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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
| | | | | |
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2023
Or
| | | | | |
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from __________ to __________
Commission File Number: 000-55983
(Exact name of registrant as specified in its charter)
| | | | | |
Pennsylvania | 83-1561918 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
9 Old Lincoln Highway, Malvern, Pennsylvania 19355
(Address of principal executive offices) (Zip Code)
(484) 568-5000
(Registrant’s telephone number, including area code)
| | | | | | | | |
Title of class | Trading Symbol | Name of exchange on which registered |
Common Stock, $1 par value | MRBK | The NASDAQ Stock Market |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒Yes ☐No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒Yes ☐No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| | | | | | | | | | | | | | |
| Large Accelerated Filer | ☐ | Accelerated Filer | ☒ |
| Non-accelerated Filer | ☐ | Smaller Reporting Company | ☒ |
| Emerging Growth Company | ☐ | | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of May 5, 2023 there were 11,177,751 outstanding shares of the issuer’s common stock, par value $1.00 per share.
TABLE OF CONTENTS
Glossary of Acronyms, Abbreviations, and Terms
The acronyms, abbreviations, and terms listed below are used in various sections of this report. As used throughout this report, the terms "Meridian", “we”, “our”, or “us” refer to Meridian Corporation and its consolidated subsidiaries, unless the context otherwise requires.
| | | | | |
Acronym | Description |
| |
ACH | Automated clearing house |
ACL | Allowance for credit losses |
AFS | Available-for-sale |
ALCO | Asset/Liability Committee |
ALLL | Allowance for loan and lease losses |
ALM | Asset / liability management |
AOCI | Accumulated other comprehensive income |
ASC | Accounting Standards Codification |
ASU | Accounting Standards Update |
BHC Act | Bank Holding Company Act of 1956 |
BOLI | Bank owned life insurance |
BSA-AML | Bank Secrecy Act - Anti-Money Laundering |
BTFP | Federal Reserve Bank Term Funding Program |
CBCA | Change in Bank Control Act |
CBLR | Community Bank Leverage Ratio |
CDARS | Certificate of Deposit Account Registry Service |
CECL | Current expected credit losses |
CET1 | Common equity tier 1 |
CFPB | Consumer Financial Protection Bureau |
CMO | Collateralized mortgage obligation |
COVID-19 | Coronavirus Disease 2019 |
CRE | Commercial real estate |
DIF | FDIC’s deposit insurance fund |
ECOA | Equal Credit Opportunity Act |
ESOP | Employee Stock Ownership Plan |
FASB | Financial Accounting Standards Board |
| |
FDIC | Federal Deposit Insurance Corporation |
FFIEC | Federal Financial Institutions Examination Council |
FHA | Federal Housing Authority |
FHFA | Federal Housing Finance Agency |
FHLB | Federal Home Loan Bank of Pittsburgh |
FHLMC | Federal Home Loan Mortgage Corporation or Freddie Mac |
FICO | Financing Corporation |
FNMA | Federal National Mortgage Association or Fannie Mae |
FRB | Federal Reserve Bank of Philadelphia |
FTE | Fully taxable equivalent |
GAAP | U.S. generally accepted accounting principles |
GLB Act | Gramm-Leach-Bliley Act |
GNMA | Government National Mortgage Association or Ginnie Mae |
GSE | Government-sponsored entities |
HTM | Held-to-maturity |
ICBA | Independent Community Bankers of America |
JOBS Act | Jumpstart Our Business Startups Act of 2012 |
LBP | Look-back period |
LEP | Loss emergence period |
| | | | | |
LGD | Loss given default |
LIBOR | London Inter-bank Offering Rate |
MBS | Mortgage-backed securities |
MSLP | Main Street Lending Programs |
MSR | Mortgage servicing rights |
OFAC | Office of Foreign Assets Control |
OREO | Other real estate owned |
PCAOB | Public Company Accounting Oversight Board |
PD | Probability of default |
PDBS | Pennsylvania Department of Banking and Securities |
PPP | Paycheck Protection Program |
ROU | Right-of-use |
SBA | Small Business Administration |
SEC | Securities and Exchange Commission |
SERP | Supplemental Executive Retirement Plan |
SNC | Shared national credit |
TILA | Truth in Lending Act |
TDR | Troubled debt restructuring |
USDA | U.S. Department of Agriculture |
VA | U.S. Department of Veteran’s Affairs |
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
| | | | | | | | | | | |
(dollars in thousands, except share data) | March 31, 2023 | | December 31, 2022 |
Assets: | | | |
Cash and due from banks | $ | 8,473 | | | $ | 11,299 | |
Interest-bearing deposits at other banks | 100,030 | | | 27,092 | |
| | | |
Cash and cash equivalents | 108,503 | | | 38,391 | |
Securities available-for-sale, at fair value (amortized cost of $154,431 and $148,976, respectively) | 142,933 | | | 135,346 | |
