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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
| | | | | |
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2023
Or
| | | | | |
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from __________ to __________
Commission File Number: 000-55983
(Exact name of registrant as specified in its charter)
| | | | | |
Pennsylvania | 83-1561918 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
9 Old Lincoln Highway, Malvern, Pennsylvania 19355
(Address of principal executive offices) (Zip Code)
(484) 568-5000
(Registrant’s telephone number, including area code)
| | | | | | | | |
Title of class | Trading Symbol | Name of exchange on which registered |
Common Stock, $1 par value | MRBK | The NASDAQ Stock Market |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒Yes ☐No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒Yes ☐No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| | | | | | | | | | | | | | |
| Large Accelerated Filer | ☐ | Accelerated Filer | ☒ |
| Non-accelerated Filer | ☐ | Smaller Reporting Company | ☒ |
| Emerging Growth Company | ☐ | | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of November 3, 2023 there were 11,177,751 outstanding shares of the issuer’s common stock, par value $1.00 per share.
TABLE OF CONTENTS
Glossary of Acronyms, Abbreviations, and Terms
The acronyms, abbreviations, and terms listed below are used in various sections of this report. As used throughout this report, the terms "Meridian", “we”, “our”, or “us” refer to Meridian Corporation and its consolidated subsidiaries, unless the context otherwise requires.
| | | | | |
Acronym | Description |
| |
ACH | Automated clearing house |
ACL | Allowance for credit losses |
AFS | Available-for-sale |
ALCO | Asset/Liability Committee |
ALLL | Allowance for loan and lease losses |
ALM | Asset / liability management |
AOCI | Accumulated other comprehensive income |
ASC | Accounting Standards Codification |
ASU | Accounting Standards Update |
BHC Act | Bank Holding Company Act of 1956 |
BOLI | Bank owned life insurance |
BSA-AML | Bank Secrecy Act - Anti-Money Laundering |
BTFP | Federal Reserve Bank Term Funding Program |
CBCA | Change in Bank Control Act |
CBLR | Community Bank Leverage Ratio |
CDARS | Certificate of Deposit Account Registry Service |
CECL | Current expected credit losses |
CET1 | Common equity tier 1 |
CFPB | Consumer Financial Protection Bureau |
CMO | Collateralized mortgage obligation |
COVID-19 | Coronavirus Disease 2019 |
CRE | Commercial real estate |
DIF | FDIC’s deposit insurance fund |
ECOA | Equal Credit Opportunity Act |
ESOP | Employee Stock Ownership Plan |
FASB | Financial Accounting Standards Board |
| |
FDIC | Federal Deposit Insurance Corporation |
FFIEC | Federal Financial Institutions Examination Council |
FHA | Federal Housing Authority |
FHFA | Federal Housing Finance Agency |
FHLB | Federal Home Loan Bank of Pittsburgh |
FHLMC | Federal Home Loan Mortgage Corporation or Freddie Mac |
FICO | Financing Corporation |
FNMA | Federal National Mortgage Association or Fannie Mae |
FRB | Federal Reserve Bank of Philadelphia |
FTE | Fully taxable equivalent |
GAAP | U.S. generally accepted accounting principles |
GLB Act | Gramm-Leach-Bliley Act |
GNMA | Government National Mortgage Association or Ginnie Mae |
GSE | Government-sponsored entities |
HTM | Held-to-maturity |
ICBA | Independent Community Bankers of America |
JOBS Act | Jumpstart Our Business Startups Act of 2012 |
LBP | Look-back period |
LEP | Loss emergence period |
| | | | | |
LGD | Loss given default |
LIBOR | London Inter-bank Offering Rate |
LIHTC | Low-income-housing tax credit |
MBS | Mortgage-backed securities |
MSLP | Main Street Lending Programs |
MSR | Mortgage servicing rights |
OFAC | Office of Foreign Assets Control |
OREO | Other real estate owned |
PCAOB | Public Company Accounting Oversight Board |
PD | Probability of default |
PDBS | Pennsylvania Department of Banking and Securities |
PPP | Paycheck Protection Program |
ROU | Right-of-use |
SBA | Small Business Administration |
SEC | Securities and Exchange Commission |
SERP | Supplemental Executive Retirement Plan |
SNC | Shared national credit |
SOFR | Secure Overnight Financing Rate |
TILA | Truth in Lending Act |
TDR | Troubled debt restructuring |
USDA | U.S. Department of Agriculture |
VA | U.S. Department of Veteran’s Affairs |
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
| | | | | | | | | | | |
(dollars in thousands, except share data) | September 30, 2023 | | December 31, 2022 |
Assets: | | | |
Cash and due from banks | $ | 13,737 | | | $ | 11,299 | |
Interest-bearing deposits at other banks | 46,022 | | | 27,092 | |
| | | |
Cash and cash equivalents | 59,759 | | | 38,391 | |
Securities available-for-sale, at fair value (amortized cost of $138,014 and $148,976, respectively) | 122,218 | | | 135,346 | |
Securities held-to-maturity, at amortized cost (fair value of $30,665 and $33,085, respectively) | 36,232 | | | 37,479 | |
Equity investments | 2,019 | | | 2,086 | |
Mortgage loans held for sale | 23,144 | | | 22,243 | |
Loans, net of fees and costs | 1,885,629 | | | 1,743,682 | |
Allowance for credit losses | (19,683) | | | (18,828) | |
Loans and other finance receivables, net of the allowance for credit losses | 1,865,946 | | | 1,724,854 | |
Restricted investment in bank stock | 8,309 | | | 6,931 | |
Bank premises and equipment, net | 13,310 | | | 13,349 | |
Bank owned life insurance | 28,641 | | | 28,055 | |
Accrued interest receivable | 8,984 | | | 7,363 | |
Other real estate owned | 1,703 | | | 1,703 | |
Deferred income taxes | 4,993 | | | 3,936 | |
Servicing assets | 11,835 | | | 12,346 | |
Goodwill | 899 | | | 899 | |
Intangible assets | 3,022 | | | 3,175 | |
Other assets | 39,957 | | | 24,072 | |
Total assets | $ | 2,230,971 | | | $ | 2,062,228 | |
| | | |
Liabilities: | | | |
Deposits: | | | |
Non-interest bearing | $ | 244,668 | | | $ | 301,727 | |
Interest bearing | 1,563,977 | | | 1,410,752 | |
Total deposits | 1,808,645 | | | 1,712,479 | |
Borrowings | 177,959 | | | 122,082 | |
| | | |
Subordinated debentures | 50,079 | | | 40,346 | |
Accrued interest payable | 7,814 | | | 2,389 | |
Other liabilities | 31,360 | | | 31,652 | |
Total liabilities | 2,075,857 | | | 1,908,948 | |
| | | |
Stockholders’ equity: | | | |
Common stock, $1 par value per share. 25,000,000 shares authorized; 13,180,934 and 13,156,308 shares issued and 11,177,751 and 11,465,572 shares outstanding, respectively | 13,181 | | | 13,156 | |
Surplus | 79,731 | | | 79,072 | |
Treasury stock, 2,003,183 and 1,690,736 shares, respectively, at cost | (26,079) | | | (21,821) | |
Unearned common stock held by employee stock ownership plan | (1,403) | | | (1,403) | |
Retained earnings | 102,043 | | | 95,815 | |
Accumulated other comprehensive loss | (12,359) | | | (11,539) | |
Total stockholders’ equity | 155,114 | | | 153,280 | |
Total liabilities and stockholders’ equity | $ | 2,230,971 | | | $ | 2,062,228 | |
See accompanying notes to the unaudited consolidated financial statements.
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
(dollars in thousands, except per share data) | 2023 | | 2022 | | 2023 | | 2022 |
Interest income: | | | | | | | |
Loans and other finance receivables, including fees | $ | 33,980 | | | $ | 21,848 | | | $ | 95,612 | | | $ | 58,187 | |
Securities - taxable | 901 | | | 648 | | | 2,853 | | | 1,599 | |
Securities - tax-exempt | 333 | | | 369 | | | 1,038 | | | 1,015 | |
Cash and cash equivalents | 245 | | | 93 | | | 741 | | | 157 | |
Total interest income | 35,459 | | | 22,958 | | | 100,244 | | | 60,958 | |
Interest expense: | | | | | | | |
Deposits | 15,543 | | | 4,075 | | | 41,013 | | | 7,182 | |
Borrowings | 2,692 | | | 857 | | | 7,230 | | | 2,166 | |
Total interest expense | 18,235 | | | 4,932 | | | 48,243 | | | 9,348 | |
Net interest income | 17,224 | | | 18,026 | | | 52,001 | | | 51,610 | |
Provision for credit losses | 82 | | | 526 | | | 2,186 | | | 1,743 | |
Net interest income after provision for credit losses | 17,142 | | | 17,500 | | | 49,815 | | | 49,867 | |
Non-interest income: | | | | | | | |
Mortgage banking income | 4,819 | | | 7,329 | | | 13,143 | | | 21,367 | |
Wealth management income | 1,258 | | | 1,114 | | | 3,689 | | | 3,672 | |
SBA loan income | 982 | | | 989 | | | 3,463 | | | 3,946 | |
Earnings on investment in life insurance | 201 | | | 138 | | | 585 | | | 413 | |
Net change in the fair value of derivative instruments | 103 | | | 127 | | | 217 | | | (713) | |
Net change in the fair value of loans held-for-sale | 111 | | | (237) | | | (88) | | | (1,094) | |
Net change in the fair value of loans held-for-investment | (570) | | | (886) | | | (673) | | | (2,499) | |
Net gain on hedging activity | 82 | | | 399 | | | 81 | | | 4,941 | |
Net loss on sale of investment securities available-for-sale | (3) | | | — | | | (58) | | | — | |
| | | | | | | |
Other | 1,103 | | | 1,251 | | | 3,489 | | | 3,695 | |
Total non-interest income | 8,086 | | | 10,224 | | | 23,848 | | | 33,728 | |
Non-interest expense: | | | | | | | |
Salaries and employee benefits | 12,420 | | | 13,360 | | | 35,633 | | | 41,585 | |
Occupancy and equipment | 1,226 | | | 1,191 | | | 3,610 | | | 3,619 | |
Professional fees | 1,104 | | | 899 | | | 2,930 | | | 2,659 | |
Advertising and promotion | 848 | | | 1,165 | | | 2,799 | | | 3,340 | |
Data processing and software | 1,652 | | | 1,442 | | | 4,764 | | | 3,939 | |
| | | | | | | |
Other | 2,768 | | | 2,204 | | | 7,686 | | — | | 6,258 | |
Total non-interest expense | 20,018 | | | 20,261 | | | 57,422 | | | 61,400 | |
Income before income taxes | 5,210 | | | 7,463 | | | 16,241 | | | 22,195 | |
Income tax expense | 1,205 | | | 1,665 | | | 3,568 | | | 4,927 | |
Net income | $ | 4,005 | | | $ | 5,798 | | | $ | 12,673 | | | $ | 17,268 | |
Basic earnings per common share | $ | 0.36 | | | $ | 0.49 | | | $ | 1.14 | | | $ | 1.45 | |
Diluted earnings per common share | $ | 0.35 | | | $ | 0.48 | | | $ | 1.11 | | | $ | 1.40 | |
Basic weighted average shares outstanding | 11,058 | | | 11,736 | | | 11,129 | | | 11,928 | |
Diluted weighted average shares outstanding | 11,363 | | | 12,118 | | | 11,449 | | | 12,344 | |
See accompanying notes to the unaudited consolidated financial statements.
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
(dollars in thousands) | 2023 | | 2022 | | 2023 | | 2022 |
Net income: | $ | 4,005 | | | $ | 5,798 | | | $ | 12,673 | | | $ | 17,268 | |
| | | | | | | |
Net change in unrealized gains (losses) on investment securities available for sale: | | | | | | | |
Change in fair value of investment securities, net of tax of $(575), $(1,129), $(489), and $(3,694), respectively | (2,059) | | | (3,910) | | | (1,757) | | | (12,760) | |
Reclassification adjustment for net losses (gains) realized in net income, net of tax effect of $1, $0, $13, and $(1), respectively | 2 | | | — | | | 45 | | | (9) | |
Reclassification adjustment for investment securities transferred to held-to-maturity, net of tax effect of $7, $8, $19, and $(293), respectively | 22 | | | 37 | | | 67 | | | (962) | |
Unrealized investment losses, net of tax effect of $(566), $(1,121), $(457), and $(3,989), respectively | $ | (2,035) | | | $ | (3,873) | | | $ | (1,645) | | | $ | (13,731) | |
Net change in unrealized gains (losses) on interest rate swaps used in cash flow hedges, net of tax effect of $(140), $0, $(233), and $0, respectively | 497 | | | — | | | 825 | | | — | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Total other comprehensive loss | $ | (1,538) | | | $ | (3,873) | | | $ | (820) | | | $ | (13,731) | |
Total comprehensive income | $ | 2,467 | | | $ | 1,925 | | | $ | 11,853 | | | $ | 3,537 | |
See accompanying notes to the unaudited consolidated financial statements.
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(dollars in thousands, except per share data) | Common Stock | | Surplus | | Treasury Stock | | Unearned ESOP | | Retained Earnings | | AOCI | | Total |
Three Months Ended September 30, 2023 | | | | | | | | | | | | | |
Balance at July 1, 2023 | $ | 13,181 | | | $ | 79,650 | | | $ | (26,079) | | | $ | (1,403) | | | $ | 99,434 | | | $ | (10,821) | | | $ | 153,962 | |
Net income | — | | | — | | | — | | | — | | | 4,005 | | | — | | | 4,005 | |
Other comprehensive loss | — | | | — | | | — | | | — | | | — | | | (1,538) | | | (1,538) | |
Dividends declared ($0.125 per share) | — | | | — | | | — | | | — | | | (1,396) | | | — | | | (1,396) | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Stock based compensation expense | — | | | 81 | | | — | | | — | | | — | | | — | | | 81 | |
Balance at September 30, 2023 | $ | 13,181 | | | $ | 79,731 | | | $ | (26,079) | | | $ | (1,403) | | | $ | 102,043 | | | $ | (12,359) | | | $ | 155,114 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(dollars in thousands, except per share data) | Common Stock | | Surplus | | Treasury Stock | | Unearned ESOP | | Retained Earnings | | AOCI | | Total |
Nine Months Ended September 30, 2023 | | | | | | | | | | | | | |
Balance at January 1, 2023 | $ | 13,156 | | | $ | 79,072 | | | $ | (21,821) | | | $ | (1,403) | | | $ | 95,815 | | | $ | (11,539) | | | $ | 153,280 | |
Adjustment to initially apply ASU No. 2016-13 for CECL (1), net of tax | | | | | | | | | (2,228) | | | | | (2,228) | |
Net income | — | | | — | | | — | | | — | | | 12,673 | | | — | | | 12,673 | |
Other comprehensive loss | — | | | — | | | — | | | — | | | — | | | (820) | | | (820) | |
Dividends declared ($0.375 per share) | — | | | — | | | — | | | — | | | (4,217) | | | — | | | (4,217) | |
Net purchase of treasury stock through publicly announced plans (127,849 shares) | — | | | — | | | (4,258) | | | — | | | — | | | — | | | (4,258) | |
Common stock issued through share-based awards and exercises | 25 | | | 144 | | | — | | | — | | | — | | | — | | | 169 | |
| | | | | | | | | | | | | |
Stock based compensation expense | — | | | 515 | | | — | | | — | | | — | | | — | | | 515 | |
Balance at September 30, 2023 | $ | 13,181 | | | $ | 79,731 | | | $ | (26,079) | | | $ | (1,403) | | | $ | 102,043 | | | $ | (12,359) | | | $ | 155,114 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(dollars in thousands, except per share data) | Common Stock | | Surplus | | Treasury Stock | | Unearned ESOP | | Retained Earnings | | AOCI | | Total |
Three Months Ended September 30, 2022 | | | | | | | | | | | | | |
Balance at July 1, 2022 | $ | 13,096 | | | $ | 77,824 | | | $ | (11,896) | | | $ | (1,602) | | | $ | 87,815 | | | $ | (9,150) | | | $ | 156,087 | |
Net income | — | | | — | | | — | | | — | | | 5,798 | | | — | | | 5,798 | |
Other comprehensive loss | — | | | — | | | — | | | — | | | — | | | (3,873) | | | (3,873) | |
Dividends declared ($0.10 per share) | — | | | — | | | — | | | — | | | (1,208) | | | — | | | (1,208) | |
Net purchase of treasury stock through publicly announced plans (394,838 shares) | — | | | — | | | (6,137) | | | — | | | — | | | — | | | (6,137) | |
Common stock issued through share-based awards and exercises | 5 | | | 112 | | | — | | | — | | | — | | | — | | | 117 | |
Stock based compensation expense | — | | | 377 | | | — | | | — | | | — | | | — | | | 377 | |
Balance at September 30, 2022 | $ | 13,101 | | | $ | 78,313 | | | $ | (18,033) | | | $ | (1,602) | | | $ | 92,405 | | | $ | (13,023) | | | $ | 151,161 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(dollars in thousands, except per share data) | Common Stock | | Surplus | | Treasury Stock | | Unearned ESOP | | Retained Earnings | | AOCI | | Total |
Nine Months Ended September 30, 2022 | | | | | | | | | | | | | |
Balance at January 1, 2022 | $ | 13,070 | | | $ | 77,128 | | | $ | (8,860) | | | $ | (1,602) | | | $ | 84,916 | | | $ | 708 | | | $ | 165,360 | |
Net income | — | | | — | | | — | | | — | | | 17,268 | | | — | | | 17,268 | |
Other comprehensive loss | — | | | — | | | — | | | — | | | — | | | (13,731) | | | (13,731) | |
Dividends declared ($0.80 per share) | — | | | — | | | — | | | — | | | (9,779) | | | — | | | (9,779) | |
Net purchase of treasury stock through publicly announced plans (589,608 shares) | — | | | — | | | (9,173) | | | — | | | — | | | — | | | (9,173) | |
Common stock issued through share-based awards and exercises | 31 | | | 454 | | | — | | | — | | | — | | | — | | | 485 | |
Stock based compensation expense | — | | | 731 | | | — | | | — | | | — | | | — | | | 731 | |
Balance at September 30, 2022 | $ | 13,101 | | | $ | 78,313 | | | $ | (18,033) | | | $ | (1,602) | | | $ | 92,405 | | | $ | (13,023) | | | $ | 151,161 | |
(1) See Note 1, "Summary of Significant Accounting Policies - Pronouncements Adopted in 2023" for additional information.
See accompanying notes to the unaudited consolidated financial statements.
