Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
When used in this report, the terms “the Company,” “we,” “us,” and “our” refer to Severn Bancorp and, unless the context requires otherwise, its consolidated subsidiaries. The following discussion should be read and reviewed in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth in Severn Bancorp’s Annual Report on Form 10‑K for the year ended December 31, 2018.
The Company
The Company is a savings and loan holding company chartered as a corporation in the state of Maryland in 1990. It conducts business primarily through three subsidiaries, Severn Savings Bank, FSB (the “Bank”), Mid-Maryland Title Company, Inc. (the “Title Company”), and SBI Mortgage Company (“SBI”). SBI holds mortgages that do not meet the underwriting criteria of the Bank, and is the parent company of Crownsville Development Corporation (“Crownsville”), which is doing business as Annapolis Equity Group and acquires real estate for syndication and investment purposes. The Title Company is a real estate settlement company that handles commercial and residential real estate settlements in Maryland. The Bank’s principal subsidiary Louis Hyatt, Inc. (“Hyatt Commercial”), conducts business as Hyatt Commercial, a commercial real estate brokerage and property management company. We maintain six branches in Anne Arundel County, Maryland. The branches offer a full range of deposit products and we originate mortgages in the Bank’s primary market of Anne Arundel County, Maryland and, to a lesser extent, in other parts of Maryland, Delaware, and Virginia. As of March 31, 2019, we had 163 full-time equivalent employees.
Overview
The Company provides a wide range of personal and commercial banking services. Personal services include mortgage lending and various other lending services as well as deposit products such as personal Internet banking and online bill pay, checking accounts, individual retirement accounts, money market accounts, and savings and time deposit accounts. Commercial services include commercial secured and unsecured lending services as well as business Internet banking, corporate cash management services, and deposit services. The Company also provides ATMs, credit cards, debit cards, safe deposit boxes, and telephone banking, among other products and services.
We have experienced an improved level of profitability for the three months ended March 31, 2019, primarily due an improvement in net interest income as well as improved profitability of our mortgage-banking operations. We recognized increased deposit service charges as a result of fees from medical-use cannabis deposit accounts and saw improvement in our real estate sales commissions from Hyatt Commercial. Additionally, during the
three months ended March 31,
2019, we recognized increased revenue from the Title Company.
The Company expects to experience similar market conditions during the remainder of 2019, provided interest rates do not increase rapidly. If interest rates increase rapidly, demand for loans may decrease and our interest rate spread could decrease. We will continue to manage loan and deposit pricing against the risks of rising costs of our deposits and borrowings. Interest rates are outside of our control, so we must attempt to balance the pricing and duration of the loan portfolio against the risks of rising costs of our deposits and borrowings. The continued success and attraction of Anne Arundel County, Maryland, and vicinity, will also be important to our ability to originate and grow mortgage loans and deposits, as will our continued focus on maintaining a low overhead. If volatility in the market and the economy occurs, our business, financial condition, results of operations, access to funds, and the price of our stock could be materially and adversely impacted.
Critical Accounting Policies
Our accounting and financial reporting policies conform to accounting principles generally accepted in the United States of America (“U.S.”) (“GAAP”) and general practice within the banking industry. Accordingly, preparation of the financial statements requires management to exercise significant judgment or discretion or make significant assumptions and estimates based on the information available that have, or could have, a material impact on the carrying value of certain assets or on income. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. The accounting
policies we view as critical are those relating to the allowance for loan losses (“Allowance”), the valuation of securities, the valuation of real estate acquired through foreclosure, and the valuation of deferred tax assets and liabilities. Significant accounting policies are discussed in detail in “Notes to Consolidated Financial Statements - Note 1 - Summary of Significant Account Policies” in our Annual Report on Form 10-K for the year ended December 31, 2018. There have been no material changes to the significant accounting policies as described in the Annual Report other than those mentioned in Note 1 to the financial statements in this Quarterly Report on Form 10-Q. Disclosures regarding the effects of new accounting pronouncements are included in Note 1 to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.
Results of Operations
Net Income
Net income increased $724,000, or 38.4%, to $2.6 million for the three months ended March 31, 2019, compared to $1.9 million for the three months ended March 31, 2018. Basic and diluted income per share were $0.20 for the three months ended March 31, 2019, compared to basic and diluted income per share of $0.15 for the three months ended March 31, 2018. The increase in net income reflected improved net interest income and noninterest income, partially offset by increased noninterest expense and income tax provision.
Net Interest Income
Net interest income increased by $1.1 million, or 15.8%, to $8.1 million for the three months ended March 31, 2019, compared to $7.0 million for the three months ended March 31, 2018. Our net interest margin decreased slightly from 3.66% for the three months ended March 31, 2018 to 3.65% for the three months ended March 31, 2019. Our net interest spread decreased from 3.42% for the three months ended March 31, 2018 to 3.35% for the three months ended March 31, 2019.
Interest Income
Interest income increased by $1.7 million, or 18.8%, to
$10.5 million
for the three months ended March 31, 2019, compared to
$8.9 million
for the three months ended March 31, 2018, primarily due to increases in interest income on loans and other interest-earning assets. Average interest-earning assets increased from $773.9 million for the three months ended March 31, 2018 to
$898.4 million
for the three months ended March 31, 2019, due primarily to growth in interest-earning deposits in banks of $127.6 million, included in other interest-earning assets. The increase in interest-bearing depostits in banks was the result of increased deposits from our medical-use cannabis customers. Average loans outstanding increased $9.7 million from $668.6 million for the three months ended March 31, 2018 to $678.4 million for the three months ended March 31, 2019. The average yield on loans held for investment increased from 5.06% for the three months ended March 31, 2018 to 5.47% for the three months ended March 31, 2019 as a result of the increased interest rate environment. Average HTM securities decreased by
$15.0 million
due to securities maturities and repayments from mortgage-backed securities during the latter part of 2018 and the first quarter of 2019. The proceeds were used to fund the increase in loan originations.
Interest Expense
Interest expense increased by $565,000, or 29.8%, to
$2.5 million
for the three months ended March 31, 2019, compared to
$1.9 million
for the three months ended March 31, 2018 as a result of a $736,000 increase in interest expense on deposits. The increase in deposit interest expense was primarily due to an increase in the average rate paid on interest-bearing deposits, driven by the rising interest rate environment as well as increased effects of competition with other financial institutions, and increased the average rate paid on deposits from 0.91% for the three months ended March 31, 2018 to 1.22% for the three months ended March 31, 2019. The average rate paid on certificates of deposit increased from 1.46% for the three months ended March 31, 2018 to 2.02% for the same period of 2019. Additionally, the average rate paid on checking and savings accounts increased from 0.47% for the three months ended March 31, 2018 to 0.81% for the three months ended March 31, 2019. The average balance of checking and savings accounts increased significantly from $284.7 million for the three months ended March 31, 2018 to $411.3 million for the three months ended March 31, 2019, primarily
due to increases in our medical-use cannabis related accounts. The average balance of certificates of deposit decreased from $222.5 million for the three months ended March 31, 2018 to $211.1 million for the same period of 2019 due to runoff from maturing certificates of deposit. Average borrowings decreased $34.6 million due to payoffs of Federal Home Loan Bank of Atlanta (“FHLB”) advances in the latter part of 2018 and the first quarter of 2019, decreasing our interest expense on borrowings by $171,000 from the three months ended March 31, 2018 to the same period of 2019.