Securities held-to-maturity, at amortized cost (fair value of $33,076 and $33,085, respectively) | 36,525 | | | 37,479 | |
Equity investments | 2,110 | | | 2,086 | |
Mortgage loans held for sale | 35,701 | | | 22,243 | |
Loans, net of fees and costs | 1,818,189 | | | 1,743,682 | |
Allowance for credit losses | (20,442) | | | (18,828) | |
Loans and other finance receivables, net of the allowance for credit losses | 1,797,747 | | | 1,724,854 | |
Restricted investment in bank stock | 10,173 | | | 6,931 | |
Bank premises and equipment, net | 13,281 | | | 13,349 | |
Bank owned life insurance | 28,247 | | | 28,055 | |
Accrued interest receivable | 7,651 | | | 7,363 | |
Other real estate owned | 1,703 | | | 1,703 | |
Deferred income taxes | 4,017 | | | 3,936 | |
Servicing assets | 12,125 | | | 12,346 | |
Goodwill | 899 | | | 899 | |
Intangible assets | 3,124 | | | 3,175 | |
Other assets | 25,044 | | | 24,072 | |
Total assets | $ | 2,229,783 | | | $ | 2,062,228 | |
| | | |
Liabilities: | | | |
Deposits: | | | |
Non-interest bearing | $ | 262,636 | | | $ | 301,727 | |
Interest bearing | 1,507,777 | | | 1,410,752 | |
Total deposits | 1,770,413 | | | 1,712,479 | |
Borrowings | 233,883 | | | 122,082 | |
| | | |
Subordinated debentures | 40,319 | | | 40,346 | |
Accrued interest payable | 3,836 | | | 2,389 | |
Other liabilities | 28,283 | | | 31,652 | |
Total liabilities | 2,076,734 | | | 1,908,948 | |
| | | |
Stockholders’ equity: | | | |
Common stock, $1 par value per share. 25,000,000 shares authorized; 13,180,184 and 13,156,308 shares issued and 11,177,001 and 11,465,572 shares outstanding, respectively | 13,180 | | | 13,156 | |
Surplus | 79,473 | | | 79,072 | |
Treasury stock, 2,003,183 and 1,690,736 shares, respectively, at cost | (24,512) | | | (21,821) | |
Unearned common stock held by employee stock ownership plan | (1,403) | | | (1,403) | |
Retained earnings | 96,180 | | | 95,815 | |
Accumulated other comprehensive loss | (9,869) | | | (11,539) | |
Total stockholders’ equity | 153,049 | | | 153,280 | |
Total liabilities and stockholders’ equity | $ | 2,229,783 | | | $ | 2,062,228 | |
See accompanying notes to the unaudited consolidated financial statements.
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
| | | | | | | | | | | | | | | |
| Three months ended March 31, | | |
(dollars in thousands, except per share data) | 2023 | | 2022 | | | | |
Interest income: | | | | | | | |
Loans and other finance receivables, including fees | $ | 29,417 | | | $ | 17,219 | | | | | |
Securities - taxable | 959 | | | 426 | | | | | |
Securities - tax-exempt | 354 | | | 306 | | | | | |
Cash and cash equivalents | 217 | | | 13 | | | | | |
Total interest income | 30,947 | | | 17,964 | | | | | |
Interest expense: | | | | | | | |
Deposits | 11,447 | | | 1,289 | | | | | |
Borrowings | 1,823 | | | 640 | | | | | |
Total interest expense | 13,270 | | | 1,929 | | | | | |
Net interest income | 17,677 | | | 16,035 | | | | | |
Provision for credit losses | 1,399 | | | 615 | | | | | |
Net interest income after provision for credit losses | 16,278 | | | 15,420 | | | | | |
Non-interest income: | | | | | | | |
Mortgage banking income | 3,272 | | | 7,096 | | | | | |
Wealth management income | 1,196 | | | 1,304 | | | | | |
SBA loan income | 713 | | | 2,520 | | | | | |
Earnings on investment in life insurance | 192 | | | 138 | | | | | |
Net change in the fair value of derivative instruments | (69) | | | (166) | | | | | |
Net change in the fair value of loans held-for-sale | (1) | | | (1,124) | | | | | |
Net change in the fair value of loans held-for-investment | 117 | | | (778) | | | | | |
Net gain (loss) on hedging activity | — | | | 2,827 | | | | | |
| | | | | | | |
Service charges | 35 | | | 27 | | | | | |
Other | 1,183 | | | 1,258 | | | | | |
Total non-interest income | 6,638 | | | 13,102 | | | | | |
Non-interest expense: | | | | | | | |
Salaries and employee benefits | 11,061 | | | 15,298 | | | | | |
Occupancy and equipment | 1,244 | | | 1,252 | | | | | |
Professional fees | 823 | | | 848 | | | | | |
Advertising and promotion | 861 | | | 986 | | | | | |
Data processing and software | 1,432 | | | 1,189 | | | | | |
Pennsylvania bank shares tax | 245 | | | 199 | | | | | |
Other | 2,123 | | | 1,661 | | | | | |
Total non-interest expense | 17,789 | | | 21,433 | | | | | |
Income before income taxes | 5,127 | | | 7,089 | | | | | |
Income tax expense | 1,106 | | | 1,554 | | | | | |
Net income | $ | 4,021 | | | $ | 5,535 | | | | | |
Basic earnings per common share | $ | 0.36 | | | $ | 0.46 | | | | | |
Diluted earnings per common share | $ | 0.34 | | | $ | 0.44 | | | | | |
Basic weighted average shares outstanding | 11,272 | | | 12,046 | | | | | |
Diluted weighted average shares outstanding | 11,656 | | | 12,524 | | | | | |
See accompanying notes to the unaudited consolidated financial statements.
