UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

For the Quarter Ended June 30, 2018

OR

For the transition period from              to                 

Commission File No. 001-16197

PEAPACK-GLADSTONE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

500 Hills Drive, Suite 300

Bedminster, New Jersey 07921-0700

(Address of principal executive offices, including zip code)

(908) 234-0700

(Registrant’s telephone number, including area code)

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 requirement for the past 90 days.

Yes ☒ No ☐.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 or Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☒ No ☐

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

 

 

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 ☒

Number of shares of Common Stock outstanding as of August 1, 2018:

19,011,212

 

 

 

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PEAPACK-GLADSTONE FINANCIAL CORPORATION

PART 1 FINANCIAL INFORMATION

 

 

 

PART 2 OTHER INFORMATION

 

 

 

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Item 1. Financial Statements (Unaudited)

PEAPACK-GLADSTONE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CONDITION

(Dollars in thousands, except share and per share data)

 

 

See accompanying notes to consolidated financial statements

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PEAPACK-GLADSTONE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except share data)

(Unaudited)

 

 

See accompanying notes to consolidated financial statements

 

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PEAPACK-GLADSTONE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

(Unaudited)

 

 

See accompanying notes to consolidated financial statements

 

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PEAPACK-GLADSTONE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in thousands)

(Unaudited)

Six Months Ended June 30, 2018

 

 

See accompanying notes to consolidated financial statements

 

 

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PEAPACK-GLADSTONE FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

 

See accompanying notes to consolidated financial statements

 

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PEAPACK-GLADSTONE FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Certain information and footnote disclosures normally included in the audited consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the period ended December 31, 2017 for Peapack-Gladstone Financial Corporation (the “Corporation” or the “Company”). In the opinion of the management of the Corporation, the accompanying unaudited Consolidated Interim Financial Statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position as of June 30, 2018, the results of operations and comprehensive income for the three and six months ended June 30, 2018 and 2017, shareholders’ equity for the six months ended June 30, 2018 and cash flow statements for the six months ended June 30, 2018 and 2017. The results of operations for the three and six months ended June 30, 2018 are not necessarily indicative of the results that may be expected for any future period.

Principles of Consolidation and Organization: The consolidated financial statements of the Company are prepared on the accrual basis and include the accounts of the Company and its wholly-owned subsidiary, Peapack-Gladstone Bank (the “Bank”). The consolidated statements also include the Bank’s wholly-owned subsidiaries, PGB Trust & Investments of Delaware, Peapack Capital Corporation (formed in the second quarter of 2017), Murphy Capital Management (“MCM”) (acquired in the third quarter of 2017), Quadrant Capital Management (“Quadrant”) (acquired in the fourth quarter of 2017), Peapack-Gladstone Mortgage Group, Inc. and Peapack-Gladstone Mortgage Group’s wholly-owned subsidiary, PG Investment Company of Delaware, Inc. and its wholly-owned subsidiary, Peapack-Gladstone Realty, Inc., a New Jersey real estate investment company. While the following footnotes include the collective results of the Company and the Bank, these footnotes primarily reflect the Bank’s and its subsidiaries’ activities. All significant intercompany balances and transactions have been eliminated from the accompanying consolidated financial statements.

Basis of Financial Statement Presentation: The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. In preparing the financial statements, Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the statement of condition and revenues and expenses for that period. Actual results could differ from those estimates.

Segment Information:  The Company’s business is conducted through two business segments: its banking subsidiary, which involves the delivery of loan and deposit products to customers and the Private Wealth Management Division, which includes asset management and other services provided for individuals and institutions. Management uses certain methodologies to allocate income and expense to the business segments.

The Banking segment includes commercial (includes C&I and equipment financing), commercial real estate, multifamily, residential and consumer lending activities; deposit generation; operation of ATMs; telephone and internet banking services; merchant credit card services and customer support services.

Peapack-Gladstone Bank’s Private Wealth Management Division includes: asset management services provided for individuals and institutions; personal trust services, including services as executor, trustee, administrator, custodian and guardian; corporate trust services including services as trustee for pension and profit sharing plans; and other financial planning and advisory services. This segment also includes the activities of PGB Trust and Investments of Delaware, MCM and Quadrant.  Income is recognized as it is earned.

Cash and Cash Equivalents:  For purposes of the statements of cash flows, cash and cash equivalents include cash and due from banks, interest-earning deposits and federal funds sold. Generally, federal funds are sold for one-day periods.  Cash equivalents are of original maturities of 90 days or less. Net cash flows are reported for customer loan and deposit transactions and overnight borrowings.

Interest-Earning Deposits in Other Financial Institutions: Interest-earning deposits in other financial institutions mature within one year and are carried at cost.

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Securities: All securities are classified as available for sale and are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax, with the exception of the Company’s investment in a CRA investment fund, which is classified as an equity security.  In accordance with ASU 2016-01, “Financial Instruments” (adopted January 1, 2018) unrealized holding gains and losses on equity securities are marked to market through the income statement.

Interest income includes amortization of purchase premiums and discounts. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated and premiums on callable debt securities will be amortized to the earliest call date. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

Management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market conditions warrant. For securities in an unrealized loss position, Management considers the extent and duration of the unrealized loss and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) other-than-temporary impairment related to credit loss, which must be recognized in the income statement and 2) other-than-temporary impairment related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.

Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB) Stock:  The Bank is a member of the FHLB system. Members are required to own a certain amount of FHLB stock, based on the level of borrowings and other factors. FHLB stock is carried at cost, classified as a restricted security and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

The Bank is also a member of the Federal Reserve Bank System and required to own a certain amount of FRB stock. FRB stock is carried at cost and classified as a restricted security. Both cash and stock dividends are reported as income.

Loans Held for Sale:  Mortgage loans originated with the intent to sell in the secondary market are carried at fair value, as determined by outstanding commitments from investors.

Mortgage loans held for sale are generally sold with servicing rights released; therefore, no servicing rights are recorded. Gains and losses on sales of mortgage loans, shown as gain on sale of loans at fair value on the Statements of Income, are based on the difference between the selling price and the fair value of the related loan sold.

SBA loans originated with the intent to sell in the secondary market are carried at the lower of cost or fair value. SBA loans are generally sold with the servicing rights retained. Gains and losses on the sale of SBA loans are based on the difference between the selling price and the carrying value of the related loan sold.  Total SBA loans serviced totaled $27.8 million and $20.1 million as of June 30, 2018 and December 31, 2017, respectively.  SBA loans held for sale totaled $3.0 million and $187 thousand at June 30, 2018 and December 31, 2017, respectively.

Loans originated with the intent to hold and subsequently transferred to loans held for sale are carried at the lower of cost or fair value. These are loans that the Company no longer has the intent to hold for the foreseeable future.

Loans:  Loans that Management has the intent and ability to hold for the foreseeable future or until maturity are stated at the principal amount outstanding. Interest on loans is recognized based upon the principal amount outstanding. Loans are stated at face value, less purchased premium and discounts and net deferred fees. Loan origination fees and certain direct loan origination costs are deferred and recognized on a level-yield method, over the life of the loan as an adjustment to the loan’s yield. The definition of recorded investment in loans includes accrued interest receivable and deferred fees/cost, however, for the Company’s loan disclosures, accrued interest and deferred fees/cost was excluded as the impact was not material.

Loans are considered past due when they are not paid within 30 days in accordance with contractual terms. The accrual of income on loans, including impaired loans, is discontinued if, in the opinion of Management, principal or interest is not likely to be paid in accordance with the terms of the loan agreement, or when principal or interest is past due 90 days or more and collateral, if any, is insufficient to cover principal and interest. All interest accrued but not received for loans placed on nonaccrual are reversed against interest income. Payments received on nonaccrual loans are recorded as principal payments. A nonaccrual loan is returned to accrual status only when interest and principal payments are brought current and future payments are reasonably assured, generally when the Bank receives contractual payments for a minimum of six months. Commercial loans are generally charged off after an analysis is completed which indicates that collectability of the full principal balance is in doubt. Consumer loans are generally charged off after they become 120 days past due. Subsequent payments are credited to income only if collection of

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principal is not in doubt. If principal and interest payments are brought contractually current and future collectability is reasonably assured, loans are returned to accrual status. Nonaccrual mortgage loans are generally charged off when the value of the underlying collateral does not cover the outstanding principal balance. The majority of the Company’s loans are secured by real estate in New Jersey and New York.

Allowance for Loan and Lease Losses: The allowance for loan and lease losses is a valuation allowance for credit losses that is management’s estimate of losses in the loan portfolio.  The process to determine reserves utilizes analytic tools and management judgement and is reviewed on a quarterly basis. When Management is reasonably certain that a loan balance is not fully collectable, an impairment analysis is completed whereby a specific reserve may be established or a full or partial charge off is recorded against the allowance.  Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the size and composition of the portfolio, information about specific borrower situations, estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans via a specific reserve, but the entire allowance is available for any loan that, in Management’s judgment, should be charged off.

The allowance consists of specific and general components. The specific component of the allowance relates to loans that are individually classified as impaired.

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors considered by Management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Loans are individually evaluated for impairment when they are classified as substandard by Management. If a loan is considered impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or if repayment is expected solely from the underlying collateral, the loan principal balance is compared to the fair value of collateral less estimated disposition costs to determine the need, if any, for a charge off.

A troubled debt restructuring (“TDR”) is a modified loan with concessions made by the lender to a borrower who is experiencing financial difficulty. TDRs are impaired and are generally measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a TDR is a collateral dependent loan, the loan is reported, net, of the fair value of the collateral, less estimated disposition costs. For TDRs that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan and lease losses.

The general component of the allowance covers non-impaired loans and is based primarily on the Bank’s historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experience by the Company on a weighted average basis over the previous three years. This actual loss experience is adjusted by other qualitative factors based on the risks present for each portfolio segment. These qualitative factors include consideration of the following:  levels of and trends in delinquencies and impaired loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures and practices; ability and depth of lending management and other relevant staffing and experience; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.  For loans that are graded as non-impaired, the Company allocates a higher general reserve percentage than pass-rated loans using a multiple that is calculated annually through a migration analysis.  At June 30, 2018 and at December 31, 2017, the multiple was 3.50 times for non-impaired substandard loans and 2.25 times for non-impaired special mention loans.

In determining an appropriate amount for the allowance, the Bank segments and evaluates the loan portfolio based on Federal call report codes, which are based on collateral or purpose. The following portfolio classes have been identified:

Primary Residential Mortgages.  The Bank originates one to four family residential mortgage loans in the Tri-State area (New York, New Jersey and Connecticut), Pennsylvania and Florida.  Loans are secured by first liens on the primary residence or investment property.  Primary risk characteristics associated with residential mortgage loans typically involve major living or lifestyle changes to the borrower, including unemployment or other loss of income; unexpected significant expenses, such as for major medical issues or catastrophic events; and divorce or death. In addition, residential mortgage loans that have adjustable rates could expose the borrower to higher debt service requirements in a rising interest rate environment. Further, real estate values could drop significantly and cause the value of the property to fall below the loan amount, creating additional potential exposure for the Bank.

