic activity and the increase in unemployment. This may result in increases in loan delinquencies, downgrades of loan credit ratings and charge-offs in future periods. The allowance for loan losses may increase significantly to reflect the decline in the performance of the loan portfolio and the higher level of estimated incurred losses. All, or part, of the principal balance of commercial business and commercial real estate loans and construction loans are charged off against the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Consumer loans are generally charged off no later than 120 days past due on a contractual basis, earlier in the event of bankruptcy, or if there is an amount deemed uncollectible. Because all identified losses are charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans and the entire allowance is available to absorb any and all loan losses. Management reviews the adequacy of the allowance on at least a quarterly basis to ensure that the provision for loan losses has been charged against earnings in an amount necessary to maintain the allowance at a level that is adequate based on management's assessment of probable estimated losses. The Company's methodology for assessing the adequacy of the allowance for loan losses consists of several key elements and is consistent withU.S. GAAP and interagency supervisory guidance. The allowance for loan losses methodology consists of two major components. The first component is an estimation of losses associated with individually identified impaired loans, which follows ASC Topic 310. The second major component is an estimation of losses under ASC Topic 450, which provides guidance for estimating losses on groups of loans with similar risk characteristics. The Company's methodology results in an allowance for loan losses that includes a specific reserve for impaired loans, an allocated reserve and an unallocated portion. When analyzing groups of loans, the Company follows the Interagency Policy Statement on the Allowance for Loan and Lease Losses. The methodology considers the Company's historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans as of the evaluation date. These adjustment factors, known as qualitative factors, include: •Delinquencies and non-accruals; •Portfolio quality; •Concentration of credit; •Trends in volume of loans; •Quality of collateral; •Policy and procedures; •Experience, ability and depth of management; •Economic trends - national and local; and •External factors - competition, legal and regulatory. The methodology includes the segregation of the loan portfolio into loan types with a further segregation into risk rating categories, such as special mention, substandard, doubtful and loss. This allows for an allocation of the allowance for loan losses by loan type; however, the allowance is available to absorb any loan loss without restriction. Larger-balance, non-homogeneous loans representing significant individual credit exposures are evaluated individually through the internal loan review process. This process produces the watch list. The borrower's overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated. Based on this evaluation, an estimate of probable losses for the individual larger-balance loans is determined, whenever possible, and used to establish specific loan loss reserves. In general, for non-homogeneous loans not individually assessed and for homogeneous groups of loans, such as residential mortgages and consumer credits, the loans are collectively evaluated based on delinquency status, loan type and historical losses. These loan groups are then internally risk rated. 49 -------------------------------------------------------------------------------- The watch list includes loans that are assigned a rating of special mention, substandard, doubtful and loss. Loans classified as special mention have potential weaknesses that deserve management's close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as doubtful have all the weaknesses inherent in loans classified as substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans rated as doubtful are placed in non-accrual status. Loans classified as a loss are considered uncollectible and are charged-off against the allowance for loan losses. The specific allowance for impaired loans is established for specific loans that have been identified by management as being impaired. These loans are considered to be impaired primarily because the loans have not performed according to payment terms and there is reason to believe that repayment of the loan principal in whole, or in part, is unlikely. The specific portion of the allowance is the total amount of potential unconfirmed losses for these individual impaired loans. To assist in determining the fair value of loan collateral, the Company often utilizes independent third-party qualified appraisal firms, which employ their own criteria and assumptions that may include occupancy rates, rental rates and property expenses, among others. The second category of reserves consists of the allocated portion of the allowance. The allocated portion of the allowance is determined by taking pools of outstanding loans that have similar characteristics and applying historical loss experience for each pool. This estimate represents the potential unconfirmed losses within the portfolio. Individual loan pools are created for commercial business loans, commercial real estate loans, construction loans, warehouse lines of credit and various types of loans to individuals. The historical estimation for each loan pool is then adjusted to account for current conditions, current loan portfolio performance, loan policy or management changes or any other qualitative factor that management believes may cause future losses to deviate from historical levels. The Company also maintains an unallocated allowance. The unallocated allowance is used to cover any factors or conditions that may cause a potential loan loss but are not specifically identifiable. It is prudent to maintain an unallocated portion of the allowance because no matter how detailed an analysis of potential loan losses is performed, these estimates, by definition, lack precision. Management must make estimates using assumptions and information that is often subjective and changing rapidly. The following discusses the risk characteristics of each of our loan portfolios.