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
| | | | | | | | | | | | | | | |
| Three months ended March 31, | | |
(dollars in thousands) | 2023 | | 2022 | | | | |
Net income: | $ | 4,021 | | | $ | 5,535 | | | | | |
| | | | | | | |
Net change in unrealized gains (losses) on investment securities available for sale: |
Change in fair value of investment securities available for sale, net of tax of $460, $(1,626), respectively | 1,670 | | | (5,369) | | | | | |
Reclassification adjustment for net losses realized in net income, net of tax effect of $0, and $(3), respectively | — | | | (9) | | | | | |
Reclassification adjustment for securities transferred from available-for-sale to held-to-maturity, net of tax effect of $0, and $308, respectively | — | | | (1,021) | | | | | |
Unrealized investment gains (losses), net of tax effect of $460, and $(1,937), respectively | 1,670 | | | (6,399) | | | | | |
Total other comprehensive income (loss) | 1,670 | | | (6,399) | | | | | |
Total comprehensive income (loss) | $ | 5,691 | | | $ | (864) | | | | | |
See accompanying notes to the unaudited consolidated financial statements.
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(dollars in thousands, except per share data) | Common Stock | | Surplus | | Treasury Stock | | Unearned ESOP | | Retained Earnings | | AOCI | | Total |
Balance at January 1, 2023 | $ | 13,156 | | | $ | 79,072 | | | $ | (21,821) | | | $ | (1,403) | | | $ | 95,815 | | | $ | (11,539) | | | $ | 153,280 | |
Adjustment to initially apply ASU No. 2016-13 for CECL (1), net of tax | | | | | | | | | (2,228) | | | | | (2,228) | |
Net income | — | | | — | | | — | | | — | | | 4,021 | | | — | | | 4,021 | |
Other comprehensive income | — | | | — | | | — | | | — | | | — | | | 1,670 | | | 1,670 | |
Dividends paid or accrued, $0.125 per share | — | | | — | | | — | | | — | | | (1,428) | | | — | | | (1,428) | |
Net purchase of treasury stock through publicly announced plans (184,598 shares) | — | | | — | | | (2,691) | | | — | | | — | | | — | | | (2,691) | |
Common stock issued through share-based awards and exercises | 24 | | | 124 | | | — | | | — | | | — | | | — | | | 148 | |
Stock based compensation expense | — | | | 277 | | | — | | | — | | | — | | | — | | | 277 | |
Balance at March 31, 2023 | $ | 13,180 | | | $ | 79,473 | | | $ | (24,512) | | | $ | (1,403) | | | $ | 96,180 | | | $ | (9,869) | | | $ | 153,049 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(dollars in thousands, except per share data) | Common Stock | | Surplus | | Treasury Stock | | Unearned ESOP | | Retained Earnings | | AOCI | | Total |
Balance at January 1, 2022 | $ | 13,070 | | | $ | 77,128 | | | $ | (8,860) | | | $ | (1,602) | | | $ | 84,916 | | | $ | 708 | | | $ | 165,360 | |
Net income | — | | | — | | | — | | | — | | | 5,535 | | | — | | | 5,535 | |
Other comprehensive loss | — | | | — | | | — | | | — | | | — | | | (6,399) | | | (6,399) | |
Dividends paid or accrued, $0.60 per share | — | | | — | | | — | | | — | | | (7,347) | | | — | | | (7,347) | |
| | | | | | | | | | | | | |
Common stock issued through share-based awards and exercises | 21 | | | 254 | | | — | | | — | | | — | | | — | | | 275 | |
Stock based compensation expense | — | | | 260 | | | — | | | — | | | — | | | — | | | 260 | |
Balance at March 31, 2022 | $ | 13,091 | | | $ | 77,642 | | | $ | (8,860) | | | $ | (1,602) | | | $ | 83,104 | | | $ | (5,691) | | | $ | 157,684 | |
(1) See Note 1, "Summary of Significant Accounting Policies - Pronouncements Adopted in 2023" for additional information.