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Home Equity Lines of Credit.  The Bank provides revolving lines of credit against one to four family residences in the Tri-State area. Primary risk characteristics associated with home equity lines of credit typically involve major living or lifestyle changes to the borrower, including unemployment or other loss of income; unexpected significant expenses, such as for major medical issues or catastrophic events; and divorce or death. In addition, home equity lines of credit typically are made with variable or floating interest rates, which could expose the borrower to higher debt service requirements in a rising interest rate environment. Further, real estate values could drop significantly and cause the value of the property to fall below the loan amount, creating additional potential exposure for the Bank.

Junior Lien Loan on Residence.  The Bank provides junior lien loans (“JLL”) against one to four family properties in the Tri-State area. JLLs can be either in the form of an amortizing home equity loan or a revolving home equity line of credit. These loans are subordinate to a first mortgage which may be from another lending institution. Primary risk characteristics associated with JLLs typically involve major living or lifestyle changes to the borrower, including unemployment or other loss of income; unexpected significant expenses, such as for major medical issues or catastrophic events; and divorce or death. Further, real estate values could drop significantly and cause the value of the property to fall below the loan amount, creating additional potential exposure for the Bank.

Multifamily and Commercial Real Estate Loans.  The Bank provides mortgage loans for multifamily properties (i.e. buildings which have five or more residential units) and other commercial real estate that is either owner occupied or managed as an investment property (non-owner occupied) in the Tri-State area and Pennsylvania. Commercial real estate properties primarily include retail buildings/shopping centers, hotels, office/medical buildings and industrial/warehouse space. Some properties are considered “mixed use” as they are a combination of building types, such as a building with retail space on the ground floor and either residential apartments or office suites on the upper floors. Multifamily loans are expected to be repaid from the cash flows of the underlying property so the collective amount of rents must be sufficient to cover all operating expenses, property management and maintenance, taxes and debt service. Increases in vacancy rates, interest rates or other changes in general economic conditions can have an impact on the borrower and its ability to repay the loan. Commercial real estate loans are generally considered to have a higher degree of credit risk than multifamily loans as they may be dependent on the ongoing success and operating viability of a fewer number of tenants who are occupying the property and who may have a greater degree of exposure to economic conditions.

Commercial and Industrial Loans. The Bank provides lines of credit and term loans to operating companies for business purposes. The loans are generally secured by business assets such as accounts receivable, inventory, business vehicles and equipment as well as the stock of the company if privately held.  Commercial and industrial loans are typically repaid first by the cash flows generated by the borrower’s business operation. The primary risk characteristics are specific to the underlying business and its ability to generate sustainable profitability and resulting positive cash flow. Factors that may influence a business’s profitability include, but are not limited to, demand for its products or services, quality and depth of management, degree of competition, regulatory changes, and general economic conditions. Commercial and industrial loans are generally secured by business assets; however, the ability of the Bank to foreclose and realize sufficient value from the assets is often highly uncertain. To mitigate the risk characteristics of commercial and industrial loans, these loans often include commercial real estate as collateral to strengthen the Bank’s position and the Bank will often require more frequent reporting requirements from the borrower in order to better monitor its business performance.

Leasing and Equipment Finance.  Peapack Capital Corporation (“PCC”), a subsidiary of the Bank, offers a range of finance solutions nationally. PCC provides term loans and leases secured by assets financed for U.S. based mid-size and large companies. Facilities tend to be fully drawn under fixed rate terms. PCC serves a broad range of industries including transportation, manufacturing, heavy construction and utilities.

Asset risk in PCC’s portfolio is generally recognized through changes to loan income, or though changes to lease related income streams due to fluctuations in lease rates.  Changes to lease income can occur when the existing lease contract expires, the asset comes off lease or the business seeks to enter a new lease agreement.  Asset risk may also change depreciation, resulting from changes in the residual value of the operating lease asset or through impairment of the asset carrying value, which can occur at any time during the life of the asset.

Credit risk in PCC’s portfolio generally results from the potential default of borrowers or lessees, which may be driven by customer specific or broader industry related conditions.  Credit losses can impact multiple parts of the income statement including loss of interest/lease/rental income and/or via higher costs and expenses related to the repossession, refurbishment, re-marketing and or re-leasing of assets.

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Consumer and Other.  These are loans to individuals for household, family and other personal expenditures as well as obligations of states and political subdivisions in the U.S. This also represents all other loans that cannot be categorized in any of the previous mentioned loan segments.

Derivatives:  At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to likely effectiveness as a hedge. These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation.  For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item, are recognized in current earnings as fair values change. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. For both types of hedges, changes in the fair value of derivatives that are not highly effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as non-interest income.

Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in non-interest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.

The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship.  This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions.  The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminated, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.

When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as non-interest income.  When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.

Stock-Based Compensation: The Company’s 2006 Long-Term Stock Incentive Plan and 2012 Long-Term Stock Incentive Plan allow the granting of shares of the Company’s common stock as incentive stock options, nonqualified stock options, restricted stock awards, restricted stock units and stock appreciation rights to directors, officers and employees of the Company and its subsidiaries. The options granted under these plans are, in general, exercisable not earlier than one year after the date of grant, at a price equal to the fair value of common stock on the date of grant, and expire not more than ten years after the date of grant. Stock options may vest during a period of up to five years after the date of grant.  Some options granted to officers at or above the senior vice president level were immediately exercisable at the date of grant.  The Company has a policy of using authorized but unissued shares to satisfy option exercises.

Upon adoption of Accounting Standards Update (“ASU”) 2016-09, “Compensation - Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting,” the Company has elected to account for forfeitures as they occur, rather than estimate expected forfeitures.

For the three and six months ended June 30, 2018, there was no unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s stock incentive plans.  For the three months ended June 30, 2017, the Company recorded less than $1 thousand of unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s stock incentive plans. There was no recognized tax benefit for the quarter ended June 30, 2017.  The Company recorded total compensation cost for stock options for the six months ended June 30, 2017 of $6 thousand. There was no recognized tax benefit for the six months ended June 30, 2017.  

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For the Company’s stock option plans, changes in options outstanding during the six months ended June 30, 2018 were as follows:

 

 

The aggregate intrinsic value represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the second quarter of 2018 and the exercise price, multiplied by the number of in-the-money options). The Company’s closing stock price on June 30, 2018 was $34.59.

There were no stock options granted in the three or six months ended June 30, 2018.  

The Company has previously granted performance-based and service-based restricted stock awards/units. Service-based awards/units vest ratably over a , three or five-year period.  There were 2,836 restricted stock units granted in the second quarter of 2018.

The performance-based awards that were granted in previous periods are dependent upon the Company meeting certain performance criteria and cliff vest at the end of the performance period.  During the fourth quarter of 2015, the Company concluded that the performance targets will no longer be met.  The Company did not meet the performance criteria by the end of the performance period at end of year 2017.  Therefore, as of March 31, 2018, the Company forfeited 92,767 performance-based awards.

Changes in non-vested shares dependent on performance criteria for the six months ended June 30, 2018 were as follows:

 

 

Changes in service based restricted stock awards/units for the six months ended June 30, 2018 were as follows:

 

 

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As of June 30, 2018, there was $293 thousand of total unrecognized compensation cost related to service-based awards.  That cost is expected to be recognized over a weighted average period of 0.46 years.  As of June 30, 2018, there was $9.3 million of total unrecognized compensation cost related to service-based units.  That cost is expected to be recognized over a weighted average period of 1.34 years. Stock compensation expense recorded for the second quarters of 2018 and 2017 totaled $1.3 million and $837 thousand, respectively. Stock compensation expense recorded for the six months ended June 30, 2018 and 2017 totaled $2.4 million and $1.7 million, respectively.

Employee Stock Purchase Plan (“ESPP”): The ESPP provides for the granting of rights to purchase up to 150,000 shares of Corporation common stock. Subject to certain eligibility requirements and restrictions, the ESPP allows employees to purchase shares during four three-month offering periods (“Offering Periods”).  Each participant in the Offering Period is granted an option to purchase a number of shares and may contribute between 1% and 15% of their compensation.  At the end of each Offering Period on the purchase date, the number of shares to be purchased by the employee is determined by dividing the employee’s contributions accumulated during the Offering Period by the applicable purchase price.  The purchase price is an amount equal to 85% of the closing market price of a share of Company common stock on the purchase date.  Participation in the ESPP is voluntary and employees can cancel their purchases at any time during the Offering Period without penalty.  The fair value of each share purchase right is determined using the Black-Scholes option pricing model.  

The Company recorded $59 thousand and $43 thousand of expense in salaries and employee benefits expense for the three months ended June 30, 2018 and 2017, respectively, related to the ESPP.  Total shares issued under the ESPP during the second quarters of 2018 and 2017 were 9,127 and 7,499, respectively.

The Company recorded $112 thousand and $73 thousand of expense in salaries and employee benefits expense for the six months ended June 30, 2018 and 2017, respectively related to the ESPP.  Total shares issued under the ESPP for the six months ended June 30, 2018 and 2017 were 15,490 and 12,833, respectively.  

Earnings per share – Basic and Diluted:  The following is a reconciliation of the calculation of basic and diluted earnings per share. Basic net income per share is calculated by dividing net income available to shareholders by the weighted average shares outstanding during the reporting period. Diluted net income per share is computed similarly to that of basic net income per share, except that the denominator is increased to include the number of additional shares that would have been outstanding utilizing the Treasury Stock Method if all shares underlying potentially dilutive stock options were issued and all restricted stock, stock warrants or restricted stock units were to vest during the reporting period.

 

 

As of June 30, 2018, and June 30, 2017, all stock options and warrants were included in the computation of diluted earnings per share because they were all dilutive, meaning that the exercise price of the stock option was greater than the average market price for the period.  

Income Taxes:  The Company files a consolidated Federal income tax return. Separate state income tax returns are filed for each subsidiary based on current laws and regulations.

The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in its financial statements or tax returns. The measurement of deferred tax assets and liabilities is based on the enacted tax rates. Such tax assets and liabilities are adjusted for the effect of a change in tax rates in the period of enactment.

The Company recognizes a tax position as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50 percent likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

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The Company is no longer subject to examination by the U.S. Federal tax authorities for years prior to 2014 or by New Jersey tax authorities for years prior to 2013.  

The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are any such matters that will have a material effect on the financial statements.

Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank was required to meet regulatory reserve and clearing requirements.

Comprehensive Income: Comprehensive income consists of net income and the change during the period in the Company’s net unrealized gains or losses on securities available for sale and unrealized gains and losses on cash flow hedge, net of tax, less adjustments for realized gains and losses.

Transfers of Financial Assets:  Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished.  Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Goodwill and Other Intangible Assets:  Goodwill is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree (if any), over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.  Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed. The Company has selected September 30 as the date to perform the annual impairment test.  Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill and assembled workforce are the intangible assets with an indefinite life on our balance sheet.