Commercial Business
The Company offers a variety of commercial loan services, including term loans, lines of credit and loans secured by equipment and receivables. A broad range of short-to-medium term commercial loans, both secured and unsecured, are made available to businesses for working capital (including inventory and receivables), business expansion (including acquisition and development of real estate and improvements) and the purchase of equipment and machinery. Commercial business loans are granted based on the borrower's ability to generate cash flow to support its debt obligations and other cash related expenses. A borrower's ability to repay commercial business loans is substantially dependent on the success of the business itself and on the quality of its management. As a general practice, the Company takes, as collateral, a security interest in any available real estate, equipment, inventory, receivables or other personal property of its borrowers, although the Company occasionally makes commercial business loans on an unsecured basis. Generally, the Company requires personal guarantees of its commercial business loans to offset the risks associated with such loans. Included in the commercial business loans are SBA PPP loans, which are fully guaranteed by the SBA and are therefore excluded from the allowance for loan losses. Much of the Company's lending is in northern and centralNew Jersey , communities along theNew Jersey shore, and theNew York City metropolitan area. As a result of this geographic concentration, a significant broad-based deterioration in economic conditions inNew Jersey and theNew York City metropolitan area could have a material adverse impact on the Company's loan portfolio. A prolonged decline in economic conditions in our market area could restrict borrowers' ability to pay outstanding principal and interest on loans when due. The value of assets pledged as collateral may decline and the proceeds from the sale or liquidation of these assets may not be sufficient to repay the loan.
Commercial real estate loans are made to businesses to expand their facilities
and operations and to real estate operators to finance the acquisition of income
producing properties. The Company's loan policy requires that borrowers have
sufficient cash flow to meet the debt service requirements and the value of the
property meets the loan-to-value criteria set in the loan policy. The Company
monitors loan concentrations by borrower, by type of property and by location
and other criteria.
50
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The Company's commercial real estate portfolio is largely secured by real estate
collateral located in New Jersey and the New York City metropolitan area.
Conditions in the real estate markets in which the collateral for the Company's
loans are located strongly influence the level of the Company's non-performing
loans. A decline in the New Jersey and New York City metropolitan area real
estate markets could adversely affect the Company's loan portfolio. Decreases in
local real estate values would adversely affect the value of property used as
collateral for the Company's loans. Adverse changes in the economy also may have
a negative effect on the ability of our borrowers to make timely repayments of
their loans.
Construction Financing
Construction financing is provided to businesses to expand their facilities and
operations and to real estate developers for the acquisition, development and
construction of residential and commercial properties. First mortgage
construction loans are made to developers and builders primarily for single
family homes and multi-family buildings that are presold or are to be sold or
leased on a speculative basis.
The Company lends to builders and developers with established relationships,
successful operating histories and sound financial resources. Management has
established underwriting and monitoring criteria to minimize the inherent risks
of real estate construction lending. The risks associated with speculative
construction lending include the borrower's inability to complete the
construction process on time and within budget, the sale or rental of the
project within projected absorption periods and the economic risks associated
with real estate collateral. Such loans may include financing the development
and/or construction of residential subdivisions. This activity may involve
financing land purchases and infrastructure development (such as roads,
utilities, etc.), as well as construction of residences or multi-family
dwellings for subsequent sale by the developer/builder. Because the sale or
rental of developed properties is integral to the success of developer business,
loan repayment may be especially subject to the volatility of real estate market
values.