See accompanying notes to the unaudited consolidated financial statements.
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| | | | | | | | | | | |
| Three months ended March 31, |
(dollars in thousands) | 2023 | | 2022 |
Net income | $ | 4,021 | | | $ | 5,535 | |
Adjustments to reconcile net income to net cash (used in) provided by operating activities: | | | |
| | | |
Net amortization of investment premiums and discounts and change in fair value of equity securities | 373 | | | (27) | |
Depreciation and amortization (accretion), net | (2) | | | 50 | |
Provision for credit losses | 1,399 | | | 615 | |
Amortization of issuance costs on subordinated debt | 27 | | | 30 | |
Stock based compensation | 277 | | | 260 | |
Net change in fair value of derivative instruments | 4 | | | 166 | |
Net change in fair value of loans held for sale | 1 | | | 1,124 | |
Net change in fair value of loans held for investment | (117) | | | 778 | |
Amortization and net impairment of servicing rights | 435 | | | 494 | |
SBA loan income | (713) | | | (2,520) | |
Proceeds from sale of loans | 136,837 | | | 319,610 | |
Loans originated for sale | (147,238) | | | (313,485) | |
Mortgage banking income | (3,272) | | | (7,096) | |
(Increase) decrease in accrued interest receivable | (288) | | | 161 | |
Decrease (increase) in other assets | (1,542) | | | (9,962) | |
Earnings from investment in life insurance | (192) | | | (138) | |
(Increase) decrease in deferred income tax | (54) | | | 159 | |
Increase in accrued interest payable | 1,447 | | | 544 | |
(Decrease) increase in other liabilities | (2,803) | | | 10,156 | |
Net cash (used in) provided by operating activities | (11,400) | | | 6,454 | |
| | | |
Cash flows from investing activities: | | | |
Activity in available-for-sale securities: | | | |
Maturities, repayments and calls | 2,222 | | | 3,843 | |
| | | |
Purchases | (10,702) | | | (9,885) | |
Activity in held-to-maturity securities: | | | |
Maturities, repayments and calls | 865 | | | 390 | |
Purchases | — | | | (2,500) | |
(Decrease) increase in restricted stock | (3,242) | | | 787 | |
Net increase in loans | (73,057) | | | (59,762) | |
Purchases of premises and equipment | (284) | | | (77) | |
| | | |
Net cash used in investing activities | (84,198) | | | (67,204) | |
| | | |
Cash flows from financing activities: | | | |
Net increase in deposits | 57,934 | | | 118,438 | |
| | | |
Increase (decrease) in short-term borrowings | 108,368 | | | (5,208) | |
Increase in long-term debt | 3,433 | | | — | |
| | | |
Repayment of subordinated debt | (54) | | | — | |
| | | |
Net purchase of treasury stock | (2,691) | | | — | |
Dividends paid | (1,428) | | | (7,347) | |
Share based awards and exercises | 148 | | | 275 | |
Net cash provided by financing activities | 165,710 | | | 106,158 | |
| | | |
Net change in cash and cash equivalents | 70,112 | | | 45,408 | |
Cash and cash equivalents at beginning of period | 38,391 | | | 23,480 | |
Cash and cash equivalents at end of period | $ | 108,503 | | | $ | 68,888 | |
| | | |
Supplemental disclosure of cash flow information: | | | |
Cash paid during the period for: | | | |
Interest | $ | 11,823 | | | $ | 1,386 | |
| | | |
| | | |
| | | |
Transfers from loans held for sale to loans held for investment | — | | | 1,653 | |
| | | |
| | | |
Transfer of securities from AFS to HTM | — | | | 23,522 | |
| | | |
See accompanying notes to the unaudited consolidated financial statements.
MERIDIAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) Summary of Significant Accounting Policies
Basis of Presentation
The Corporation’s unaudited consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial position and the results of operations for the interim periods presented have been included.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Amounts subject to significant estimates are items such as the allowance for credit losses, lending related commitments and the related unfunded commitment reserve, the fair value of financial instruments, other-than-temporary impairments of investment securities, and the valuations of goodwill, intangible assets, and servicing assets.
These unaudited consolidated financial statements should be read in conjunction with the Corporation’s filings with the SEC (including our Annual Report on Form 10-K for the year ended December 31, 2022), subsequently filed quarterly reports on Form 10-Q and current reports on Form 8-K that update or provide information in addition to the information included in Form 10-K and Form 10-Q filings, if any.
Certain prior period amounts have been reclassified to conform with current period presentation. Reclassifications had no effect on net income or stockholders’ equity. Operating results for the three months ended March 31, 2023 are not necessarily indicative of the results for the year ending December 31, 2023 or for any other period.