Other intangible assets which primarily consist of customer relationship intangible assets arising from acquisition, are amortized on an accelerated method over their estimated useful lives, which range from 5 to 15 years.

2.  INVESTMENT SECURITIES

A summary of amortized cost and approximate fair value of investment securities available for sale included in the consolidated statements of condition as of June 30, 2018 and December 31, 2017 follows:

 

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The following tables present the Corporation’s available for sale securities with continuous unrealized losses and the approximate fair value of these investments as of June 30, 2018 and December 31, 2017.

 

 

 

Management believes that the unrealized losses on investment securities available for sale are temporary and are due to interest rate fluctuations and/or volatile market conditions rather than the creditworthiness of the issuers.  As of June 30, 2018, the Company does not intend to sell these securities nor is it likely that it will be required to sell the securities before their anticipated recovery; therefore, none of the securities in an unrealized loss position were determined to be other-than-temporarily impaired.

During the first quarter of 2018, the Company adopted ASU 2016-01 “Financial Instruments” which resulted in the reclassification of the Company’s investment in the CRA investment fund from available for sale to equity securities, which resulted in a loss of $36 thousand and $114 thousand for the three months and six months ended June 30, 2018.  This amount is included in securities losses on the Consolidated Statements of Income.

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3.  LOANS

Loans outstanding, excluding those held for sale, by general ledger classification, as of June 30, 2018 and December 31, 2017, consisted of the following:

 

 

In determining an appropriate amount for the allowance, the Bank segments and evaluates the loan portfolio based on federal call report codes.  The following portfolio classes have been identified as of June 30, 2018 and December 31, 2017:

 

 

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The following tables present the loan balances by portfolio class, based on impairment method, and the corresponding balances in the allowance for loan and lease losses (ALLL) as of June 30, 2018 and December 31, 2017:

 

 

 

Impaired loans include nonaccrual loans of $12.0 million at June 30, 2018 and $13.5 million at December 31, 2017. Impaired loans also include performing TDR loans of $18.7 million at June 30, 2018 and $9.5 million at December 31, 2017.  At June 30, 2018, the allowance allocated to TDR loans totaled $1.5 million, of which $1.4 million was allocated to nonaccrual loans.  At December 31, 2017, the allowance allocated to TDR loans totaled $423 thousand of which $173 thousand was allocated to nonaccrual loans.  All accruing TDR loans were paying in accordance with restructured terms as of June 30, 2018.  The Company has not committed to lend additional amounts as of June 30, 2018 to customers with outstanding loans that are classified as TDR loans.

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The following tables present loans individually evaluated for impairment by class of loans as of June 30, 2018 and December 31, 2017 (The average impaired loans on the following tables represent year to date impaired loans.):

 

 

 

Interest income recognized on impaired loans for the quarters ended June 30, 2018 and 2017 was not material.  The Company did not recognize any income on nonaccruing impaired loans for the three and six months ended June 30, 2018 and 2017.

The following tables present the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of June 30, 2018 and December 31, 2017:

 

 

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The following tables present the aging of the recorded investment in past due loans as of June 30, 2018 and December 31, 2017 by class of loans, excluding nonaccrual loans:

 

 

 

Credit Quality Indicators:

The Company places all commercial loans into various credit risk rating categories based on an assessment of the expected ability of the borrowers to properly service their debt.  The assessment considers numerous factors including, but not limited to, debt service capacity, current financial information on the borrower, historical payment experience, strength of any guarantor, nature of and value of any collateral, acceptability of the loan structure and documentation, relevant public information and current economic trends.  This credit risk rating analysis is performed when the loan is initially underwritten and then annually based on set criteria in the loan policy.  

In addition, the Bank has engaged an independent loan review firm to validate risk ratings and to ensure compliance with our policies and procedures.  This review of the following types of loans is performed quarterly:

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The Company uses the following regulatory definitions for criticized and classified risk ratings:

Special Mention:  These loans have a potential weakness that deserves Management’s close attention.  If left uncorrected, the potential weaknesses may result in deterioration of the repayment prospects for the loans or of the institution’s credit position at some future date.

Substandard:  These loans are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful: These loans have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable, based on currently existing facts, conditions and values.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans.  

Loans that are considered to be impaired are individually evaluated for potential loss and allowance adequacy.  Loans not deemed impaired are collectively evaluated for potential loss and allowance adequacy.  

As of June 30, 2018, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

 

As of December 31, 2017, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

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At June 30, 2018, $25.8 million of substandard loans were also considered impaired compared to December 31, 2017, when $21.8 million of substandard loans were also impaired.

The activity in the allowance for loan and lease losses for the three months ended June 30, 2018 is summarized below:

 

 

The activity in the allowance for loan and lease losses for the three months ended June 30, 2017 is summarized below:

 

 

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The activity in the allowance for loan and lease losses for the six months ended June 30, 2018 is summarized below:

 

 

The activity in the allowance for loan and lease losses for the six months ended June 30, 2017 is summarized below:

 

 

Troubled Debt Restructurings:

The Company has allocated $1.5 million and $423 thousand of specific reserves on TDRs to customers whose loan terms have been modified in TDRs as of June 30, 2018 and December 31, 2017, respectively.  There were no unfunded commitments to lend additional amounts to customers with outstanding loans that are classified as TDRs.

The terms of certain loans were modified as TDRs when one or a combination of the following occurred:  a reduction of the stated interest rate of the loan was reduced; the maturity date was extended; or some other modification or extension occurred which would not be readily available in the market.

The following table presents loans by class modified as TDRs during the three-month period ended June 30, 2018:

 

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The following table presents loans by class modified as TDRs during the six-month period ended June 30, 2018:

 

The following table presents loans by class modified as TDRs during the three-month period ended June 30, 2017:

 

 

The following table presents loans by class modified as TDRs during the six-month period ended June 30, 2017:

 

 

The identification of the TDRs did not have a significant impact on the allowance for loan and lease losses.  

The following table presents loans by class modified as TDRs that failed to comply with the modified terms in the twelve months following modification and resulted in a payment default at June 30, 2018:

 

 

There were no loans that were modified as TDRs for which there was a payment default, within twelve months of modification, during the three and six months ended June 30, 2017.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification.  This evaluation is performed under the Company’s internal underwriting policy. The modification of the terms of such loans may include one or more of the following: (1) a reduction of the stated interest rate of the loan to a rate that is lower than the current market rate for new debt with similar risk; (2) an extension of an interest only period for a predetermined period of time; (3) an extension of the maturity date; or (4) an extension of the amortization period over which future payments will be computed.  At the time a loan is restructured, the Bank performs a full re-underwriting analysis, which includes, at a minimum, obtaining current financial statements and tax returns, copies of all leases, and an updated independent appraisal of the property. A loan will continue to accrue interest if it can be reasonably determined that the borrower should be able to perform under the modified terms, that the loan has not been chronically delinquent (both to debt service and real estate taxes) or in nonaccrual status since its inception, and that there have been no charge-offs on the loan.  Restructured loans with previous charge-offs would not accrue interest at the time of the TDR. At a minimum, six months of contractual payments would need to be made on a restructured loan before returning it to accrual status. Once a loan is classified as a TDR, the loan is reported as a TDR until the loan is paid in full, sold or charged-off.  In rare circumstances, a loan may be removed from TDR status if it meets the requirements of ASC 310-40-50-2.

 

4.  DEPOSITS

Certificates of deposit, excluding brokered certificates of deposit over $250,000, totaled $136.8 million and $160.0 million at June 30, 2018 and December 31, 2017, respectively.

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The following table sets forth the details of total deposits as of June 30, 2018 and December 31, 2017:

 

 

The scheduled maturities of certificates of deposit, including brokered certificates of deposit, as of June 30, 2018 are as follows:

 

 

5.  FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS

Advances from the FHLB totaled $52.9 million with a weighted average interest rate of 2.59 percent and $37.9 million with a weighted average interest rate of 2.20 percent at June 30, 2018 and December 31, 2017, respectively.

At June 30, 2018, advances totaling $52.9 million with a weighted average interest rate of 2.59 percent had fixed maturity dates. The fixed maturity date advances at December 31, 2017 totaled $28.9 million with a weighted average interest rate of 1.96 percent.  The fixed rate advances are secured by blanket pledges of certain 1-4 family residential mortgages totaling $504.0 million and multifamily mortgages totaling $1.1 billion at June 30, 2018, while at December 31, 2017, the fixed rate advances are secured by blanket pledges of certain 1-4 family residential mortgages totaling $550.0 million and multifamily mortgages totaling $1.1 billion.

At December 31, 2017, the Company had $9.0 million in variable rate advances, with a weighted average interest rate of 2.95 percent, that are noncallable for two or three years and then callable quarterly with final maturities of ten years from the original date of the advance. All of these advances are beyond their initial noncallable periods.

The final maturity dates of the FHLB advances are scheduled as follows:

 

 

There were overnight borrowings of $127.4 million as of June 30, 2018 with a weighted average rate of 2.08 percent at the FHLB.  There were no overnight borrowings as of December 31, 2017.  At June 30, 2018, unused short-term overnight borrowing commitments totaled $1.1 billion from FHLB, $22.0 million from correspondent banks and $913.7 million at the FRB.

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6.  BUSINESS SEGMENTS

The Corporation assesses its results among two operating segments, Banking and Peapack-Gladstone Bank’s Private Wealth Management Division. Management uses certain methodologies to allocate income and expense to the business segments. A funds transfer pricing methodology is used to assign interest income and interest expense.  Certain indirect expenses are allocated to segments. These include support unit expenses such as technology and operations and other support functions. Taxes are allocated to each segment based on the effective rate for the period shown.

Banking

The Banking segment includes commercial, commercial real estate, multifamily, residential and consumer lending activities; deposit generation; operation of ATMs; telephone and internet banking services; merchant credit card services and customer support and sales.

Private Wealth Management Division

Peapack-Gladstone Bank’s Private Wealth Management Division, including PGB Trust & Investments of Delaware, MCM and Quadrant, includes asset management services provided for individuals and institutions; personal trust services, including services as executor, trustee, administrator, custodian and guardian; corporate trust services including services as trustee for pension and profit sharing plans; and other financial planning and advisory services.

The following tables present the statements of income and total assets for the Corporation’s reportable segments for the three and six months ended June 30, 2018 and 2017.

 

 

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7.  FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

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The Company used the following methods and significant assumptions to estimate the fair value:

Investment Securities:  The fair values for investment securities are determined by quoted market prices (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Loans Held for Sale, at Fair Value: The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan or other observable market data, such as outstanding commitments from third party investors (Level 2).

Derivatives:  The fair values of derivatives are based on valuation models using observable market data as of the measurement date (Level 2).  Our derivatives are traded in an over-the-counter market where quoted market prices are not always available.  Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs.  The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position.  The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.