The following table sets forth, for the periods indicated, information regarding the average balances of interest-earning assets and interest-bearing liabilities and the resulting yields on average interest-earning assets and average rates paid on average interest-bearing liabilities. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2019
|
|
2018
|
|
|
|
Average
|
|
|
|
Yield/
|
|
Average
|
|
|
|
Yield/
|
|
|
|
Balance
(1)
|
|
Interest
(2)
|
|
Rate
(4)
|
|
Balance
(1)
|
|
Interest
(2)
|
|
Rate
(4)
|
|
ASSETS
|
|
(dollars in thousands)
|
|
Loans
|
|
$
|
678,357
|
|
$
|
9,151
|
|
5.47
|
%
|
$
|
668,615
|
|
$
|
8,335
|
|
5.06
|
%
|
Loans held for sale ("LHFS")
|
|
|
6,573
|
|
|
16
|
|
0.99
|
%
|
|
3,421
|
|
|
36
|
|
4.27
|
%
|
Available-for-sale ("AFS") securities
|
|
|
12,057
|
|
|
52
|
|
1.75
|
%
|
|
11,597
|
|
|
51
|
|
1.78
|
%
|
Held-to-maturity ("HTM") securities
|
|
|
37,622
|
|
|
207
|
|
2.23
|
%
|
|
52,586
|
|
|
269
|
|
2.07
|
%
|
Other interest-earning assets (3)
|
|
|
160,538
|
|
|
1,053
|
|
2.66
|
%
|
|
32,852
|
|
|
126
|
|
1.56
|
%
|
Restricted stock investments, at cost
|
|
|
3,301
|
|
|
64
|
|
7.86
|
%
|
|
4,847
|
|
|
60
|
|
5.02
|
%
|
Total interest-earning assets
|
|
|
898,448
|
|
|
10,543
|
|
4.76
|
%
|
|
773,918
|
|
|
8,877
|
|
4.65
|
%
|
Allowance
|
|
|
(8,068)
|
|
|
|
|
|
|
|
(8,141)
|
|
|
|
|
|
|
Cash and other noninterest-earning assets
|
|
|
41,857
|
|
|
|
|
|
|
|
43,233
|
|
|
|
|
|
|
Total assets
|
|
$
|
932,237
|
|
|
10,543
|
|
|
|
$
|
809,010
|
|
|
8,877
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Checking and savings
|
|
$
|
411,344
|
|
|
817
|
|
0.81
|
%
|
$
|
284,706
|
|
|
332
|
|
0.47
|
%
|
Certificates of deposit
|
|
|
211,099
|
|
|
1,052
|
|
2.02
|
%
|
|
222,508
|
|
|
801
|
|
1.46
|
%
|
Total interest-bearing deposits
|
|
|
622,443
|
|
|
1,869
|
|
1.22
|
%
|
|
507,214
|
|
|
1,133
|
|
0.91
|
%
|
Borrowings
|
|
|
82,730
|
|
|
589
|
|
2.89
|
%
|
|
117,352
|
|
|
760
|
|
2.63
|
%
|
Total interest-bearing liabilities
|
|
|
705,173
|
|
|
2,458
|
|
1.41
|
%
|
|
624,566
|
|
|
1,893
|
|
1.23
|
%
|
Noninterest-bearing deposits
|
|
|
122,859
|
|
|
|
|
|
|
|
88,160
|
|
|
|
|
|
|
Other noninterest-bearing liabilities
|
|
|
3,118
|
|
|
|
|
|
|
|
2,103
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
101,087
|
|
|
|
|
|
|
|
94,181
|
|
|
|
|
|
|
Total liabilities and stockholders' equity
|
|
$
|
932,237
|
|
|
2,458
|
|
|
|
$
|
809,010
|
|
|
1,893
|
|
|
|
Net interest income/net interest spread
|
|
|
|
|
$
|
8,085
|
|
3.35
|
%
|
|
|
|
$
|
6,984
|
|
3.42
|
%
|
Net interest margin
|
|
|
|
|
|
|
|
3.65
|
%
|
|
|
|
|
|
|
3.66
|
%
|
(1)
Nonaccrual loans are included in average loans.
(2)
There are no tax equivalency adjustments.
(3)
Other interest-earning assets include interest-earning deposits, federal funds sold, and certificates of deposit held for investment.
(4)
Annualized.
The “Rate/Volume Analysis” below indicates the changes in our net interest income as a result of changes in volume and rates. We maintain an asset and liability management policy designed to provide a proper balance between rate-sensitive assets and rate-sensitive liabilities to attempt to optimize interest margins while providing adequate liquidity for our
anticipated needs. Changes in interest income and interest expense that result from variances in both volume and rates have been allocated to rate and volume changes in proportion to the absolute dollar amounts of the change in each.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2019 vs. 2018
|
|
|
|
Due to Variances in
|
|
|
|
Rate
|
|
Volume
|
|
Total
|
Interest earned on:
|
|
|
(dollars in thousands)
|
Loans
|
|
|
$
|
693
|
|
$
|
123
|
|
$
|
816
|
LHFS
|
|
|
|
(131)
|
|
|
111
|
|
|
(20)
|
AFS securities
|
|
|
|
(3)
|
|
|
4
|
|
|
1
|
HTM Securities
|
|
|
|
116
|
|
|
(178)
|
|
|
(62)
|
Other interest-earning assets
|
|
|
|
143
|
|
|
784
|
|
|
927
|
Restricted stock investments, at cost
|
|
|
|
102
|
|
|
(98)
|
|
|
4
|
Total interest income
|
|
|
|
920
|
|
|
746
|
|
|
1,666
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid on:
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits:
|
|
|
|
|
|
|
|
|
|
|
Checking and savings
|
|
|
|
274
|
|
|
211
|
|
|
485
|
Certificates of deposit
|
|
|
|
515
|
|
|
(264)
|
|
|
251
|
Total interest-bearing deposits
|
|
|
|
789
|
|
|
(53)
|
|
|
736
|
Borrowings
|
|
|
|
415
|
|
|
(586)
|
|
|
(171)
|
Total interest expense
|
|
|
|
1,204
|
|
|
(639)
|
|
|
565
|
Net interest income
|
|
|
$
|
(284)
|
|
$
|
1,385
|
|
$
|
1,101
|
Provision for Loan Losses
Our loan portfolio is subject to varying degrees of credit risk and an Allowance is maintained to absorb losses inherent in our loan portfolio. Credit risk includes, but is not limited to, the potential for borrower default and the failure of collateral to be worth what we determined it was worth at the time of the granting of the loan. We monitor loan delinquencies at least monthly. All loans that are delinquent and all loans within the various categories of our portfolio as a group are evaluated. Management, with the advice and recommendation of the Company’s Board of Directors, estimates an Allowance to be set aside for loan losses. Included in determining the calculation are such factors as historical losses for each loan portfolio, current market value of the loan’s underlying collateral, inherent risk contained within the portfolio after considering the state of the general economy, economic trends, consideration of particular risks inherent in different kinds of lending and consideration of known information that may affect loan collectability.