Stock Split
On February 28, 2023, the Corporation approved and declared a two-for-one stock split in the form of a stock dividend, payable March 20, 2023, to shareholders of record as of March 14, 2023. Under the terms of the stock split, the Corporation’s shareholders will receive a dividend of one share for every share held on the record date. The dividend will be paid in authorized but unissued shares of common stock of the Corporation. The par value of the Corporation's stock was not affected by the split and remained at $1.00 per share. All share and per share amounts reported in the consolidated financial statements have been adjusted to reflect the two-for-one stock split.
Loans
Loans held for investment are recorded at amortized cost, net of ACL. Amortized cost is the amount at which a financial asset is originated or acquired, adjusted for the amortization of premium and discount, net deferred fees or costs, collection of cash, and write-offs. Interest income on loans is recognized using the level yield method. Loan origination fees, commitment fees and direct loan origination costs are deferred and recognized over the life of the related loans using a level yield method over the period to maturity.
Allowance for Credit Losses - Loans and Leases
On January 1, 2023, we adopted ASU 2016-13, Financial Instruments-Credit Losses ("Topic 326"), which replaced the incurred loss impairment model with an expected loss methodology that is referred to as the CECL methodology. We now establish our ACL in accordance with Topic 326. The ACL includes quantitative and qualitative factors that comprise management's current estimate of expected credit losses, including our portfolio mix and segmentation, modeling methodology, historical loss experience, relevant available information from internal and external sources relating to reasonable and supportable forecasts about future economic conditions, prepayment speeds, and qualitative adjustment factors.
The Corporation's portfolio segments, established based on similar risk characteristics and loss behaviors, are:
• Commercial mortgage, commercial and industrial, construction, SBA loans, and commercial small business leases (commercial loans), and
• Residential, equity secured lines and loans, and installment loans (retail loans).
Expected credit losses are estimated over the contractual term, adjusted for expected prepayments and recoveries. The contractual term excludes any extensions, renewals and modifications unless the Corporation has reasonable expectations at the reporting date that it will result in a modification, or they are not unconditionally cancellable. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.
The allowance includes two primary components: (i) an allowance established on loans which share similar risk characteristics collectively evaluated for credit losses (collective basis) and (ii) an allowance established on loans which do not share similar risk characteristics with any loan segment and are individually evaluated for credit losses (individual basis).
Loans that share similar risk characteristics are collectively reviewed for credit loss and are evaluated based on historical loss experience, adjusted for current economic conditions and future economic forecasts. Estimated losses are determined differently for commercial and consumer loans, and each portfolio segment is further segmented by internally assessed risk ratings.
Management uses a third-party economic forecast to modify the calculated historical loss rates of the portfolio segments. Our economic forecast extends out 4 quarters (the forecast period) and reverts to the historical loss rates on a straight-line basis over 1 quarter (the reversion period) as we believe this to be reasonable and supportable in the current environment. The economic forecast and reversion periods will be evaluated periodically by management and updated as appropriate.
The historical loss rates for commercial loans are estimated by determining the PD and expected LGD. The PD is calculated based on the historical rate of migration to an event of credit loss during the look-back period. The historical loss rates for retail loans is calculated based solely on average net loss rates over the same look-back period. Our current look-back period is 32 quarters which allows us to ensure that historical loss rates are adequately considering losses over a full economic cycle.
Loans that do not share similar risk characteristics with any loan segments are evaluated on an individual basis. These loans, which may include borrowers experiencing financial difficulties, are not included in the collective basis evaluation. When it is probable we will not collect all principal and interest due according to their contractual terms, which is assessed based on the credit characteristics of the loan and/or payment status, these loans are individually reviewed and measured for potential credit loss.
The amount of the potential credit loss is measured using one of three methods: (i) the present value of expected future cash flows discounted at the loan’s effective interest rate; (ii) the fair value of collateral, if the loan is collateral dependent; or (iii) the loan’s observable market price. If the measured fair value of the loan is less than the amortized cost basis of the loan, an allowance for credit loss is recorded.
For collateral dependent loans, the expected credit losses at the individual asset level is the difference between the collateral's fair value (less cost to sell) and the amortized cost.
Qualitative adjustment factors consider various internal and external conditions which are allocated among loan segments and take into consideration:
• Current underwriting policies, staff and portfolio concentrations,
• Risk rating accuracy, credit and administration,
• Internal risk emergence (including internal trends of delinquency, portfolio growth, and collateral value), and
• , Competitive environment, as it could impact loan structure and underwriting.
These factors are based on their relative standing compared to the period in which historical losses are used in quantitative reserve estimates and current directional trends, and reasonable and supportable forecasts. Qualitative factors in our model can add to or subtract from quantitative reserves.