Impaired Loans:  The fair value of impaired loans with specific allocations of the allowance for loan and lease losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other Real Estate Owned:  Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by Management. Once received, a third party conducts a review of the appraisal for compliance with the Uniform Standards of Professional Appraisal Practice and appropriate analysis methods for the type of property. Subsequently, a member of the Credit Department reviews the assumptions and approaches utilized in the appraisal, as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Appraisals on collateral dependent impaired loans and other real estate owned (consistent for all loan types) are obtained on an annual basis, unless a significant change in the market or other factors warrants a more frequent appraisal. On an annual basis, Management compares the actual selling price of any collateral that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value for other properties. The most recent analysis performed indicated that a discount up to 15 percent should be applied to appraisals on properties. The discount is determined based on the nature of the underlying properties, aging of appraisals and other factors. For each collateral-dependent impaired loan, we consider other factors, such as certain indices or other market information, as well as property specific circumstances to determine if an adjustment to the appraised value is needed. In situations where there is evidence of change in value, the Bank will determine if there is a need for an adjustment to the specific reserve on the collateral dependent impaired loans. When the Bank applies an interim adjustment, it generally shows the adjustment as an incremental specific reserve against the loan until it has received the full updated appraisal. All collateral-dependent impaired loans and other real estate owned valuations were supported by an appraisal less than 12 months old or in the process of obtaining an appraisal as of June 30, 2018.

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The following table summarizes, for the periods indicated, assets measured at fair value on a recurring basis, including financial assets for which the Corporation has elected the fair value option:

Assets Measured on a Recurring Basis

 

 

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Assets Measured on a Recurring Basis

 

 

The Company has elected the fair value option for certain loans held for sale.  These loans are intended for sale and the Company believes that the fair value is the best indicator of the resolution of these loans.  Interest income is recorded based on the contractual terms of the loan and in accordance with the Company’s policy on loans held for investment.  None of these loans are 90 days or more past due nor on nonaccrual as of June 30, 2018 and December 31, 2017.

The following tables present residential loans held for sale, at fair value for the periods indicated:

 

 

There were no transfers between Level 1 and Level 2 during the three and six months ended June 30, 2018.

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The following table summarizes, for the periods indicated, assets measured at fair value on a non-recurring basis (Quantitative disclosures for non-recurring Level 3 assets have been omitted due to immateriality):

Assets Measured on a Non-Recurring Basis

 

There were no loans measured for impairment using the fair value of collateral as of December 31, 2017.  

The carrying amounts and estimated fair values of financial instruments at June 30, 2018 are as follows:

 

 

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The carrying amounts and estimated fair values of financial instruments at December 31, 2017 are as follows:

 

 

8.  REVENUE FROM CONTRACTS WITH CUSTOMERS

All of the Company’s revenue from contracts with customers in the scope of ASC 606 is recognized within noninterest income.

The following table presents the sources of noninterest income for the periods indicated:

 

 

 

(a)All of the other category is outside the scope of ASC 606.

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The following table presents the sources of noninterest income by operating segment for the periods indicated:

 

 

 

A description of the Company’s revenue streams accounted for under ASC 606 follows:

Service charges on deposit accounts:  The Company earns fees from its deposits customers for transaction-based, account maintenance, and overdraft fees.  Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that point in time the Company fulfills the customer’s request.  Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation.  Overdraft fees are recognized at the point in time that the overdraft occurs.  Service charges on deposits are withdrawn from the customer’s account balance.

Interchange income:  The Company earns interchange fees from debit cardholder transactions conducted through the Visa payment network.  Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.  Interchange income is presented gross of cardholder rewards.  Cardholder rewards are included in other expenses in the statement of income.  Cardholder rewards reduced interchange income by $63 thousand and $62 thousand for the six months ended June 30, 2018 and 2017, respectively.  Cardholder rewards reduced interchange income by $34 thousand and $32 thousand for the second quarters of 2018 and 2017.

Wealth management fees (gross):  The Company earns wealth management fees from its contracts with trust customers to manage assets for investment, and/or to transact on their accounts.  These fees are primarily earned over time as the Company provides the contracted monthly or quarterly services and are generally assessed based on a tiered scale of the market value of AUM at month-end.  Fees that are transaction based, including trade execution services, are recognized at the point in time that the transaction is executed, (i.e. trade date.)

Investment brokerage fees (net):  The Company earns fees from investment brokerage services provided to its customers by a third-party service provider.  The Company receives commissions from the third-party service provider twice a month based upon customer activity for the month.  The fees are recognized monthly and a receivable is recorded until commissions are generally

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paid by the 15^th of the following month.  Because the Company (i) acts as an agent in arranging the relationship between the customer and the third-party service provider and (ii) does not control the services rendered to the customers, investment brokerage fees are presented net of related costs.

Gains/(losses) on sales of OREO:  The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed.  When the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer.  In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain/(loss) on sale if a significant financing component is present.  The company recorded a gain on sale of OREO of $26 thousand in the second quarter of 2018.

Other:  All of the other income items are outside the scope of ASC 606.

9.  OTHER OPERATING EXPENSES

The following table presents the major components of other operating expenses for the periods indicated:

 

 

10.  ACCUMULATED OTHER COMPREHENSIVE (LOSS)/INCOME

The following is a summary of the accumulated other comprehensive income/(loss) balances, net of tax, for the three months ended June 30, 2018 and 2017:

 

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The following represents the reclassifications out of accumulated other comprehensive income for the three months ended June 30, 2018 and 2017:

 

 

The following is a summary of the accumulated other comprehensive (loss)/income balances, net of tax, for the six months ended June 30, 2018 and 2017:

 

 

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The following represents the reclassifications out of accumulated other comprehensive income for the six months ended June 30, 2018 and 2017:

 

 

11.  DERIVATIVES

The Company utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position. The notional amount of the interest rate swaps does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual interest rate swap agreements.

Interest Rate Swaps Designated as Cash Flow Hedges: Interest rate swaps with a notional amount of $230.0 million and $180.0 million as of June 30, 2018 and December 31, 2017, respectively, were designated as cash flow hedges of certain interest-bearing deposits and were determined to be fully effective during the six months ended June 30, 2018. As such, no amount of ineffectiveness has been included in net income during the three and six months ended June 30, 2018. Therefore, the aggregate fair value of the swaps is recorded in other assets/liabilities with changes in fair value recorded in other comprehensive income. The amount included in accumulated other comprehensive income would be reclassified to current earnings should the hedges no longer be considered effective. The Company expects the hedges to remain fully effective during the remaining terms of the swaps.

The following table presents information about the interest rate swaps designated as cash flow hedges as of June 30, 2018 and December 31, 2017:

 

 

Net interest income recorded on these swap transactions totaled $33 thousand and $13 thousand for the three and six months ended June 30, 2018, respectively, and is reported as a component of interest expense.  Net interest expense recorded on these

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swap transactions totaled $251 thousand and $613 for the three and six months ended June 30, 2017, respectively, and is reported as a component of interest expense.  

Cash Flow Hedges

The following table presents the net gain recorded in accumulated other comprehensive (loss)/income and the consolidated financial statements relating to the cash flow derivative instruments for the three months ended June 30, 2018 (after tax):

 

 

During the first quarter of 2018, the Company recognized an unrealized after-tax gain of $220 thousand in accumulated other comprehensive income/(loss) related to the termination of two interest rate swaps designated as cash flow hedges.  The gain will be amortized into earnings over the remaining life of the terminated swaps.  The Company recognized pre-tax interest income of $31 thousand for the three months ended June 30, 2018 related to the amortization of the gain on the terminated interest rate swaps designated as cash flow hedges.

 

The following table presents the net (loss) recorded in accumulated other comprehensive (loss)/income and the consolidated financial statements relating to the cash flow derivative instruments for the three months ended June 30, 2017 (after tax):

 

 

The following table presents the net gain recorded in accumulated other comprehensive income/(loss) and the consolidated financial statements relating to the cash flow derivative instruments for the six months ended June 30, 2018 (after tax):

 

 

The Company recognized pre-tax interest income of $62 thousand for the six months ended June 30, 2018 related to the amortization of the gain on the terminated interest rate swaps designated as cash flow hedges.

 

The following table presents the net gain recorded in accumulated other comprehensive income/(loss) and the consolidated financial statements relating to the cash flow derivative instruments for the six months ended June 30, 2017 (after tax):

 

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The following tables reflect the cash flow hedges included in the financial statements as of June 30, 2018 and December 31, 2017:

 

 

 

Derivatives Not Designated as Accounting Hedges:  The Company offers facility specific/loan level swaps to its customers and offsets its exposure from such contracts by entering into mirror image swaps with a financial institution / swap counterparty (loan level / back to back swap program).  The customer accommodations and any offsetting swaps are treated as non-hedging derivative instruments which do not qualify for hedge accounting (“standalone derivatives”).  The notional amount of the swaps does not represent amounts exchanged by the parties.  The amount exchanged is determined by reference to the notional amount and the other terms of the individual contracts.  The fair value of the swaps is recorded as both an asset and a liability, in other assets and other liabilities, respectively, in equal amounts for these transactions.

Information about these swaps is as follows:

 

 

12.  SUBORDINATED DEBT

During June 2016, the Company issued $50.0 million in aggregate principal amount of fixed-to-floating subordinated notes (the “2016 Notes”) to certain institutional investors. The 2016 Notes are non-callable for five years, have a stated maturity of June 30, 2026, and bear interest at a fixed rate of 6.0% per year until June 30, 2021. From June 30, 2021 to the maturity date or early redemption date, the interest rate will reset quarterly to a level equal to the then current three-month LIBOR rate plus 485 basis points, payable quarterly in arrears. Debt issuance costs incurred totaled $1.3 million and are being amortized to maturity.  

Approximately $40.0 million of the net proceeds from the sale of the 2016 Notes were contributed by the Company to the Bank in the second quarter of 2016.  The remaining funds (approximately $10 million) were retained by the Company for operational purposes.

During December 2017, the Company issued $35.0 million in aggregate principal amount of fixed-to-floating subordinated notes (the “2017 Notes”) to certain institutional investors.  The 2017 Notes are non-callable for five years, have a stated maturity of December 15, 2027, and bear interest at a fixed rate of 4.75% per year until December 15, 2022.  From December 16, 2022 to the maturity date or early redemption date, the interest rate will reset quarterly to a level equal to the then current three-month LIBOR rate plus 254 basis points, payable quarterly in arrears.  Debt issuance costs incurred totaled $875 thousand and are being amortized to maturity.

Approximately $29.1 million of the net proceeds from the sale of the 2017 Notes were contributed by the Company to the Bank in the fourth quarter of 2017.  The remaining funds of approximately $5 million, representing three years of interest payments, were retained by the Company for operational purposes.

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Subordinated debt is presented net of issuance costs on the Consolidated Statements of Condition.  The subordinated debt issuances are included in the Company’s regulatory total capital amount and ratio.

In connection with the issuance of the 2017 Notes, the Company obtained ratings from Kroll Bond Rating Agency (“KBRA”). KBRA assigned investment grade rating of BBB- for the Company’s subordinated debt.  