We did not record provision for loan losses during the three months ended March 31, 2019 or 2018.
See additional information about the provision for loan losses under “Credit Risk Management and the Allowance” later in this Item.
Noninterest Income
Total noninterest income increased by $467,000, or 26.0%, to
$2.3 million
for the three months ended March 31, 2019, compared to
$1.8 million
for the three months ended March 31, 2018, with increases in most noninterest income categories. Mortgage-banking revenue increased $125,000, or 21.0%, due to the increased volume of loans originated from $15.9 million in the three months ended March 31, 2018 to $19.4 million in the three months ended March 31, 2019. Deposit service charges increased $214,000 due primarily to on-boarding and monthly fees associated with medical-use cannabis customer accounts. Real estate commissions increased $97,000, or 1.5% due to an increase in the volume of properties sold during the three months ended March 31, 2019. The Title Company generated $217,000 in revenue during the three months ended March 31, 2019 compared to $142,000 for the three months ended March 31, 2018 due to an increase in loan closings and related title work.
Noninterest Expense
Total noninterest expense increased $603,000, or 9.8%, to
$6.8 million
for the three months ended March 31, 2019, compared to
$6.1 million
for the three months ended March 31, 2018, primarily due to increases in compensation and related expenses and increased write-downs on real estate acquired through foreclosure. Compensation and related expenses increased by $247,000, or 5.8%, to
$4.5 million
for the three months ended March 31, 2019, compared to
$4.3 million
for the three months ended March 31, 2018. This increase was primarily due to annual salary increases, additional hirings, and increased commission expense that corresponds with our increased loan origination and mortgage-banking volumes. We experienced write-downs and costs related to real estate acquired through foreclosure of $125,000 during the three months ended March 31, 2019 compared to $32,000 during the same period of 2018. The majority of the increase from 2018 to 2019 was due to the write down of one property.
Income Tax Provision
We recorded an $986,000 tax provision on net income before income taxes of
$3.6 million
for the three months ended March 31, 2019, compared to an income tax provision of $745,000 on net income before income taxes of
$2.6 million
for the three months ended March 31, 2018.
The Tax Cuts and Jobs Act (“Tax Act”) was enacted on December 22, 2017, which lowered the corporate federal tax rate from 35% to 21% effective January 1, 2018. Among other things, the Tax Act has significantly lowered our effective tax rate. Our effective tax rate was reduced to 27.4% for the three ended March 31, 2019 compared to 28.3% for the three months ended March 31, 2018. Our effective tax rate is affected by temporary and permanent book to tax differences arising during the periods.
Financial Condition
Total assets decreased $89.2 million to $885.0 million at March 31, 2019, compared to $974.2 million at December 31, 2018. This decrease was primarily due to a $75.2 million, or 39.9%, decrease in cash and cash equivalents, to $113.1 million at March 31, 2019 from $188.3 million at December 31, 2018. Additionally, we experienced a decrease in loans of $8.1 million, or 1.2%, to $674.2 million at March 31, 2019 from $682.3 million at December 31, 2018. Total deposits decreased $69.6 million, or 8.9%, to $709.9 million at March 31, 2019 compared to $779.5 million at December 31, 2018. Total borrowings decreased by $25.0 million or 34.0%, to $48.5 million at March 31, 2019 compared to $73.5 million at December 31, 2018 due to the paydown of FHLB advances in the first quarter of 2019. Stockholders’ equity increased $2.4 million to $100.8 million at March 31, 2019 compared to $98.5 million at December 31, 2018. Primarily due to the increase in retained earnings.
Securities
We utilize the securities portfolio as part of our overall asset/liability management practices to enhance interest revenue while providing necessary liquidity for the funding of loan growth or deposit withdrawals. We continually monitor the credit risk associated with investments and diversify the risk in the securities portfolios. We held $11.0 million and $12.0 million in securities classified as AFS as of March 31, 2019 and December 31, 2018, respectively. We held $35.8 million and $38.9 million, respectively, in securities classified as HTM as of March 31, 2019 and December 31, 2018.
Changes in current market conditions, such as interest rates and the economic uncertainties in the mortgage, housing, and banking industries impact the securities market. Quarterly, we review each security in our portfolio to determine the nature of any decline in value and evaluate if any impairment should be classified as other-than-temporary impairment (“OTTI”). For the three months ended March 31, 2019, we determined that no OTTI charges were required.
All of the AFS and HTM securities that are temporarily impaired as of March 31, 2019 are so due to declines in fair values resulting from changes in interest rates or decreased credit/liquidity spreads compared to the time they were purchased. We have the intent to hold these securities to maturity (including those designated as AFS) and it is more likely than not that we will not be required to sell the securities before recovery of value. As such, management considers the impairments to be temporary.
Our securities portfolio composition is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AFS
|
|
HTM
|
|
|
March 31, 2019
|
|
December 31, 2018
|
|
March 31, 2019
|
|
December 31, 2018
|
|
|
(dollars in thousands)
|
U.S. Treasury securities
|
|
$
|
1,988
|
|
$
|
1,981
|
|
$
|
1,991
|
|
$
|
1,991
|
U.S. government agency notes
|
|
|
9,004
|
|
|
9,997
|
|
|
9,991
|
|
|
11,992
|
Mortgage-backed securities
|
|
|
—
|
|
|
—
|
|
|
23,811
|
|
|
24,929
|
|
|
$
|
10,992
|
|
$
|
11,978
|
|
$
|
35,793
|
|
$
|
38,912
|
LHFS
We originate residential mortgage loans for sale on the secondary market. Such LHFS, which are carried at fair value, amounted to $6.7 million at March 31, 2019 and $9.7 million at December 31, 2018, the majority of which are subject to purchase commitments from investors. LHFS decreased by $3.0 million, or 31.2%, compared to December 31, 2018, primarily due to the timing of loans pending sale on the secondary market.
Loans
Our loan portfolio is expected to produce higher yields than investment securities and other interest-earning assets; the absolute volume and mix of loans and the volume and mix of loans as a percentage of total interest-earning assets is an important determinant of our net interest margin.