Our loan officers and risk managers meet at least quarterly to discuss and review the conditions and risks associated with individual problem loans. In addition, various regulatory agencies periodically review our loan ratings and allowance for credit losses and the Bank’s internal loan review department performs loan reviews.
Accrued interest receivable on loans is excluded from the estimate of credit losses and is included in Accrued interest receivable on the Consolidated Balance Sheets.
For additional detail regarding the allowance for credit losses and the provision for credit losses, see Note 5.
Past Due and Nonaccrual Loans
Past due loans are defined as loans contractually past due 30 days or more as to principal or interest payments but which remain in accrual status because they are considered well secured and in the process of collection.
Nonaccruing loans and leases are those on which the accrual of interest has ceased. Loans are placed on nonaccrual status immediately if, in the opinion of management, collection is doubtful, or when principal or interest is past due 90 days or more and the loan is not well secured and in the process of collection. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed and charged against interest income. In addition, the amortization of net deferred loan fees is suspended when a loan is placed on nonaccrual status. Subsequent cash receipts are applied either to the outstanding principal balance or recorded as interest income, depending on management’s assessment of the ultimate collectability of principal and interest. Loans are returned to accrual status when we assess that the borrower has the ability to make all principal and interest payments in accordance with the terms of the loan (i.e. a consistent repayment record, generally six consecutive payments, has been demonstrated).
Unless loans are well-secured and collection is imminent, for loans greater than 90 days past due their respective reserves are generally charged off once the loss has been confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged off and expected to be charged off.
Securities
Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date.
Securities classified as available-for-sale are those securities that the Corporation intends to hold for an indefinite period of time but not necessarily to maturity. Securities available-for-sale are carried at fair value. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movement in interest rates, changes in maturity mix of the Corporation’s assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Unrealized gains and losses are reported as increases or decreases in other comprehensive income. Gains or losses on disposition are based on the net proceeds and cost of the securities sold, adjusted for the amortization of premiums and accretion of discounts, using the specific identification method.
Securities classified as held to maturity are those debt securities the Corporation has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for the amortization of premium and accretion of discount, computed on a level yield basis.
Investments in equity securities are recorded in accordance with ASC 321-10, Investments - Equity Securities. Equity securities are carried at fair value, with changes in fair value reported in net income. At March 31, 2023 and December 31, 2022, investments in equity securities consisted of an investment in mutual funds with a fair value of $2.1 million, and $2.1 million, respectively.
The Corporation’s accounting policy specifies that (a) if the Corporation does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired, unless there is a credit loss. When the Corporation does not intend to sell the security, and it is more likely than not, the Corporation will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. The Corporation did not recognize any other-than-temporary impairment charges during the quarters ended March 31, 2023 and 2022.
Allowance for Credit Losses - Held-to-Maturity Debt Securities
We follow Accounting Standards Codification (ASC) 326-20, Financial Instruments - Credit Loss - Measured at Amortized Cost, to measure expected credit losses on held-to-maturity debt securities on a collective basis by security investment grade. The estimate of expected credit losses considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts.
The Corporation classifies the held-to-maturity debt securities into the following major security types: state and municipal securities. These securities are highly rated with a history of no credit losses, and are assigned ratings based on the most recent data from ratings agencies depending on the availability of data for the security. Credit ratings of held-to-maturity debt securities, which are a significant input in calculating the expected credit loss, are reviewed on a quarterly basis.
Accrued interest receivable on held-to-maturity debt securities is excluded from the estimate of credit losses and is included in Accrued interest receivable on the Consolidated Balance Sheets.
Allowance for Credit Losses - Available-for-Sale Debt Securities
We follow ASC 326-30, Financial Instruments - Credit Loss - Available-for-Sale Debt Securities, which provides guidance related to the recognition of and expanded disclosure requirements for expected credit losses on available-for-sale debt securities. For available-for-sale debt securities in an unrealized loss position, the Corporation first evaluates whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either criteria is met, the security's amortized cost basis is reduced to fair value and recognized as a reduction to Noninterest income in the Consolidated Statements of Income.
For debt securities available-for-sale which the Corporation does not intend to sell, or it is not likely the security would be required to be sold before recovery, we evaluate whether a decline in fair value has resulted from credit losses or other adverse factors, such as a change in the security's credit rating. In assessing whether a credit loss exists, the Corporation compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance is recorded, limited to the fair value of the security.
Management performs this analysis on a quarterly basis to review the conditions and risks associated with the individual securities. Credit losses on an impaired security shall continue to be measured using the present value of expected future cash flows. Any impairment not recorded through an allowance for credit loss is included in other comprehensive income (loss), net of the tax effect. We are required to use our judgment in determining impairment in certain circumstances.
For additional detail regarding debt securities, see Note 3.