13.  ACCOUNTING PRONOUNCEMENTS

On January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)” and all subsequent amendments to the ASU (collectively, “ASC 606”).  The majority of the Company’s revenues come from interest income, income from bank owned life insurance, gains on sales of loans and securities and derivatives income that are outside the scope of ASC 606.  The Company’s services that fall within the scope of ASC 606 include wealth management fee income, investment brokerage fees, service charges and fees, sale of OREO and other income are presented within Non-Interest Income. Refer to footnote 8 “Revenue from Contracts with Customers” for further discussion on the Company’s accounting policies for revenue sources within the scope of ASC 606. The adoption of this guidance has not changed the recognition of our current revenue sources and did not have a material impact to the consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments”.  This guidance amends existing guidance to improve accounting standards for financial instruments including clarification and simplification of accounting and disclosure requirements and the requirement for public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. The Company recorded a cumulative effect adjustment for its sole equity instrument to the balance sheet as of January 1, 2018 in the amount of $127 thousand, representing the unrealized loss of $176 thousand at December 31, 2017 net of taxes of $49 thousand. The Company adopted the guidance effective January 1, 2018. Upon adoption, the fair value of the Company’s loan portfolio is now presented using an exit price method.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”. The standard requires a lessee to recognize assets and liabilities on the balance sheet for leases with lease terms greater than 12 months. For lessees, virtually all leases will be required to be recognized on the balance sheet by recording a right-of-use asset and lease liability. Subsequent accounting for leases varies depending on whether the lease is an operating lease or a finance lease. The ASU requires additional qualitative and quantitative disclosures with the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. The Company continues to evaluate the effect that ASU 2016-02 will have on its financial position, results of operations, and its financial statement disclosures. The adoption of ASU 2016-02 is expected to result in leased assets and related lease liabilities to be included on its balance sheet, along with the related leasehold amortization and interest expense included in its statement of income.

On June 16, 2016, the FASB issued Accounting Standards Update No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”.  This ASU replaces the incurred loss model with an expected loss model, referred to as “current expected credit loss” (CECL) model.  It will significantly change estimates for credit losses related to financial assets measured at amortized cost, including loans receivable, held-to-maturity (HTM) debt securities and certain other contracts.  The largest impact will be on lenders and the allowance for loan and lease losses (ALLL).  This ASU will be effective for public business entities (PBEs) in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.  The Company has reviewed the potential impact to our securities portfolio, which primarily consists of U.S. government sponsored entities, mortgage-backed securities and municipal securities which have no history of credit loss and have strong credit ratings. The Company does not expect the standard to have a material impact on its financial statements as it relates to the Company’s securities portfolio.  The Company is also currently evaluating the impact the CECL model will have on our accounting and allowance for loans losses. The Company is in the process of evaluating third party firms to assist in the development of a CECL program, and has selected an in-house software model to assist in the calculation of the allowance for loan and lease losses in preparation for the change to the expected loss model. The Company expects to recognize a one-time cumulative-effect adjustment to our allowance for loan and lease losses as of the beginning of the first reporting period in which the new standard is effective, consistent with regulatory expectations set forth in interagency guidance issued at the end of 2016. The Company cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on our financial condition or results of operations.

 

On August 26, 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments)”. This ASU addresses the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance

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policies (COLIs) (including bank-owned life insurance policies (BOLIs)); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This amendment is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. There is no material impact on our statement of cash flows as a result of the adoption of this ASU.

 

In January 2017, the FASB issued ASU 2017-04: “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”.  This accounting standard updated simplifies the subsequent measurement of goodwill, by eliminating Step 2 from the goodwill impairment test.  In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.  An entity should apply the amendments in this update on a prospective basis.  A public business entity that is a SEC filer should adopt the amendments in this update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019.  Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.  The adoption of this ASU will not have a material impact to the consolidated financial statements at this time.

 

In May 2017, the FASB issued ASU 2017-09: “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting”. The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. An entity should account for the effects of a modification unless all the following are met: 1.) The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification. 2.) The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified. 3.) The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The current disclosure requirements in Topic 718 apply regardless of whether an entity is required to apply modification accounting under the amendments in this update. The amendments in this update are effective for public business entities for annual periods beginning after December 15, 2018, including interim periods within those annual periods.  The Company does not anticipate a material impact to the consolidated financial statements at this time.

 

In August 2017, the FASB issued ASU 2017-12: “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities”. The updated guidance makes targeted changes to the existing hedge accounting model to better align the accounting rules with a company’s risk management activities, and to simplify the application of the hedge accounting model.  ASU 2017-12 expands the types of transactions eligible for hedge accounting, eliminates the requirement to separately measure and present hedge ineffectiveness, simplifies the way assessments of hedge ineffectiveness may be performed and relaxes the documentation requirements for entering into hedging positions. ASU 2017-12 is effective for public business entities for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period, permitted. The Company early adopted ASU 2017-12 on July 1, 2018. ASU 2017-12 requires a modified retrospective transition method in which the Company will recognize the cumulative effect of the change on the opening balance of each affected component of equity in the statement of financial position as of the date of adoption. The Company anticipates that the impact of the adoption is not expected to have a significant impact on the Company’s consolidated financial statements.

In February 2018, the FASB issued ASU No. 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” The ASU required a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the newly enacted federal corporate income tax rate as a result of the Tax Cuts and Jobs Act. The amount of the reclassification is the difference between the historical corporate income tax rate and the newly enacted twenty-one percent corporate income tax rate. The Company chose to early adopt the new standard for the year ending December 31, 2017, as allowed under the new standard. The amount of the reclassification for the Company was $215 thousand.

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Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS:  This Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about Management’s view of future financial condition and results of operations, Management’s confidence and strategies and Management’s expectations about new and existing programs and products, relationships, opportunities and market conditions. These statements may be identified by such forward-looking terminology as “expect”, “look”, “believe”, “anticipate”, “may”, “will”, or similar statements or variations of such terms. Actual results may differ materially from such forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, those risk factors identified in the Company’s Form 10-K for the year ended December 31, 2017, in addition to/which include the following:

Except as required by law, the Company assumes no responsibility to update such forward-looking statements in the future. Although we believe that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance, or achievements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES: Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon the Company’s consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Company’s Audited Consolidated Financial Statements for the year ended December 31, 2017 contains a summary of the Company’s significant accounting policies.

Management believes that the Company’s policy with respect to the methodology for the determination of the allowance for loan and lease losses involves a higher degree of complexity and requires Management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or

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estimates could materially impact results of operations. This critical policy and its application are periodically reviewed with the Audit Committee and the Board of Directors.  

The provision for loan and lease losses is based upon Management’s evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated fair value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although Management uses the best information available, the level of the allowance for loan and lease losses remains an estimate, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan and lease losses. Such agencies may require the Company to make additional provisions for loan and lease losses based upon information available to them at the time of their examination. Furthermore, the majority of the Company’s loans are secured by real estate in New Jersey and, to a lesser extent, New York City.  Accordingly, the collectability of a substantial portion of the carrying value of the Company’s loan portfolio is susceptible to changes in local market conditions and any adverse economic conditions. Future adjustments to the provision for loan and lease losses and allowance for loan and lease losses may be necessary due to economic, operating, regulatory and other conditions beyond the Company’s control.

The Company accounts for its securities in accordance with “Accounting for Certain Investments in Debt and Equity Securities,” which was codified into Accounting Standards Codification (“ASC”) 320. All securities are classified as available for sale and are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax with the exception of the Company’s investment in a CRA investment fund which is classified as an equity security.  In accordance with ASU 2016-01, “Financial Instruments” unrealized holding gains and losses are marked to market through the income statement.

Management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, Management considers the extent and duration of the unrealized loss and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) other-than-temporary impairment related to credit loss, which must be recognized in the income statement and 2) other-than-temporary impairment related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.  No impairment charges were recognized in the three or six months ended June 30, 2018 and 2017.  

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EXECUTIVE SUMMARY: The following table presents certain key aspects of our performance for the three months ended June 30, 2018 and 2017.

 

 

The following table presents certain key aspects of our performance for the six months ended June 30, 2018 and 2017.

 

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For the second quarter of 2018, the Company recorded net income of $11.9 million compared to $7.9 million for the same quarter of 2017.  For the three months ended June 30, 2018 and 2017, diluted earnings per share were $0.62 and $0.45, respectively.  Annualized return on average assets was 1.11 percent and annualized return on average equity was 11.11 percent for the second quarter of 2018, compared to 0.79 percent and 9.06 percent, respectively, for the second quarter of 2017.

 

For the six months ended June 30, 2018, the Company recorded net income of $22.7 million compared to $15.9 million for the same period of 2017.  Diluted earnings per common share were $1.20 and $0.91 for the first six months of 2018 and 2017, respectively.  Annualized return on average assets was 1.06 percent and annualized return on average common equity was 10.83 percent for the first six months of 2018, compared to 0.80 percent and 9.33 percent, respectively, for the six months ended June 30, 2017.

The improved performance for the three and six months ended June 30, 2018, when compared to the same period of 2017, reflected: increased net interest income (partially due to increased loan balances and higher yields on loans); greater wealth management fee income (partially due to the acquisitions of MCM and Quadrant in August and November 2017, respectively); reduced provision for loan and lease losses (partially due to low charge-off levels and lower loan growth during the first six months of 2018); and a lower income tax expense (due to a lower effective tax rate because of the passage of tax legislation in December 2017). These positive effects were partially offset by higher operating expenses in the three and six months ended June 30, 2018 (partially due to operating expenses of MCM and Quadrant, which were acquired in the second half of 2017, the Bank’s equipment finance subsidiary, which began operations in May 2017).  

CONTRACTUAL OBLIGATIONS:  For a discussion of our contractual obligations, see the information set forth in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2017 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations.”

OFF-BALANCE SHEET ARRANGEMENTS:  For a discussion of our off-balance sheet arrangements, see the information set forth in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2017 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Off-Balance Sheet Arrangements.”

EARNINGS ANALYSIS

NET INTEREST INCOME/AVERAGE BALANCE SHEET:  

The primary source of the Company’s operating income is net interest income, which is the difference between interest and dividends earned on earning assets and fees earned on loans, and interest paid on interest-bearing liabilities. Earning assets include loans, investment securities, interest-earning deposits and federal funds sold. Interest-bearing liabilities include interest-bearing checking, savings and time deposits, Federal Home Loan Bank advances, subordinated debt and other borrowings. Net interest income is determined by the difference between the average yields earned on earning assets and the average cost of interest-bearing liabilities (“net interest spread”) and the relative amounts of earning assets and interest-bearing liabilities. The Company’s net interest spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows and general levels of nonperforming assets.