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| | | | | | | | | | | |
| Nine months ended September 30, |
(dollars in thousands) | 2023 | | 2022 |
Net income | $ | 12,673 | | | $ | 17,268 | |
Adjustments to reconcile net income to net cash (used in) provided by operating activities: | | | |
Loss on sale of investment securities | 58 | | | — | |
Net amortization of investment premiums and discounts and change in fair value of equity securities | 1,225 | | | 668 | |
Depreciation and amortization (accretion), net | 289 | | | (1,343) | |
Provision for credit losses | 2,186 | | | 1,743 | |
Amortization of issuance costs on subordinated debt | 56 | | | 89 | |
Stock based compensation | 515 | | | 731 | |
Net change in fair value of derivative instruments | (217) | | | 713 | |
Net change in fair value of loans held for sale | 88 | | | 1,094 | |
Net change in fair value of loans held for investment | 673 | | | 2,499 | |
Amortization and net impairment of servicing rights | 1,618 | | | 1,753 | |
SBA loan income | (3,463) | | | (3,946) | |
Proceeds from sale of loans | 515,573 | | | 863,056 | |
Loans originated for sale | (504,880) | | | (794,541) | |
Mortgage banking income | (13,143) | | | (21,367) | |
Increase in accrued interest receivable | (1,621) | | | (999) | |
Increase in other assets | (4,874) | | | (1,675) | |
Earnings from investment in bank owned life insurance | (585) | | | (413) | |
(Increase) decrease in deferred income tax | 170 | | | (219) | |
Increase in accrued interest payable | 5,425 | | | 1,123 | |
Decrease in other liabilities | (778) | | | (2,579) | |
Net cash provided by operating activities | $ | 10,988 | | | $ | 63,655 | |
| | | |
Cash flows from investing activities: | | | |
Activity in available-for-sale securities: | | | |
Maturities, repayments and calls | 7,301 | | | 8,662 | |
Sales | 13,514 | | | — | |
Purchases | (12,949) | | | (22,176) | |
Activity in held-to-maturity securities: | | | |
Maturities, repayments and calls | 1,020 | | | 540 | |
Purchases | — | | | (5,500) | |
Increase in restricted stock | (1,378) | | | (100) | |
Net increase in loans | (149,462) | | | (225,967) | |
Purchases of premises and equipment | (1,080) | | | (2,020) | |
| | | |
Net cash used in investing activities | $ | (143,034) | | | $ | (246,561) | |
| | | |
Cash flows from financing activities: | | | |
Net increase in deposits | 96,166 | | | 227,140 | |
| | | |
Increase (decrease) in short-term borrowings | 37,201 | | | (17,886) | |
Increase in long-term debt | 18,676 | | | — | |
| | | |
| | | |
Repayment of subordinated debt | (54) | | | — | |
Proceeds from issuance of subordinated debt | 9,740 | | | — | |
Issuance costs on subordinated debt | (9) | | | — | |
Net purchase of treasury stock | (4,258) | | | (9,173) | |
Dividends paid | (4,217) | | | (9,779) | |
Share based awards and exercises | 169 | | | 485 | |
Net cash provided by financing activities | $ | 153,414 | | | $ | 190,787 | |
| | | |
Net change in cash and cash equivalents | 21,368 | | | 7,881 | |
Cash and cash equivalents at beginning of period | 38,391 | | | 23,480 | |
Cash and cash equivalents at end of period | $ | 59,759 | | | $ | 31,361 | |
| | | |
Supplemental disclosure of cash flow information: | | | |
Cash paid during the period for: | | | |
Interest | $ | 42,818 | | | $ | 8,225 | |
Income taxes | 1,839 | | | 5,365 | |
| | | |
| | | |
Transfers from loans held for sale to loans held for investment | 351 | | | 2,955 | |
Net loans sold, not settled | 12,820 | | | — | |
| | | |
Transfer of securities from AFS to HTM | — | | | 23,655 | |
| | | |
See accompanying notes to the unaudited consolidated financial statements.
MERIDIAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) Summary of Significant Accounting Policies
Basis of Presentation
The Corporation’s unaudited consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial position and the results of operations for the interim periods presented have been included.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Amounts subject to significant estimates are items such as the allowance for credit losses, lending related commitments and the related unfunded commitment reserve, the fair value of financial instruments, other-than-temporary impairments of investment securities, and the valuations of goodwill, intangible assets, and servicing assets.
These unaudited consolidated financial statements should be read in conjunction with the Corporation’s filings with the SEC (including our Annual Report on Form 10-K for the year ended December 31, 2022), subsequently filed quarterly reports on Form 10-Q and current reports on Form 8-K that update or provide information in addition to the information included in Form 10-K and Form 10-Q filings, if any.
Certain prior period amounts have been reclassified to conform with current period presentation. Reclassifications had no effect on net income or stockholders’ equity. Operating results for the three and nine months ended September 30, 2023 are not necessarily indicative of the results for the year ending December 31, 2023 or for any other period.
Stock Split
On February 28, 2023, the Corporation approved and declared a two-for-one stock split in the form of a stock dividend, paid March 20, 2023, to shareholders of record as of March 14, 2023. Under the terms of the stock split, the Corporation’s shareholders received a dividend of one share for every share held on the record date. The dividend was paid in authorized but unissued shares of common stock of the Corporation. The par value of the Corporation's stock was not affected by the split and remained at $1.00 per share. All share and per share amounts reported in the consolidated financial statements have been adjusted to reflect the two-for-one stock split.
Loans
Loans held for investment are recorded at amortized cost, net of ACL. Amortized cost is the amount at which a financial asset is originated or acquired, adjusted for the amortization of premium and discount, net deferred fees or costs, collection of cash, and write-offs. Interest income on loans is recognized using the level yield method. Loan origination fees, commitment fees and direct loan origination costs are deferred and recognized over the life of the related loans using a level yield method over the period to maturity.
Allowance for Credit Losses - Loans and Leases
On January 1, 2023, the Corporation adopted ASU 2016-13, Financial Instruments-Credit Losses ("Topic 326"), which replaced the incurred loss impairment model with an expected loss methodology that is referred to as the CECL methodology. The Corporation now establishes an ACL in accordance with Topic 326. The ACL includes quantitative and qualitative factors that comprise management's current estimate of expected credit losses, including portfolio mix and segmentation, modeling methodology, historical loss experience, relevant available information from internal and external sources relating to reasonable and supportable forecasts about future economic conditions, prepayment speeds, and qualitative adjustment factors.
The Corporation's portfolio segments, established based on similar risk characteristics and loss behaviors, are:
• Commercial mortgage, commercial and industrial, construction, SBA loans, and commercial small business leases (commercial loans), and
• Residential, equity secured lines and loans, and installment loans (retail loans).
Expected credit losses are estimated over the contractual term, adjusted for expected prepayments and recoveries. The contractual term excludes any extensions, renewals and modifications unless the Corporation has reasonable expectations at the reporting date that it will result in a modification, or they are not unconditionally cancellable. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.
The allowance includes two primary components: (i) an allowance established on loans which share similar risk characteristics collectively evaluated for credit losses (collective basis) and (ii) an allowance established on loans which do not share similar risk characteristics with any loan segment and are individually evaluated for credit losses (individual basis).
Loans that share similar risk characteristics are collectively reviewed for credit loss and are evaluated based on historical loss experience, adjusted for current economic conditions and future economic forecasts. Estimated losses are determined differently for commercial and consumer loans, and each portfolio segment is further segmented by internally assessed risk ratings.
Management uses a third-party economic forecast to modify the calculated historical loss rates of the portfolio segments. The Corporation's economic forecast extends out 4 quarters (the forecast period) and reverts to the historical loss rates on a straight-line basis over 1 quarter (the reversion period) as we believe this to be reasonable and supportable in the current environment. The economic forecast and reversion periods will be evaluated periodically by management and updated as appropriate.
The historical loss rates for commercial loans are estimated by determining the PD and expected LGD. The PD is calculated based on the historical rate of migration to an event of credit loss during the look-back period. The historical loss rates for retail loans is calculated based solely on average net loss rates over the same look-back period. The Corporation's current look-back period is 32 quarters which helps to ensure that historical loss rates are adequately considering losses over a full economic cycle.
Loans that do not share similar risk characteristics with any loan segments are evaluated on an individual basis. These loans, which may include borrowers experiencing financial difficulties, are not included in the collective basis evaluation. When it is probable that collection of all principal and interest due according to their contractual terms is not likely, which is assessed based on the credit characteristics of the loan and/or payment status, these loans are individually reviewed and measured for potential credit loss.
The amount of the potential credit loss is measured using one of three methods: (i) the present value of expected future cash flows discounted at the loan’s effective interest rate; (ii) the fair value of collateral, if the loan is collateral dependent; or (iii) the loan’s observable market price. If the measured fair value of the loan is less than the amortized cost basis of the loan, an allowance for credit loss is recorded.
For collateral dependent loans, the expected credit losses at the individual asset level is the difference between the collateral's fair value (less cost to sell) and the amortized cost.
Qualitative adjustment factors consider various internal and external conditions which are allocated among loan segments and take into consideration:
• Current underwriting policies, staff and portfolio concentrations,
• Risk rating accuracy, credit and administration,
• Internal risk emergence (including internal trends of delinquency, portfolio growth, and collateral value), and
• , Competitive environment, as it could impact loan structure and underwriting.
These factors are based on their relative standing compared to the period in which historical losses are used in quantitative reserve estimates and current directional trends, and reasonable and supportable forecasts. Qualitative factors in the model can add to or subtract from quantitative reserves.
Loan officers and risk managers meet at least quarterly to discuss and review the conditions and risks associated with individual problem loans. In addition, various regulatory agencies periodically review our loan ratings and allowance for credit losses and the Bank’s internal loan review department performs loan reviews.
Accrued interest receivable on loans is excluded from the estimate of credit losses and is included in Accrued interest receivable on the Consolidated Balance Sheets.
For additional detail regarding the allowance for credit losses and the provision for credit losses, see Note 5.
Past Due and Nonaccrual Loans
Past due loans and leases are defined as loans contractually past due 30 - 89 days as to principal or interest payments but which remain in accrual status, or loans delinquent 90 days or more but are considered well secured and in the process of collection.
Nonaccruing loans and leases are those on which the accrual of interest has ceased. Loans are placed on nonaccrual status immediately if, in the opinion of management, collection is doubtful, or when principal or interest is past due 90 days or more and the loan is not well secured and in the process of collection. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed and charged against interest income. In addition, the amortization of net deferred loan fees is suspended when a loan is placed on nonaccrual status. Subsequent cash receipts are applied either to the outstanding principal balance or recorded as interest income, depending on management’s assessment of the ultimate collectability of principal and interest. Loans are returned to accrual status when it is determined that the borrower has the ability to make all principal and interest payments in accordance with the terms of the loan (i.e. a consistent repayment record, generally six consecutive payments, has been demonstrated).
Unless loans are well-secured and collection is imminent, for loans greater than 90 days past due their respective reserves are generally charged off once the loss has been confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged off and expected to be charged off.
Securities
Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date.
Securities classified as available-for-sale are those securities that the Corporation intends to hold for an indefinite period of time but not necessarily to maturity. Securities available-for-sale are carried at fair value. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movement in interest rates, changes in maturity mix of the Corporation’s assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Unrealized gains and losses are reported as increases or decreases in other comprehensive income. Gains or losses on disposition are based on the net proceeds and cost of the securities sold, adjusted for the amortization of premiums and accretion of discounts, using the specific identification method.
Securities classified as held to maturity are those debt securities the Corporation has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for the amortization of premium and accretion of discount, computed on a level yield basis.
Investments in equity securities are recorded in accordance with ASC 321-10, Investments - Equity Securities. Equity securities are carried at fair value, with changes in fair value reported in net income. At September 30, 2023 and December 31, 2022, investments in equity securities consisted of an investment in mutual funds with a fair value of $2.0 million, and $2.1 million, respectively.
The Corporation’s accounting policy specifies that (a) if the Corporation does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired, unless there is a credit loss. When the Corporation does not intend to sell the security, and it is more likely than not, the Corporation will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. The Corporation did not recognize any other-than-temporary impairment charges during the three and nine months ended September 30, 2023 and 2022.
Allowance for Credit Losses - Held-to-Maturity Debt Securities
We follow Accounting Standards Codification (ASC) 326-20, Financial Instruments - Credit Loss - Measured at Amortized Cost, to measure expected credit losses on held-to-maturity debt securities on a collective basis by security investment grade. The estimate of expected credit losses considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts.
The Corporation classifies the held-to-maturity debt securities into the following major security types: state and municipal securities. These securities are highly rated with a history of no credit losses, and are assigned ratings based on the most recent data from ratings agencies depending on the availability of data for the security. Credit ratings of held-to-maturity debt securities, which are a significant input in calculating the expected credit loss, are reviewed on a quarterly basis.
Accrued interest receivable on held-to-maturity debt securities is excluded from the estimate of credit losses and is included in Accrued interest receivable on the Consolidated Balance Sheets.
Allowance for Credit Losses - Available-for-Sale Debt Securities
We follow ASC 326-30, Financial Instruments - Credit Loss - Available-for-Sale Debt Securities, which provides guidance related to the recognition of and expanded disclosure requirements for expected credit losses on available-for-sale debt securities. For available-for-sale debt securities in an unrealized loss position, the Corporation first evaluates whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either criteria is met, the security's amortized cost basis is reduced to fair value and recognized as a reduction to Noninterest income in the Consolidated Statements of Income.
For debt securities available-for-sale which the Corporation does not intend to sell, or it is not likely the security would be required to be sold before recovery, we evaluate whether a decline in fair value has resulted from credit losses or other adverse factors, such as a change in the security's credit rating. In assessing whether a credit loss exists, the Corporation compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance is recorded, limited to the fair value of the security.
Management performs this analysis on a quarterly basis to review the conditions and risks associated with the individual securities. Credit losses on an impaired security shall continue to be measured using the present value of expected future cash flows. Any impairment not recorded through an allowance for credit loss is included in other comprehensive income (loss), net of the tax effect. We are required to use our judgment in determining impairment in certain circumstances. For additional detail regarding debt securities, see Note 3.
Unfunded Lending Commitments
For unfunded lending commitments, the Corporation estimates expected credit losses over the contractual period in which the Corporation is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Corporation. The estimate includes consideration of the probability of default and utilization rate at default to calculate expected credit losses on commitments expected to be funded over its estimated life of one year, based on historical losses, and qualitative adjustment factors.
The allowance for credit losses for off-balance sheet exposures is included in Other liabilities on the Consolidated Balance Sheets and the provision for credit losses for off-balance sheet exposure is included in the provision for credit losses on the Consolidated Statements of Income for the periods ended September 30, 2023, and in other non-interest expense for periods prior to the adoption of ASU-2016-13 on January 1, 2023. The allowance for credit losses for off-balance sheet exposures was $1.0 million and $173 thousand as of September 30, 2023 and December 31, 2022, respectively.
Pronouncements Adopted in 2023
FASB ASU 2016-13 (Topic 326), “Measurement of Credit Losses on Financial Instruments”
The Corporation adopted ASU 2016-13, as amended, on January 1, 2023, which replaced the incurred loss methodology with an expected loss methodology that is referred to as the CECL methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loans, net of fees and costs, securities HTM, unfunded lending commitments (including loan commitments on loans held for investment, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor in accordance with Topic 842. In addition, ASC 326 made changes to the accounting for securities AFS which now requires credit losses to be presented as an allowance rather than as an other-than-temporary impairment on securities AFS management does not intend to sell or believes that it is more likely than not they will be required to sell.
We applied the modified retrospective method for all financial assets measured at amortized cost and securities AFS. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Corporation recorded a one-time decrease to retained earnings of $2.2 million on January 1, 2023 for the cumulative effect of adopting ASC 326, net of tax. The transition adjustment includes $1.2 million and $974 thousand post-tax impacts for loans, net of fees and costs and unfunded loan commitments, respectively, due to higher expected credit losses compared to the incurred loss methodology primarily driven by longer duration commercial and consumer real estate loans.
FASB ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments”
Issued in April 2019, ASU 2019-04 clarifies certain aspects of accounting for credit losses, hedging activities, and financial instruments (addressed by ASUs 2016-13, 2017-12, and 2016-01, respectively). The amendments to estimating expected credit losses (ASU 2016-13), in particular, how a company considers recoveries and extension options when estimating expected credit losses, are the most relevant to the Corporation. The ASU clarifies that (1) the estimate of expected credit losses should include expected recoveries of financial assets, including recoveries of amounts expected to be written off and those previously written off, and (2) that contractual extension or renewal options that are not unconditionally cancellable by the lender are considered when determining the contractual term over which expected credit losses are measured. The Corporation adopted ASU 2019-04 at the same time ASU 2016-13 was adopted.
FASB ASU 2022-02, "Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures."
In March 2022, the FASB issued ASU No. 2022-02, "Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures." The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted CECL and enhance the disclosure requirements for modifications of receivables made with borrowers experiencing financial difficulty. In addition, the amendments require disclosure of current period gross write-offs by year of origination for financing receivables and net investment in leases in the existing vintage disclosures. The Corporation adopted ASU 2022-02 at the same time ASU 2016-13 was adopted, as of January 1, 2023. The adoption of this ASU resulted in updated disclosures within our financial statements but otherwise did not have a material impact on the Corporation's financial statements. See Note 5.
Pronouncements Not Yet Effective as of September 30, 2023:
FASB ASU 2020-04 (Topic 848), “Reference Rate Reform (“ASC 848”): Facilitation of the Effects of Reference Rate Reform on Financial Reporting”
Issued in March 2020, ASU 2020-04 contains optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The Corporation does not have a significant concentration of loans, derivative contracts, borrowings or other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. The Corporation expects to adopt the LIBOR transition relief allowed under this standard.
FASB ASU 2020-06, “Debt With Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity”
This ASU clarifies the accounting for certain financial instruments with characteristics of liabilities and equity. The amendments in this update reduce the number of accounting models for convertible debt instruments and convertible preferred stock by removing the cash conversion model and the beneficial conversion feature models. For public business entities that meet the definition of an SEC filer (excluding smaller reporting entities), the amendments are effective for fiscal years beginning after Dec. 15, 2021, and interim periods within. For all other entities, the amendments are effective for fiscal years beginning after Dec. 15, 2023, and interim periods within. Early adoption is permitted, but no earlier than for fiscal years beginning after Dec. 15, 2020. The Corporation does not expect this to have a material impact on our consolidated financial statements.
FASB ASU 2023-02, "Investments Equity Method and Joint Ventures (Topic 323) Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method"
In March 2023, the FASB issued ASU 2023-02, Investments Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method to allow reporting entities to consistently account for equity investments made primarily for the purpose of receiving income tax credits and other income tax benefits. If certain conditions are met,
a reporting entity may elect to account for its tax equity investments by using the proportional amortization method regardless of the program from which it receives income tax credits, instead of only LIHTC structures. This amendment also eliminates certain LIHTC specific guidance aligning the accounting with other equity investments in tax credit structures. The amendments in this update are effective for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years. We are evaluating the accounting and disclosure requirements of ASU 2023-02 and do not expect them to have a material effect on our consolidated financial statements.
(2) Earnings per Common Share
Basic earnings per common share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period reduced by unearned ESOP Plan shares and treasury shares. Diluted earnings per common share takes into account the potential dilution computed pursuant to the treasury stock method that could occur if stock options were exercised and converted into common stock and if restricted stock awards were vested, and SERP plan liabilities were satisfied with common shares. The effects of stock options are excluded from the computation of diluted earnings per share in periods in which the effect would be anti-dilutive.
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| Three months ended September 30, | | Nine months ended September 30, |
(dollars in thousands, except per share data) | 2023 | | 2022 | | 2023 | | 2022 |
Numerator for earnings per share: | | | | | | | |
Net income available to common stockholders | $ | 4,005 | | | $ | 5,798 | | | $ | 12,673 | | | $ | 17,268 | |
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Denominators for earnings per share: | | | | | | | |
Weighted average shares outstanding | 11,228 | | | 11,936 | | | 11,307 | | | 12,076 | |
Average unearned ESOP shares | (170) | | | (200) | | | (178) | | | (148) | |
Basic weighted averages shares outstanding | 11,058 | | | 11,736 | | | 11,129 | | | 11,928 | |
Dilutive effects of assumed exercises of stock options | 119 | | | 232 | | | 149 | | | 274 | |
Dilutive effects of SERP shares | 186 | | | 150 | | | 171 | | | 142 | |
Diluted weighted averages shares outstanding | 11,363 | | | 12,118 | | | 11,449 | | | 12,344 | |
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Basic earnings per share | $ | 0.36 | | | $ | 0.49 | | | $ | 1.14 | | | $ | 1.45 | |
Diluted earnings per share | $ | 0.35 | | | $ | 0.48 | | | $ | 1.11 | | | $ | 1.40 | |
Antidilutive shares excluded from computation of average dilutive earnings per share | 490 | | | 474 | | | 490 | | | 472 | |
(3) Securities
The following tables presents the amortized cost, allowance for credit losses, and fair value of securities at the dates indicated:
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| September 30, 2023 |
(dollars in thousands) | Amortized cost | | Gross unrealized gains | | Gross unrealized losses | | Allowance for Credit Losses | | Fair value | | # of Securities in unrealized loss position |
Securities available-for-sale: | | | | | | | | | | | |
U.S. asset backed securities | $ | 11,580 | | | $ | 98 | | | $ | (202) | | | $ | — | | | $ | 11,476 | | | 9 | |
U.S. government agency MBS | 11,744 | | | — | | | (610) | | | — | | | 11,134 | | | 13 | |
U.S. government agency CMO | 22,226 | | | — | | | (2,854) | | | — | | | 19,372 | | | 30 | |
State and municipal securities | 40,275 | | | — | | | (6,890) | | | — | | | 33,385 | | | 31 | |
U.S. Treasuries | 32,982 | | | — | | | (3,453) | | | — | | | 29,529 | | | 25 | |
Non-U.S. government agency CMO | 11,007 | | | 1 | | | (788) | | | — | | | 10,220 | | | 13 | |
Corporate bonds | 8,200 | | | — | | | (1,098) | | | — | | | 7,102 | | | 13 | |
Total securities available-for-sale | $ | 138,014 | | | $ | 99 | | | $ | (15,895) | | | $ | — | | | $ | 122,218 | | | 134 | |
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Securities held to maturity: | | | | | | | | | | | |
State and municipal securities | $ | 36,232 | | | $ | — | | | $ | (5,567) | | | $ | — | | | $ | 30,665 | | | 24 | |
Total securities held-to-maturity | $ | 36,232 | | | $ | — | | | $ | (5,567) | | | $ | — | | | $ | 30,665 | | | 24 | |
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| December 31, 2022 |
(dollars in thousands) | Amortized cost | | Gross unrealized gains | | Gross unrealized losses | | Fair value | | # of Securities in unrealized loss position |
Securities available-for-sale: | | | | | | | | | |
U.S. asset backed securities | $ | 15,581 | | | $ | 14 | | | $ | (314) | | | $ | 15,281 | | | 12 | |
U.S. government agency MBS | 12,272 | | | 5 | | | (538) | | | 11,739 | | | 12 | |
U.S. government agency CMO | 25,520 | | | 40 | | | (2,242) | | | 23,318 | | | 29 | |
State and municipal securities | 44,700 | | | — | | | (5,862) | | | 38,838 | | | 34 | |
U.S. Treasuries | 32,980 | | | — | | | (3,457) | | | 29,523 | | | 25 | |
Non-U.S. government agency CMO | 9,722 | | | — | | | (633) | | | 9,089 | | | 11 | |
Corporate bonds | 8,201 | | | — | | | (643) | | | 7,558 | | | 12 | |
Total securities available-for-sale | $ | 148,976 | | | $ | 59 | | | $ | (13,689) | | | $ | 135,346 | | | 135 | |
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Securities held-to-maturity: | | | | | | | | | |
State and municipal securities | $ | 37,479 | | | $ | — | | | $ | (4,394) | | | $ | 33,085 | | | 25 | |
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Although the Corporation’s investment portfolio overall is in a net unrealized loss position at September 30, 2023, the temporary impairment in the above noted securities is primarily the result of changes in market interest rates subsequent to purchase and it is more likely than not that the Corporation will not be required to sell these securities prior to recovery to satisfy liquidity needs, and therefore, no securities are deemed to be other-than-temporarily impaired.