Mortgage Warehouse Lines of Credit
The Company'sMortgage Warehouse Funding Group provides revolving lines of credit that are available to licensed mortgage banking companies. The warehouse line of credit is used by the mortgage banker to originate one-to-four family residential mortgage loans that are pre-sold to the secondary mortgage market, which includes state and national banks, national mortgage banking firms, insurance companies and government-sponsored enterprises, including the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, theGovernment National Mortgage Association and others. On average, an advance under the warehouse line of credit remains outstanding for a period of less than 30 days, with repayment coming directly from the sale of the loan into the secondary mortgage market. Interest and a transaction fee are collected by the Bank at the time of repayment. As a separate class of the total loan portfolio, the warehouse loan portfolio is analyzed as a whole for the purposes of allowance for loan losses. Warehouse lines of credit are subject to the same inherent risks as other commercial lending, but the overall degree of risk differs. While the Company's loss experience with this type of lending has been non-existent since the product was introduced in 2008, there are other risks unique to this lending that still must be considered in assessing the adequacy of the allowance for loan losses. These unique risks may include, but are not limited to, (i) credit risks relating to the mortgage bankers that borrow from us, (ii) the risk of intentional misrepresentation or fraud by any of such mortgage bankers, (iii) changes in the market value of mortgage loans originated by the mortgage banker, the sale of which is the expected source of repayment of the borrowings under a warehouse line of credit, due to changes in interest rates during the time in warehouse or (iv) unsalable or impaired mortgage loans so originated, which could lead to decreased collateral value and the failure of a purchaser of the mortgage loan to purchase the loan from the mortgage banker.
Consumer
The Company's consumer loan portfolio is comprised of residential real estate
loans, home equity loans and other loans to individuals. Individual loan pools
are created for the various types of loans to individuals. The principal risk is
the borrower becomes unemployed or has a significant reduction in income.
In general, for homogeneous groups such as residential mortgages and consumer
credits, the loans are collectively evaluated based on delinquency status, loan
type and historical losses. These loan groups are then internally risk rated.
51--------------------------------------------------------------------------------
The Company considers the following credit quality indicators in assessing the risk in the loan portfolio:
•Consumer credit scores; •Internal credit risk grades; •Loan-to-value ratios; •Collateral; and •Collection experience.
The following table presents, for the periods indicated, an analysis of the allowance for loan losses and other related data:
Year Ended
Nine Months Ended December 31, Nine Months Ended
(Dollars in thousands) September 30, 2021 2020 September 30, 2020
Balance, beginning of period $ 15,641 $
9,271
Provision charged to operating expenses 2,600 6,698 5,340 Loans charged off: Construction loans (692) - - Commercial business and commercial real estate (396) (364) (165) Loans to individuals - (3) - All other loans (1) - (3) Total loans charged off (1,089) (367) (168) Recoveries: Commercial business and commercial real estate 8 39 7 Total recoveries 8 39 7 Net charge offs (1,081) (328) (161) Balance, end of period$ 17,160 $ 15,641 $ 14,450 Loans: At period end$ 1,198,455 $ 1,433,706 $ 1,455,684 Average during the period 1,264,949 1,333,330 1,292,304 Net charge offs to average loans outstanding (0.09) % (0.02) % (0.01) % Net charge offs to average loans outstanding, excluding mortgage warehouse loans (0.11) % (0.03) % (0.02) %
Allowance for loan losses to:
Total loans at period end 1.43 % 1.09 % 0.99 %
Total loans at period end excluding mortgage
warehouse
loans 1.67 % 1.32 % 1.18 %
Non-performing loans 179.93 % 90.77 % 83.79 %
52-------------------------------------------------------------------------------- The following table represents the allocation of the allowance for loan losses among the various categories of loans and certain other information as ofSeptember 30, 2021 andDecember 31, 2020 , respectively. The total allowance is available to absorb losses from any portfolio of loans. September 30, 2021 December 31, 2020 Loans as a % Loans as a % As a % of As a % of (Dollars in thousands) Amount of Loan Class Total Loans Amount of Loan Class Total Loans Commercial real estate$ 6,659 1.09 % 51 %$ 6,422 1.04 % 43 % Commercial business 2,992 2.14 % 12 % 2,727 1.44 % 13 % Construction 5,083 3.92 % 11 % 3,741 2.89 % 9 % Residential real estate 389 0.62 % 5 % 619 0.70 % 6 % Loans to individuals 102 0.57 % 1 % 125 0.59 % 2 % Subtotal 15,225 1.58 % 80 % 13,634 1.30 % 73 % Mortgage warehouse lines 1,062 0.45 % 20 % 1,807 0.47 % 27 % Unallocated reserves 873 - - 200 - - Total$ 17,160 1.43 % 100 %$ 15,641 1.09 % 100 % For the nine months endedSeptember 30, 2021 , the Company recorded a provision for loan losses of$2.6 million , and net charge-offs of$1.1 million compared to a provision for loan losses of$5.3 million , and net charge-offs of$161,000 recorded for the first nine months of 2020. The higher provision for loan losses recorded for the first nine months of 2020 was due primarily to an increase in the allowance for the estimated increase in incurred losses resulting from economic and social disruption caused by the COVID-19 pandemic. As part of the review of the adequacy of the allowance for loan losses atSeptember 30, 2021 , management reviewed substantially all of the$132.1 million of commercial business and commercial real estate loans that had been modified to defer interest and or principal for up to 90 days in 2020 and 2021. Loans with balances of less than$250,000 were generally excluded from management's review. AtSeptember 30, 2021 , the allowance for loan losses included$348,000 for loans that were rated Pass-Watch and had received a deferral. This reflects management's previously reported determination that "Pass-Watch" credit rated loans with modifications or deferrals suggest a weaker financial strength of the borrower than "Pass" credit rated loans, thereby warranting a higher allowance for loan losses than would ordinarily be reserved for "Pass-Watch" credit rated loans. Within the loan portfolio, hotel and restaurant-food service industries have been adversely impacted by the economic disruption caused by the COVID-19 pandemic. AtSeptember 30, 2021 , loans to borrowers in the hotel and restaurant-food service industries were$62.2 million and$53.3 million , respectively. Management reviewed over 90% of the hotel loans and over 96% of the restaurant-food service loans. AtSeptember 30, 2021 , management continued to maintain an additional allowance for loan losses of 75 basis points, or$357,000 , attributable to restaurant-food service loans and 25 basis points, or$148,000 , attributable to hotel loans due to the challenging operating environment for these businesses as a result of the COVID-19 pandemic.
All construction loans are closely monitored on a quarterly basis and are reviewed to assess the progress of construction relative to the plan and budget and lease-up or sales of units.
Management also reviewed loans to schools that are private educational
institutions that are generally sponsored or affiliated with religious
organizations. These loans totaled
AtSeptember 30, 2021 , the allowance for loan losses was$17.2 million , or 1.43% of loans, compared to$15.6 million , or 1.09% of loans, atDecember 31, 2020 and$14.5 million , or 0.99% of loans, atSeptember 30, 2020 . The allowance for loan losses was 179.93% of non-performing loans atSeptember 30, 2021 compared to 90.77% of non-performing loans atDecember 31, 2020 and 83.79% of non-performing loans atSeptember 30, 2020 . The allowance for loan losses atSeptember 30, 2021 included$3.2 million in specific reserves for impaired loans and$1.4 million attributed to management's qualitative factors for the estimated increase in incurred losses resulting from economic and social disruption caused by the COVID-19 pandemic. Acquisition accounting for the merger withShore Community Bank ("Shore") in 2019 and the merger withNew Jersey Community Bank ("NJCB") in 2018 resulted in the Shore and NJCB loans being recorded at their fair value and no allowance for loan losses as 53 -------------------------------------------------------------------------------- of the effective time of the respective mergers. The unaccreted general credit fair value discounts related to the former Shore and NJCB loans were approximately$1.1 million and$317,000 atSeptember 30, 2021 , respectively. In addition, atSeptember 30, 2021 , there were$23.1 million of SBA PPP loans which are 100% guaranteed by the SBA and, accordingly, no allowance was provided. Management believes that the allowance for loan losses is adequate in relation to credit risk exposure levels and the estimated incurred and inherent losses in the loan portfolio atSeptember 30, 2021 . However, management expects that the economic disruption resulting from the COVID-19 pandemic will continue to impact businesses, borrowers, employees and consumers in the near term, notwithstanding the wider distribution and availability of vaccines, as uncertainty remains with respect to variants of the virus and the potential reimplementation of certain restrictions and precautionary measures in the Bank's primary market areas. Management may further increase the provision for loan losses and the allowance for loan losses in response to changes in economic conditions and the performance of the loan portfolio in future periods.