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The following table summarizes the Company’s net interest income and related spread and margin, on a fully tax-equivalent basis, for the periods indicated:

 

 

 

Net interest income, on a fully tax-equivalent basis for the three months ended June 30, 2018 grew $2.4 million, or 9 percent, from the three months ended June 30, 2017.  Net interest income on a fully tax equivalent basis for the six months ended June 30, 2018 increased $5.3 million, or 10 percent, when compared to the same period in 2017.  The growth in net interest income for both the three and six months ended June 30, 2018 was due to increases in the average balance and yield on the Company’s interest-earning assets, especially commercial and industrial (C&I) loans, which typically have higher yields.  This increase was partially offset by increases in the average balance of interest-bearing liabilities and the Company’s cost of funds. The June 2018 quarter included approximately $736 thousand of premiums received on the prepayment of certain multifamily loans as compared to $780 thousand for the quarter ended June 30, 2017.  Premiums received on the prepayment of certain multifamily loans for the six months ended June 30, 2018 was $1.2 million, compared to $1.3 million for the same period of 2017.  Net interest income for the three and six months ended June 30, 2018 also benefitted from the amortization of loan fees of $321 thousand related to the full paydown of a special mention C&I credit.  Net interest margin for the three and six months ended June 30, 2018 increased due to the effect of the increased market rates on our adjustable rate assets, partially offset by an increase in our cost of deposits and lower prepayment penalties.  The issuance of $35.0 million of subordinated debt in mid-December 2017 negatively impacted net interest margin for the three and six months ended June 30, 2018.

The following table summarizes the Company’s loans closed for the periods indicated:

 

 

 

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The Company has managed its balance sheet such that multifamily and 1-4 family residential loans declined as a percentage of the overall loan portfolio and C&I loans became a larger percentage of the overall loan portfolio.

At June 30, 2018, December 31, 2017 and June 30, 2017, the Bank had a concentration in commercial real estate (“CRE”) loans as defined by applicable regulatory guidance.

The following table presents such concentration levels for the following periods:

 

 

The Bank believes it addresses the key elements in the risk management framework laid out by its regulators for the effective management of CRE concentration risks.

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The following tables reflect the components of the average balance sheet and of net interest income for the periods indicated:

Average Balance Sheet

Unaudited

Three Months Ended

 

 

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Average Balance Sheet

Unaudited

Six Months Ended

 

 

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The effect of volume and rate changes on net interest income (on a tax-equivalent basis) for the periods indicated are shown below:

 

 

 

Interest income on interest-earning assets, on a fully tax-equivalent basis, totaled $40.1 million for the second quarter of 2018 compared to $33.7 million for the second quarter of 2017, reflecting an increase of $6.4 million, or 19 percent.  Average interest-earning assets totaled $4.21 billion for the second quarter of 2018, an increase of $264.5 million, or 7 percent, from the same period of 2017. The average balance of the commercial loan portfolio increased $334.2 million, or 47 percent, from the second quarter of 2017, to $1.05 billion for the second quarter of 2018. The increase in this portfolio was attributed to: the addition of seasoned bankers including an equipment finance team in 2017; a continued focus on client service and value-added aspects of the lending process; and a continued focus on markets outside of the immediate branch service area, including markets around the Teaneck and Princeton, New Jersey private banking offices.  This increase was partially offset by a decrease in the average balance of the commercial mortgage portfolio (which includes multifamily mortgage loans) of $99.5 million, or 5 percent, to $1.99 billion for the second quarter of 2018 when compared to the same period in 2017. The Company continued to manage its

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balance sheet such that lower yielding, primarily fixed rate multifamily loans declined as a percentage of the overall loan portfolio and higher yielding, primarily floating rate or short duration C&I loans became a larger percentage of the overall loan portfolio. The average balance of investment securities totaled $382.2 million for the second quarter of 2018 compared to $319.1 million for the same quarter of 2017 reflecting an increase of $63.1 million, or 20 percent.  This increase coincides with the Company’s desire to increase liquid portfolios.

For the quarters ended June 30, 2018 and 2017, the average rates earned on interest-earning assets were 3.81 percent and 3.42 percent, respectively, an increase of 39 basis points.  The increase in the overall yield was principally due to the benefit from the increased market rates on adjustable rate assets during the second half of 2017 and the first half of 2018.

For the second quarter of 2018, the average balance of interest-bearing deposits was $3.00 billion, an increase of $17.7 million, or 1 percent, from the average balance for the same period of 2017. The growth in customer deposits (excluding brokered CDs and brokered interest-bearing demand deposits, but including reciprocal funds discussed below) has come from: an increase in retail deposits from our branch network; focus on providing high-touch client service; and a full array of treasury management products that support core deposit growth.  

Average rates paid on total interest-bearing deposits were 106 basis points and 70 basis points for the second quarters of 2018 and 2017, respectively, an increase of 36 basis points.  The increase in the average rate paid on deposits was principally due to growth in higher costing certificates of deposit and money market accounts and competitive pressures in attracting new deposits.

The average balance of borrowings totaled $221.3 million for the quarter ended June 30, 2018, an increase of $143.9 million when compared to the same period of 2017.  The increase was principally due to an increase in overnight borrowings and $30 million in FHLB advances used to fund loans, the maturity of FHLB advances and the maturity of $152.0 million of listing service deposits. The Company has chosen not to participate in listing service programs at this time, so maturing listing service deposits are not replaced with new listing service deposits.

The Company is a participant in the Reich & Tang Demand Deposit Marketplace (“DDM”) program and the Promontory. The Company uses these deposit sweep services to place customer funds into interest-bearing demand (checking) accounts issued by other participating banks.  Customer funds are placed at one or more participating banks to ensure that each deposit customer is eligible for the full amount of FDIC insurance.  As a program participant, the Company receives reciprocal amounts of deposits from other participating banks.  The DDM program is considered to be a source of brokered deposits for bank regulatory purposes.  However, the Company considers these reciprocal deposits to be in-market customer deposits as distinguished from traditional out-of-market brokered deposits. Such reciprocal deposit balances are included in the Company’s interest-bearing checking balances. The average balance of reciprocal deposits was $375.3 million for the quarter ended June 30, 2018 compared to $395.5 million for the quarter ended June 30, 2017.

The average balance of brokered deposits was $180.0 million for the second quarters of both 2017 and 2018.  The brokered deposits are at the minimum level required to support the Company’s existing $180.0 million of interest rate swaps, transacted previously as part of the Company’s interest rate risk management program.

In December 2017, the Company issued $35.0 million of subordinated debt ($34.1 million net of issuance costs) bearing interest at an annual rate of 4.75 percent for the first five years, and thereafter at an adjustable rate until maturity in December 2027 or earlier redemption.  In June 2016, the Company issued $50.0 million of subordinated debt ($48.7 million net of issuance costs) bearing interest at an annual rate of 6 percent for the first five years, and thereafter at an adjustable rate and until maturity in June 2026 or earlier redemption.  For the second quarter of 2018, the average balance of the subordinated debt was $83.1 million compared to $48.8 million for the same period in 2017.

Interest income on earning assets, on a fully tax-equivalent basis increased by $12.2 million, or 19 percent, for the first six months of 2018 compared to the same period in 2017.  For the six months ended June 30, 2018, average interest-earning assets increased $306.4 million to $4.19 billion from $3.89 billion for the same period in 2017.  For the six months ended June 30, 2018 the average balance of the commercial portfolio increased $327.7 million, or 48 percent, from the same period in 2017.  The increase in this portfolio was attributed to: the addition of seasoned bankers including an equipment finance team in 2017; a continued focus on client service and value-added aspects of the lending process; and a continued focus on markets outside of the immediate branch service area, including markets around the Teaneck and Princeton private banking offices.  For the six months ended June 30, 2018 the average balance of the commercial mortgage portfolio (which includes multifamily mortgage loans) decreased $61.0 million to $2.00 billion from the same period in 2017.  The Company continued to manage its balance sheet such that lower yielding, primarily fixed rate multifamily loans declined as a percentage of the overall loan portfolio and higher yielding, primarily floating rate or short duration C&I loans became a larger percentage of the overall loan portfolio.

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For the six months ended June 30, 2018 and 2017, the average rates earned on interest-earning assets was 3.70 percent and 3.36 percent, respectively, an increase of 34 basis points.  The increase in average rates on loans was due to an increase in market rates and a shift from lower yielding commercial mortgages into higher yielding commercial loans (C&I and equipment financings).

For the six months ended June 30, 2018, the average balance of interest-bearing deposits was $3.05 billion, increasing $91.2 million, or 3 percent, from the average balance of $2.96 billion for the same 2017 period.  The growth in customer deposits (excluding brokered CDs and brokered interest-bearing demand, but including funds from reciprocal deposits) was $116.5 million for the first six months of 2018 when compared to the same period in 2017.  Reciprocal deposit balances are included in the Company’s interest-bearing checking balances.  The average balance of reciprocal deposits was $373.8 million for the six months ended June 30, 2018 compared to $396.5 million for the same 2017 period.

Average rates paid on interest-bearing deposits for the six months ended June 30, 2018 were 98 basis points compared to 66 basis points for the same period in 2017, reflecting an increase of 32 basis points. The increase in the average rate paid on deposits was principally due to growth in higher costing certificates of deposit and money market accounts and competitive pressures in attracting new deposits.

The average balance of borrowings increased by $85.4 million to $154.3 million for the six months ended June 30, 2018 when compared to the same 2017 period.  The increase was principally due to an increase in overnight borrowings and $30 million in FHLB advances used to fund loans, the maturity of FHLB advances and the maturity of $152.0 million of listing service deposits. The Company has chosen not to participate in listing service programs at this time, so maturing listing service deposits are not replaced with new listing service deposits.

As previously stated, in December 2017, the Company issued $35.0 million of subordinated debt ($34.1 million net of issuance costs) bearing interest at an annual rate of 4.75 percent for the first five years, and thereafter at an adjustable rate until maturity in December 2027 or earlier redemption.  In June 2016, the Company issued $50.0 million of subordinated debt ($48.7 million net of issuance costs) bearing interest at an annual rate of 6 percent for the first five years, and thereafter at an adjustable rate and until maturity in June 2026 or earlier redemption.  For the six months ended June 30, 2018, the average balance of the subordinated debt was $83.1 million compared to $48.8 million from the same period in 2017.

INVESTMENT SECURITIES:  Investment securities are purchased, sold and/or maintained as a part of the Company’s overall balance sheet management and in response to interest rate risk management strategies, changes in interest rates, liquidity needs, prepayment speeds and/or other factors.  Investment securities available for sale are carried at estimated fair value, and unrealized changes in fair value are recognized as a separate component of shareholders’ equity, net of income taxes.  Realized gains and losses are recognized in income at the time the securities are sold.  Trading securities are carried at fair value, with unrealized gains and losses recorded in non-interest income.

At June 30, 2018, the Company had investment securities available for sale with a fair value of $346.8 million compared with $327.6 million at December 31, 2017.  Net unrealized losses (net of income tax) of $4.8 million and $1.8 million were included in shareholders’ equity at June 30, 2018 and December 31, 2017, respectively.

The Company has one equity security (a CRA investment security) with a fair value of $4.7 million at June 30, 2018.  The Company recorded a $114 thousand unrealized loss in securities losses, net on the Consolidated Statements of Income for the six months ended June 30, 2018.  Such security has been owned for years for CRA purposes, but under Accounting Standards Update (“ASU”) 2016-01, “Financial Instruments”, equity securities now require a quarterly mark to market through the income statement.