ACL on Securities AFS and HTM
We use credit ratings quarterly and the most recent financial information of securities' issuers annually to help evaluate the credit quality of our securities AFS and HTM portfolios on a quarterly basis. The securities portfolio consists primarily of U.S. government treasuries and U.S. government agency asset backed securities which have no probability of default. The remaining portfolio consists of highly rated municipal bonds, non-agency CMO, and corporate bonds that have a low probability of default.
For the three and nine months ended September 30, 2023, we had no significant ACL or provision expense and no charge-offs or recoveries on AFS or HTM securities.
The following table shows the Corporation’s investment gross unrealized losses and fair value aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position at the dates indicated:
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| September 30, 2023 |
| Less than 12 Months | | 12 Months or more | | Total |
(dollars in thousands) | Fair value | | Unrealized losses | | Fair value | | Unrealized losses | | Fair value | | Unrealized losses |
Securities available-for-sale: | | | | | | | | | | | |
U.S. asset backed securities | $ | 1,345 | | | $ | — | | | $ | 6,489 | | | $ | (202) | | | $ | 7,834 | | | $ | (202) | |
U.S. government agency mortgage-backed securities | 3,092 | | | (32) | | | 8,042 | | | (578) | | | 11,134 | | | (610) | |
U.S. government agency collateralized mortgage obligations | 2,728 | | | (76) | | | 16,644 | | | (2,778) | | | 19,372 | | | (2,854) | |
State and municipal securities | — | | | — | | | 33,385 | | | (6,890) | | | 33,385 | | | (6,890) | |
U.S. Treasuries | — | | | — | | | 29,529 | | | (3,453) | | | 29,529 | | | (3,453) | |
Non-U.S. government agency collateralized mortgage obligations | 3,229 | | | (22) | | | 6,400 | | | (766) | | | 9,629 | | | (788) | |
Corporate bonds | 907 | | | (93) | | | 6,195 | | | (1,005) | | | 7,102 | | | (1,098) | |
Total securities available-for-sale | $ | 11,301 | | | $ | (223) | | | $ | 106,684 | | | $ | (15,672) | | | $ | 117,985 | | | $ | (15,895) | |
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Securities held-to-maturity: | | | | | | | | | | | |
State and municipal securities | $ | 2,966 | | | $ | (155) | | | $ | 27,245 | | | $ | (5,412) | | | $ | 30,211 | | | $ | (5,567) | |
Total securities held-to-maturity | $ | 2,966 | | | $ | (155) | | | $ | 27,245 | | | $ | (5,412) | | | $ | 30,211 | | | $ | (5,567) | |
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| December 31, 2022 |
| Less than 12 Months | | 12 Months or more | | Total |
(dollars in thousands) | Fair value | | Unrealized losses | | Fair value | | Unrealized losses | | Fair value | | Unrealized losses |
Securities available-for-sale: | | | | | | | | | | | |
U.S. asset backed securities | $ | 6,531 | | | $ | (80) | | | $ | 4,863 | | | $ | (234) | | | $ | 11,394 | | | $ | (314) | |
U.S. government agency MBS | 6,022 | | | (230) | | | 4,637 | | | (308) | | | 10,659 | | | (538) | |
U.S. government agency CMO | 9,859 | | | (821) | | | 9,549 | | | (1,421) | | | 19,408 | | | (2,242) | |
State and municipal securities | 7,487 | | | (726) | | | 31,351 | | | (5,136) | | | 38,838 | | | (5,862) | |
U.S. Treasuries | 1,902 | | | (97) | | | 27,622 | | | (3,360) | | | 29,524 | | | (3,457) | |
Non-U.S. government agency CMO | 8,423 | | | (464) | | | 666 | | | (169) | | | 9,089 | | | (633) | |
Corporate bonds | 5,019 | | | (431) | | | 1,538 | | | (212) | | | 6,557 | | | (643) | |
Total securities available-for-sale | $ | 45,243 | | | $ | (2,849) | | | $ | 80,226 | | | $ | (10,840) | | | $ | 125,469 | | | $ | (13,689) | |
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Securities held-to-maturity: | | | | | | | | | | | |
State and municipal securities | $ | 10,130 | | | $ | (364) | | | $ | 22,543 | | | $ | (4,030) | | | $ | 32,673 | | | $ | (4,394) | |
Total securities held-to-maturity | $ | 10,130 | | | $ | (364) | | | $ | 22,543 | | | $ | (4,030) | | | $ | 32,673 | | | $ | (4,394) | |
The amortized cost and carrying value of securities are shown below by contractual maturities at the dates indicated. Actual maturities may differ from contractual maturities as issuers may have the right to call or repay obligations with or without call or prepayment penalties.
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| September 30, 2023 | | December 31, 2022 |
| Available-for-sale | | Held-to-maturity | | Available-for-sale | | Held-to-maturity |
(dollars in thousands) | Amortized cost | | Fair value | | Amortized cost | | Fair value | | Amortized cost | | Fair value | | Amortized cost | | Fair value |
Due in one year or less | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Due after one year through five years | 30,793 | | | 27,666 | | | 4,226 | | | 4,147 | | | 18,865 | | | 17,289 | | | 4,275 | | | 4,238 | |
Due after five years through ten years | 19,161 | | | 17,047 | | | 2,901 | | | 2,326 | | | 28,647 | | | 25,459 | | | 2,998 | | | 2,683 | |
Due after ten years | 43,083 | | | 36,780 | | | 29,105 | | | 24,192 | | | 53,950 | | | 48,453 | | | 30,206 | | | 26,164 | |
Subtotal | 93,037 | | | 81,493 | | | 36,232 | | | 30,665 | | | 101,462 | | | 91,201 | | | 37,479 | | | 33,085 | |
Mortgage-related securities | 44,977 | | | 40,725 | | | — | | | — | | | 47,514 | | | 44,145 | | | — | | | — | |
Total | $ | 138,014 | | | $ | 122,218 | | | $ | 36,232 | | | $ | 30,665 | | | $ | 148,976 | | | $ | 135,346 | | | $ | 37,479 | | | $ | 33,085 | |
The following table presents the gross loss on sale of investment securities available for sale on the dates indicated:
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| Three months ended September 30, | | Nine months ended September 30, |
(dollars in thousands) | 2023 | | 2022 | | 2023 | | 2022 |
Proceeds from sale of investment securities | $ | 155 | | | $ | — | | | $ | 13,514 | | | $ | — | |
Gross gain on sale of available for sale investments | — | | | — | | | — | | | — | |
Gross loss on sale of available for sale investments | 3 | | | — | | | 58 | | | — | |
Pledged Securities
As of September 30, 2023 and December 31, 2022, securities having a fair value of $51.8 million and $78.4 million, respectively, were specifically pledged as collateral for public funds, the FRB discount window program, FHLB borrowings and other purposes. The FHLB has a blanket lien on non-pledged, mortgage-related loans and securities as part of the Corporation’s borrowing agreement with the FHLB.
(4) Loans and Other Finance Receivables
The following table presents loans and other finance receivables detailed by category at the dates indicated:
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(dollars in thousands) | September 30, 2023 | | December 31, 2022 |
Real estate loans: | | | |
Commercial mortgage | $ | 696,124 | | | $ | 565,400 | |
Home equity lines and loans | 73,844 | | | 59,399 | |
Residential mortgage | 256,343 | | | 221,837 | |
Construction | 276,590 | | | 271,955 | |
Total real estate loans | 1,302,901 | | | 1,118,591 | |
Commercial and industrial | 299,861 | | | 341,378 | |
Small business loans | 141,265 | | | 136,155 | |
Consumer | 434 | | | 488 | |
Leases, net | 138,963 | | | 138,986 | |
Total loans | $ | 1,883,424 | | | $ | 1,735,598 | |
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Balances included in loans, net of fees and costs: | | | |
Residential mortgage real estate loans accounted under fair value option, at fair value | $ | 13,231 | | | $ | 14,502 | |
Residential mortgage real estate loans accounted under fair value option, at amortized cost | 16,508 | | | 16,930 | |
Unearned lease income included in leases, net | (22,385) | | | (25,715) | |
Unamortized net deferred loan origination costs | $ | 2,205 | | | $ | 8,084 | |
Fair Value Option for Residential Mortgage Real Estate Loans
Residential mortgage real estate loans that were originated by the Corporation and intended for sale in the secondary market to permanent investors, but were either repurchased or unsalable due to defect, and that the Corporation has the ability and intent to hold for the foreseeable future or until maturity or payoff are carried at fair value pursuant to the Corporation's election of the fair value option for these loans. The remaining loans, net of fees and costs are stated at their outstanding unpaid principal balances, net of deferred fees or costs, since the original intent for these loans was to hold them until payoff or maturity.
Nonaccrual and Past Due Loans
The following tables present an aging of the Corporation’s loans at the dates indicated:
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| September 30, 2023 |
(dollars in thousands) | 30-89 days past due | | 90+ days past due and still accruing | | Total past due | | Current | | Total Accruing Loans and leases | | Nonaccrual loans and leases | | Total loans portfolio and leases | | % Delinquent |
Commercial mortgage | $ | 574 | | | $ | — | | | $ | 574 | | | $ | 695,550 | | | $ | 696,124 | | | $ | — | | | $ | 696,124 | | | 0.08 | % |
Home equity lines and loans | 216 | | | — | | | 216 | | | 72,699 | | | 72,915 | | | 929 | | | 73,844 | | | 1.55 | |
Residential mortgage (1) | 5,525 | | | — | | | 5,525 | | | 247,721 | | | 253,246 | | | 3,097 | | | 256,343 | | | 3.36 | |
Construction | — | | | — | | | — | | | 275,384 | | | 275,384 | | | 1,206 | | | 276,590 | | | 0.44 | |
Commercial and industrial | — | | | — | | | — | | | 284,286 | | | 284,286 | | | 15,575 | | | 299,861 | | | 5.19 | |
Small business loans | 1,842 | | | — | | | 1,842 | | | 132,186 | | | 134,028 | | | 7,237 | | | 141,265 | | | 6.43 | |
Consumer | — | | | — | | | — | | | 434 | | | 434 | | | — | | | 434 | | | — | |
Leases, net | 2,346 | | | — | | | 2,346 | | | 135,550 | | | 137,896 | | | 1,067 | | | 138,963 | | | 2.46 | % |
Total | $ | 10,503 | | | $ | — | | | $ | 10,503 | | | $ | 1,843,810 | | | $ | 1,854,313 | | | $ | 29,111 | | | $ | 1,883,424 | | | 2.10 | % |
(1) Includes $13,231 of loans at fair value of which $12,108 are current, $376 are 30-89 days past due and $747 are nonaccrual.
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| December 31, 2022 |
(dollars in thousands) | 30-89 days past due | | 90+ days past due and still accruing | | Total past due | | Current | | Total Accruing Loans and leases | | Nonaccrual loans and leases | | Total loans portfolio and leases | | % Delinquent |
Commercial mortgage | $ | — | | | $ | — | | | $ | — | | | $ | 565,260 | | | $ | 565,260 | | | $ | 140 | | | $ | 565,400 | | | 0.02 | % |
Home equity lines and loans | 146 | | | — | | | 146 | | | 58,156 | | | 58,302 | | | 1,097 | | | 59,399 | | | 2.09 | |
Residential mortgage (1) | 4,262 | | | — | | | 4,262 | | | 215,490 | | | 219,752 | | | 2,085 | | | 221,837 | | | 2.86 | |
Construction | 1,206 | | | — | | | 1,206 | | | 270,749 | | | 271,955 | | | — | | | 271,955 | | | 0.44 | |
Commercial and industrial | 101 | | | — | | | 101 | | | 328,730 | | | 328,831 | | | 12,547 | | | 341,378 | | | 3.70 | |
Small business loans | 939 | | | — | | | 939 | | | 130,751 | | | 131,690 | | | 4,465 | | | 136,155 | | | 3.97 | |
Consumer | — | | | — | | | — | | | 488 | | | 488 | | | — | | | 488 | | | — | |
Leases, net | 1,173 | | | — | | | 1,173 | | | 136,911 | | | 138,084 | | | 902 | | | 138,986 | | | 1.49 | % |
Total | $ | 7,827 | | | $ | — | | | $ | 7,827 | | | $ | 1,706,535 | | | $ | 1,714,362 | | | $ | 21,236 | | | $ | 1,735,598 | | | 1.67 | % |
(1) Includes $14,502 of loans at fair value of which $13,760 are current, $184 are 30-89 days past due and $558 are nonaccrual.
Foreclosed and Repossessed Assets
At September 30, 2023, there were 4 consumer mortgage loans secured by residential real estate properties (included in loans, net of fees and costs on the Consolidated Balance Sheets) totaling $937 thousand for which formal foreclosure proceedings were in process.
Risks and Uncertainties
We have no particular credit concentration. Our commercial loans have been proactively managed in an effort to achieve a balanced portfolio with no unusual exposure to one industry. Additionally, most of our lending activity occurs within our primary market areas which are concentrated in southeastern Pennsylvania, Delaware, and Maryland as well as other contiguous markets and represents a geographic concentration. Additionally, our loan portfolio is concentrated in commercial loans. Commercial loans are generally viewed as having more inherent risk of default than residential real estate loans or other consumer loans. Also, the commercial loan balance per borrower is typically larger than that for residential real estate loans and consumer loans, implying higher potential losses on an individual loan basis.
Past Due and Nonaccrual Status
The following table presents the amortized costs basis of loans and leases on nonaccrual status and loans 90 days or more past due and still accruing, net of fees and costs as of September 30, 2023. As of this date here were no loans 90 days or more past due and still accruing. | | | | | | | | | | | | | | | | | |
| September 30, 2023 |
(dollars in thousands) | Nonaccrual Without ACL | | Nonaccrual With ACL | | Total Nonaccrual |
| | | | | |
| | | | | |
Home equity lines and loans | $ | 929 | | | $ | — | | | $ | 929 | |
Residential mortgage | 3,097 | | | — | | | 3,097 | |
Construction | 1,206 | | | — | | | 1,206 | |
| | | | | |
Commercial and industrial | 3,346 | | | 12,229 | | | 15,575 | |
Small business loans | 3,457 | | | 3,780 | | | 7,237 | |
| | | | | |
Leases, net | 1,067 | | | — | | | 1,067 | |
Total | $ | 13,102 | | | $ | 16,009 | | | $ | 29,111 | |
Collateral-dependent Loans
The following table presents the amortized cost basis of non-accruing collateral-dependent loans by class or loans as of September 30, 2023 under the current expected credit loss model: | | | | | | | | | | | | | | | | | |
| September 30, 2023 |
(dollars in thousands) | Real Estate | | Equipment and Other | | Total |
| | | | | |
Home equity lines and loans | $ | 929 | | | $ | — | | | $ | 929 | |
Residential mortgage | 3,097 | | | — | | | 3,097 | |
Construction | 1,206 | | | — | | | 1,206 | |
Commercial and industrial | 1,893 | | | 13,682 | | | 15,575 | |
Small business loans | 5,347 | | | 1,890 | | | 7,237 | |
| | | | | |
Leases, net | — | | | 1,067 | | | 1,067 | |
Total | $ | 12,472 | | | $ | 16,639 | | | $ | 29,111 | |
(5) Allowance for Credit Losses
The ACL is maintained at a level considered adequate to provide for estimated expected credit losses within the loan portfolio over the
contractual life of an instrument that considers our historical loss experience, current conditions and forecasts of future economic conditions as of the balance sheet date. Management’s periodic evaluation of the adequacy of the ACL is based on known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is subjective as it requires material estimates that may be susceptible to significant revisions as more information becomes available.