Deposits
Deposits, which include demand deposits (interest bearing and non-interest bearing), savings deposits and time deposits, are a fundamental and cost-effective source of funding. The flow of deposits is influenced significantly by general economic conditions, changes in market interest rates and competition. The Company offers a variety of products designed to attract and retain customers, with the Company's primary focus on the building and expanding of long-term relationships.
The following table summarizes deposits at
(Dollars in thousands) September 30, 2021 December 31, 2020
Demand
Non-interest bearing $ 534,436 $ 425,210
Interest bearing 493,207 441,772
Savings 451,309 334,226
Certificates of deposit 159,609 361,631
Total $ 1,638,561 $ 1,562,839
Total deposits were $1.6 billion at September 30, 2021 , representing an increase
of $75.7 million from December 31, 2020 . There was a significant change in the
composition of total deposits as non-interest-bearing demand deposits increased
$109.2 million due in part to the funding of the second round of SBA PPP loans
and additional financial assistance received by customers from the Restaurant
Revitalization Fund and Closed Venue Fund provided under the Economic Aid Act,
while interest-bearing deposits decreased $33.5 million from December 31, 2020
to September 30, 2021 . Of the total decrease in interest-bearing deposits,
certificates of deposit decreased $202.0 million due primarily to the maturity
of approximately $149.9 million of short-term internet listing service
certificates of deposit. Funds from a portion of maturing certificates of
deposit were also deposited by customers into non-maturity deposits. Due to the
low interest rate environment, customers generally chose to deposit funds to
non-maturity deposit accounts such as NOW and savings accounts, which resulted
in a $117.1 million increase in savings deposits and a $51.4 million increase in
interest-bearing demand deposits. There were no short-term borrowings at
September 30, 2021 compared to $9.8 million in short-term borrowings at
December 31, 2020 .
The COVID-19 pandemic may impact the Bank's ability to increase and or retain
customers' deposits. As the pandemic continues, businesses may experience a loss
of revenue and consumers may experience a reduction of income, which may in turn
cause them to withdraw their funds to pay expenses or reduce their ability to
increase their deposits.
Borrowings
Borrowings are mainly comprised of Federal Home Loan Bank of New York ("FHLB")
borrowings and overnight funds purchased. These borrowings are primarily used to
fund asset growth not supported by deposit generation. At September 30, 2021 ,
the Company had no borrowings compared to $9.8 million of short-term borrowings
December 31, 2020 .