The following table sets forth the composition of our loan portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
|
|
|
|
|
|
Percent
|
|
|
|
Percent
|
|
|
|
|
Amount
|
|
of Total
|
|
Amount
|
|
of Total
|
|
|
|
|
(dollars in thousands)
|
|
|
Residential Mortgage
|
|
$
|
269,443
|
|
40.0
|
%
|
$
|
274,759
|
|
40.3
|
%
|
|
Commercial
|
|
|
44,725
|
|
6.6
|
%
|
|
35,884
|
|
5.2
|
%
|
|
Commercial real estate
|
|
|
237,259
|
|
35.2
|
%
|
|
242,693
|
|
35.6
|
%
|
|
Land acquisition, development, and construction ("ADC")
|
|
|
108,933
|
|
16.2
|
%
|
|
114,540
|
|
16.8
|
%
|
|
Home equity/2nds
|
|
|
12,714
|
|
1.9
|
%
|
|
13,386
|
|
2.0
|
%
|
|
Consumer
|
|
|
1,146
|
|
0.1
|
%
|
|
1,087
|
|
0.1
|
%
|
|
|
|
$
|
674,220
|
|
100.0
|
%
|
$
|
682,349
|
|
100.0
|
%
|
|
Loans decreased by $8.1 million, or 1.2%, to $674.2 million at March 31, 2019, compared to $682.3 million at December 31, 2018. This decrease was due to decreased demand and originations, as well as increased payoffs of residential mortgage, commercial real estate, home equity/2nds, and ADC loans. We did experience a slight increase in commercial loan demand during the three months ended March 31, 2019.
Credit Risk Management and the Allowance
Credit risk is the risk of loss arising from the inability of a borrower to meet his or her obligations and entails both general risks, which are inherent in the process of lending, and risks specific to individual borrowers. Our credit risk is mitigated through portfolio diversification, which limits exposure to any single customer, industry, or collateral type.
We manage credit risk by evaluating the risk profile of the borrower, repayment sources, the nature of the underlying collateral, and other support given current events, conditions, and expectations. We attempt to manage the risk characteristics of our loan portfolio through various control processes, such as credit evaluation of borrowers, establishment of lending limits, and application of lending procedures, including the holding of adequate collateral and the maintenance of compensating balances. However, we seek to rely primarily on the cash flow of our borrowers as the principal source of repayment. Although credit policies and evaluation processes are designed to minimize our risk, management recognizes that loan losses will occur and the amount of these losses will fluctuate depending on the risk characteristics of our loan portfolio, as well as general and regional economic conditions.
Management has an established methodology to determine the adequacy of the Allowance that assesses the risks and losses inherent in the loan portfolio. Our Allowance methodology employs management’s assessment as to the level of future losses on existing loans based on our internal review of the loan portfolio, including an analysis of the borrowers’ current financial position, and the consideration of current and anticipated economic conditions and their potential effects on specific borrowers and/or lines of business. In determining our ability to collect certain loans, we also consider the fair value of any underlying collateral. In addition, we evaluate credit risk concentrations, including trends in large dollar exposures to related borrowers, industry and geographic concentrations, and economic and environmental factors. Our risk management practices are designed to ensure timely identification of changes in loan risk profiles; however, undetected losses may inherently exist within the loan portfolio. The assessment aspects involved in analyzing the quality of individual loans and assessing collateral values can also contribute to undetected, but probable, losses. For more detailed information about our Allowance methodology and risk rating system, see Note 3 to the Consolidated Financial Statements.
The following table summarizes the activity in our Allowance by portfolio segment:
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
2019
|
|
2018
|
|
|
(dollars in thousands)
|
|
Allowance, beginning of year
|
|
$
|
8,044
|
|
$
|
8,055
|
|
Charge-offs:
|
|
|
|
|
|
|
|
Residential mortgage
|
|
|
—
|
|
|
(323)
|
|
Commercial
|
|
|
—
|
|
|
—
|
|
Commercial real estate
|
|
|
—
|
|
|
—
|
|
ADC
|
|
|
—
|
|
|
(13)
|
|
Home equity/2nds
|
|
|
—
|
|
|
—
|
|
Consumer
|
|
|
—
|
|
|
—
|
|
Total charge-offs
|
|
|
—
|
|
|
(336)
|
|
Recoveries:
|
|
|
|
|
|
|
|
Residential mortgage
|
|
|
5
|
|
|
221
|
|
Commercial
|
|
|
—
|
|
|
—
|
|
Commercial real estate
|
|
|
34
|
|
|
211
|
|
ADC
|
|
|
—
|
|
|
—
|
|
Home equity/2nds
|
|
|
2
|
|
|
18
|
|
Consumer
|
|
|
—
|
|
|
—
|
|
Total recoveries
|
|
|
41
|
|
|
450
|
|
Net recoveries
|
|
|
41
|
|
|
114
|
|
Provision for loan losses
|
|
|
—
|
|
|
—
|
|
Allowance, end of period
|
|
$
|
8,085
|
|
$
|
8,169
|
|
Loans:
|
|
|
|
|
|
|
|
Period-end balance
|
|
$
|
674,220
|
|
$
|
669,912
|
|
Average balance during period
|
|
|
678,357
|
|
|
668,615
|
|
Allowance as a percentage of
|
|
|
|
|
|
|
|
period-end loan balance
|
|
|
1.20
|
%
|
|
1.22
|
%
|
Percent of average loans (annualized):
|
|
|
|
|
|
|
|
Provision for loan losses
|
|
|
—
|
%
|
|
—
|
%
|
Net recoveries
|
|
|
0.02
|
%
|
|
0.07
|
%
|
The following table summarizes our allocation of the Allowance by loan segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
|
|
|
|
|
|
|
|
Percent
|
|
|
|
|
|
Percent
|
|
|
|
|
|
|
|
|
of Loans
|
|
|
|
|
|
of Loans
|
|
|
|
|
|
|
Percent
|
|
to Total
|
|
|
|
Percent
|
|
to Total
|
|
|
|
|
Amount
|
|
of Total
|
|
Loans
|
|
Amount
|
|
of Total
|
|
Loans
|
|
|
|
|
(dollars in thousands)
|
|
|
Residential mortgage
|
|
$
|
2,572
|
|
31.8
|
%
|
40.0
|
%
|
$
|
2,224
|
|
27.6
|
%
|
40.3
|
%
|
|
Commercial
|
|
|
1,740
|
|
21.5
|
%
|
6.6
|
%
|
|
2,736
|
|
34.0
|
%
|
5.2
|
%
|
|
Commercial real estate
|
|
|
712
|
|
8.8
|
%
|
35.2
|
%
|
|
457
|
|
5.7
|
%
|
35.6
|
%
|
|
ADC
|
|
|
2,579
|
|
31.9
|
%
|
16.2
|
%
|
|
2,239
|
|
27.9
|
%
|
16.8
|
%
|
|
Home equity/2nds
|
|
|
242
|
|
3.0
|
%
|
1.9
|
%
|
|
222
|
|
2.8
|
%
|
2.0
|
%
|
|
Consumer
|
|
|
1
|
|
—
|
%
|
0.1
|
%
|
|
1
|
|
—
|
%
|
0.1
|
%
|
|
Unallocated
|
|
|
239
|
|
3.0
|
%
|
—
|
%
|
|
165
|
|
2.1
|
%
|
—
|
%
|
|
Total
|
|
$
|
8,085
|
|
100.0
|
%
|
100.0
|
%
|
$
|
8,044
|
|
100.0
|
%
|
100.0
|
%
|
|
Based upon management’s evaluation, provisions are made to maintain the Allowance as a best estimate of inherent losses within the portfolio. The Allowance totaled $8.1 million at March 31, 2019 and $8.0 million at December 31, 2018. Any changes in the Allowance from period to period reflect management’s ongoing application of its methodologies to establish the Allowance, which, for the three months ended March 31, 2019, resulted in increased allocated Allowances for residential mortgage, commercial real estate, and ADC loans, with the other categories resulting in decreased or relatively stable allocated Allowances. The Allowance for Commercial loans decreased due to a large favorable resolution to a credit with an allocated reserve in previous periods of $430,000 and due to a high charge-off year rolling out of our lookback period.