Roll-Forward of ACL by Portfolio Segment
The following tables provide the activity of our allowance for credit losses for the three and nine months ended September 30, 2023 under the CECL model in accordance with ASC 326 (as adopted on January 1, 2023):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, 2023 |
(dollars in thousands) | Beginning Balance | | Charge-offs | | Recoveries | | Provision (recovery of provision) for credit losses | | Ending balance |
Commercial mortgage | $ | 3,249 | | | $ | — | | | $ | — | | | $ | 916 | | | $ | 4,165 | |
Home equity lines and loans | 790 | | | | | 2 | | | 153 | | | 945 | |
Residential mortgage | 1,047 | | | — | | | — | | | 157 | | | 1,204 | |
Construction | 1,294 | | | — | | | — | | | (453) | | | 841 | |
Commercial and industrial | 2,241 | | | (130) | | | 1 | | | 267 | | | 2,379 | |
Small business loans | 6,868 | | | (272) | | | 1 | | | (511) | | | 6,086 | |
Consumer | — | | | (1) | | | 1 | | | — | | | — | |
Leases | 4,753 | | | (606) | | | 90 | | | (174) | | | 4,063 | |
Total | $ | 20,242 | | | $ | (1,009) | | | $ | 95 | | | $ | 355 | | | $ | 19,683 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, 2023 |
(dollars in thousands) | Beginning Balance, prior to adoption of ASU No. 2016-13 for CECL | | Adjustment to initially apply ASU No. 2016-13 for CECL | | Charge-offs | | Recoveries | | Provision (recovery of provision) for credit losses | | Ending balance |
Commercial mortgage | $ | 4,095 | | | $ | (526) | | | $ | — | | | $ | — | | | $ | 596 | | | $ | 4,165 | |
Home equity lines and loans | 188 | | | 439 | | | (87) | | | 5 | | | 400 | | | 945 | |
Residential mortgage | 948 | | | 17 | | | — | | | — | | | 239 | | | 1,204 | |
Construction | 3,075 | | | (1,763) | | | — | | | — | | | (471) | | | 841 | |
Commercial and industrial | 4,012 | | | (1,023) | | | (130) | | | 57 | | | (537) | | | 2,379 | |
Small business loans | 4,909 | | | 1,110 | | | (598) | | | 1 | | | 664 | | | 6,086 | |
Consumer | 3 | | | (3) | | | (1) | | | 3 | | | (2) | | | — | |
Leases | 1,598 | | | 3,345 | | | (2,845) | | | 242 | | | 1,723 | | | 4,063 | |
Total | $ | 18,828 | | | $ | 1,596 | | | $ | (3,661) | | | $ | 308 | | | $ | 2,612 | | | $ | 19,683 | |
The following tables provide the activity of the allowance for loan and lease losses for the three and nine months ended September 30, 2022 under the incurred loss model:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, 2022 |
(dollars in thousands) | Beginning Balance | | Charge-offs | | Recoveries | | Provision (Reversal) | | Ending balance |
Commercial mortgage | $ | 4,327 | | | $ | — | | | $ | — | | | $ | (238) | | | $ | 4,089 | |
Home equity lines and loans | 240 | | | (12) | | | 34 | | | (25) | | | 237 | |
Residential mortgage | 489 | | | — | | | — | | | 217 | | | 706 | |
Construction | 2,481 | | | — | | | — | | | 378 | | | 2,859 | |
Commercial and industrial | 6,287 | | | — | | | 39 | | | (657) | | | 5,669 | |
Small business loans | 3,681 | | | — | | | — | | | 319 | | | 4,000 | |
Consumer | 3 | | | — | | | 1 | | | (1) | | | 3 | |
Leases | 1,297 | | | (419) | | | — | | | 533 | | | 1,411 | |
Total | $ | 18,805 | | | $ | (431) | | | $ | 74 | | | $ | 526 | | | $ | 18,974 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, 2022 |
(dollars in thousands) | Beginning Balance | | Charge-offs | | Recoveries | | Provision (Reversal) | | Ending balance |
Commercial mortgage | $ | 4,950 | | | $ | — | | | $ | — | | | $ | (861) | | | $ | 4,089 | |
Home equity lines and loans | 224 | | | (12) | | | 42 | | | (17) | | | 237 | |
Residential mortgage | 283 | | | — | | | 2 | | | 421 | | | 706 | |
Construction | 2,042 | | | — | | | — | | | 817 | | | 2,859 | |
Commercial and industrial | 6,533 | | | — | | | 58 | | | (922) | | | 5,669 | |
Small business loans | 3,737 | | | — | | | — | | | 263 | | | 4,000 | |
Consumer | 3 | | | — | | | 3 | | | (3) | | | 3 | |
Leases | 986 | | | (1,682) | | | 62 | | | 2,045 | | | 1,411 | |
Total | $ | 18,758 | | | $ | (1,694) | | | $ | 167 | | | $ | 1,743 | | | $ | 18,974 | |
Reconciliation of Provision for Credit Losses
The following table provides a reconciliation of the provision for credit losses on the consolidated statements of income between the funded and unfunded components at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
(dollars in thousands) | 2023 | | 2022 | | 2023 | | 2022 |
Provision for credit losses - funded | $ | 355 | | | $ | 526 | | | $ | 2,612 | | | $ | 1,743 | |
Recovery of provision for credit losses - unfunded | (273) | | | — | | | (426) | | | — | |
Total provision for credit losses | $ | 82 | | | $ | 526 | | | $ | 2,186 | | | $ | 1,743 | |
Allowance Allocated by Portfolio Segment
The following tables detail the allocation of the ACL and the carrying value for loans and leases by portfolio segment based on the methodology used to evaluate the loans and leases at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2023 |
| Allowance for credit losses | | Carrying value of loans and leases |
(dollars in thousands) | Individually evaluated | | Collectively evaluated | | Total | | Individually evaluated | | Collectively evaluated | | Total |
Commercial mortgage | $ | — | | | $ | 4,165 | | | $ | 4,165 | | | $ | — | | | $ | 696,124 | | | $ | 696,124 | |
Home equity lines and loans | — | | | 945 | | | 945 | | | 929 | | | 72,915 | | | 73,844 | |
Residential mortgage | — | | | 1,204 | | | 1,204 | | | 2,164 | | | 240,948 | | | 243,112 | |
Construction | — | | | 841 | | | 841 | | | 1,206 | | | 275,384 | | | 276,590 | |
Commercial and industrial | 1,145 | | | 1,234 | | | 2,379 | | | 15,575 | | | 284,286 | | | 299,861 | |
Small business loans | 1,393 | | | 4,693 | | | 6,086 | | | 7,237 | | | 134,028 | | | 141,265 | |
Consumer | — | | | — | | | — | | | — | | | 434 | | | 434 | |
Leases, net | — | | | 4,063 | | | 4,063 | | | 1,067 | | | 137,896 | | | 138,963 | |
Total (1) | $ | 2,538 | | | $ | 17,145 | | | $ | 19,683 | | | $ | 28,178 | | | $ | 1,842,015 | | | $ | 1,870,193 | |
(1) Excludes deferred fees and loans carried at fair value.
The following table details the pre-CECL allocation of the allowance for loan and lease losses and the carrying value for loans and leases by portfolio segment based on the methodology used to evaluate the loans and leases for impairment at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 |
| Allowance on loans and leases | | Carrying value of loans and leases |
(dollars in thousands) | Individually evaluated | | Collectively evaluated | | Total | | Individually evaluated | | Collectively evaluated | | Total |
Commercial mortgage | $ | — | | | $ | 4,095 | | | $ | 4,095 | | | $ | 2,445 | | | $ | 562,955 | | | $ | 565,400 | |
Home equity lines and loans | — | | | 188 | | | 188 | | | 1,097 | | | 58,302 | | | 59,399 | |
Residential mortgage | — | | | 948 | | | 948 | | | 1,454 | | | 205,881 | | | 207,335 | |
Construction | — | | | 3,075 | | | 3,075 | | | 1,206 | | | 270,749 | | | 271,955 | |
Commercial and industrial | 776 | | | 3,236 | | | 4,012 | | | 12,547 | | | 328,831 | | | 341,378 | |
Small business loans | 1,449 | | | 3,460 | | | 4,909 | | | 4,527 | | | 131,628 | | | 136,155 | |
Consumer | — | | | 3 | | | 3 | | | — | | | 488 | | | 488 | |
Leases, net | — | | | 1,598 | | | 1,598 | | | 902 | | | 138,084 | | | 138,986 | |
Total (1) | $ | 2,225 | | | $ | 16,603 | | | $ | 18,828 | | | $ | 24,178 | | | $ | 1,696,918 | | | $ | 1,721,096 | |
(1) Excludes deferred fees and loans carried at fair value.
Credit Quality Indicators
As part of the process of determining the ACL to the different segments of the loan and lease portfolio, Management considers certain credit quality indicators. For the commercial mortgage, construction and commercial and industrial loan segments, periodic reviews of the individual loans are performed by Management. The results of these reviews are reflected in the risk grade assigned to each loan. These internally assigned grades are as follows:
•Pass – Loans considered to be satisfactory with no indications of deterioration.
•Special mention – Loans classified as special mention have a potential weakness that deserves Management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
•Substandard – Loans classified as substandard are inadequately protected by the current net worth and payment capacity of the obligor or of the collateral pledged, if any. Substandard loans 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 – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loan balances classified as doubtful have been reduced by partial charge-offs and are carried at their net realizable values.
The following tables detail the carrying value of loans and leases by portfolio segment based on the credit quality indicators used to
determine the allowance for credit losses at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2023 | | Revolving Loans Converted to Term Loans | | Revolving Loans | | Total |
| Term Loans | | | |
| 2023 | | 2022 | | 2021 | | 2020 | | 2019 | | Prior | | | |
Commercial mortgage | | | | | | | | | | | | | | | | |
Pass/Watch | $ | 82,314 | | | $ | 137,909 | | | $ | 161,963 | | | $ | 96,103 | | | $ | 51,149 | | | $ | 136,069 | | | $ | 511 | | | $ | 426 | | | $ | 666,444 | |
Special Mention | — | | | 4,625 | | | — | | | — | | | 9,291 | | | 10,060 | | | 667 | | | — | | | 24,643 | |
Substandard | 200 | | | — | | | 574 | | | — | | | 1,648 | | | 2,287 | | | — | | | 328 | | | 5,037 | |
| | | | | | | | | | | | | | | | | |
Total | $ | 82,514 | | | $ | 142,534 | | | $ | 162,537 | | | $ | 96,103 | | | $ | 62,088 | | | $ | 148,416 | | | $ | 1,178 | | | $ | 754 | | | $ | 696,124 | |
Current period gross charge-offs | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | | | |
Construction | | | | | | | | | | | | | | | | | |
Pass/Watch | $ | 53,495 | | | $ | 101,776 | | | $ | 29,115 | | | $ | 47,458 | | | $ | 4,548 | | | $ | 2,120 | | | $ | 123 | | | $ | 24,083 | | | $ | 262,718 | |
Special Mention | — | | | — | | | 1,084 | | | — | | | 511 | | | 8,934 | | | — | | | 2,137 | | | 12,666 | |
Substandard | — | | | — | | | — | | | — | | | — | | | 1,206 | | | — | | | — | | | 1,206 | |
| | | | | | | | | | | | | | | | | |
Total | $ | 53,495 | | | $ | 101,776 | | | $ | 30,199 | | | $ | 47,458 | | | $ | 5,059 | | | $ | 12,260 | | | $ | 123 | | | $ | 26,220 | | | $ | 276,590 | |
Current period gross charge-offs | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | | | |
Commercial and industrial | | | | | | | | | | | | | | | | |
Pass/Watch | $ | 18,566 | | | $ | 35,631 | | | $ | 26,734 | | | $ | 8,891 | | | $ | 4,579 | | | $ | 37,658 | | | $ | — | | | $ | 126,466 | | | $ | 258,525 | |
Special Mention | 1,000 | | | 4,766 | | | — | | | — | | | — | | | 1,665 | | | — | | | 2,816 | | | 10,247 | |
Substandard | — | | | — | | | 2,906 | | | — | | | 300 | | | 9,730 | | | — | | | 18,153 | | | 31,089 | |
| | | | | | | | | | | | | | | | | |
Total | $ | 19,566 | | | $ | 40,397 | | | $ | 29,640 | | | $ | 8,891 | | | $ | 4,879 | | | $ | 49,053 | | | $ | — | | | $ | 147,435 | | | $ | 299,861 | |
Current period gross charge-offs | $ | (73) | | | $ | (55) | | | $ | — | | | $ | (2) | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | (130) | |
| | | | | | | | | | | | | | | | | |
Small business loans | | | | | | | | | | | | | | | | | |
Pass/Watch | $ | 39,356 | | | $ | 19,977 | | | $ | 39,053 | | | $ | 13,148 | | | $ | 6,996 | | | $ | 1,018 | | | $ | — | | | $ | 13,102 | | | $ | 132,650 | |
Special Mention | — | | | — | | | — | | | — | | | — | | | — | | | — | | | 100 | | | 100 | |
Substandard | — | | | 673 | | | 5,038 | | | 1,914 | | | 890 | | | — | | | — | | | — | | | 8,515 | |
| | | | | | | | | | | | | | | | | |
Total | $ | 39,356 | | | $ | 20,650 | | | $ | 44,091 | | | $ | 15,062 | | | $ | 7,886 | | | $ | 1,018 | | | $ | — | | | $ | 13,202 | | | $ | 141,265 | |
Current period gross charge-offs | $ | — | | | $ | — | | | $ | — | | | $ | (411) | | | $ | (187) | | | $ | — | | | $ | — | | | $ | — | | | $ | (598) | |
| | | | | | | | | | | | | | | | | |
Total by risk rating | | | | | | | | | | | | | | | | | |
Pass/Watch | $ | 193,731 | | | $ | 295,293 | | | $ | 256,865 | | | $ | 165,600 | | | $ | 67,272 | | | $ | 176,865 | | | $ | 634 | | | $ | 164,077 | | | $ | 1,320,337 | |
Special Mention | 1,000 | | | 9,391 | | | 1,084 | | | — | | | 9,802 | | | 20,659 | | | 667 | | | 5,053 | | | 47,656 | |
Substandard | 200 | | | 673 | | | 8,518 | | | 1,914 | | | 2,838 | | | 13,223 | | | — | | | 18,481 | | | 45,847 | |
| | | | | | | | | | | | | | | | | |
Total | $ | 194,931 | | | $ | 305,357 | | | $ | 266,467 | | | $ | 167,514 | | | $ | 79,912 | | | $ | 210,747 | | | $ | 1,301 | | | $ | 187,611 | | | $ | 1,413,840 | |
Total current period gross charge-offs | $ | (73) | | | $ | (55) | | | $ | — | | | $ | (413) | | | $ | (187) | | | $ | — | | | $ | — | | | $ | — | | | $ | (728) | |
The Corporation had no loans with a risk rating of Doubtful included within recorded investment in loans and leases held for investment at September 30, 2023.
In addition to credit quality indicators as shown in the above tables, allowance allocations for residential mortgages, consumer loans and leases are also applied based on their performance status at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2023 | | Revolving Loans | | Total |
| Term Loans | | |
| 2023 | | 2022 | | 2021 | | 2020 | | 2019 | | Prior | | |
Home equity lines and loans | | | | | | | | | | | | | | | |
Performing | $ | 52 | | | $ | 801 | | | $ | 318 | | | $ | 359 | | | $ | 2,289 | | | $ | 2,375 | | | $ | 66,721 | | | $ | 72,915 | |
Nonperforming | — | | | — | | | — | | | — | | | — | | | — | | | 929 | | | 929 | |
Total | $ | 52 | | | $ | 801 | | | $ | 318 | | | $ | 359 | | | $ | 2,289 | | | $ | 2,375 | | | $ | 67,650 | | | $ | 73,844 | |
Current period gross charge-offs | $ | — | | | $ | — | | | $ | — | | | $ | (54) | | | $ | — | | | $ | (33) | | | $ | — | | | $ | (87) | |
| | | | | | | | | | | | | | | |
Residential mortgage (1) | | | | | | | | | | | | | | | |
Performing | $ | 42,601 | | | $ | 157,600 | | | $ | 21,967 | | | $ | 7,353 | | | $ | 461 | | | $ | 11,408 | | | $ | — | | | $ | 241,390 | |
Nonperforming | — | | | — | | | — | | | | | — | | | 1,722 | | | — | | | 1,722 | |
Total | $ | 42,601 | | | $ | 157,600 | | | $ | 21,967 | | | $ | 7,353 | | | $ | 461 | | | $ | 13,130 | | | $ | — | | | $ | 243,112 | |
Current period gross charge-offs | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | |
Consumer | | | | | | | | | | | | | | | |
Performing | $ | 41 | | | $ | 35 | | | $ | — | | | $ | — | | | $ | 34 | | | $ | 248 | | | $ | 76 | | | $ | 434 | |
Nonperforming | — | | | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Total | $ | 41 | | | $ | 35 | | | $ | — | | | $ | — | | | $ | 34 | | | $ | 248 | | | $ | 76 | | | $ | 434 | |
Current period gross charge-offs | $ | — | | | $ | (1) | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | (1) | |
| | | | | | | | | | | | | | | |
Leases, net | | | | | | | | | | | | | | | |
Performing | $ | 25,583 | | | $ | 64,581 | | | $ | 35,930 | | | $ | 11,802 | | | $ | — | | | $ | — | | | $ | — | | | $ | 137,896 | |
Nonperforming | — | | | 499 | | | 385 | | | 183 | | | — | | | — | | | — | | | 1,067 | |
Total | $ | 25,583 | | | $ | 65,080 | | | $ | 36,315 | | | $ | 11,985 | | | $ | — | | | $ | — | | | $ | — | | | $ | 138,963 | |
Current period gross charge-offs | $ | (3) | | | $ | (1,438) | | | $ | (1,268) | | | $ | (136) | | | $ | — | | | $ | — | | | $ | — | | | $ | (2,845) | |
| | | | | | | | | | | | | | | |
Total by Payment Performance | | | | | | | | | | | | | | | |
Performing | $ | 68,277 | | | $ | 223,017 | | | $ | 58,215 | | | $ | 19,514 | | | $ | 2,784 | | | $ | 14,031 | | | $ | 66,797 | | | $ | 452,635 | |
Nonperforming | — | | | 499 | | | 385 | | | 183 | | | — | | | 1,722 | | | 929 | | | 3,718 | |
Total | $ | 68,277 | | | $ | 223,516 | | | $ | 58,600 | | | $ | 19,697 | | | $ | 2,784 | | | $ | 15,753 | | | $ | 67,726 | | | $ | 456,353 | |
Total current period gross charge-offs | $ | (3) | | | $ | (1,439) | | | $ | (1,268) | | | $ | (190) | | | $ | — | | | $ | (33) | | | $ | — | | | $ | (2,933) | |
(1) Excludes $14,403 of loans at fair value. | | | | | | | | | | | | | | |
Commercial and industrial loans classified as substandard totaled $31.1 million as of September 30, 2023, a decrease of $8.2 million, from $39.3 million as of December 31, 2022. This decrease was the result of the payoff of one credit in the amount of $3 million, combined with the upgrade of several loan relationships that make up the remainder of the decrease. The majority of commercial and industrial substandard loans is comprised of 15 different loan relationships with no specific industry concentration and an $11.0 million commercial loan relationship in the advertising industry that became a non-performing loan relationship late in 2021.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 |
(dollars in thousands) | Pass | | Special mention | | Substandard | | Doubtful | | Total |
Commercial mortgage | $ | 536,705 | | | $ | 25,309 | | | $ | 3,386 | | | $ | — | | | $ | 565,400 | |
Home equity lines and loans | 57,822 | | | — | | | 1,577 | | | — | | | 59,399 | |
Construction | 260,085 | | | 11,870 | | | — | | | — | | | 271,955 | |
Commercial and industrial | 295,502 | | | 6,587 | | | 39,289 | | | — | | | 341,378 | |
Small business loans | 131,690 | | | — | | | 4,465 | | | — | | | 136,155 | |
Total | $ | 1,281,804 | | | $ | 43,766 | | | $ | 48,717 | | | $ | — | | | $ | 1,374,287 | |
In addition to credit quality indicators as shown in the above tables, allowance allocations for residential mortgages, consumer loans and leases are also applied based on their performance status at the dates indicated:
| | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 |
(dollars in thousands) | | Performing | | Non- performing | | Total |
Residential mortgage (1) | | $ | 205,881 | | | $ | 1,454 | | | $ | 207,335 | |
Consumer | | 488 | | | — | | | 488 | |
Leases, net | | 138,084 | | | 902 | | | 138,986 | |
Total | | $ | 344,453 | | | $ | 2,356 | | | $ | 346,809 | |
(1) There were four nonperforming residential mortgage loans at September 30, 2023 and four nonperforming residential mortgage loans at December 31, 2022 with a combined outstanding principal balance of $550 thousand and $558 thousand, respectively, which were carried at fair value and not included in the table above.
Impaired Loans
The following table details the recorded investment and principal balance of impaired loans by portfolio segment, their related Allowance and interest income recognized at the dates indicated.
| | | | | | | | | | | | | | | | | | | | |
| | December 31, 2022 |
(dollars in thousands) | | Recorded investment | | Principal balance | | Related allowance |
Impaired loans with related allowance: |
Commercial and industrial | | $ | 11,099 | | | $ | 12,095 | | | $ | 776 | |
Small business loans | | 3,730 | | | 3,730 | | | 1,449 | |
| | | | | | |
| | | | | | |
Total | | $ | 14,829 | | | $ | 15,825 | | | $ | 2,225 | |
Impaired loans without related allowance: |
Commercial mortgage | | $ | 2,445 | | | $ | 2,456 | | | $ | — | |
Commercial and industrial | | 1,448 | | | 1,494 | | | — | |
Small business loans | | 797 | | | 797 | | | — | |
Home equity lines and loans | | 1,097 | | | 1,097 | | | — | |
Residential mortgage | | 1,454 | | | 1,454 | | | — | |
Construction | | 1,206 | | | 1,206 | | | — | |
Leases | | 902 | | | 902 | | | — | |
Total | | 9,349 | | | 9,406 | | | — | |
Grand Total | | $ | 24,178 | | | $ | 25,231 | | | $ | 2,225 | |
| | | | | | |
| | | | | | |
The following table details the average recorded investment and interest income recognized on individually evaluated loans by portfolio segment.