Unfunded Lending Commitments
For unfunded lending commitments, the Corporation estimates expected credit losses over the contractual period in which the Corporation is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Corporation. The estimate includes consideration of the probability of default and utilization rate at default to calculate expected credit losses on commitments expected to be funded over its estimated life of one year, based on historical losses, and qualitative adjustment factors.
The allowance for credit losses for off-balance sheet exposures is included in Other liabilities on the Consolidated Balance Sheets and the provision for credit losses for off-balance sheet exposure is included in the provision for credit losses on the Consolidated Statements of Income. The allowance for credit losses for off-balance sheet exposures was $1.4 million and $173 thousand as of March 31, 2023 and December 31, 2022, respectively.
Pronouncements Adopted in 2023
FASB ASU 2016-13 (Topic 326), “Measurement of Credit Losses on Financial Instruments”
The Corporation adopted ASU 2016-13, as amended, on January 1, 2023, which replaced the incurred loss methodology with an expected loss methodology that is referred to as the CECL methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loans, net of fees and costs, securities HTM,
unfunded lending commitments (including loan commitments on loans held for investment, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor in accordance with Topic 842. In addition, ASC 326 made changes to the accounting for securities AFS which now requires credit losses to be presented as an allowance rather than as an other-than-temporary impairment on securities AFS management does not intend to sell or believes that it is more likely than not they will be required to sell.
We applied the modified retrospective method for all financial assets measured at amortized cost and securities AFS. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Corporation recorded a one-time decrease to retained earnings of $2.2 million on January 1, 2023 for the cumulative effect of adopting ASC 326, net of tax. The transition adjustment includes $1.2 million and $974 thousand post-tax impacts for loans, net of fees and costs and unfunded loan commitments, respectively, due to higher expected credit losses compared to the incurred loss methodology primarily driven by longer duration commercial and consumer real estate loans.
The impact of the change from the incurred loss model to the current expected credit loss model is detailed below.
| | | | | | | | | | | | | | | | | | | | |
| | January 1, 2023 |
(dollars in thousands) | | Pre-adoption | | Adoption Impact | | As Reported |
Assets: | | | | | | |
ACL on loans and leases: | | | | | | |
Commercial mortgage | | $ | 4,095 | | | $ | (526) | | | $ | 3,569 | |
Home equity lines and loans | | 188 | | | 439 | | | 627 | |
Residential mortgage | | 948 | | | 17 | | | 965 | |
Construction | | 3,075 | | | (1,763) | | | 1,312 | |
Commercial and industrial | | 4,012 | | | (1,023) | | | 2,989 | |
Small business loans | | 4,909 | | | 1,110 | | | 6,019 | |
Consumer | | 3 | | | (3) | | | — | |
Leases, net | | 1,598 | | | 3,345 | | | 4,943 | |
Total ACL on loans and leases | | $ | 18,828 | | | $ | 1,596 | | | $ | 20,424 | |
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Liabilities: | | | | | | |
Reserve for unfunded commitments | | $ | 173 | | | $ | 1,256 | | | $ | 1,429 | |
FASB ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments”
Issued in April 2019, ASU 2019-04 clarifies certain aspects of accounting for credit losses, hedging activities, and financial instruments (addressed by ASUs 2016-13, 2017-12, and 2016-01, respectively). The amendments to estimating expected credit losses (ASU 2016-13), in particular, how a company considers recoveries and extension options when estimating expected credit losses, are the most relevant to the Corporation. The ASU clarifies that (1) the estimate of expected credit losses should include expected recoveries of financial assets, including recoveries of amounts expected to be written off and those previously written off, and (2) that contractual extension or renewal options that are not unconditionally cancellable by the lender are considered when determining the contractual term over which expected credit losses are measured. The Corporation adopted ASU 2019-04 at the same time ASU 2016-13 was adopted.
FASB ASU 2022-02, "Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures."
In March 2022, the FASB issued ASU No. 2022-02, "Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures." The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted CECL and enhance the disclosure requirements for modifications of receivables made with borrowers experiencing financial difficulty. In addition, the amendments require disclosure of current period gross write-offs by year of origination for financing receivables and net investment in leases in the existing vintage disclosures. The Corporation adopted ASU 2022-02 at the same time
ASU 2016-13 was adopted, as of January 1, 2023. The adoption of this ASU resulted in updated disclosures within our financial statements but otherwise did not have a material impact on the Corporation's financial statements.
Pronouncements Not Yet Effective as of March 31, 2023:
FASB ASU 2020-04 (Topic 848), “Reference Rate Reform (“ASC 848”): Facilitation of the Effects of Reference Rate Reform on Financial Reporting”
Issued in March 2020, ASU 2020-04 contains optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The Corporation does not have a significant concentration of loans, derivative contracts, borrowings or other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. The Corporation expects to adopt the LIBOR transition relief allowed under this standard.