At December 31, 2018, due to a re-evaluation of its qualitative factors, the Company changed its estimates of the Allowance relative to historical loss experience within specific loan portfolio segments in order to better align its qualitative factors with historical losses experienced over a longer period of time, relative to those specific loan segments. The result of this change in estimate did not result in a material increase in the Allowance compared to the year ended December 31, 2017, however there were material changes to the Allowance between loan segments. Due to the change in accounting estimate, the Allowance allocated to commercial loans and ADC loans increased approximately $2.2 million and $1.1 million, respectively, while the Allowance allocated to residential mortgage loans and commercial real estate loans decreased $600,000 and $2.7 million, respectively, as of December 31, 2018. This change in accounting estimate had no impact on earnings or diluted earnings per share. This change in estimate did not have any impact on the current period provision for loan losses, rather it resulted in re-allocation of existing Allowances between loan classifications.
As result of our Allowance analysis, we did not record any provision for loan losses during the
three months ended March 31, 2019
. We recorded net recoveries of $41,000 and $114,000, respectively, during the
three months ended March 31, 2019 and 2018.
During the three months ended March 31, 2019, annualized net recoveries as a percentage of average loans outstanding amounted to 0.02%. The Allowance as a percentage of outstanding loans was 1.20% as of March 31, 2019 compared to 1.18% as of December 31, 2018.
Although management uses available information to establish the appropriate level of the Allowance, future additions or reductions to the Allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions, and other factors. As a result, our Allowance may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our Allowance and related methodology. Such agencies may require us to recognize adjustments to the Allowance based on their judgments about information available to them at the time of their examination. Management believes the Allowance is adequate as of March 31, 2019 and is sufficient to address the credit losses inherent in the current loan portfolio.
Nonperforming Assets (“NPAs”)
Given the volatility of the real estate market, it is very important for us to have current valuations on our NPAs. Generally, we obtain appraisals or alternative valuations on NPAs annually. In addition, as part of our asset monitoring activities, we
maintain a Loss Mitigation Committee that meets monthly. During these Loss Mitigation Committee meetings, all NPAs and loan delinquencies are reviewed. We also produce an NPA report which is distributed monthly to senior management and is also discussed and reviewed at the Loss Mitigation Committee meetings. This report contains all relevant data on the NPAs, including the latest appraised value (or alternative valuation vehicle) and valuation date. Accordingly, these reports identify which assets will require an updated valuation. As a result, we have not experienced any internal delays in identifying which loans/credits require updated valuations. With respect to the ordering process of appraisals, we have not experienced any delays in turnaround time nor has this been an issue over the past three years. Furthermore, we have not had any delays in turnaround time or variances thereof in our specific loan operating markets.
NPAs, expressed as a percentage of total assets, totaled 0.61% at March 31, 2019 and 0.64% at December 31, 2018. The ratio of the Allowance to nonperforming loans was 213.0% at March 31, 2019 and 172.8% at December 31, 2018.
The distribution of our NPAs is illustrated in the following table. We did not have any loans greater than 90 days past due and still accruing at March 31, 2019 and December 31, 2018.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
|
Nonaccrual Loans:
|
|
(dollars in thousands)
|
|
Residential mortgage
|
|
$
|
2,170
|
|
$
|
2,580
|
|
Commercial
|
|
|
—
|
|
|
430
|
|
Commercial real estate
|
|
|
814
|
|
|
660
|
|
ADC
|
|
|
388
|
|
|
558
|
|
Home equity/2nds
|
|
|
423
|
|
|
428
|
|
Consumer
|
|
|
—
|
|
|
—
|
|
|
|
|
3,795
|
|
|
4,656
|
|
Real Estate Acquired Through Foreclosure:
|
|
|
|
|
|
|
|
Residential mortgage
|
|
|
1,259
|
|
|
1,366
|
|
Commercial
|
|
|
—
|
|
|
—
|
|
Commercial real estate
|
|
|
—
|
|
|
—
|
|
ADC
|
|
|
171
|
|
|
171
|
|
Home equity/2nds
|
|
|
171
|
|
|
—
|
|
Consumer
|
|
|
—
|
|
|
—
|
|
|
|
|
1,601
|
|
|
1,537
|
|
Total Nonperforming Assets
|
|
$
|
5,396
|
|
$
|
6,193
|
|
Nonaccrual loans totaled $3.8 million, or 0.56% of total loans, at March 31, 2019 and $4.7 million, or 0.68% of total loans at December 31, 2018. Significant activity in nonaccrual loans included the transfer of one loan to real estate acquired through foreclosure of $171,000 and payoffs of $670,000 in nonaccrual loans that existed at December 31, 2018 during the three months ended March 31, 2019.
Real estate acquired through foreclosure increased $64,000 to $1.6 million at March 31, 2019 compared to December 31, 2018 due to one property addition, partially offset by write downs on properties existing at December 31, 2018.
The activity in our real estate acquired through foreclosure was as follows:
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
2019
|
|
2018
|
|
|
(dollars in thousands)
|
Balance at beginning of period
|
|
$
|
1,537
|
|
$
|
403
|
Real estate acquired in satisfaction of loans
|
|
|
171
|
|
|
—
|
Write-downs and losses on real estate acquired through foreclosure
|
|
|
(107)
|
|
|
(44)
|
Proceeds from sales of real estate acquired through foreclosure
|
|
|
—
|
|
|
(122)
|
Balance at end of period
|
|
$
|
1,601
|
|
$
|
237
|
Troubled Debt Restructures (“TDRs”)
In situations where, for economic or legal reasons related to a borrower’s financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a TDR.
The composition of our TDRs is illustrated in the following table:
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
|
Residential mortgage:
|
|
(dollars in thousands)
|
|
Nonaccrual
|
|
$
|
443
|
|
$
|
446
|
|
<90 days past due/current
|
|
|
9,401
|
|
|
9,469
|
|
Commercial real estate:
|
|
|
|
|
|
|
|
Nonaccrual
|
|
|
—
|
|
|
—
|
|
<90 days past due/current
|
|
|
1,010
|
|
|
1,019
|
|
ADC:
|
|
|
|
|
|
|
|
Nonaccrual
|
|
|
—
|
|
|
—
|
|
<90 days past due/current
|
|
|
134
|
|
|
134
|
|
Consumer:
|
|
|
|
|
|
|
|
Nonaccrual
|
|
|
—
|
|
|
—
|
|
<90 days past due/current
|
|
|
74
|
|
|
76
|
|
Totals:
|
|
|
|
|
|
|
|
Nonaccrual
|
|
|
443
|
|
|
446
|
|
<90 days past due/current
|
|
|
10,619
|
|
|
10,698
|
|
|
|
$
|
11,062
|
|
$
|
11,144
|
|
See additional information on TDRs in Note 3 to the Consolidated Financial Statements herein.