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended September 30, 2022 | | Nine Months Ended September 30, 2022 |
(dollars in thousands) | | | | | Average recorded investment | | Interest income recognized | | Average recorded investment | | Interest income recognized |
Individually evaluated loans with related allowance: | | | | | | | | | | | |
Commercial and industrial | | | | | $ | 16,195 | | | $ | — | | | $ | 16,363 | | | $ | — | |
Small business loans | | | | | 666 | | | — | | | 666 | | | — | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Total | | | | | $ | 16,861 | | | $ | — | | | $ | 17,029 | | | $ | — | |
Individually evaluated loans without related allowance: | | | | | | | | | | | |
Commercial mortgage | | | | | 4,212 | | | 29 | | | 4,257 | | | 77 | |
Commercial and industrial | | | | | 286 | | | — | | | 293 | | | — | |
Small business loans | | | | | 819 | | | 2 | | | 835 | | | 7 | |
Home equity lines and loans | | | | | 878 | | | 15 | | | 878 | | | 39 | |
Residential mortgage | | | | | 1,468 | | | 22 | | | 1,478 | | | 190 | |
Construction | | | | | 1,206 | | | 20 | | | 1,206 | | | 51 | |
Leases | | | | | 500 | | | — | | | 510 | | | — | |
Total | | | | | $ | 9,369 | | | $ | 88 | | | $ | 9,457 | | | $ | 364 | |
Grand Total | | | | | $ | 26,230 | | | $ | 88 | | | $ | 26,486 | | | $ | 364 | |
Troubled Debt Restructuring
As result of the adoption of guidance related to CECL effective as of January 1, 2023, the Corporation had no reportable balances related to TDRs as of and for the three and nine months ended September 30, 2023. See Note 1 “Summary of Significant Accounting Policies” for additional information.
The following table presents information about TDRs at the dates indicated:
| | | | | | | |
(dollars in thousands) | | | December 31, 2022 |
TDRs included in nonperforming loans and leases | | | $ | 207 | |
TDRs in compliance with modified terms | | | 3,573 | |
Total TDRs | | | $ | 3,780 | |
There was 1 new modification on a commercial mortgage for $684 thousand for the year ended December 31, 2022. Total TDRs declined year-over-year, despite the new modification in 2022, as two TDRs from prior to 2021 totaling $563 thousand paid off in 2022. No modifications granted during the twelve months ended December 31, 2022 subsequently defaulted during the same time period.
Modifications to Borrowers Experiencing Financial Difficulty
An assessment of whether a borrower is experiencing financial difficulty is made on the date of a modification. Because the effect of most modifications made to borrowers experiencing financial difficulty is already included in the ACL on loans and leases, a change to the allowance for credit losses is generally not recorded upon modification. However, when principal forgiveness is provided, the amortized cost basis of the asset is written off against the ACL on loans and leases. The amount of the principal forgiveness is deemed to be uncollectible; therefore, that portion of the loan is written off, resulting in a reduction of the amortized cost basis and a corresponding adjustment to the allowance for credit losses.
The following presents, by class of loans, information regarding accruing and nonaccrual modified loans to borrowers experiencing financial difficulty during the three and nine months ended September 30, 2023.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, 2023 |
| Number of Loans | | Amortized Cost Basis | | % of Total Class of Financing Receivable | | Related Reserve |
(dollars in thousands) | | | |
Accruing Modified Loans to Borrowers Experiencing Financial Difficulty: | | | | | | | |
Small business loans | 3 | | $ | 1,517 | | | 1.1% | | $ | — | |
Total | 3 | | $ | 1,517 | | | | | $ | — | |
Nonaccrual Modified Loans to Borrowers Experiencing Financial Difficulty: | | | | | | | |
Small business loans | 2 | | $ | 306 | | | 0.2% | | $ | 77 | |
Total | 2 | | $ | 306 | | | | | $ | 77 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, 2023 |
| Number of Loans | | Amortized Cost Basis | | % of Total Class of Financing Receivable | | Related Reserve |
(dollars in thousands) | | | |
Accruing Modified Loans to Borrowers Experiencing Financial Difficulty: | | | | | | | |
Small business loans | 3 | | $ | 1,517 | | | 1.1% | | $ | — | |
Commercial & industrial | 1 | | 2,407 | | | 0.8% | | — | |
Total | 4 | | $ | 3,924 | | | | | $ | — | |
Nonaccrual Modified Loans to Borrowers Experiencing Financial Difficulty: | | | | | | | |
Small business loans | 2 | | $ | 306 | | | 0.2% | | $ | 77 | |
Commercial & industrial | 1 | | 1,406 | | | 0.5% | | 422 | |
Total | 3 | | $ | 1,712 | | | | | $ | 499 | |
The following presents, by class of loans, information regarding accruing and nonaccrual modified loans to borrowers experiencing financial difficulty during the three and nine months ended September 30, 2023.
| | | | | | | | | | | | | | | | | | | | | | | |
| |
| Number of Loans | | | | | | |
| | Financial Effect |
Accruing Modified Loans to Borrowers Experiencing Financial Difficulty: | | | | | | | |
Small business loans | 3 | | Extend maturity date |
Commercial & industrial | 1 | | Extend maturity date |
Total | 4 | | | | | | |
Nonaccrual Modified Loans to Borrowers Experiencing Financial Difficulty: | | | | | | | |
Small business loans | 2 | | Extend term and allow additional lender funding |
Commercial & industrial | 1 | | Extend term and allow additional lender funding |
Total | 3 | | | | | | |
There were 5 modifications granted to borrowers experiencing financial difficulty for the three months ended September 30, 2023. There were no loans that had a payment default during the three and nine months ended September 30, 2023 that were modified in the 12 months before default to borrowers experiencing financial difficulty. There were no commitments to lend additional funds to the borrowers experiencing financial difficulty that had modifications during the three and nine months ended September 30, 2023.
(6) Short-Term Borrowings and Long-Term Debt
The Corporation’s short-term borrowings generally consist of federal funds purchased and short-term borrowings extended under agreements with the FHLB or other correspondent banks. The Corporation has one unsecured Federal funds borrowing facility with a correspondent bank for up to $15 million. Federal funds purchased generally represent one-day borrowings. The Corporation had $0 in Federal funds purchased at September 30, 2023 and December 31, 2022. The Corporation also has a facility with the Federal Reserve Bank discount window of $7.7 million. This facility is fully secured by investment securities. There were no borrowings under this at September 30, 2023 and December 31, 2022. Additionally, the Corporation has a facility with the Federal Reserve’s BTFP of $33 million. This facility was created by the Federal Reserve in March 2023 and is fully secured by United States Treasury Bonds. There were $33 million in borrowings under this facility at September 30, 2023.
The following table presents short-term borrowings at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
(dollars in thousands) | Maturity date | | Interest rate | | September 30, 2023 | | December 31, 2022 |
FHLB Open Repo Plus Weekly | 06/10/2024 | | 5.68% | | $ | 117,348 | | | $ | 113,147 | |
FRB BTFP Advances | 03/29/2024 | | 4.76% | | 33,000 | | | — | |
Total Short-Term Borrowings | | | | | $ | 150,348 | | | $ | 113,147 | |
The following table presents long-term borrowings at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
(dollars in thousands) | Maturity date | | Interest rate | | September 30, 2023 | | December 31, 2022 |
FHLB Mid-term Repo Fixed | 12/22/2025 | | 4.23% | | $ | 8,935 | | | $ | 8,935 | |
FHLB Mid-term Repo Fixed | 9/30/2024 | | 4.60% | | 3,432 | | | — | |
FHLB Mid-term Repo Fixed | 7/14/2026 | | 4.57% | | 15,244 | | | — | |
Total Long-Term Borrowings | | | | | $ | 27,611 | | | $ | 8,935 | |
The FHLB has also issued $112.7 million of letters of credit to the Corporation for the benefit of the Corporation’s public deposit funds and loan customers. These letters of credit expire throughout the remainder of 2023 and through 2024.
The Corporation has a maximum borrowing capacity with the FHLB of $637.6 million as of September 30, 2023 and $505.4 million as of December 31, 2022. All advances and letters of credit from the FHLB are secured by a blanket lien on non-pledged, mortgage-related loans and securities as part of the Corporation’s borrowing agreement with the FHLB.
(7) Servicing Assets
The Corporation sells certain residential mortgage loans and the guaranteed portion of certain SBA loans to third parties and retains servicing rights and receives servicing fees. All such transfers are accounted for as sales. When the Corporation sells a residential mortgage loan, it does not retain any portion of that loan and its continuing involvement in such transfers is limited to certain servicing responsibilities. While the Corporation may retain a portion of certain sold SBA loans, its continuing involvement in the portion of the loan that was sold is limited to certain servicing responsibilities. When the contractual servicing fees on loans sold with servicing retained are expected to be more than adequate compensation to a servicer for performing the servicing, a capitalized servicing asset is recognized.
Residential Mortgage Loans
The related MSR asset is amortized over the period of the estimated future net servicing life of the underlying assets. MSRs are evaluated quarterly for impairment based upon the fair value of the rights as compared to their amortized cost. Impairment is recognized on the income statement to the extent the fair value is less than the capitalized amount of the MSR. The Corporation serviced $1.0 billion of residential mortgage loans as of September 30, 2023 and December 31, 2022. During the three and nine months ended September 30, 2023, the Corporation recognized servicing fee income of $612 thousand and $1.9 million, respectively, compared to $643 thousand and $1.9 million, during the three and nine months ended September 30, 2022, respectively.
Changes in the MSR balance are summarized as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
(dollars in thousands) | 2023 | | 2022 | | 2023 | | 2022 |
Balance at beginning of the period | $ | 9,238 | | | $ | 10,610 | | | $ | 9,942 | | | $ | 10,756 | |
Servicing rights capitalized | 9 | | | 65 | | | 9 | | | 648 | |
Amortization of servicing rights | (319) | | | (356) | | | (1,025) | | | (1,092) | |
Change in valuation allowance | — | | | (4) | | | 2 | | | 3 | |
Balance at end of the period | $ | 8,928 | | | $ | 10,315 | | | $ | 8,928 | | | $ | 10,315 | |
Activity in the valuation allowance for MSRs was as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
(dollars in thousands) | 2023 | | 2022 | | 2023 | | 2022 |
Valuation allowance, beginning of period | $ | — | | | $ | (1) | | | $ | (2) | | | $ | (8) | |
Impairment | — | | | (4) | | | — | | | (4) | |
Recovery | — | | | — | | | 2 | | | 7 | |
Valuation allowance, end of period | $ | — | | | $ | (5) | | | $ | — | | | $ | (5) | |
The Corporation uses assumptions and estimates in determining the fair value of MSRs. These assumptions include prepayment speeds and discount rates. The assumptions used in the valuation were based on input from buyers, brokers and other qualified personnel, as well as market knowledge. At September 30, 2023, the key assumptions used to determine the fair value of the Corporation’s MSRs included a lifetime constant prepayment rate equal to 8.73% and a discount rate equal to 9.50%. At December 31, 2022, the key assumptions used to determine the fair value of the Corporation’s MSRs included a lifetime constant prepayment rate equal to 8.05% and a discount rate equal to 9.50%. Due in part to market volatility as interest rates increased, the prepayment speed assumption has decreased from December 31, 2022 to September 30, 2023. As interest rates have started to increase and the number of mortgage refinancings have started to decline, model inputs have been adjusted to align the MSRs fair value with market conditions.
The sensitivity of the current fair value of the residential mortgage servicing rights to immediate 10% and 20% favorable and unfavorable changes in key economic assumptions are included in the following table.
| | | | | | | | | | | |
(dollars in thousands) | September 30, 2023 | | December 31, 2022 |
Fair value of residential mortgage servicing rights | $ | 11,977 | | | $ | 11,567 | |
| | | |
Weighted average life (months) | 28 | | 22 |
| | | |
Prepayment speed | 8.73 | % | | 8.05 | % |
Impact on fair value: | | | |
10% adverse change | $ | (512) | | | $ | (268) | |
20% adverse change | (986) | | | (525) | |
| | | |
Discount rate | 9.50 | % | | 9.50 | % |
Impact on fair value: | | | |
10% adverse change | $ | (460) | | | $ | (404) | |
20% adverse change | (889) | | | (777) | |
The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of an adverse variation in a articular assumption on the fair value of the MSRs is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or counteract the effect of the change.
SBA Loans
SBA loan servicing assets are amortized over the period of the estimated future net servicing life of the underlying assets. SBA loan servicing assets are evaluated quarterly for impairment based upon the fair value of the rights as compared to their amortized cost. Impairment is recognized on the income statement to the extent the fair value is less than the capitalized amount of the SBA loan
servicing asset. The Corporation serviced $211.1 million and $166.1 million of SBA loans, as of September 30, 2023 and December 31, 2022, respectively.
Changes in the SBA loan servicing asset balance are summarized as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
(dollars in thousands) | 2023 | | 2022 | | 2023 | | 2022 |
Balance at beginning of the period | $ | 2,955 | | | $ | 2,250 | | | $ | 2,404 | | | $ | 2,009 | |
Servicing rights capitalized | 373 | | | 306 | | | 1,099 | | | 1,146 | |
Amortization of servicing rights | (243) | | | (173) | | | (690) | | | (523) | |
Change in valuation allowance | (178) | | | 109 | | | 94 | | | (140) | |
Balance at end of the period | $ | 2,907 | | | $ | 2,492 | | | $ | 2,907 | | | $ | 2,492 | |
Activity in the valuation allowance for SBA loan servicing assets was as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
(dollars in thousands) | 2023 | | 2022 | | 2023 | | 2022 |
Valuation allowance, beginning of period | $ | (92) | | | $ | (345) | | | $ | (364) | | | $ | (96) | |
Impairment | (178) | | | — | | | (178) | | | (280) | |
Recovery | — | | | 109 | | | 272 | | | 140 | |
Valuation allowance, end of period | $ | (270) | | | $ | (236) | | | $ | (270) | | | $ | (236) | |
The Corporation uses assumptions and estimates in determining the fair value of SBA loan servicing rights. These assumptions include prepayment speeds, discount rates, and other assumptions. The assumptions used in the valuation were based on input from buyers, brokers and other qualified personnel, as well as market knowledge. At September 30, 2023, the key assumptions used to determine the fair value of the Corporation’s SBA loan servicing rights included a lifetime constant prepayment rate equal to 13.79% and a discount rate equal to 17.06%. At December 31, 2022, the key assumptions used to determine the fair value of the Corporation’s SBA loan servicing rights included a lifetime constant prepayment rate equal to 12.73% and a discount rate equal to 18.96%.
The sensitivity of the current fair value of the SBA loan servicing rights to immediate 10% and 20% favorable and unfavorable changes in key economic assumptions are included in the following table.
| | | | | | | | | | | |
(dollars in thousands) | September 30, 2023 | | December 31, 2022 |
Fair value of SBA loan servicing rights | $ | 3,009 | | | $ | 2,422 | |
| | | |
Weighted average life (years) | 3.5 | | 3.8 |
| | | |
Prepayment speed | 13.79 | % | | 12.73 | % |
Impact on fair value: | | | |
10% adverse change | $ | (102) | | | $ | (73) | |
20% adverse change | (196) | | | (141) | |
| | | |
Discount rate | 17.06 | % | | 18.96 | % |
Impact on fair value: | | | |
10% adverse change | $ | (64) | | | $ | (53) | |
20% adverse change | (125) | | | (104) | |
The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of an adverse variation in a particular assumption on the fair value of the SBA servicing rights is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or counteract the effect of the change.
(8) Fair Value Measurements and Disclosures
The Corporation uses fair value measurements to record fair value adjustments to certain assets and liabilities. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation techniques or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
In accordance with this guidance, the Corporation groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 – Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.
Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis.
Securities
The fair value of securities available-for-sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.
Mortgage Loans Held for Sale
The fair value of loans held for sale is based on secondary market prices.
Mortgage Loans Held for Investment
The fair value of mortgage loans held for investment is based on the price secondary markets are currently offering for similar loans using observable market data.
Derivative Financial Instruments
The fair values of forward commitments and interest rate swaps are based on market pricing and therefore are considered Level 2. Derivatives classified as Level 3 consist of interest rate lock commitments related to mortgage loan commitments. The determination of fair value includes assumptions related to the likelihood that a commitment will ultimately result in a closed loan, which is a significant unobservable assumption. A significant increase or decrease in the external market price would result in a significantly higher or lower fair value measurement.
The following table presents the fair value of financial assets measured at fair value on a recurring basis by level within the fair value hierarchy at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2023 |
(dollars in thousands) | Total | | Level 1 | | Level 2 | | Level 3 |
Assets | | | | | | | |
Securities available for sale: | | | | | | | |
U.S. asset backed securities | $ | 11,476 | | | $ | — | | | $ | 11,476 | | | $ | — | |
U.S. government agency MBS | 11,134 | | | — | | | 11,134 | | | — | |
U.S. government agency CMO | 19,372 | | | — | | | 19,372 | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2023 |
(dollars in thousands) | Total | | Level 1 | | Level 2 | | Level 3 |
State and municipal securities | 33,385 | | | — | | | 33,385 | | | — | |
U.S. Treasuries | 29,529 | | | 29,529 | | | — | | | — | |
Non-U.S. government agency CMO | 10,220 | | | — | | | 10,220 | | | |
Corporate bonds | 7,102 | | | — | | | 7,102 | | | — | |
Equity investments | 2,019 | | | — | | | 2,019 | | | — | |
Mortgage loans held for sale | 23,144 | | | — | | | 23,144 | | | — | |
Mortgage loans held for investment | 13,231 | | | — | | | 13,231 | | | — | |
Interest rate lock commitments | 229 | | | — | | | — | | | 229 | |
Forward commitments | 50 | | | — | | | 50 | | | — | |
Customer derivatives - interest rate swaps | 4,387 | | | — | | | 4,387 | | | — | |
Interest rate swaps | 1,023 | | | — | | | 1,023 | | | — | |
Total | $ | 166,303 | | | $ | 29,529 | | | $ | 136,545 | | | $ | 229 | |
| | | | | | | |
Liabilities | | | | | | | |
Interest rate lock commitments | $ | 83 | | | $ | — | | | $ | — | | | $ | 83 | |
Forward commitments | — | | | — | | | — | | | — | |
Customer derivatives - interest rate swaps | 4,321 | | | — | | | 4,321 | | | — | |
Risk Participation Agreements | 6 | | | — | | | 6 | | | — | |
Total | $ | 4,410 | | | $ | — | | | $ | 4,327 | | | $ | 83 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 |
(dollars in thousands) | Total | | Level 1 | | Level 2 | | Level 3 |
Assets | | | | | | | |
Securities available for sale: | | | | | | | |
U.S. asset backed securities | $ | 15,281 | | | $ | — | | | $ | 15,281 | | | $ | — | |
U.S. government agency MBS | 11,739 | | | — | | | 11,739 | | | — | |
U.S. government agency CMO | 23,318 | | | — | | | 23,318 | | | — | |
State and municipal securities | 38,838 | | | — | | | 38,838 | | | — | |
U.S. Treasuries | 29,523 | | | 29,523 | | | — | | | — | |
Non-U.S. government agency CMO | 9,089 | | | — | | | 9,089 | | | — | |
Corporate bonds | 7,558 | | | — | | | 7,558 | | | — | |
Equity investments | 2,086 | | | — | | | 2,086 | | | — | |
Mortgage loans held for sale | 22,243 | | | — | | | 22,243 | | | — | |
Mortgage loans held for investment | 14,502 | | | — | | | 14,502 | | | — | |
Interest rate lock commitments | 87 | | | — | | | — | | | 87 | |
Customer derivatives - interest rate swaps | 3,846 | | | — | | | 3,846 | | | — | |
Total | $ | 178,110 | | | $ | 29,523 | | | $ | 148,500 | | | $ | 87 | |
| | | | | | | |
Liabilities | | | | | | | |
Interest rate lock commitments | $ | 79 | | | $ | — | | | $ | — | | | $ | 79 | |
Customer derivatives - interest rate swaps | 3,799 | | | — | | | 3,799 | | | — | |
Risk Participation Agreements | 17 | | | — | | | 17 | | | — | |
Total | $ | 3,895 | | | $ | — | | | $ | 3,816 | | | $ | 79 | |
The following table presents assets measured at fair value on a nonrecurring basis at the dates indicated:
| | | | | | | | | | | |
(dollars in thousands) | September 30, 2023 | | December 31, 2022 |
Mortgage servicing rights | $ | 8,928 | | | $ | 9,942 | |
SBA loan servicing rights | 2,907 | | | 2,404 | |
Individually evaluated loans (1) | | | |
Commercial and industrial | 12,371 | | — |
Small business loans | 2,456 | | 2,281 |
Total | $ | 26,662 | | | $ | 14,627 | |
(1) Individually evaluated loans are those in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. The increase in individually evaluated commercial and industrial loans noted above was due to reassessing how we evaluate the impairment on a loan relationship to now be based on the fair value of collateral.
The following table details the valuation techniques for Level 3 individually evaluated loans.