FASB ASU 2020-06, “Debt With Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity”
This ASU clarifies the accounting for certain financial instruments with characteristics of liabilities and equity. The amendments in this update reduce the number of accounting models for convertible debt instruments and convertible preferred stock by removing the cash conversion model and the beneficial conversion feature models. For public business entities that meet the definition of an SEC filer (excluding smaller reporting entities), the amendments are effective for fiscal years beginning after Dec. 15, 2021, and interim periods within. For all other entities, the amendments are effective for fiscal years beginning after Dec. 15, 2023, and interim periods within. Early adoption is permitted, but no earlier than for fiscal years beginning after Dec. 15, 2020. The Corporation does not expect this to have a material impact on our consolidated financial statements.
(2) Earnings per Common Share
Basic earnings per common share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period reduced by unearned ESOP Plan shares and treasury shares. Diluted earnings per common share takes into account the potential dilution computed pursuant to the treasury stock method that could occur if stock options were exercised and converted into common stock and if restricted stock awards were vested, and SERP plan liabilities were satisfied with common shares. The effects of stock options are excluded from the computation of diluted earnings per share in periods in which the effect would be anti-dilutive.
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| Three months ended March 31, | | |
(dollars in thousands, except per share data) | 2023 | | 2022 | | | | |
Numerator for earnings per share: | | | | | | | |
Net income available to common stockholders | $ | 4,021 | | | $ | 5,535 | | | | | |
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Denominators for earnings per share: | | | | | | | |
Weighted average shares outstanding | 11,456 | | | 12,256 | | | | | |
Average unearned ESOP shares | (184) | | | (210) | | | | | |
Basic weighted averages shares outstanding | 11,272 | | | 12,046 | | | | | |
Dilutive effects of assumed exercises of stock options | 230 | | | 346 | | | | | |
Dilutive effects of SERP shares | 154 | | | 132 | | | | | |
Diluted weighted averages shares outstanding | 11,656 | | | 12,524 | | | | | |
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Basic earnings per share | $ | 0.36 | | | $ | 0.46 | | | | | |
Diluted earnings per share | $ | 0.34 | | | $ | 0.44 | | | | | |
Antidilutive shares excluded from computation of average dilutive earnings per share | 463 | | | 42 | | | | | |
(3) Securities
The following tables presents the amortized cost, allowance for credit losses, and fair value of securities at the dates indicated:
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| March 31, 2023 |
(dollars in thousands) | Amortized cost | | Gross unrealized gains | | Gross unrealized losses | | Allowance for Credit Losses | | Fair value | | # of Securities in unrealized loss position |
Securities available-for-sale: | | | | | | | | | | | |
U.S. asset backed securities | $ | 17,676 | | | $ | 166 | | | $ | (250) | | | $ | — | | | $ | 17,592 | | | 14 | |
U.S. government agency MBS | 12,192 | | | 12 | | | (467) | | | — | | | 11,737 | | | 10 | |
U.S. government agency CMO | 27,059 | | | 66 | | | (2,003) | | | — | | | 25,122 | | | 30 | |
State and municipal securities | 44,514 | | | 11 | | | (4,732) | | | — | | | 39,793 | | | 32 | |
U.S. Treasuries | 32,981 | | | — | | | (2,917) | | | — | | | 30,064 | | | 25 | |
Non-U.S. government agency CMO | 11,808 | | | 7 | | | (706) | | | — | | | 11,109 | | | 12 | |
Corporate bonds | 8,201 | | | — | | | (685) | | | — | | | 7,516 | | | 12 | |
Total securities available-for-sale | $ | 154,431 | | | $ | 262 | | | $ | (11,760) | | | $ | — | | | $ | 142,933 | | | 135 | |
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Securities held-to-maturity: | | | | | | | | | | | |
State and municipal securities | $ | 36,525 | | | $ | 11 | | | $ | (3,460) | | | $ | — | | | $ | 33,076 | | | 22 | |
Total securities held-to-maturity | $ | 36,525 | | | $ | 11 | | | $ | (3,460) | | | $ | — | | | $ | 33,076 | | | 22 | |
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| December 31, 2022 |
(dollars in thousands) | Amortized cost | | Gross unrealized gains | | Gross unrealized losses | | Fair value | | # of Securities in unrealized loss position |
Securities available-for-sale: | | | | | | | | | |
U.S. asset backed securities | $ | 15,581 | | | $ | 14 | | | $ | (314) | | | $ | 15,281 | | | 12 | |
U.S. government agency MBS | 12,272 | | | 5 | | | (538) | | | 11,739 | | | 12 | |
U.S. government agency CMO | 25,520 | | | 40 | | | (2,242) | | | 23,318 | | | 29 | |
State and municipal securities | 44,700 | | | — | | | (5,862) | | | |