Deposits
Deposits totaled $709.9 million at March 31, 2019 and $779.5 million at December 31, 2018. The $69.6 million decrease resulted from decreased deposits related to our medical-use cannabis customers, where certain customers had deposited money with the Bank in anticipation of near term future withdrawals to operate their businesses at December 31, 2018. Such withdrawals occurred to a certain degree in the first quarter of 2019.
The deposit breakdown is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
|
|
|
|
|
|
Percent
|
|
|
|
Percent
|
|
|
|
|
Balance
|
|
of Total
|
|
Balance
|
|
of Total
|
|
|
|
|
(dollars in thousands)
|
|
|
NOW
|
|
$
|
101,462
|
|
14.3
|
%
|
$
|
106,508
|
|
13.7
|
%
|
|
Money market
|
|
|
176,126
|
|
24.8
|
%
|
|
203,351
|
|
26.1
|
%
|
|
Savings
|
|
|
71,171
|
|
10.0
|
%
|
|
75,692
|
|
9.7
|
%
|
|
Certificates of deposit
|
|
|
243,303
|
|
34.3
|
%
|
|
247,351
|
|
31.7
|
%
|
|
Total interest-bearing deposits
|
|
|
592,062
|
|
83.4
|
%
|
|
632,902
|
|
81.2
|
%
|
|
Noninterest-bearing deposits
|
|
|
117,811
|
|
16.6
|
%
|
|
146,604
|
|
18.8
|
%
|
|
Total deposits
|
|
$
|
709,873
|
|
100.0
|
%
|
$
|
779,506
|
|
100.0
|
%
|
|
Borrowings
Our borrowings consist of advances from the FHLB and a term loan from a commercial bank.
The FHLB advances are available under a specific collateral pledge and security agreement, which requires that we maintain collateral for all of our borrowings equal to 30% of total assets. Our advances from the FHLB may be in the form of short-term or long-term obligations. Short-term advances have maturities for one year or less and may contain prepayment penalties. Long-term borrowings through the FHLB have original maturities up to 15 years and generally contain prepayment penalties.
At March 31, 2019, our total credit line with the FHLB was $291.2 million. The Bank, from time to time, utilizes the line of credit when interest rates are more favorable than obtaining deposits from the public. Our outstanding FHLB advance balance at March 31, 2019 and December 31, 2018 was $45.0 million and $70.0 million, respectively.
On September 30, 2016, we entered into a loan agreement with a commercial bank whereby we borrowed $3.5 million out of an available $7.5 million credit line for a term of 8 years. The unsecured note bears interest at a fixed rate of 4.25% for the first 36 months then, at the option of the Company, converts to either (1) floating rate of the Wall Street Journal Prime plus 50 basis points or (2) fixed rate at two hundred seventy five (275) basis points over the five year amortizing FHLB rate for the remaining five years. Repayment terms are monthly interest only payments for the first 36 months, then quarterly principal payments of $175,000 plus interest. The loan is subject to a prepayment penalty of 1% of the principal amount prepaid during the first 36 months. If we elect the 5 year fixed rate of 275 basis points over the FHLB rate (“FHLB Rate Period”), the loan will be subject to a prepayment penalty of 2% during the first and second years of the FHLB Rate Period and 1% of the principal repaid during the third, fourth, and fifth years of the FHLB Rate Period. We may make additional principal payments from internally generated funds of up to $875,000 per year during any fixed rate period without penalty. There is no prepayment penalty during any floating rate period.
The following table sets forth information concerning the interest rates and maturity dates of the advances from the FHLB as of March 31, 2019:
|
|
|
|
|
|
Principal
|
|
|
|
|
Amount
(in thousands)
|
|
Rate
|
|
Maturity
|
$
|
10,000
|
|
1.59%
|
|
2019
|
|
25,000
|
|
1.75% to 1.92%
|
|
2020
|
|
10,000
|
|
2.19%
|
|
2022
|
$
|
45,000
|
|
|
|
|
Subordinated Debentures
As of both March 31, 2019 and December 31, 2018, the Company had outstanding $20.6 million in principal amount of Junior Subordinated Debt Securities, due in 2035 (the “2035 Debentures”). The 2035 Debentures were issued pursuant to an Indenture dated as of December 17, 2004 (the “2035 Indenture”) between the Company and Wells Fargo Bank, National Association as Trustee. The 2035 Debentures pay interest quarterly at a floating rate of interest of 3‑month LIBOR plus 200 basis points, and mature on January 7, 2035. Payments of principal, interest, premium and other amounts under the 2035 Debentures are subordinated and junior in right of payment to the prior payment in full of all senior indebtedness of the Company, as defined in the 2035 Indenture. The 2035 Debentures became redeemable, in whole or in part, by the Company on January 7, 2010.
The 2035 Debentures were issued and sold to Severn Capital Trust I (the “Trust”), of which 100% of the common equity is owned by the Company. The Trust was formed for the purpose of issuing corporation-obligated mandatorily redeemable Capital Securities (“Capital Securities”) to third-party investors and using the proceeds from the sale of such Capital Securities to purchase the 2035 Debentures. The 2035 Debentures held by the Trust are the sole assets of the Trust. Distributions on the Capital Securities issued by the Trust are payable quarterly at a rate per annum equal to the interest rate being earned by the Trust on the 2035 Debentures. The Capital Securities are subject to mandatory redemption, in whole or in part, upon repayment of the 2035 Debentures. We have entered into an agreement which, taken collectively, fully and unconditionally guarantees the Capital Securities subject to the terms of the guarantee.
Under the terms of the 2035 Debentures, we are permitted to defer the payment of interest on the 2035 Debentures for up to 20 consecutive quarterly periods, provided that no event of default has occurred and is continuing. As of March 31, 2019, we were current on all interest due on the 2035 Debentures.
Capital Resources
Total stockholders’ equity increased $2.4 million to $100.8 million at March 31, 2019 compared to $98.5 million as of December 31, 2018. The increase was principally the result of 2019 net income, partially offset by dividends paid during the three months ended March 31, 2019.
Series A Preferred Stock
On November 15, 2008, the Company completed a private placement offering consisting of a total of 70 units, at an offering price of $100,000 per unit, for gross proceeds of $7.0 million. Each unit consisted of 6,250 shares of the Company’s Series A 8.0% Non-Cumulative Convertible Preferred Stock. On March 13, 2018, the Company notified holders of its Series A preferred stock that the Company had exercised its option to convert each of the 437,500 outstanding shares of Series A preferred stock for one share of common stock. The Company converted the Series A preferred stock on April 2, 2018. As of that date, the Series A preferred stock was no longer deemed outstanding, and all rights with respect to such stock have ceased and terminated.