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(dollars in thousands) | Fair Value | | Valuation Technique | | Significant Unobservable Input | | Range of Inputs |
September 30, 2023 | $ | 14,827 | | | Appraisal of collateral | | Management adjustments on appraisals for property type and recent activity | | 2%-33% discount |
December 31, 2022 | 2,281 | | | Appraisal of collateral | | Management adjustments on appraisals for property type and recent activity | | 2%-15% discount |
Below is management’s estimate of the fair value of all financial instruments, whether carried at cost or fair value on the Corporation’s balance sheet. The following information should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair value of the Corporation’s financial instruments:
Cash and Cash Equivalents
The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.
Loans Receivable
The fair value of loans receivable is estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value below is reflective of an exit price.
Servicing Assets
The Corporation estimates the fair value of mortgage servicing rights and SBA loan servicing rights using discounted cash flow models that calculate the present value of estimated future net servicing income. The model uses readily available prepayment speed assumptions for the interest rates of the portfolios serviced. These servicing rights are classified within Level 3 in the fair value hierarchy based upon management’s assessment of the inputs. The Corporation reviews the servicing rights portfolios on a quarterly basis for impairment.
Individually Evaluated Loans
Individually evaluated loans are those in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third‑party appraisals of the properties, or discounted cash flows based upon the expected proceeds. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements. Individually evaluated loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the Allowance policy.
Accrued Interest Receivable and Payable
The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.
Deposit Liabilities
The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Short-Term Borrowings
The carrying amounts of short-term borrowings approximate their fair values.
Long-Term Debt
Fair values of FHLB advances and the acquisition purchase note payable are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.
Subordinated Debt
Fair values of junior subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity.
Off-Balance Sheet Financial Instruments
Off-balance sheet instruments are primarily comprised of loan commitments, which are generally priced at market at the time of funding. Fees on commitments to extend credit and stand-by letters of credit are deemed to be immaterial and these instruments are expected to be settled at face value or expire unused. It is impractical to assign any fair value to these instruments and as a result they are not included in the table below. Fair values assigned to the notional value of interest rate lock commitments and forward sale contracts are based on market quotes.
Derivative Financial Instruments
The fair value of forward commitments and interest rate swaps is based on market pricing and therefore are considered Level 2. Derivatives classified as Level 3 consist of interest rate lock commitments related to mortgage loan commitments. The determination of fair value includes assumptions related to the likelihood that a commitment will ultimately result in a closed loan, which is a significant unobservable assumption. A significant increase or decrease in the external market price would result in a significantly higher or lower fair value measurement.
The following table presents the estimated fair values of the Corporation’s financial instruments at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | September 30, 2023 | | December 31, 2022 |
(dollars in thousands) | Fair Value Hierarchy Level | | Carrying amount | | Fair value | | Carrying amount | | Fair value |
Financial assets: | | | | | | | | | |
Cash and cash equivalents | Level 1 | | $ | 59,759 | | | $ | 59,759 | | | $ | 38,391 | | | $ | 38,391 | |
Mortgage loans held for sale | Level 2 | | 23,144 | | | 23,144 | | | 22,243 | | | 22,243 | |
Loans receivable, net of the allowance for credit losses | Level 3 | | 1,872,398 | | | 1,827,125 | | | 1,729,180 | | | 1,679,955 | |
Mortgage loans held for investment | Level 2 | | 13,231 | | | 13,231 | | | 14,502 | | | 14,502 | |
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| | | | | | | | | |
Financial liabilities: | | | | | | | | | |
Deposits | Level 2 | | 1,808,645 | | | 1,780,200 | | | 1,712,479 | | | 1,575,600 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Borrowings | Level 2 | | 177,959 | | | 179,000 | | | 122,082 | | | 122,082 | |
Subordinated debentures | Level 2 | | 50,079 | | | 50,218 | | | 40,346 | | | 40,020 | |
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The following table includes a rollforward of interest rate lock commitments for which the Corporation utilized Level 3 inputs to determine fair value on a recurring basis for the periods indicated.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
(dollars in thousands) | 2023 | | 2022 | | 2023 | | 2022 |
Balance at beginning of the period | $ | 261 | | | $ | 374 | | | $ | 87 | | | $ | 1,122 | |
(Decrease) increase in value | (32) | | | (237) | | | 142 | | | (985) | |
Balance at end of the period | $ | 229 | | | $ | 137 | | | $ | 229 | | | $ | 137 | |
The following table details the valuation techniques for Level 3 interest rate lock commitments.
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(dollars in thousands) | Fair Value | | Valuation Technique | | Significant Unobservable Input | | Range of Inputs | | Weighted Average |
September 30, 2023 | $ | 229 | | | Market comparable pricing | | Pull through | | 1 - 99% | | 84.12% |
December 31, 2022 | 87 | | | Market comparable pricing | | Pull through | | 1 - 99% | | 84.05 |
(9) Derivative Financial Instruments
Risk Management Objective of Using Derivatives
The Corporation is exposed to certain risk arising from both its business operations and economic conditions. The Corporation principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Corporation manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Corporation enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Corporation’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Corporation’s known or expected cash receipts and its known or expected cash payments principally related to the Corporation’s loan portfolio.
Interest Rate Swaps
The Corporation uses interest rate swap agreements to modify interest rate characteristics from variable to fixed or fixed to variable in order to reduce the impact of interest rate changes on future net interest income. The Corporation’s credit exposure on interest rate swaps includes changes in fair value and any collateral that is held by a third party.
In June 2023, the Corporation entered into three interest rate swaps classified as cash flow hedges with notional amounts of $25 million each, to hedge the interest payments received on short term borrowings. Under the terms of the three swap agreements, the Corporation pays average fixed rates of 4.070%, 4.027% and 4.117%, and receives variable rates in return indexed to SOFR. The swaps mature between May, June, and December 2026. The Corporation performed an assessment of the hedge for effectiveness at the inception of the hedge and performs an assessment on a recurring basis and determined that the derivative currently is and is expected to be highly effective in offsetting changes in cash flows of the hedged item. For the three and nine months ended September 30, 2023, approximately $497 thousand and $825 thousand respectively, net of tax, is recorded in total comprehensive income as unrealized gains. This amount could differ from amounts actually recognized due to changes in interest rates, hedge de-designations and the addition of other hedges subsequent to September 30, 2023. At September 30, 2023, the combined notional amount of the interest rate swaps was $75 million and the fair value was an asset of $1.0 million.
Mortgage Banking Derivatives
In connection with its mortgage banking activities, the Corporation enters into commitments to originate certain fixed rate residential mortgage loans for customers, also referred to as interest rate locks. In addition, the Corporation may enter into forward commitments for the future sales or purchases of mortgage-backed securities to or from third-party counterparties to hedge the effect of changes in interest rates on the values of both the interest rate locks and mortgage loans held for sale. Forward sales commitments may also be in the form of commitments to sell individual mortgage loans or interest rate locks at a fixed price at a future date. The amount necessary to settle each interest rate lock is based on the price that secondary market investors would pay for loans with similar characteristics, including interest rate and term, as of the date fair value is measured. Interest rate lock commitments and forward commitments are recorded within other assets/liabilities on the consolidated balance sheets, with changes in fair values during the period recorded within net change in the fair value of derivative instruments on the consolidated statements of income.
Customer Derivatives – Interest Rate Swaps
Derivatives not designated as hedges are not speculative and result from a service the Corporation provides to certain customers to swap a fixed rate product for a variable rate product, or vice versa. The Corporation executes interest rate derivatives with commercial banking customers to facilitate their respective risk management strategies. Those interest rate derivatives are simultaneously hedged
by offsetting derivatives that the Corporation executes with a third party, such that the Corporation minimizes its net interest rate risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings.
The following table presents a summary of notional amounts and fair values of derivative financial instruments at the dates indicated:
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| | | September 30, 2023 | | December 31, 2022 |
(dollars in thousands) | Balance Sheet Line Item | | Notional Amount | | Asset (Liability) Fair Value | | Notional Amount | | Asset (Liability) Fair Value |
Interest Rate Lock Commitments |
Positive fair values | Other assets | | $ | 40,015 | | | $ | 229 | | | $ | 16,590 | | | $ | 87 | |
Negative fair values | Other liabilities | | 21,260 | | | (83) | | | 16,108 | | | (79) | |
Total | | | $ | 61,275 | | | $ | 146 | | | $ | 32,698 | | | $ | 8 | |
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Forward Commitments | | | | | | | | | |
Positive fair values | Other assets | | $ | 6,750 | | | $ | 50 | | | $ | — | | | $ | — | |
Negative fair values | Other liabilities | | — | | | — | | | — | | | — | |
Total | | | $ | 6,750 | | | $ | 50 | | | $ | — | | | $ | — | |
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Customer Derivatives - Interest Rate Swaps |
Positive fair values | Other assets | | $ | 46,337 | | | $ | 4,387 | | | $ | 43,779 | | | $ | 3,846 | |
Negative fair values | Other liabilities | | 46,337 | | | (4,321) | | | 43,779 | | | (3,799) | |
Total | | | $ | 92,674 | | | $ | 66 | | | $ | 87,558 | | | $ | 47 | |
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Risk Participation Agreements |
Positive fair values | Other assets | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Negative fair values | Other liabilities | | 7,111 | | | (6) | | | 7,200 | | | (17) | |
Total | | | $ | 7,111 | | | $ | (6) | | | $ | 7,200 | | | $ | (17) | |
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Interest Rate Swaps | | | | | | | | | |
Positive fair values | Other assets | | $ | 75,000 | | | $ | 1,023 | | | $ | — | | | $ | — | |
Negative fair values | Other liabilities | | — | | | — | | | — | | | — | |
Total | | | $ | 75,000 | | | $ | 1,023 | | | $ | — | | | $ | — | |
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Total derivative financial instruments | | | $ | 242,810 | | | $ | 1,279 | | | $ | 127,456 | | | $ | 38 | |
Interest rate lock commitments are considered Level 3 in the fair value hierarchy, while the forward commitments and interest rate swaps are considered Level 2 in the fair value hierarchy.
The following table presents a summary of the fair value gains and (losses) on derivative financial instruments:
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| Three months ended September 30, | | Nine months ended September 30, |
(dollars in thousands) | 2023 | | 2022 | | 2023 | | 2022 |
Interest Rate Lock Commitments | $ | 29 | | | $ | (405) | | | $ | 138 | | | $ | (1,380) | |
Forward Commitments | 37 | | | 485 | | | 50 | | | 516 | |
Customer Derivatives - Interest Rate Swaps | 33 | | | 47 | | | 19 | | | 151 | |
Risk Participation Agreements | 6 | | | — | | | 11 | | | — | |
Interest Rate Swaps | 588 | | | — | | | 1,023 | | | — | |
Net fair value gains (losses) on derivative financial instruments | $ | 693 | | | $ | 127 | | | $ | 1,241 | | | $ | (713) | |
Net realized gains on derivative hedging activities were $82 thousand and $81 thousand for the three and nine months ended September 30, 2023, respectively, and net realized gains on derivative hedging activities were $399 thousand and $4.9 million for the three and nine months ended September 30, 2022, respectively, and are included in non-interest income in the consolidated statements of income.
(10) Segments
ASC Topic 280 – Segment Reporting identifies operating segments as components of an enterprise which are evaluated regularly by the Corporation’s Chief Operating Decision Maker, our Chief Executive Officer, in deciding how to allocate resources and assess performance. The Corporation has applied the aggregation criterion set forth in this codification to the results of its operations.
Our Banking segment (“Bank”) consists of commercial and retail banking. The Banking segment generates interest income from its lending and investing activities and is dependent on the gathering of lower cost deposits from its branch network or borrowed funds from other sources for funding its loans, resulting in the generation of net interest income. The Banking segment also derives revenues from other sources including gains on the sale of available for sale investment securities, service charges on deposit accounts, cash sweep fees, overdraft fees, BOLI income, title insurance fees, and other less significant non-interest income.
Meridian Wealth (“Wealth”), a registered investment advisor and wholly-owned subsidiary of the Bank, provides a comprehensive array of wealth management services and products and the trusted guidance to help its clients and our banking customers prepare for the future. The unit generates non-interest income through advisory fees.
Meridian’s mortgage banking segment (“Mortgage”) consists of 12 loan production offices throughout suburban Philadelphia and Maryland. The Mortgage segment originates 1 – 4 family residential mortgages and sells nearly all of its production to third party investors. The unit generates net interest income on the loans it originates and holds temporarily, then earns fee income (primarily gain on sales) at the time of the sale. The unit also recognizes income from document preparation fees, changes in portfolio pipeline fair values and net hedging gains (losses), if any.
The table below summarizes income and expenses, directly attributable to each business line, which have been included in the statement of operations. Total assets for each segment is also provided.
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| Segment Information |
| Three Months Ended September 30, 2023 | | Three Months Ended September 30, 2022 |
(Dollars in thousands) | Bank | | Wealth | | Mortgage | | Total | | Bank | | Wealth | | Mortgage | | Total |
Net interest income | $ | 17,205 | | | $ | (15) | | | $ | 34 | | | $ | 17,224 | | | $ | 17,664 | | | $ | 218 | | | $ | 144 | | | $ | 18,026 | |
Provision for credit losses | 82 | | | — | | | — | | | 82 | | | 526 | | | — | | | — | | | 526 | |
Net interest income after provision | 17,123 | | | (15) | | | 34 | | | 17,142 | | | 17,138 | | | 218 | | | 144 | | | 17,500 | |
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Non-interest Income | | | | | | | | | | | | | | | |
Mortgage banking income | 80 | | | — | | | 4,739 | | | 4,819 | | | 72 | | | — | | | 7,257 | | | 7,329 | |
Wealth management income | — | | | 1,258 | | | — | | | 1,258 | | | — | | | 1,114 | | | — | | | 1,114 | |
SBA loan income | 982 | | | — | | | — | | | 982 | | | 989 | | | — | | | — | | | 989 | |
Net change in fair values | 38 | | | — | | | (394) | | | (356) | | | 47 | | | — | | | (1,043) | | | (996) | |
Net gain on hedging activity | — | | | — | | | 82 | | | 82 | | | — | | | — | | | 399 | | | 399 | |
Other | 658 | | | — | | | 643 | | | 1,301 | | | 622 | | | — | | | 767 | | | 1,389 | |
Non-interest income | 1,758 | | | 1,258 | | | 5,070 | | | 8,086 | | | 1,730 | | | 1,114 | | | 7,380 | | | 10,224 | |
Non-interest expense | 12,564 | | | 826 | | | 6,628 | | | 20,018 | | | 11,354 | | | 780 | | | 8,127 | | | 20,261 | |
Income (loss) before income taxes | $ | 6,317 | | | $ | 417 | | | $ | (1,524) | | | $ | 5,210 | | | $ | 7,514 | | | $ | 552 | | | $ | (603) | | | $ | 7,463 | |
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Total Assets | $ | 2,177,145 | | | $ | 8,833 | | | $ | 44,993 | | | $ | 2,230,971 | | | $ | 1,858,770 | | | $ | 7,927 | | | $ | 55,227 | | | $ | 1,921,924 | |
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| Segment Information |
| Nine Months Ended September 30, 2023 | | Nine Months Ended September 30, 2022 |
(Dollars in thousands) | Bank | | Wealth | | Mortgage | | Total | | Bank | | Wealth | | Mortgage | | Total |
Net interest income | $ | 51,928 | | | $ | (12) | | | $ | 85 | | | $ | 52,001 | | | $ | 50,197 | | | $ | 628 | | | $ | 785 | | | $ | 51,610 | |
Provision for credit losses | 2,186 | | | — | | | — | | | 2,186 | | | 1,743 | | | — | | | — | | | 1,743 | |
Net interest income after provision | 49,742 | | | (12) | | | 85 | | | 49,815 | | | 48,454 | | | 628 | | | 785 | | | 49,867 | |
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Non-interest Income | | | | | | | | | | | | | | | |
Mortgage banking income | 221 | | | — | | | 12,922 | | | 13,143 | | | 394 | | | — | | | 20,973 | | | 21,367 | |
Wealth management income | — | | | 3,689 | | | — | | | 3,689 | | | — | | | 3,672 | | | — | | | 3,672 | |
SBA loan income | 3,463 | | | — | | | — | | | 3,463 | | | 3,946 | | | — | | | — | | | 3,946 | |
Net change in fair values | 30 | | | — | | | (574) | | | (544) | | | 151 | | | — | | | (4,457) | | | (4,306) | |
Net gain on hedging activity | — | | | — | | | 81 | | | 81 | | | — | | | — | | | 4,941 | | | 4,941 | |
Other | 1,982 | | | — | | | 2,034 | | | 4,016 | | | 1,776 | | | (1) | | | 2,333 | | | 4,108 | |
Non-interest income | 5,696 | | | 3,689 | | | 14,463 | | | 23,848 | | | 6,267 | | | 3,671 | | | 23,790 | | | 33,728 | |
Non-interest expense | 35,608 | | | 2,704 | | | 19,110 | | | 57,422 | | | 32,186 | | | 2,480 | | | 26,734 | | | 61,400 | |
Income (loss) before income taxes | $ | 19,830 | | | $ | 973 | | | $ | (4,562) | | | $ | 16,241 | | | $ | 22,535 | | | $ | 1,819 | | | $ | (2,159) | | | $ | 22,195 | |
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Total Assets | $ | 2,177,145 | | | $ | 8,833 | | | $ | 44,993 | | | $ | 2,230,971 | | | $ | 1,858,770 | | | $ | 7,927 | | | $ | 55,227 | | | $ | 1,921,924 | |
(11) Subordinated Debentures
In September, Meridian Corporation raised $9.7 million in subordinated debt at 8.00% with a term of 10 years, the 2023 Debentures. The issuance of this subordinated debt improved tier 2 capital, as well as tangible book value of the Corporation. The funds will be used for general corporate purposes, including providing capital to the Corporation's bank subsidiary, Meridian Bank, and supporting organic growth. The subordinated debt also helped to improve Meridian Bank's tier 1 capital.
The following table presents subordinated debentures at the dates indicated:
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(dollars in thousands) | Maturity date | | Interest rate | | September 30, 2023 | | December 31, 2022 |
2023 Debentures | 8/31/2033 | | 8.00% | | $ | 9,740 | | | $ | — | |
2019 Debentures | 12/30/2029 | | 5.38% | | 40,000 | | | 40,000 | |
2013 Debentures | 12/31/2028 | | 6.50% | | 596 | | | 653 | |
2011 Debentures | 12/31/2026 | | 6.00% | | 463 | | | 463 | |
2008 Debentures | 12/18/2023 | | 6.00% | | 56 | | | 56 | |
Debt Origination Costs | | | | | (776) | | | (826) | |
Total Subordinated Debentures | | | | | $ | 50,079 | | | $ | 40,346 | |
The Corporation issued the 2023 and 2019 Debentures, while the Bank issued the 2013, 2011 and 2008 Debentures. Upon formation of the bank holding company, the Corporation assumed the 2013, 2011 and 2008 Debentures.
Interest is paid semi-annually on the 2023 and 2019 Debentures, and paid quarterly on the 2013, 2011 and 2008 debentures. The 2013, 2011 and 2008 Debentures are includable as Tier 2 capital for determining the Bank’s compliance with regulatory capital requirements. The 2019 and 2023 Debentures are included as Tier 2 capital for the Corporation and as Tier 1 capital for the Bank.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis in conjunction with the unaudited consolidated interim financial statements contained in Part I, Item 1 of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and the related notes and the discussion under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the year ended December 31, 2022 included in Meridian Corporation’s Annual Report on Form 10-K filed with the SEC.
Forward-Looking Statements
Meridian Corporation may from time to time make written or oral “forward-looking statements” within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with respect to Meridian Corporation’s strategies, goals, beliefs, expectations, estimates, intentions, capital raising efforts, financial condition and results of operations, future performance and business. Statements preceded by, followed by, or that include the words “may,” “could,” “should,” “pro forma,” “looking forward,” “would,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” or similar expressions generally indicate a forward-looking statement. These forward-looking statements involve risks and uncertainties that are subject to change based on various important factors (some of which, in whole or in part, are beyond Meridian Corporation’s control). Numerous competitive, economic, regulatory, legal and technological factors, risks and uncertainties that could cause actual results to differ materially include, without limitation: credit losses and the credit risk of our commercial and consumer loan products; changes in the level of charge-offs and changes in estimates of the adequacy of the allowance for credit losses, or ACL; cyber-security concerns; rapid technological developments and changes; increased competitive pressures; changes in spreads on interest-earning assets and interest-bearing liabilities; changes in general economic conditions and conditions within the securities markets; unanticipated changes in our liquidity position; unanticipated changes in regulatory and governmental policies impacting interest rates and financial markets; legislation affecting the financial services industry as a whole, and Meridian Corporation, in particular; changes in accounting policies, practices or guidance; developments affecting the industry and the soundness of financial institutions and further disruption to the economy and U.S. banking system; among others, could cause Meridian Corporation’s financial performance to differ materially from the goals, plans, objectives, intentions and expectations expressed in such forward-looking statements.