Liquidity
AtSeptember 30, 2021 , the amount of liquid assets and the Bank's access to off-balance sheet liquidity remained at a level management deemed adequate to ensure that contractual liabilities, depositors' withdrawal requirements and other operational and customer credit needs could be satisfied. 54 -------------------------------------------------------------------------------- Liquidity management refers to the Company's ability to support asset growth while satisfying the borrowing needs and deposit withdrawal requirements of customers. In addition to maintaining liquid assets, factors such as capital position, profitability, asset quality and availability of funding affect a bank's ability to meet its liquidity needs. On the asset side, liquid funds are maintained in the form of cash and cash equivalents, federal funds sold, investment securities held to maturity maturing within one year, securities available for sale and loans held for sale. Additional asset-based liquidity is derived from scheduled loan repayments as well as investment repayments of principal and interest. Investment securities and loans may also be pledged to the FHLB to collateralize additional borrowings. On the liability side, the primary source of liquidity is the ability to generate core deposits. Long-term and short-term borrowings are used as supplemental funding sources when growth in the core deposit base does not keep pace with that of interest-earning assets. The Bank has established a borrowing relationship with the FHLB that further supports and enhances liquidity. The FHLB provides member banks with a fully secured line of credit of up to 50% of a bank's quarter-end total assets. Under the terms of this facility, the Bank's total credit exposure to the FHLB cannot exceed 50% of its total assets, or$955.3 million , atSeptember 30, 2021 . In addition, the aggregate outstanding principal amount of the Bank's advances, letters of credit, the dollar amount of the FHLB's minimum collateral requirement for off-balance sheet financial contracts and advance commitments cannot exceed 30% of the Bank's total assets, unless the Bank obtains approval from the FHLB's Board of Directors or its Executive Committee. These limits are further restricted by a member's ability to provide eligible collateral to support its obligations to the FHLB as well as the ability to meet the FHLB's stock requirement. AtSeptember 30, 2021 andDecember 31, 2020 , the Bank pledged approximately$346.4 million and$469.5 million of loans, respectively, to support the FHLB borrowing capacity. AtSeptember 30, 2021 andDecember 31, 2020 , the Bank had available borrowing capacity of$270.6 million and$301.8 million , respectively, at the FHLB. The Bank also maintains unsecured federal funds lines of$46.0 million with two correspondent banks, all of which were unused and available atSeptember 30, 2021 . The Bank has access to theFederal Reserve Bank of New York Discount Window facility. At this time the Bank has not pledged investment securities or loans, which would be required, to support borrowings through the Discount Window facility. The Consolidated Statements of Cash Flows present the changes in cash from operating, investing and financing activities. AtSeptember 30, 2021 , the balance of cash and cash equivalents was$273.9 million . Net cash provided by operating activities totaled$67.4 million for the nine months endedSeptember 30, 2021 compared to net cash used in operating activities of$12.4 million for the nine months endedSeptember 30, 2020 . A source of funds is net income from operations adjusted for activity related to loans originated for sale and sold, the provision for loan losses, depreciation and amortization expenses and net amortization of premiums and discounts on securities. The increase in net cash provided by operating activities for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 was due primarily to the net sales (cash provided) of loans held for sale of approximately$31.5 million and the increase in net accrued expenses and other liabilities of$26.4 million , which reflected primarily a$24.5 million liability for unsettled investment securities purchased. The net cash used in operating activities for the nine months endedSeptember 30, 2020 reflected net cash of$15.3 million used in the origination and sale of loans. Net cash provided by investing activities totaled$121.6 million for the nine months endedSeptember 30, 2021 compared to net cash used in investing activities of$226.9 million for the nine months endedSeptember 30, 2020 . The loans and securities portfolios are a source of liquidity, providing cash flows from maturities and periodic payments of principal. The primary source of cash from investing activities for the nine months endedSeptember 30, 2021 was the cash flow from the decrease in loans. During the nine months endedSeptember 30, 2021 , loans decreased$234.4 million compared to an increase in loans of$239.5 million during the nine months endedSeptember 30, 2020 . Net cash provided by financing activities was$62.9 million for the nine months endedSeptember 30, 2021 compared to net cash provided by financing activities of$244.5 million for the nine months endedSeptember 30, 2020 . The primary source of funds for the 2021 period was the increase in deposits of$75.7 million . Management believes that the Company's and the Bank's liquidity resources are adequate to provide for the Company's and the Bank's planned operations over the next 12 months followingSeptember 30, 2021 .
Shareholders' Equity and Dividends
Shareholders' equity increased by$12.3 million to$199.9 million atSeptember 30, 2021 from$187.7 million atDecember 31, 2020 . The increase in shareholders' equity was due primarily to increases of$12.5 million in retained earnings and$1.0 million in common stock, partially offset by a$1.1 million decrease in accumulated other comprehensive income and a$160,000 increase in treasury stock. 55 -------------------------------------------------------------------------------- The Company began declaring and paying cash dividends on its common stock inSeptember 2016 and has declared and paid a cash dividend for each quarter since then. The timing and the amount of the payment of future cash dividends, if any, on the Company's common stock will be at the discretion of the Company's Board of Directors and will be determined after consideration of various factors, including the level of earnings, cash requirements, regulatory capital and financial condition.