Capital Adequacy
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary, actions by the regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. As of March 31, 2019 and December 31, 2018, the Bank exceeded all capital adequacy requirements to which it is subject and meets the qualifications to be considered “well capitalized.” See details of our capital ratios in Note 4 of the Consolidated Financial Statements.
Liquidity
Liquidity describes our ability to meet financial obligations, including lending commitments and contingencies, which arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers, to fund the operations of our mortgage-banking business, as well as to meet current and planned expenditures. These cash requirements are met on a daily basis through the inflow of deposit funds, the maintenance of short-term overnight investments, maturities and calls in our securities portfolio, and available lines of credit with the FHLB, which requires pledged collateral. Fluctuations in deposit and short-term borrowing balances may be influenced by the interest rates paid, general consumer confidence, and the overall economic environment. There can be no assurances that deposit withdrawals and loan fundings will not exceed all available sources of liquidity on a short-term basis. Such a situation would have an adverse effect on our ability to originate new loans and maintain reasonable loan and deposit interest rates, which would negatively impact earnings.
Our principal sources of liquidity are loan repayments, maturing investments, deposits, borrowed funds, and proceeds from loans sold on the secondary market. The levels of such sources are dependent on the Bank’s operating, financing, and investing activities at any given time. We consider core deposits stable funding sources and include all deposits, except time deposits of $100,000 or more. The Bank’s experience has been that a substantial portion of certificates of deposit renew at time of maturity and remain on deposit with the Bank. Additionally, loan payments, maturities, deposit growth, and earnings contribute to our flow of funds.
In addition to our ability to generate deposits, we have external sources of funds, which may be drawn upon when desired. The primary source of external liquidity is an available line of credit with the FHLB. The Bank’s total credit availability
under the FHLB’s credit availability program was $291.2 million at March 31, 2019, of which $45.0 million was outstanding. We also have $7.5 million in credit availability with another financial institution, of which $3.5 million was outstanding at March 31, 2019.
The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit (collectively “commitments”), which totaled $118.1 million at March 31, 2019. Historically, many of the commitments expire without being fully drawn; therefore, the total commitment amounts do not necessarily represent future cash requirements. We expect to fund these commitments from the sources of liquidity described above.
Customer withdrawals are also a principal use of liquidity, but are generally mitigated by growth in customer funding sources, such as deposits and short-term borrowings.
In addition to the foregoing, the payment of dividends is a use of cash, but is not expected to have a material effect on liquidity. As of March 31, 2019, we had no material commitments for capital expenditures.
Our ability to acquire deposits or borrow could be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. At March 31, 2019, management considered the Company’s liquidity level to be sufficient for the purposes of meeting our cash flow requirements. We are not aware of any undisclosed known trends, demands, commitments, or uncertainties that are reasonably likely to result in material changes in our liquidity.
We anticipate that our primary sources of liquidity over the next twelve months will be from loan repayments, maturing investments, deposit growth, and borrowed funds. We believe that these sources of liquidity will be sufficient for us to meet our liquidity needs over the next twelve months.
Off-Balance Sheet Arrangements and Derivatives
We enter into off-balance sheet arrangements in the normal course of business. These arrangements consist primarily of commitments to extend credit, lines of credit, and letters of credit. In addition, we have certain operating lease obligations.
Credit Commitment
s
Credit commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party.
Our exposure to credit loss in the event of nonperformance by the borrower is the contract amount of the commitment. Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. We are not aware of any accounting loss we would incur by funding our commitments.
See detailed information on credit commitments above under “Liquidity.”
Derivatives
We maintain and account for derivatives, in the form of interest-rate lock commitments (“IRLCs”) and mandatory forward contracts, in accordance with the Financial Accounting Standards Board guidance on accounting for derivative instruments and hedging activities. We recognize gains and losses on IRLCs, mandatory forward contracts, and best effort forward contracts on the loan pipeline through mortgage-banking revenue in the Consolidated Statements of Operations.
IRLCs on mortgage loans that we intend to sell in the secondary market are considered derivatives. We are exposed to price risk from the time a mortgage loan closes until the time the loan is sold. The period of time between issuance of a
loan commitment and closing and sale of the loan generally ranges from 14 days to 60 days. For these IRLCs, we attempt to protect the Bank from changes in interest rates through the use of best efforts and mandatory forward contracts.
Information pertaining to the carrying amounts of our derivative financial instruments follows:
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March 31, 2019
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December 31, 2018
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|
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Notional
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Estimated
|
|
Notional
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|
Estimated
|
|
|
Amount
|
|
Fair Value
|
|
Amount
|
|
Fair Value
|
|
|
(dollars in thousands)
|
Asset - IRLCs
|
|
$
|
14,158
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|
$
|
335
|
|
$
|
3,710
|
|
$
|
100
|
Asset - best effort forward contracts
|
|
|
—
|
|
|
—
|
|
|
3,710
|
|
|
—
|
Liability - best efforts forward contracts
|
|
|
14,158
|
|
|
16
|
|
|
—
|
|
|
—
|
Liability - mandatory forward contracts
|
|
|
6,411
|
|
|
7
|
|
|
9,363
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|
|
16
|
Inflation
The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with GAAP and practices within the banking industry which require the measurement of financial condition and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. As a financial institution, virtually all of our assets and liabilities are monetary in nature and interest rates have a more significant impact on our performance than the effects of general levels of inflation. A prolonged period of inflation could cause interest rates, wages, and other costs to increase and could adversely affect our results of operations unless mitigated by a corresponding increase in our revenues. However, we believe that the impact of inflation on our operations was not material for the three months ended March 31, 2019 and 2018.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The principal objective of the Company’s interest rate risk management is to evaluate the interest rate risk included in balance sheet accounts, determine the level of risks appropriate given our business strategy, operating environment, capital and liquidity requirements, and performance objectives, and manage the risk consistent with our interest rate risk management policy. Through this management, we seek to reduce the vulnerability of our operations to changes in interest rates. The Board of Directors of the Company is responsible for reviewing our asset/liability policy and interest rate risk position. The Board of Directors reviews the interest rate risk position on a quarterly basis and, in connection with this review, evaluates the Company’s business activities and strategies, the effect of those strategies on the Company’s net interest margin and the effect that changes in interest rates will have on the loan portfolio. While continuous movement of interest rates is certain, the extent and timing of these movements is not always predictable. Any movement in interest rates has an effect on our profitability. We face the risk that rising interest rates could cause the cost of
interest-bearing liabilities, such as deposits and borrowings, to rise faster than the yield on interest-earning assets, such as loans and investments. Our interest rate spread and interest rate margin also may be negatively impacted in a declining interest rate environment even though we generally borrow at short-term interest rates and lend at longer-term interest rates. This is because loans and other interest-earning assets may be prepaid and replaced with lower yielding assets before the supporting interest-bearing liabilities reprice downward. Our interest rate margin may also be negatively impacted in a flat or inverse-yield curve environment. Mortgage origination activity tends to increase when interest rates trend lower and decrease when interest rates rise.