Meridian Corporation cautions that the foregoing factors are not exclusive, and neither such factors nor any such forward-looking statement takes into account the impact of any future events. All forward-looking statements and information set forth herein are based on management’s current beliefs and assumptions as of the date hereof and speak only as of the date they are made. For a more complete discussion of the assumptions, risks and uncertainties related to our business, you are encouraged to review Meridian Corporation’s filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2022 and subsequently filed quarterly reports on Form 10-Q and current reports on Form 8-K that update or provide information in addition to the information included in the Form 10-K and Form 10-Q filings, if any. Meridian Corporation does not undertake to update any forward-looking statement whether written or oral, that may be made from time to time by Meridian Corporation or by or on behalf of Meridian Bank.
Critical Accounting Policies and Estimates
Our critical accounting policies are described in detail in the "Critical Accounting Policies" section within Item 7 of our 2022 Annual Form Form 10-K. The SEC defines "critical accounting policies" as those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. See Note 1, "Summary of Significant Accounting Policies" for additional information on the adoption of ASC 326, which changes the methodology under which management calculates its reserve for loans and leases, now referred to as the allowance for credit losses. Management considers the measurement of the allowance for credit losses to be a critical accounting policy.
Executive Overview
The following items highlight the Corporation’s changes in its financial condition as of September 30, 2023 compared to December 31, 2022 and the results of operations for the three and nine months ended September 30, 2023 compared to the same periods in 2022. More detailed information related to these highlights can be found in the sections that follow.
Bank Sector Considerations
Meridian is a regional community bank with loans and deposits that are well diversified in size, type, location and industry. We manage this diversification carefully, while avoiding concentrations in business lines. Meridian’s model continues to build on our strong and stable financial position, which serves our regional customers and communities with the banking products and services needed to help build their prosperity.
As a commercial bank, the majority of Meridian's deposit base is comprised of business deposits (58%), with consumer deposits amounting to 12% at September 30, 2023. Municipal deposits (8%) and brokered deposits (22%) provide growth funding. Historically, business deposits lag loan fundings. A typical business relationship maintains operating accounts, investment accounts or sweep accounts and business owners may also have personal savings or wealth accounts. Deposit balances in business accounts have a tendency to be higher on average than consumer accounts. At September 30, 2023, 63% of business accounts and 88% of consumer accounts were fully insured by the FDIC. The municipal deposits are 100% collateralized and brokered deposits are 100% FDIC insured. The level of uninsured deposits for the entire deposit base was 23% at September 30, 2023.
Meridian also maintains borrowing arrangements with various correspondent banks to meet short-term liquidity needs and has access to approximately $1.0 billion in liquidity from numerous sources including its borrowing capacity with the FHLB and other financial institutions, as well as funding through the CDARS program or through brokered CD arrangements. In addition, the Bank is eligible to receive funds under the new BTFP announced by the Federal Reserve. Meridian elected to secure borrowings from the Federal Reserve under the BTFP due to the favorable rate and as of September 30, 2023 had a balance of $33 million. Management believes that the above sources of liquidity provide Meridian with the necessary resources to meet its short-term and long-term funding requirements.
Changes in Financial Condition - September 30, 2023 Compared to December 31, 2022
•Total assets increased $168.7 million, or 8.2%, to $2.2 billion as of September 30, 2023.
•Portfolio loans increased $147.8 million, or 8.5%, to $1.9 billion as of September 30, 2023.
•Mortgage loans held for sale increased $901 thousand, or 4.1%, to $23.1 million at September 30, 2023.
•Upon adoption ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326) (“CECL”) effective January 1, 2023, we recorded an increase to our allowance for credit losses of $1.6 million and an adjustment to the reserve for unfunded commitments of $1.3 million. The after-tax retained earnings impact of this adoption was $2.2 million.
•Total deposits increased $96.2 million or 5.6% to $1.8 billion at September 30, 2023.
•Non-interest bearing deposits decreased $57.1 million, or 18.9%, to $244.7 million as of September 30, 2023.
•The Corporation returned $4.2 million of capital to Meridian shareholders during the nine months ended September 30, 2023 through a $0.125 quarterly dividend in each of the first three quarters of 2023, and also purchased $4.3 million or 312,447 shares of treasury stock.
Three Month Results of Operations - September 30, 2023 Compared to the Same Period in 2022
•Net income was $4.0 million, or $0.35 per diluted share, down $1.8 million, or 30.9%, driven by a decline in non-interest income, and to a lesser degree a decline in net interest income, partially offset by lower operating expenses.
•The return on average assets and return on average equity were 0.73% and 10.17%, respectively, for the third quarter 2023, compared to 1.23% and 14.59%, respectively, for the third quarter 2022.
•Net interest margin decreased to 3.29% from 4.01% due to the impact of deposit and borrowing repricing outpacing the repricing of interest earnings assets, mainly loans.
•On January 1, 2023, the Corporation adopted the new accounting standard, referred to as CECL, which transitioned from the incurred loss model based on historical loss experience and economic and market conditions to the expected loss model. Expected credit losses are estimated over the contractual term, adjusted for expected prepayments and recoveries, and take into account macroeconomic forecasts. The provision for credit losses decreased $444 thousand when comparing the third quarter 2023 to the third quarter 2022. The reduction was due in part to a decline in the overall exposure to unfunded loan
balances at the end of the third quarter, causing a reduction in the unfunded reserve of $273 thousand. The decrease in provision was also due to favorable changes in some baseline loss rates and certain macroeconomic factors underlying the funded loss model. In addition, the provision for credit losses is impacted by the change in expected loss rates under CECL.
•Non-interest income decreased $2.1 million, or 20.9%, to $8.1 million driven by a $2.5 million decrease in mortgage banking income and a $317 thousand decrease in net gains on hedging activities.
•Non-interest expense decreased $243 thousand, or 1.2%, to $20.0 million due to a $940 thousand decrease in salaries and employee benefits, largely offset by increases in professional fees ($205 thousand), data processing ($210 thousand), and other expenses ($564 thousand).
Nine Month Results of Operations - September 30, 2023 Compared to the Same Period in 2022
•Net income was $12.7 million, or $1.11 per diluted share, down $4.6 million, or 26.6%, driven by a decline in non-interest income, partially offset by an increase in net interest income and lower operating expenses.
•The return on average assets and return on average equity was 0.79% and 10.96%, respectively, for the nine months ended September 30, 2023, compared to 1.28% and 14.49%, respectively, for the nine months ended September 30, 2022.
•Net interest margin decreased to 3.40% from 3.99% due to the impact of deposit and borrowing repricing outpacing the repricing of interest earnings assets, mainly loans.
•Provision for credit losses increased $443 thousand to cover for increased loan growth period over period, combined with providing for the $1.8 million increase in net charge-offs period over period. As noted above, the provision for credit losses is impacted by the change in expected loss rates under CECL.
•Non-interest income decreased $9.9 million, or 29.3%, to $23.8 million driven by a $8.2 million decrease in mortgage banking income, combined with decreased net gains on hedging activity of $4.9 million.
•Non-interest expense decreased $4.0 million, or 6.5%, to $57.4 million as salaries and employee benefits decreased $6.0 million.
Key Performance Ratios
The following table presents key financial performance ratios for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three months ended September 30, | | Nine months ended September 30, |
| 2023 | | 2022 | | 2023 | | 2022 |
Return on average assets, annualized | 0.73 | % | | 1.23 | % | | 0.79 | % | | 1.28 | % |
Return on average equity, annualized | 10.17 | % | | 14.59 | % | | 10.96 | % | | 14.49 | % |
Net interest margin (tax effected yield) | 3.29 | % | | 4.01 | % | | 3.40 | % | | 3.99 | % |
Basic earnings per share | $ | 0.36 | | | $ | 0.49 | | | $ | 1.14 | | | $ | 1.45 | |
Diluted earnings per share | $ | 0.35 | | | $ | 0.48 | | | $ | 1.11 | | | $ | 1.40 | |
The following table presents certain key period-end balances and ratios at the dates indicated:
| | | | | | | | | | | |
(dollars in thousands, except per share amounts) | September 30, 2023 | | December 31, 2022 |
Book value per common share | $ | 13.88 | | | $ | 13.37 | |
Tangible book value per common share (1) | $ | 13.53 | | | $ | 13.01 | |
Allowance as a percentage of loans and leases held for investment | 1.04 | % | | 1.08 | % |
Allowance as a percentage of loans and leases held for investment (excl. loans at fair value and PPP loans) (1) | 1.05 | % | | 1.09 | % |
Tier I capital to risk weighted assets | 8.43 | % | | 8.77 | % |
Tangible common equity to tangible assets ratio (1) | 6.79 | % | | 7.25 | % |
Loans and other finance receivables, net of fees and costs | $ | 1,885,629 | | | $ | 1,743,682 | |
Total assets | $ | 2,230,971 | | | $ | 2,062,228 | |
Total stockholders’ equity | $ | 155,114 | | | $ | 153,280 | |
(1) Non-GAAP financial measure. See “Non-GAAP Financial Measures” below for Non-GAAP to GAAP reconciliation.
Components of Net Income
Net income is comprised of five major elements:
•Net Interest Income, or the difference between the interest income earned on loans, leases and investments and the interest expense paid on deposits and borrowed funds;
•Provision For Credit Losses, or the amount added to the Allowance to provide for current expected credit losses on portfolio loans and leases;
•Non-interest Income, which is made up primarily of mortgage banking income, wealth management income, SBA loan sale income, fair value adjustments, gains and losses from the sale of loans, gains and losses from the sale of investment securities available for sale and other fees from loan and deposit services;
•Non-interest Expense, which consists primarily of salaries and employee benefits, occupancy, professional fees, advertising & promotion, data processing, information technology, loan expenses, and other operating expenses; and
•Income Taxes, which include state and federal jurisdictions.
NET INTEREST INCOME
Net interest income is an integral source of the Corporation’s revenue. The tables below present a summary for the three and nine months ended September 30, 2023 and 2022, of the Corporation’s average balances and yields earned on its interest-earning assets and the rates paid on its interest-bearing liabilities. The net interest margin is the net interest income as a percentage of average interest-earning assets. The net interest spread is the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. The difference between the net interest margin and the net interest spread is the result of net free funding sources such as non-interest bearing deposits and stockholders’ equity.
Analyses of Interest Rates and Interest Differential
The tables below present the major asset and liability categories on an average daily balance basis for the periods presented, along with interest income, interest expense and key rates and yields on a tax equivalent basis.
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| For the Three Months Ended September 30, | | | | | | |
(dollars in thousands) | 2023 | | 2022 | | |
Average Balance | | Interest Income/ Expense | | Yields/ Rates | | Average Balance | | Interest Income/ Expense | | Yields/ Rates | | | | | | |
Assets: | | | | | | | | | | | | | | | | | |
Due from banks | $ | 17,356 | | | $ | 244 | | | 5.58 | % | | $ | 15,678 | | | $ | 92 | | | 2.33 | % | | | | | | |
Federal funds sold | 44 | | | 1 | | | 9.02 | | | 219 | | | 1 | | | 1.81 | | | | | | | |
Investment securities - taxable | 106,369 | | | 901 | | | 3.36 | | | 107,929 | | | 648 | | | 2.38 | | | | | | | |
Investment securities - tax exempt (1) | 58,196 | | | 410 | | | 2.80 | | | 63,711 | | | 450 | | | 2.80 | | | | | | | |
Loans held for sale | 27,718 | | | 456 | | | 6.53 | | | 37,857 | | | 479 | | | 5.02 | | | | | | | |
Loans held for investment (1) | 1,876,648 | | | 33,526 | | | 7.09 | | | 1,565,861 | | | 21,371 | | | 5.41 | | | | | | | |
Total loans | 1,904,366 | | | 33,982 | | | 7.08 | | | 1,603,718 | | | 21,850 | | | 5.41 | | | | | | | |
Total interest-earning assets | 2,086,331 | | | 35,538 | | | 6.76 | % | | 1,791,255 | | | 23,041 | | | 5.10 | % | | | | | | |
Noninterest earning assets | 98,054 | | | | | | | 76,939 | | | | | | | | | | | |
Total assets | $ | 2,184,385 | | | | | | | $ | 1,868,194 | | | | | | | | | | | |
Liabilities and stockholders' equity: | | | | | | | | | | | | | | | | |
Interest-bearing demand deposits | $ | 160,886 | | | $ | 1,488 | | | 3.67 | % | | $ | 221,402 | | | $ | 798 | | | 1.43 | % | | | | | | |
Money market and savings deposits | 719,123 | | | 6,755 | | | 3.73 | | | 718,744 | | | 2,075 | | | 1.15 | | | | | | | |
Time deposits | 648,646 | | | 7,300 | | | 4.46 | | | 361,527 | | | 1,202 | | | 1.32 | | | | | | | |
Total deposits | 1,528,655 | | | 15,543 | | | 4.03 | | | 1,301,673 | | | 4,075 | | | 1.24 | | | | | | | |
Borrowings | 167,889 | | | 2,086 | | | 4.93 | | | 41,313 | | | 266 | | | 2.55 | | | | | | | |
Subordinated debentures | 41,311 | | | 606 | | | 5.82 | | | 40,578 | | | 591 | | | 5.78 | | | | | | | |
Total interest-bearing liabilities | 1,737,855 | | | 18,235 | | | 4.16 | | | 1,383,564 | | | 4,932 | | | 1.41 | | | | | | | |
Noninterest-bearing deposits | 253,485 | | | | | | | 295,975 | | | | | | | | | | | |
Other noninterest-bearing liabilities | 36,774 | | | | | | | 31,041 | | | | | | | | | | | |
Total liabilities | 2,028,114 | | | | | | | 1,710,580 | | | | | | | | | | | |
Total stockholders' equity | 156,271 | | | | | | | 157,614 | | | | | | | | | | | |
Total stockholders' equity and liabilities | $ | 2,184,385 | | | | | | | $ | 1,868,194 | | | | | | | | | | | |
Net interest income and spread (1) | | $ | 17,303 | | | 2.60 | | | | | $ | 18,109 | | | 3.69 | | | | | | | |
Net interest margin (1) | | | | | 3.29 | % | | | | | | 4.01 | % | | | | | | |
(1)Yields and net interest income are reflected on a tax-equivalent basis.
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| For the Nine Months Ended September 30, |
(dollars in thousands) | 2023 | | 2022 |
Average Balance | | Interest Income/ Expense | | Yields/ Rates | | Average Balance | | Interest Income/ Expense | | Yields/ Rates |
Assets: | | | | | | | | | | | |
Due from banks | $ | 19,358 | | | $ | 735 | | | 5.08 | % | | $ | 23,612 | | | $ | 153 | | | 0.87 | % |
Federal funds sold | 156 | | | 6 | | | 5.14 | | | 1,440 | | | 4 | | | 0.37 | |
Investment securities - taxable | 111,884 | | | 2,853 | | | 3.41 | | | 105,624 | | | 1,599 | | | 2.02 | |
Investment securities - tax exempt (1) | 60,042 | | | 1,266 | | | 2.82 | | | 63,848 | | | 1,240 | | | 2.60 | |
Loans held for sale | 23,459 | | | 1,080 | | | 6.16 | | | 52,495 | | | 1,580 | | | 4.02 | % |
Loans held for investment (1) | 1,836,244 | | | 94,538 | | | 6.88 | | | 1,489,345 | | | 56,614 | | | 5.08 | |
Total loans | 1,859,703 | | | 95,618 | | | 6.87 | | | 1,541,840 | | | 58,194 | | | 5.05 | |
Total interest-earning assets | 2,051,143 | | | 100,478 | | | 6.55 | % | | 1,736,364 | | | 61,190 | | | 4.71 | % |
Noninterest earning assets | 95,740 | | | | | | | 74,313 | | | | | |
Total assets | $ | 2,146,883 | | | | | | | $ | 1,810,677 | | | | | |
Liabilities and stockholders' equity: | | | | | | | | | | |
Interest-bearing demand deposits | $ | 198,599 | | | $ | 5,184 | | | 3.49 | % | | $ | 242,863 | | | $ | 1,183 | | | 0.65 | % |
Money market and savings deposits | 673,540 | | | 16,603 | | | 3.30 | | | 702,696 | | | 4,003 | | | 0.76 | |
Time deposits | 628,419 | | | 19,226 | | | 4.09 | | | 319,927 | | | 1,996 | | | 0.83 | |
Total deposits | 1,500,558 | | | 41,013 | | | 3.65 | | | 1,265,486 | | | 7,182 | | | 0.76 | |
Borrowings | 143,955 | | | 5,450 | | | 5.06 | | | 24,621 | | | 391 | | | 2.12 | |
Subordinated debentures | 40,662 | | | 1,779 | | | 5.85 | | | 40,548 | | | 1,775 | | | 5.85 | |
Total interest-bearing liabilities | 1,685,175 | | | 48,242 | | | 3.83 | | | 1,330,655 | | | 9,348 | | | 0.94 | |
Noninterest-bearing deposits | 271,909 | | | | | | | 291,261 | | | | | |
Other noninterest-bearing liabilities | 35,234 | | | | | | | 29,452 | | | | | |
Total liabilities | 1,992,318 | | | | | | | 1,651,368 | | | | | |
Total stockholders' equity | 154,565 | | | | | | | 159,309 | | | | | |
Total stockholders' equity and liabilities | $ | 2,146,883 | | | | | | | $ | 1,810,677 | | | | | |
Net interest income and spread (1) | | $ | 52,236 | | | 2.72 | | | | | $ | 51,842 | | | 3.77 | |
Net interest margin (1) | | | | | 3.40 | % | | | | | | 3.99 | % |
(1)Yields and net interest income are reflected on a tax-equivalent basis.
Rate / Volume Analysis
The rate/volume analysis table below analyzes dollar changes in the components of interest income and interest expense as they relate to the change in balances (volume) and the change in interest rates (rate) of tax-equivalent net interest income for the three and nine months ended September 30, 2023 as compared to the same periods in 2022, allocated by rate and volume. Changes in interest income and/or expense attributable to both rate and volume have been allocated proportionately based on the relationship of the absolute dollar amount of the change in each category.
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| 2023 Compared to 2022 |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
(dollars in thousands) | Rate | | Volume | | Total | | Rate | | Volume | | Total |
Interest income: | | | | | | | | | | | |
Due from banks | $ | 141 | | | $ | 11 | | | $ | 152 | | | $ | 617 | | | $ | (35) | | | $ | 582 | |
Federal funds sold | 1 | | | (1) | | | — | | | 10 | | | (8) | | | 2 | |
Investment securities - taxable | 262 | | | (9) | | | 253 | | | 1,154 | | | 100 | | | 1,254 | |
Investment securities - tax exempt (1) | (1) | | | (39) | | | (40) | | | 103 | | | (77) | | | 26 | |
Loans held for sale | 123 | | | (146) | | | (23) | | | 610 | | | (1,110) | | | (500) | |
Loans held for investment (1) | 7,401 | | | 4,754 | | | 12,155 | | | 22,884 | | | 15,040 | | | 37,924 | |
Total loans | 7,524 | | | 4,608 | | | 12,132 | | | 23,494 | | | 13,930 | | | 37,424 | |
Total interest income | $ | 7,927 | | | $ | 4,570 | | | $ | 12,497 | | | $ | 25,378 | | | $ | 13,910 | | | $ | 39,288 | |
Interest expense: | | | | | | | | | | | |
Interest-bearing demand deposits | $ | 959 | | | $ | (269) | | | $ | 690 | | | $ | 4,254 | | | $ | (253) | | | $ | 4,001 | |
Money market and savings deposits | 4,679 | | | 1 | | | 4,680 | | | 12,773 | | | (173) | | | 12,600 | |
Time deposits | 4,575 | | | 1,523 | | | 6,098 | | | 13,817 | | | 3,413 | | | 17,230 | |
Total deposits | 10,213 | | | 1,255 | | | 11,468 | | | 30,844 | | | 2,987 | | | 33,831 | |
Borrowings | 424 | | | 1,396 | | | 1,820 | | | 1,124 | | | 3,935 | | | 5,059 | |
Subordinated debentures | 4 | | | 11 | | | 15 | | | (1) | | | 5 | | | 4 | |
Total interest expense | $ | 10,641 | | | $ | 2,662 | | | $ | 13,303 | | | $ | 31,967 | | | $ | 6,927 | | | $ | 38,894 | |
Interest differential | $ | (2,714) | | | $ | 1,908 | | | $ | (806) | | | $ | (6,589) | | | $ | 6,983 | | | $ | 394 | |
(1)Yields and net interest income are reflected on a tax-equivalent basis.