The Company's common stock is quoted on the Nasdaq Global Market under the symbol, "FCCY."
OnJanuary 21, 2016 , the Board of Directors of the Company authorized a common stock repurchase program. Under the common stock repurchase program, the Company may repurchase in the open market or privately negotiated transactions up to 5% of its common stock outstanding on the date of approval of the stock repurchase program, which limitation is adjusted for any subsequent stock dividends. For the nine months endedSeptember 30, 2021 , the Company withheld 9,469 shares of common stock in connection with the vesting of restricted stock awards to satisfy applicable tax withholding obligations.
See Part II, Item 2 of this Form 10-Q, "Unregistered Sales of
Capital Resources
The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and the Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Common Equity Tier 1, Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and Tier I capital to average assets (Leverage ratio, as defined). As ofSeptember 30, 2021 andDecember 31, 2020 , the Company and the Bank met all capital adequacy requirements to which they were subject. To be categorized as adequately capitalized, the Company and the Bank must maintain minimum Common Equity Tier 1, Total capital to risk-weighted assets, Tier 1 capital to risk-weighted assets and Tier I leverage capital ratios as set forth in the below table. As ofSeptember 30, 2021 andDecember 31, 2020 , the Bank's capital ratios exceeded the regulatory standards for well-capitalized institutions. Certain bank regulatory limitations exist on the availability of the Bank's assets for the payment of dividends by the Bank without prior approval of bank regulatory authorities. InJuly 2013 , theFederal Reserve Board and theFDIC approved revisions to their capital adequacy guidelines and prompt corrective action rules that implemented and addressed the revised standards of Basel III and addressed relevant provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. TheFederal Reserve Board's final rules and theFDIC's interim final rules (which became final inApril 2014 with no substantive changes) apply to all depository institutions, top-tier bank holding companies with total consolidated assets of$500 million or more (which was subsequently increased to$1 billion or more inMay 2015 ) and top-tier savings and loan holding companies ("banking organizations"). Among other things, the rules established a Common Equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets) and increased the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets). Banking organizations are also required to have a total capital ratio of at least 8% and a Tier 1 leverage ratio of at least 4%. The rules also limited a banking organization's ability to pay dividends, engage in share repurchases or pay discretionary bonuses if the banking organization does not hold a "capital conservation buffer" consisting of 2.5% of Common Equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The rules became effective for the Company and the Bank onJanuary 1, 2015 . The fully phased in capital conservation buffer is 2.5% of Common Equity Tier 1 capital to risk-weighted assets. AtSeptember 30, 2021 , the Company and the Bank maintained a capital conservation buffer in excess of 2.5%.
Management believes that the Company's and the Bank's capital resources are adequate to support the Company's and the Bank's current strategic and operating plans. However, if the financial position of the Company and the Bank are materially adversely
56
--------------------------------------------------------------------------------impacted by the economic disruption caused by the COVID-19 pandemic, the Company and or the Bank may be required to increase its regulatory capital position.