Our primary strategy to control interest rate risk is to strive to balance our loan origination activities with the interest rate market. We attempt to maintain a substantial portion of our loan portfolio in short-term loans such as construction loans. This has proven to be an effective hedge against rapid increases in interest rates as the construction loan portfolio reprices rapidly.
The matching of maturity or repricing of interest-earning assets and interest-bearing liabilities may be analyzed by examining the extent to which these assets and liabilities are interest rate sensitive and by monitoring the Bank’s interest rate sensitivity gap. An interest-earning asset or interest-bearing liability is interest rate sensitive within a specific time period if it will mature or reprice within that time period. The difference between rate sensitive assets and rate sensitive
liabilities represents the Bank’s interest sensitivity gap. At March 31, 2019, we had a one-year cumulative negative gap of $9.7 million.
Exposure to interest rate risk is actively monitored by management. The objective is to maintain a consistent level of profitability within acceptable risk tolerances across a broad range of potential interest rate environments. We use the PROFITstar® model to monitor our exposure to interest rate risk, which calculates changes in the economic value of equity (“EVE”).
The following table represents our EVE as of March 31, 2019:
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Change in Rates
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Amount
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$ Change
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% Change
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(dollars in thousands)
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|
|
|
+400
|
bp
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$
|
144,767
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$
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(4,824)
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|
(0.03)
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%
|
+300
|
bp
|
|
147,829
|
|
|
(1,762)
|
|
(0.01)
|
%
|
+200
|
bp
|
|
151,017
|
|
|
1,426
|
|
0.01
|
%
|
+100
|
bp
|
|
152,009
|
|
|
2,418
|
|
0.02
|
%
|
0
|
bp
|
|
149,591
|
|
|
|
|
|
|
(100)
|
bp
|
|
138,422
|
|
|
(11,169)
|
|
(0.07)
|
%
|
(200)
|
bp
|
|
119,678
|
|
|
(29,913)
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|
(0.20)
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%
|
The preceding income simulation analysis does not represent a forecast of actual results and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, which are subject to change, including: the nature and timing of interest rate levels including the yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others. Also, as market conditions vary, prepayment/refinancing levels, the varying impact of interest rate changes on caps and floors embedded in adjustable-rate loans, early withdrawal of deposits, changes in product preferences, and other internal/external variables will likely deviate from those assumed.
Item 4. Controls and Procedures
Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities and Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.
The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC. As of March 31, 2019, the Company’s management, including the Company’s CEO and CFO, has evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in Rules 13a-15 and 15d-15(e) under the Exchange Act. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must necessarily reflect the fact that there are resource constraints and that management is required to apply its judgement in evaluating the benefits of possible controls and procedures relative to their costs. Based on this evaluation, the Company's CEO and CFO concluded that, as of the end of the period covered by this quarterly report, the Company's disclosure controls and procedures were not effective because of the material weaknesses described below.
A material weakness is a deficiency or combination of deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's quarterly financial statements will not be prevented or detected on a timely basis. The identification of the material weaknesses did not impact any of our consolidated financial statements for any prior annual or interim periods, other than as described in our Annual Report on
Form 10-K for December 31, 2018. Accordingly, management believes that the financial statements included in this Quarterly Report on Form 10-Q present fairly in all material respects the Company's financial condition, results of operations and cash flows for the periods presented.
The Company has identified a material weakness in its internal control over financial reporting, specifically related to both management’s review controls and risk rating controls over the Company’s Allowance. The material weakness in internal control over financial reporting resulted from a lack of sufficient management review controls over the development and monitoring of qualitative factors used in calculating the general component of the Allowance, a lack of sufficient management review controls over the relevant inputs and assumptions used to measure the fair value of impaired loans, lack of controls to identify the completeness of TDRs, and review over the completeness of changes to loans’ risk ratings that are required to be modified within the Company’s loan accounting system.
The Company has also identified a material weakness in its internal control over financial reporting, specifically related to its reconciliation controls relating to LHFS. The material weakness in internal control over financial reporting resulted from a 2018 material reclassification entry identified during the audit. The impact of this reclassification has been corrected on the consolidated statement of financial condition as of December 31, 2018.
Management has been actively engaged in developing remediation plans to address the above control deficiencies. The remediation actions we are taking and expect to take include the following:
Allowance - The Company has enhanced its management review controls over the development and monitoring of qualitative factors and other relevant assumptions used in calculating the general component of the Allowance. The Company has also enhanced its current review process over impaired loans to ensure a timely review is being performed at an appropriate level of precision as it pertains to the relevant inputs and assumptions to measure the fair value of impaired loans, including appraisal review controls. The Company has also implemented a process to ensure the completeness and accuracy of the population to provide assurance that all required loans are properly evaluated for TDR classification. Finally, the Company has enhanced controls over the review of the completeness of changes to loans’ risk ratings that are required to be modified within the Company’s loan accounting system.
LHFS - The Company has enhanced its reconciliation procedures over LHFS to ensure that all loan sale activity is reflected.
Although the Company’s remediation efforts are well underway and are expected to be fully completed in the near future, the Company’s material weaknesses will not be considered remediated until new internal controls are operational for a period of time and are tested, and management concludes that these controls are operating effectively.
Other than the remediation described above, there has been no change in the Company’s internal control over financial reporting during the quarter ended March 31, 2019 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
In the normal course of business, we are party to litigation arising from the banking, financial, and other activities we conduct. Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising from these matters will have a material effect on the Company’s financial condition, operating results, or liquidity as of March 31, 2019.
Item 1A. Risk Factors
The risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of the Annual Report on Form 10‑K of Severn Bancorp for the year ended December 31, 2018. There have been no material changes in our risk factors since the filing of our December 31, 2018 Annual Report on Form 10‑K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None.
Item 6. Exhibits
Exhibit No.
|
|
Description
|
3.2
|
|
Unanimous Written Consent of the Board of Directors of Severn Bancorp, Inc.
|
|
|
|
31.1
|
|
Certification of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
|
|
|
|
31.2
|
|
Certification of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
|
|
|
|
32
|
|
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|
|
|
|
101
|
|
The following financial statements from the Severn Bancorp, Inc. Quarterly Report on Form 10‑Q as of March 31, 2019 and for the three months ended March 31, 2019, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Financial Condition; (ii) the Consolidated Statements of Operations; (iii) the Consolidated Statements of Accumulated Comprehensive Income; (iv) the Consolidated Statements of Changes in Stockholders’ Equity; (v) the Consolidated Statements of Cash Flows; and (vi) the Notes to Consolidated Financial Statements.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
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SEVERN BANCORP, INC.
|
|
|
May 10, 2019
|
/s/ Alan J. Hyatt
|
|
Alan J. Hyatt,
Chairman of the Board, President and Chief Executive Officer
|
|
(Principal Executive Officer)
|
|
|
May 10, 2019
|
/s/ Paul B. Susie
|
|
Paul B. Susie,
Executive Vice President, Chief Financial Officer
|
|
(Principal Financial and Accounting Officer)
|
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