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The carrying value of investment securities available for sale as of June 30, 2018 and December 31, 2017 are shown below:

 

 

The following table presents the contractual maturities and yields of debt securities available for sale, stated at fair value, as of June 301, 2018:

 

 

OTHER INCOME:  The following table presents other income, excluding income from wealth management, which is summarized and discussed subsequently:

 

 

 

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For the quarter ended June 30, 2018, income from the sale of newly originated residential mortgage loans was $79 thousand compared to $91 thousand for the same period in 2017.  For the six months ended June 30, 2018 and 2017, income from the sale of newly originated residential mortgage loans was $173 thousand and $138 thousand, respectively.  Such income is a result of the volume of residential mortgage loans originated for sale in the respective periods.

The second quarter of 2018 included $900 thousand of loan level, back-to-back swap income compared to $1.3 million in the same quarter of 2017.  The six months ended June 30, 2018 included $1.2 million of loan level, back-to-back swap income compared to $1.7 million for the same period of 2017.  The program provides a borrower with a degree of interest rate protection on a variable rate loan, while still providing an adjustable rate to the Company, thus helping to manage the Company’s interest rate risk, while contributing to income.

The second quarter of 2018 included $814 thousand of income related to the Company’s SBA lending and sale program compared to $142 thousand for the same quarter in 2017. The six months ended June 30, 2018 included $845 thousand of income related to the Company’s SBA lending and sale program compared to $297 thousand for the same period in 2017.

Income from the back-to-back swap and SBA programs are not linear from quarter to quarter, as some quarters will be higher than others.

The Company recorded a $36 thousand and $114 thousand mark to market loss on its equity security investment in the three and six months ended June 30, 2018, respectively, as a result of the adoption of Accounting Standards Update (“ASU”) 2016-01, “Financial Instruments” on January 1, 2018.  

Other income was $639 thousand for the quarter ended June 30, 2018 compared to $396 thousand for the same quarter in 2017.  The six months ended June 30, 2018 included $1.0 million in other income compared to $846 thousand for the same period of 2017.  The increase in other income was primarily due to increased fees associated with loans, SBA loan servicing income, as well as check printing income throughout the three and six months ended June 30, 2018.

OPERATING EXPENSES: The following table presents the components of operating expenses for the periods indicated:

 

 

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The Company’s total operating expenses were $24.9 million for the quarter ended June 30, 2018 compared to $20.1 million in the same 2017 quarter, reflecting a net increase of $4.8 million, or 24 percent.   Total operating expense grew by $8.9 million to $48.3 million for the six months ended June 30, 2018 when compared to the same period in 2017, reflecting an increase of 23 percent.

Compensation and benefits expense increased to $15.8 million in the second quarter of 2018 from $12.8 million in the same period in 2017, an increase of $3.1 million, or 24 percent.  For the six months ended June 30, 2018 compensation and benefits expense increased to $30.4 million from $24.7 million for the same period in 2017.  The increase was partially due to strategic hiring and normal salary increases.  Additionally, the acquisitions of MCM in August 2017 and Quadrant in November 2017 and the hiring of a team of experienced bankers to focus on equipment financing in April 2017 contributed to the increase for the three and six months ended June 30, 2018.

For the three months ended June 30, 2018, premises and equipment expense was $3.4 million compared to $3.0 million for the three months ended June 30, 2017, an increase of $373 thousand.  For the six months ended June 30, 2018, premises and equipment expense was $6.7 million compared to $5.8 million for the six months ended June 30, 2017, an increase of $827 thousand.  The increase over the same periods in 2017 was due to the Company’s growth through acquisition of two wealth management firms and the equipment finance team.  This growth also resulted in increased computer hardware and software expenses, as well as occupancy expenses.

Professional and legal fees increased $393 thousand, or 50 percent, to $1.2 million for the second quarter of 2018 as compared to $785 thousand for the second quarter of 2017.  For the six months ended June 30, 2018, professional and legal fees were $2.3 million as compared to $1.6 million for the same period in 2017, reflecting an increase of $645 thousand, or 39 percent.  The increase in professional and legal fees was primarily due to increased professional fees, including consulting, compliance, audit and advisory costs associated with the acquisitions of wealth management firms and our equipment financing division.  

Total other operating expenses for the June 2018 quarter were $5.1 million compared to $3.7 million for the June 2017 quarter.  For the six months ended June 30, 2018, total other operating expenses were $10.0 million compared to $7.6 million for the same period in 2017.  The three and six months ended June 30, 2018 included expenses related to the equipment finance business, MCM and Quadrant.  Furthermore, when compared to the same period in 2017, the June 2018 quarter included a provision of $204 thousand recorded on other real estate owned.

PRIVATE WEALTH MANAGEMENT DIVISION:  This division includes asset management services provided for individuals and institutions; personal trust services, including services as executor, trustee, administrator, custodian and guardian; corporate trust services including services as trustee for pension and profit sharing plans; and other financial planning and advisory services. Officers from the Private Wealth Management Division are available to provide wealth management, trust and investment services at the Bank’s headquarters in Bedminster, at private banking locations in Morristown, Princeton and Teaneck, New Jersey and at the Bank’s subsidiaries, PGB Trust & Investments of Delaware, in Greenville, Delaware, MCM, in Gladstone, New Jersey and Quadrant in Fairfield, New Jersey.

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The following table presents certain key aspects of the Bank’s Private Wealth Management Division performance for the quarters ended June 30, 2018 and 2017.

 

 

 

 

The market value of the assets under management and/or administration (“AUM”) of the Private Wealth Management Division was $5.7 billion at June 30, 2018, reflecting an increase of 46 percent from $3.9 billion at June 30, 2017.   The increase in AUM was due to acquisitions of two registered investment advisory firms (“RIA”) and organic growth.  Effective August 1, 2017, the Bank acquired MCM, an RIA, based in Gladstone, NJ.  MCM contributed approximately $850 million of AUM at the time of acquisition. Effective November 1, 2017, the Bank acquired Quadrant, an RIA, based in Fairfield, NJ, which contributed approximately $460 million of AUM at the time of acquisition. Organic growth, which includes equity market appreciation, contributed an additional $500 million in AUM.

In the June 2018 quarter, the Private Wealth Management Division generated $8.1 million in fee income compared to $5.1 million for the June 2017 quarter, reflecting a 60 percent increase. For the six months ended June 30, 2018, the Private Wealth Management Division generated $16.5 million in fee income compared to $9.9 million for the same period in 2017, reflecting a 67 percent increase.  The growth in fee income was due to the acquisitions noted above, as well as continued new business, partially offset by normal levels of disbursements and outflows.  

The Company continues to incorporate wealth management into conversations it has with the Company’s clients, across all business lines.  The Company has expanded its wealth management team and intends to continue to grow organically and through acquisition.

Operating expenses relative to the Private Wealth Management Division reflected increases due to the MCM and Quadrant acquisitions, overall growth in the business, new hires and select third party expenditures. Remaining expenses are in line with the Company’s Strategic Plan, particularly the hiring of key management and revenue-producing personnel.  Generally, revenue and profitability related to the new personnel will lag expenses by several quarters.  

The Private Wealth Management Division currently generates adequate revenue to support the salaries, benefits and other expenses of the Division; however, Management believes that the Bank generates adequate liquidity to support the expenses of the Private Wealth Management Division should it be necessary.

NONPERFORMING ASSETS:  OREO, loans past due in excess of 90 days and still accruing, and nonaccrual loans are considered nonperforming assets.

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The following table sets forth asset quality data on the dates indicated (dollars in thousands):

 

 

PROVISION FOR LOAN AND LEASE LOSSES:  The provision for loan and lease losses was $300 thousand and $2.2 million for the second quarters of 2018 and 2017, respectively.  For the six months ended June 30, 2018 and 2017, the provision for loan losses was $1.6 million and $3.8 million, respectively.  The amount of the loan loss provision and the level of the allowance for loan and lease losses are based upon several factors including Management’s evaluation of probable losses inherent in the portfolio, after consideration of appraised collateral values, financial condition and past credit history of the borrowers, as well as prevailing economic conditions. Commercial credits generally carry a higher risk profile compared to some of the other credits, which is reflected in Management’s determination of the proper level of the allowance for loan and lease losses.

The decrease in the provision for loan losses to $300 thousand in the second quarter of 2018 was due to slower loan growth and the full paydown of a special mention C&I credit, among other things.

The allowance for loan and lease losses was $38.1 million as of June 30, 2018, compared to $36.4 million at December 31, 2017. As a percentage of loans, the allowance for loan and lease losses was 1.02 percent as of June 30, 2018, and 0.98 percent as of December 31, 2017. The specific reserves on impaired loans were $1.6 million at June 30, 2018 compared to $522 thousand as of December 31, 2017. Total impaired loans were $30.7 million and $23.1 million as of June 30, 2018 and December 31, 2017, respectively. The general component of the allowance increased from $35.9 million at December 31, 2017 to $36.4 million at June 30, 2018.

A summary of the allowance for loan and lease losses for the quarterly periods indicated follows:

 

 

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INCOME TAXES:  For the second quarters of 2018 and 2017, income tax expense as a percentage of pre-tax income was 24.3 percent and 38.2 percent, respectively.  For the six months ended June 30, 2018 and 2017, income tax expense as a percentage of pre-tax income was 23.7 percent and 35.2 percent, respectively.  The decrease in the effective tax rate was a result of the Tax Cuts and Jobs Act, which reduced the Federal corporate income tax rate from 35 percent to 21 percent, effective January 1, 2018.

 

The Company’s effective rate for the six months ended June 30, 2018 and 2017 was positively affected by the adoption of ASU 2016-09. The six months ended June 30, 2018 included a $416 thousand reduction in income taxes, as compared to a $662 thousand reduction in income taxes for the same period in 2017.

 

On July 1, 2018, the 2019 New Jersey Budget (“Budget”) was passed which established a 2.5 percent surtax on businesses that have New Jersey allocated net income in excess of $1.0 million.  The surtax is effective as of January 1, 2018 and will continue through 2019. The surtax will adjust to 1.5 percent for 2020 and 2021. In addition, effective for taxable years beginning on or after January 1, 2019, banks will be required to file combined reports of taxable income including their parent holding company, their real estate investment trust (“REIT”) subsidiary and all other subsidiaries including those that qualify as New Jersey Investment Companies, and Delaware Investment Holding Companies. The Bank will make an adjustment to income tax expense in the third quarter of 2018 to reflect the new state tax rate which is effective January 1, 2018.  The surtax will also require an adjustment to our deferred tax assets/liabilities.  The Company believes that for 2018, the Company’s effective tax rate could increase by as much as 1 percent, due to the 2.5 percent NJ surtax.  The Company also believes its effective tax rate could increase by one to three percent in 2019 depending on how certain aspects of the new combined reporting rules are applied.

 

CAPITAL RESOURCES A solid capital base provides the Company with the ability to support future growth and financial strength and is essential to executing the Company’s Strategic Plan – “Expanding Our Reach.” The Company’s capital strategy is intended to provide stability to expand its business, even in stressed environments. Quarterly stress testing is integral to the Company’s capital management process.