The Company's actual capital amounts and ratios are presented in the following
table:
To Be Well Capitalized
Under Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provision
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
As of September 30, 2021
Common equity Tier 1 (CET1) $ 162,742 11.78 % $ 62,183 4.50 % N/A N/A
Total capital to risk-weighted assets 197,902 14.32 % 110,547 8.00 % N/A
N/A
Tier 1 capital to risk-weighted assets 180,742 13.08 % 82,910 6.00 % N/A N/A Tier 1 leverage capital 180,742 9.95 % 72,632 4.00 % N/A N/A As ofDecember 31, 2020 : Common equity Tier 1 (CET1)$ 149,292 9.92 %$ 67,701 4.50 % N/A
N/A
Total capital to risk-weighted assets 182,933 12.16 % 120,357 8.00 % N/A
N/A
Tier 1 capital to risk-weighted assets 167,292 11.12 % 90,268 6.00 % N/A N/A
Tier 1 leverage capital 167,292 9.41 % 71,105 4.00 % N/A N/A
The Bank's actual capital amounts and ratios are presented in the following
table:
To Be Well Capitalized
Under Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provision
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
As of September 30, 2021
Common equity Tier 1 (CET1) $ 180,469 13.07 % $ 62,158 4.50% $ 89,783 6.50%
Total capital to risk-weighted assets 197,629 14.31 % 110,502 8.00% 138,128 10.00%
Tier 1 capital to risk-weighted assets 180,469 13.07 % 82,877 6.00% 110,502 8.00%
Tier 1 leverage capital 180,469 9.94 % 72,610 4.00% 90,763 5.00%
As of December 31, 2020 :
Common equity Tier 1 (CET1) $ 167,067 11.11 % $ 67,676 4.50% $ 97,754 6.50%
Total capital to risk-weighted assets 182,708 12.15 % 120,313 8.00% 150,391 10.00%
Tier 1 capital to risk-weighted assets 167,067 11.11 % 90,235 6.00% 120,313 8.00%
Tier 1 leverage capital 167,067 9.40 % 71,083 4.00% 88,854 5.00%
Interest Rate Sensitivity Analysis
The largest component of the Company's total income is net interest income, and
the majority of the Company's financial instruments are composed of interest
rate-sensitive assets and liabilities with various terms and maturities. The
primary objective of management is to maximize net interest income while
minimizing interest rate risk. Interest rate risk is derived from timing
differences and the magnitude of relative changes in the repricing of assets and
liabilities, loan prepayments, deposit withdrawals and differences in lending
and funding rates. Management actively seeks to monitor and control the mix of
interest rate-sensitive assets and interest rate-sensitive liabilities.
Under the interest rate risk policy established by the Company's Board of
Directors, the Company established quantitative guidelines with respect to
interest rate risk and how interest rate shocks are projected to affect net
interest income and the economic value of equity. Summarized below is the
projected effect of a parallel shift of an increase of 100, 200 and 300 basis
points, respectively, in market interest rates on net interest income and the
economic value of equity. Due to the historically low interest rate environment
at September 30, 2021 a parallel shift down of 100 basis points was presented.
57
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Based upon the current interest rate environment, as of
Next 12 Months
(Dollars in thousands) Net Interest Income Economic Value of Equity (2)
Interest Rate Change in Basis
Points (1) Dollar Amount $ Change % Change Dollar Amount $ Change % Change
+300 $ 62,798 $ 7,600 13.77 % $ 258,866 $ 8,551 3.42 %
+200 59,815 4,617 8.36 % 255,581 5,266 2.10 %
+100 56,781 1,583 2.87 % 251,714 1,399 0.56 %
- 55,198 - - 250,315 - -
-100 55,386 188 0.34 % 233,264 (17,051) (6.81) %
(1)Assumes an instantaneous and parallel shift in interest rates at all
maturities.
(2)Economic value of equity is the discounted present value of expected cash
flows from assets, liabilities and off-balance sheet contracts.
The Company employs many assumptions to calculate the impact of changes in
interest rates on assets and liabilities, and actual results may not be similar
to projections due to several factors, including the timing and frequency of
rate changes, market conditions and the shape of the yield curve. Actual results
may also differ due to management's actions, if any, in response to changing
rates. In calculating these exposures, the Company utilized an interest rate
simulation model that is validated by third-party reviewers periodically.
Off-Balance Sheet Arrangements and Contractual Obligations
As of September 30, 2021 , there were no material changes to the Company's
off-balance sheet arrangements and contractual obligations disclosed under Part
II, Item 7 of the 2020 Form 10-K. Management continues to believe that the
Company has adequate capital and liquidity available from various sources to
fund projected contractual obligations and commitments.
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