 

The Company strives to maintain capital levels in excess of internal “triggers” and in excess of those considered to be well capitalized under regulatory guidelines applicable to banks. Maintaining an adequate capital position supports the Company’s goal of providing shareholders an attractive and stable long-term return on investment.

 

Capital for the six months ended June 30, 2018 was benefitted by net income of $22.7 million and by $12.7 million of voluntary share purchases of authorized but unissued shares by our shareholders under the Dividend Reinvestment Plan (“DRP”).  Voluntary share purchases in the DRP can be filled from the Company’s authorized but unissued shares (which benefits capital) and/or in the open market, at the discretion of the Company.  During the six months ended June 30, 2018, 392 thousand of the shares purchased were from authorized but unissued shares, while 268 thousand shares were purchased in the open market.

 

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Total, Common Equity Tier 1 and Tier 1 capital (each as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). At June 30, 2018 and December 31, 2017, all of the Bank’s capital ratios remain above the levels required to be considered “well capitalized” and the Company’s capital ratios remain above regulatory requirements.

 

To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, common equity Tier I and Tier I leverage ratios as set forth in the table.

 

As a result of the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act, the federal banking agencies are required to develop a “Community Bank Leverage Ratio” (the ratio of a bank’s tangible equity capital to average total consolidated assets) for financial institutions with assets of less than $10 billion.  A “qualifying community bank” that exceeds this ratio will be deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under Prompt Corrective Action statutes.  The federal banking agencies may consider a financial institution’s risk profile when evaluating whether it qualifies as a community bank for purposes of the capital ratio requirement. The federal banking agencies must set the minimum capital for the new Community Bank Leverage Ratio at not less than 8 percent and not more than 10 percent.  A financial institution can elect to be subject to this new definition.  The Bank’s leverage ratio is 11.27 percent at June 30, 2018.

 

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The Bank’s regulatory capital amounts and ratios are presented in the following table:

 

 

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The Company’s regulatory capital amounts and ratios are presented in the following table:

 

 

The Company’s regulatory total risk based capital ratio beginning June 30, 2016 was benefitted by the $48.7 million (net) subordinated debt issuance that closed in June 2016. At that time, the Company down-streamed approximately $40 million of those proceeds to the Bank as capital, benefitting all the Bank’s regulatory capital ratios.

In addition, on December 12, 2017, the Company issued $35 million in aggregate principal amount of Fixed-to-Floating Subordinated Notes due December 15, 2027.  The Company down streamed approximately $29.1 million of those proceeds to the Bank as capital.

The DRP of Peapack-Gladstone Financial Corporation, allows shareholders of the Company to purchase additional shares of common stock using cash dividends without payment of any brokerage commissions or other charges. Shareholders may also make voluntary cash payments of up to $200 thousand per quarter to purchase additional shares of common stock, at a 3 percent discount to market. Voluntary share purchases in the DRP can be filled from the Company’s authorized but unissued shares and/or in the open market, at the discretion of the Company.  During the June 2018 quarter, 75 thousand of the shares purchased for the DRP were from authorized but unissued shares, while 268 thousand shares were purchased in the open market.  The Company estimates that voluntary share purchases from authorized but unissued shares will be between 50 thousand and 100 thousand shares during the third quarter of 2018.

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On July 26, 2018, the Board of Directors declared a regular cash dividend of $0.05 per share payable on August 23, 2018 to shareholders of record on August 9, 2018.

Management believes the Company’s capital position and capital ratios are adequate. Further, Management believes the Company has sufficient capital to support its planned balance sheet growth for the immediate future. The Company continually assesses other potential sources of capital to support future growth.

LIQUIDITY: Liquidity refers to an institution’s ability to meet short-term requirements including funding of loans, deposit withdrawals and maturing obligations, as well as long-term obligations, including potential capital expenditures. The Company’s liquidity risk management is intended to ensure the Company has adequate funding and liquidity to support its assets across a range of market environments and conditions, including stressed conditions. Principal sources of liquidity include cash, temporary investments, securities available for sale, customer deposit inflows, loan and securities repayments and secured borrowings.  Other liquidity sources include loan sales and loan participations.

Management actively monitors and manages the Company’s liquidity position and believes it is sufficient to meet future needs. Cash and cash equivalents, including federal funds sold and interest-earning deposits, totaled $66.8 million at June 30, 2018. In addition, the Company had $346.8 million in securities designated as available for sale at June 30, 2018. These securities can be sold, or used as collateral for borrowings, in response to liquidity concerns. Securities available for sale with a fair value of $304.7 million as of June 30, 2018 were pledged to secure public funds and for other purposes required or permitted by law. In addition, the Company generates significant liquidity from scheduled and unscheduled principal repayments of loans and mortgage-backed securities.

A further source of liquidity is secured borrowing capacity. At June 30, 2018, unused borrowing commitments totaled $1.1 billion from the FHLB and $913.7 million from the Federal Reserve Bank of New York.

During the second quarter of 2018, the Company experienced net deposit outflows of $29.2 million, $35.7 million of which, however, was due to the maturity of listing service deposits. The Company has chosen not to participate in listing service programs at this time, so maturing listing service deposits are not replaced with new listing service deposits.

Brokered interest-bearing demand (“overnight”) deposits were $180.0 million at June 30, 2018. The interest rate paid on these deposits allows the Bank to fund at attractive rates and engage in interest rate swaps to hedge its asset-liability interest rate risk. The Company ensures ample available collateralized liquidity as a backup to these short-term brokered deposits.  As of June 30, 2018, the Company has transacted pay fixed, receive floating interest rate swaps totaling $230.0 million in notional amount.

The Company has a Board-approved Contingency Funding Plan in place. This plan provides a framework for managing adverse liquidity stress and contingent sources of liquidity. The Company conducts liquidity stress testing on a regular basis to ensure sufficient liquidity in a stressed environment.

Management believes the Company’s liquidity position and sources are adequate.

ITEM 3.  Quantitative and Qualitative Disclosures about Market Risk

ASSET/LIABILITY MANAGEMENT: The Company’s Asset/Liability Committee (“ALCO”) is responsible for developing, implementing and monitoring asset/liability management strategies and advising the Board of Directors on such strategies, as well as the related level of interest rate risk. In this regard, interest rate risk simulation models are prepared on a quarterly basis. These models have the ability to demonstrate balance sheet gaps and predict changes to net interest income and economic/market value of portfolio equity under various interest rate scenarios. In addition, these models, as well as the ALCO processes and reporting, are subject to annual independent third-party review.

The ALCO is generally authorized to manage interest rate risk through the management of capital, cash flows and duration of assets and liabilities, including sales and purchases of assets, as well as additions of wholesale borrowings and other sources of medium/longer term funding.  The ALCO is authorized to engage in interest rate swaps as a means of extending the duration of shorter term liabilities.

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The following strategies are among those used to manage interest rate risk:

The interest rate swap program is administered by the ALCO and follows procedures and documentation in accordance with regulatory guidance and standards as set forth in ASC 815 for cash flow hedges.  The program incorporates pre-purchase analysis, liability designation, sensitivity analysis, correlation analysis, daily mark-to-market analysis and collateral posting as required.  The Board is advised of all swap activity.  In all of these swaps, the Company is receiving floating and paying fixed interest rates with total notional value of $230.0 million as of June 30, 2018, $50 million of which was added during the quarter ended June 30, 2018.

In addition, during the second quarter of 2015, the Company initiated a loan level / back-to-back swap program in support of its commercial lending business.  Pursuant to this program, the Company extends a floating rate loan and executes a floating to fixed swap with the borrower.  At the same time, the Company executes a third-party swap, the terms of which fully offset the fixed exposure and, result in a final floating rate exposure for the Company.  As of June 30, 2018, $376.3 million of notional value in swaps were executed and outstanding with borrowers under this program.

As noted above, the ALCO uses simulation modeling to analyze the Company’s net interest income sensitivity, as well as the Company’s economic value of portfolio equity under various interest rate scenarios. The model is based on the actual maturity and repricing characteristics of rate sensitive assets and liabilities. The model incorporates certain loan prepayment, deposit beta and decay, and interest rate assumptions, which management believes to be reasonable as of June 30, 2018. The model assumes changes in interest rates without any proactive change in the balance sheet by management. In the model, the forecasted shape of the yield curve remained static as of June 30, 2018.

In an immediate and sustained 200 basis point increase in market rates at June 30, 2018, net interest income for year 1 would increase approximately 1.3 percent, when compared to a flat interest rate scenario.  In year 2 net interest income increases 4.9 percent, when compared to a flat interest rate scenario.

In an immediate and sustained 100 basis point decrease in market rates at June 30, 2018, net interest income would decline approximately 3.9 percent for year 1 and 6.1 percent for year 2, compared to a flat interest rate scenario.

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The table below shows the estimated changes in the Company’s economic value of portfolio equity (“EVPE”) that would result from an immediate parallel change in the market interest rates at June 30, 2018.

 

 

Certain shortcomings are inherent in the methodologies used in determining interest rate risk. Simulation modeling requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the modeling assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the information provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.

Model simulation results indicate the Company is slightly asset sensitive, which indicates the Company’s net interest income should improve slightly in a rising rate environment.  Management believes the Company’s interest rate risk position is reasonable.

ITEM 4.  Controls and Procedures

The Corporation’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer have concluded that the Corporation’s disclosure controls and procedures are effective as of the end of the period covered by this Quarterly Report on Form 10-Q.

The Corporation’s Chief Executive Officer and Chief Financial Officer have also concluded that there have not been any changes in the Corporation’s internal control over financial reporting during the quarter ended June 30, 2018 that have materially affected, or are reasonable likely to materially affect, the Corporation’s internal control over financial reporting.

The Corporation’s management, including the CEO and CFO, does not expect that our disclosure controls and procedures of our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, provides reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system reflects resource constraints; the benefits of controls must be considered relative to their costs. Because there are inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Corporation have been or will be detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns occur because of simple error or mistake. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all future conditions; over time, control may become inadequate because of changes in conditions or deterioration in the degree of compliance with the policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

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PART II.  OTHER INFORMATION

ITEM 1.  Legal Proceedings

In the normal course of its business, lawsuits and claims may be brought against the Company and its subsidiaries.  There is no currently pending or threatened litigation or proceedings against the Company or its subsidiaries, which if adversely decided, we believe would have a material adverse effect on the Company.

ITEM 1A.  Risk Factors

There were no material changes in the Corporation’s risk factors during the six months ended June 30, 2018 from the risk factors disclosed in Part I, Item 1A of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2017.

ITEM 2.  Unregistered Sales of Equity Securities and Use of Proceeds

There were no repurchases or unregistered sales of the Company’s stock during the quarter.

ITEM 3.  Defaults Upon Senior Securities

None.

ITEM 4.  Mine Safety Disclosures

Not applicable.

ITEM 5.  Other Information

None.

 

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ITEM 6.  Exhibits

 

 

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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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