Three Months Ended September 30, 2023 Compared to the Same Period in 2022
For the three months ended September 30, 2023 as compared to the same period in 2022, tax-equivalent interest income increased $12.5 million as favorable rate and volume changes contributed $7.9 million, and $4.6 million, respectively. The favorable change in rates led to increased yields on loans held for sale (up 151 basis points) and loans held for investment (up 168 basis points) that favorably impact interest income by $7.5 million, overall. The loans held for investment average balances increased $310.8 million, leading to a favorable volume impact on interest income of $4.8 million, while the decline in loans held for sale average balances of $10.1 million had an unfavorable impact to interest income of $146 thousand. Growth in the loans held for investment portfolio was led by average balance increases in commercial real estate ($125.2 million), residential real estate ($121.9 million), construction ($59.2 million), and SBA loans ($17.6 million).
On the funding side, overall interest expense increased $13.3 million, largely driven by the impact from rate hikes issued by the Fed. The cost of deposits were up across the board, leading to a $11.5 million increase to interest expense. The cost of interest-bearing demand deposits, money market and savings accounts and time deposits increased 224 basis points, 258 basis points and 314 basis points, respectively, while the cost of borrowings increased 238 basis points. Time deposits were the largest drivers of the interest expense increase due to volume as average balances on such accounts increased $287.1 million, while money market/savings accounts average balances increased only $379 thousand, and the average balances on interest-bearing demand deposits decreased $60.5 million, while borrowings increased $126.6 million on average.
Overall, the $806 thousand decrease in net interest income over this period was driven by rate changes as the cost of interest bearing liabilities outpaced the increase in the yield on interest earning assets.
Nine Months Ended September 30, 2023 Compared to the Same Period in 2022
For the nine months ended September 30, 2023 as compared to the same period in 2022, tax-equivalent interest income increased $39.3 million as favorable rate and volume changes contributed $25.4 million, and $13.9 million, respectively. The favorable change in rates led to increased yields on loans held for investment (up 180 basis points) and loans held for sale (up 214 basis points), that favorably impact interest income by $23.5 million, overall. The loans held for investment average balances increased $346.9 million, leading to a favorable volume impact on interest income of $15.0 million, while the decline in loans held for sale average balances of $29.0 million had an unfavorable impact to interest income of $1.1 million. Within the loans held for investment portfolio, average balances on commercial loans, SBA loans, and leases increased $1.3 million, $24.4 million, and $34.2 million, respectively, construction loans were up $71.9 million, and residential real estate loans average balances increased $145.8 million, while the average balance of PPP loans decreased $38.9 million as such loans are nearly fully forgiven now by the SBA.
On the funding side, overall interest expense increased $38.9 million, largely driven by the impact from rate hikes issued by the Fed. The cost of deposits were up across the board, leading to a $33.8 million increase to interest expense. The cost of interest-bearing demand deposits, money market and savings accounts and time deposits increased 284 basis points, 254 basis points and 326 basis points, respectively, while the cost of borrowings increased 294 basis points. Time deposit average balances increased $308.5 million, while money market/savings accounts average balances and interest-bearing demand deposits decreased $29.2 million, and $44.3 million, respectively, and borrowings increased $119.3 million on average.
Overall, the $0.4 million increase in net interest income was derived by the volume changes as the impact from increased average earning assets, particularly loans held for investment, overcame the unfavorable impact from the funding costs.
PROVISION FOR CREDIT LOSSES
Three and Nine Months Ended September 30, 2023 Compared to the Same Periods in 2022
The provision for credit losses decreased $444 thousand for the three months ended September 30, 2023, and increased $443 thousand for the nine months ended September 30, 2023. The provision decrease over the three month comparable period was due in part to a decline in the overall exposure to unfunded loan balances at the end of the third quarter, causing a reduction in the unfunded reserve. The remaining decrease in provisioning was due largely to favorable changes in the some baseline loss rates and certain economic factors. The provision increase over the nine month comparable periods was to help provide for loan growth over the period, in addition to helping to cover for the increased level of charge-offs, largely over small equipment leases.
Asset Quality Summary
The ratio of non-performing assets to total assets was 1.38% as of September 30, 2023, up from 1.11% reported as of December 31, 2022. There was $1.7 million in other real estate owned included in non-performing assets, the result of taking possession of a well collateralized residential real estate property in the quarter end December 31, 2022. Total non-performing loans of $29.1 million as of September 30, 2023, increased $7.9 million from $21.2 million as December 31, 2022 due to downgrades of 6 SBA loans, 1 shared national credit loan, 3 commercial loan relationships, and several small balance equipment leases during this period.
Meridian realized net charge-offs of 0.18% of total average loans for the nine months ending September 30, 2023, which was up from 0.10% reported for the same period in 2022. Net charge-offs for the quarter ended September 30, 2023 were $914 thousand, comprised of $1.0 million in charge-offs, with $95 thousand in recoveries for the quarter. While a large percentage of charge-offs for the quarter ended September 30, 2023 continue to be from small ticket equipment leases, the level of charge-offs in this portfolio declined by $169 thousand, while we also realized $90 thousand of recoveries related to the small ticket equipment lease portfolio. There were also charge-offs of $272 thousand on SBA loans that had previously been classified as non-performing loans in a prior period.
The ratio of allowance for credit losses to total loans held for investment, excluding loans at fair value and PPP loans (a non-GAAP measure, see reconciliation in the Appendix), was 1.05% as of September 30, 2023 and 1.09% as of December 31, 2022. As of September 30, 2023 there were specific reserves of $2.5 million against non-performing loans, an increase from $2.2 million as of December 31, 2022 due to the establishment of a specific reserve on a commercial loan that was classified as a non-performing loan, partially offset by a decline in the specific reserve on another commercial loan relationship.
The Corporation continues to be diligent in its credit underwriting process and proactive with its loan review process, including the engagement of the services of an independent outside loan review firm, which helps identify developing credit issues. Proactive steps that are taken include the procurement of additional collateral (preferably outside the current loan structure) whenever possible and frequent contact with the borrower. The Corporation believes that timely identification of credit issues and appropriate actions early in the process serve to mitigate overall risk of loss.
Nonperforming Assets and Related Ratios
The following table presents nonperforming assets and related ratios for the periods indicated:
| | | | | | | | | | | |
(dollars in thousands) | September 30, 2023 | | December 31, 2022 |
Non-performing assets: | | | |
Nonaccrual loans: | | | |
Real estate loans: | | | |
Commercial mortgage | $ | — | | | $ | 140 | |
Home equity lines and loans | 929 | | | 1,097 | |
Residential mortgage | 3,097 | | | 2,085 | |
Construction | 1,206 | | | — | |
| | | |
Total real estate loans | 5,232 | | | 3,322 | |
Commercial and industrial | 15,575 | | | 12,547 | |
Small business loans | 7,237 | | | 4,465 | |
Leases | 1,067 | | | 902 | |
Total nonaccrual loans | 29,111 | | | 21,236 | |
Other real estate owned | 1,703 | | | 1,703 | |
Total non-performing assets | $ | 30,814 | | | $ | 22,939 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
Asset quality ratios: | | | |
Non-performing assets to total assets | 1.38 | % | | 1.11 | % |
Non-performing loans to: | | | |
Total loans and leases | 1.53 | % | | 1.20 | % |
Total loans held-for-investment | 1.54 | % | | 1.22 | % |
Total loans held-for-investment (excluding loans at fair value) (1) | 1.55 | % | | 1.23 | % |
Allowance for credit losses to (2): | | | |
Total loans and leases | 1.03 | % | | 1.07 | % |
Total loans held-for-investment | 1.04 | % | | 1.08 | % |
Total loans held-for-investment (excluding loans at fair value) (1) | 1.05 | % | | 1.09 | % |
Non-performing loans | 67.61 | % | | 88.66 | % |
| | | |
Total loans and leases | $ | 1,908,773 | | | $ | 1,765,925 | |
Total loans and leases held-for-investment | $ | 1,885,629 | | | $ | 1,743,682 | |
Total loans and leases held-for-investment (excluding loans at fair value) | $ | 1,872,109 | | | $ | 1,724,601 | |
Allowance for credit losses (2) | $ | 19,683 | | | $ | 18,828 | |
(1) The allowance for credit losses to total loans held-for-investment (excluding loans at fair value) ratio is a non-GAAP financial measure. See “Non-GAAP Financial Measures” for a reconciliation of this measure to its most comparable GAAP measure.
(2) See Note 1, "Summary of Significant Accounting Policies - Pronouncements Adopted in 2023.
NON-INTEREST INCOME
Three Months Ended September 30, 2023 Compared to the Same Period in 2022
The following table presents the components of non-interest income for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Quarter Ended | | | | |
(Dollars in thousands) | September 30, 2023 | | September 30, 2022 | | $ Change | | % Change |
Mortgage banking income | $ | 4,819 | | | $ | 7,329 | | | $ | (2,510) | | | (34.2) | % |
Wealth management income | 1,258 | | | 1,114 | | | 144 | | | 12.9 | % |
SBA loan income | 982 | | | 989 | | | (7) | | | (0.7) | % |
Earnings on investment in life insurance | 201 | | | 138 | | | 63 | | | 45.7 | % |
Net change in the fair value of derivative instruments | 103 | | | 127 | | | (24) | | | (18.9) | % |
Net change in the fair value of loans held-for-sale | 111 | | | (237) | | | 348 | | | (146.8) | % |
Net change in the fair value of loans held-for-investment | (570) | | | (886) | | | 316 | | | (35.7) | % |
Net gain on hedging activity | 82 | | | 399 | | | (317) | | | (79.4) | % |
Net loss on sale of investment securities available-for-sale | (3) | | | — | | | (3) | | | (100.0) | % |
Other | 1,103 | | | 1,251 | | | (148) | | | (11.8) | % |
Total non-interest income | $ | 8,086 | | | $ | 10,224 | | | $ | (2,138) | | | (20.9) | % |
Total non-interest income decreased $2.1 million due primarily to lower income from our mortgage segment, which continues to be impacted by lower levels of mortgage loan originations in a rising rate environment and a lack of housing inventory. Mortgage loan originations decreased $104.0 million to $187.1 million when comparing the quarter ended September 30, 2023 to the quarter ended September 30, 2022.
The net change in the fair value of loans held-for-investment improved to a loss of $570 thousand for the quarter ended September 30, 2023, compared to a loss of $886 thousand for the comparable prior year quarter, due to the negative impact the rising interest rate environment had on the fair value of the loans in portfolio that are held at fair value.
Nine Months Ended September 30, 2023 Compared to the Same Period in 2022
The following table presents the components of non-interest income for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended | | | | |
(Dollars in thousands) | September 30, 2023 | | September 30, 2022 | | $ Change | | % Change |
Mortgage banking income | $ | 13,143 | | | $ | 21,367 | | | $ | (8,224) | | | (38.5) | % |
Wealth management income | 3,689 | | | 3,672 | | | 17 | | | 0.5 | % |
SBA loan income | 3,463 | | | 3,946 | | | (483) | | | (12.2) | % |
Earnings on investment in life insurance | 585 | | | 413 | | | 172 | | | 41.6 | % |
Net change in the fair value of derivative instruments | 217 | | | (713) | | | 930 | | | (130.4) | % |
Net change in the fair value of loans held-for-sale | (88) | | | (1,094) | | | 1,006 | | | (92.0) | % |
Net change in the fair value of loans held-for-investment | (673) | | | (2,499) | | | 1,826 | | | (73.1) | % |
Net (loss) gain on hedging activity | 81 | | | 4,941 | | | (4,860) | | | (98.4) | % |
Net loss on sale of investment securities available-for-sale | (58) | | | — | | | (58) | | | (100.0) | % |
Other | 3,489 | | | 3,695 | | | (206) | | | (5.6) | % |
Total non-interest income | $ | 23,848 | | | $ | 33,728 | | | $ | (9,880) | | | (29.3) | % |
Total non-interest income decreased $9.9 million due primarily to lower income from our mortgage segment, which was impacted by lower levels of mortgage loan originations in a rising rate environment and a lack of housing inventory. Mortgage loan originations decreased $392.0 million to $531.4 million when comparing the nine months ended September 30, 2023 to the nine months ended September 30, 2022. Driven by the decline in mortgage banking income over the nine month comparable periods, the net changes in the fair value of derivative instruments and loans held-for-sale, along with changes in net gains on hedging activity decreased $2.9 million, combined.
SBA loan income decreased $483 thousand as a lower volume of SBA loans were sold into the secondary market for the nine months ending September 30, 2023 ($64.9 million of loans sold at an average gross margin of 6.8%), compared to the nine months ending September 30, 2022 ($75.9 million in loans sold at an average gross margin of 7.4%).
NON-INTEREST EXPENSE
Three Months Ended September 30, 2023 Compared to the Same Period in 2022
The following table presents the components of non-interest expense for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Quarter Ended | | | | |
(Dollars in thousands) | September 30, 2023 | | September 30, 2022 | | $ Change | | % Change |
Salaries and employee benefits | $ | 12,420 | | | $ | 13,360 | | | $ | (940) | | | (7.0) | % |
Occupancy and equipment | 1,226 | | | 1,191 | | | 35 | | | 2.9 | % |
Professional fees | 1,104 | | | 899 | | | 205 | | | 22.8 | % |
Advertising and promotion | 848 | | | 1,165 | | | (317) | | | (27.2) | % |
Data processing and software | 1,652 | | | 1,442 | | | 210 | | | 14.6 | % |
Other | 2,768 | | | 2,204 | | | 564 | | | 25.6 | % |
Total non-interest expense | $ | 20,018 | | | $ | 20,261 | | | $ | (243) | | | (1.2) | % |
Total non-interest expense decreased $243 thousand, or 1.2%, largely attributable to a decrease in salaries and employee benefits expense in the mortgage segment, which had reduced fixed and variable based compensation due to the overall decline in mortgage banking income.
Professional fees increased $205 thousand over this period largely due to an increase in loan and lease workout expenses which has helped lead to an increase in recoveries when compared to recoveries in the prior year. Professional fees were also impacted by system conversion fees for a new loan servicing platform for our mortgage segment. Advertising and promotion expense decreased $317 thousand over this period as a result of a decrease in business development expense and certain advertising expenses' seasonality.
Data processing and software expense increased $210 thousand due to cybersecurity improvements, cloud-based costs, other software upgrades, and an increase in customer account volume, all as a result of growth. Other non-interest expense increased $564 thousand due largely to an increase in FDIC insurance expense, which reflected the new 2 basis point increase in assessment, and an increase in certain commercial and consumer related loan expenses due to portfolio growth.
Nine Months Ended September 30, 2023 Compared to the Same Period in 2022
The following table presents the components of non-interest expense for the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended | | | | |
(Dollars in thousands) | September 30, 2023 | | September 30, 2022 | | $ Change | | % Change |
Salaries and employee benefits | $ | 35,633 | | | $ | 41,585 | | | $ | (5,952) | | | (14.3) | % |
Occupancy and equipment | 3,610 | | | 3,619 | | | (9) | | | (0.2) | % |
Professional fees | 2,930 | | | 2,659 | | | 271 | | | 10.2 | % |
Advertising and promotion | 2,799 | | | 3,340 | | | (541) | | | (16.2) | % |
Data processing and software | 4,764 | | | 3,939 | | | 825 | | | 20.9 | % |
Other | 7,686 | | | 6,258 | | | 1,428 | | | 22.8 | % |
Total non-interest expense | $ | 57,422 | | | $ | 61,400 | | | $ | (3,978) | | | (6.5) | % |
Total non-interest expense decreased $4.0 million largely attributable to a decrease in salaries and employee benefits expense at the mortgage segment, which recognized decreased fixed and variable compensation. Partially offsetting this decrease was an increase in salaries & benefits expense for the bank and wealth segments due to an increase in FTEs and a higher level of stock-based compensation expense year-over-year.
Advertising and promotion expense decreased $541 thousand as the result of a reduction in mortgage segment advertising and leads expense as mortgage origination volume was down significantly from the prior year. Data processing and software expense increased $825 thousand due to cybersecurity improvements, cloud-based costs and other software upgrades, all as a result of growth. Other non-interest expense increased $1.4 million over the period due largely to an increase in FDIC insurance expense, which reflected the new 2 basis point increase in assessment, and the adjustment of the unfunded allowance for credit losses which increased nearly $1 million due to the adoption of ASC 326 as of January 1, 2023.
INCOME TAX EXPENSE
Income tax expense for the three months ended September 30, 2023 was $1.2 million, as compared to $1.7 million for the same period in 2022. The decrease in income tax expense was attributable to the decrease in earnings, period over period. Our effective tax rate was 23.1% for the three months ended September 30, 2023 and 22.3% for the three months ended September 30, 2022.
Income tax expense for the nine months ended September 30, 2023 was $3.6 million, as compared to $4.9 million for the same period in 2022. The decrease in income tax expense was attributable to the decrease in earnings, period over period. Our effective tax rate was 22.0% for the nine months ended September 30, 2023 and 22.2% for the nine months ended September 30, 2022.
BALANCE SHEET ANALYSIS
As of September 30, 2023, total assets were $2.2 billion which increased $168.7 million, or 8.2%, from December 31, 2022. This growth in assets over the prior period was due primarily to loan portfolio growth, as detailed in the following table:
| | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | September 30, 2023 | | December 31, 2022 | | $ Change | | % Change |
Mortgage loans held for sale | $ | 23,144 | | | $ | 22,243 | | | $ | 901 | | | 4.1 | % |
Real estate loans: | | | | | | | |
Commercial mortgage | 696,124 | | | 565,400 | | | 130,724 | | | 23.1 | |
Home equity lines and loans | 73,844 | | | 59,399 | | | 14,445 | | | 24.3 | |
Residential mortgage | 256,343 | | | 221,837 | | | 34,506 | | | 15.6 | |
Construction | 276,590 | | | 271,955 | | | 4,635 | | | 1.7 | |
Total real estate loans | 1,302,901 | | | 1,118,591 | | | 184,310 | | | 16.5 | |
| | | | | | | |
Commercial and industrial | 299,861 | | | 341,378 | | | (41,517) | | | (12.2) | |
Small business loans | 141,265 | | | 136,155 | | | 5,110 | | | 3.8 | |
Consumer | 434 | | | 488 | | | (54) | | | (11.1) | |
Leases, net | 138,963 | | | 138,986 | | | (23) | | | — | |
Total portfolio loans and leases | $ | 1,883,424 | | | $ | 1,735,598 | | | $ | 147,826 | | | 8.5 | |
Total loans and leases | $ | 1,906,568 | | | $ | 1,757,841 | | | $ | 148,727 | | | 8.5 | % |
Portfolio loans increased $147.8 million, to $1.9 billion as of September 30, 2023, from $1.8 billion as of December 31, 2022. Overall portfolio loan growth was 8.5% since December 31, 2022, or 11.4% on an annualized basis for 2023. Commercial real estate loans increased $130.7 million, or 23.1%, residential real estate loans held in portfolio increased $34.5 million, or 15.6%, construction loans increased $4.6 million, or 1.7%, and small business loans increased $5.1 million, or 3.8%.
The following table presents the major categories of deposits at the dates indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | September 30, 2023 | | December 31, 2022 | | $ Change | | % Change |
Noninterest-bearing deposits | $ | 244,668 | | | $ | 301,727 | | | $ | (57,059) | | | (18.9) | % |
Interest-bearing deposits: | | | | | | | |
Interest-bearing demand deposits | 156,537 | | | 219,838 | | | (63,301) | | | (28.8) | % |
Money market and savings deposits | 746,599 | | | 697,564 | | | 49,035 | | | 7.0 | % |
Time deposits | 660,841 | | | 493,350 | | | 167,491 | | | 33.9 | % |
Total interest-bearing deposits | $ | 1,563,977 | | | $ | 1,410,752 | | | $ | 153,225 | | | 10.9 | % |
Total deposits | $ | 1,808,645 | | | $ | 1,712,479 | | | $ | 96,166 | | | 5.6 | % |
Total deposits increased $96.2 million, or 5.6%, since December 31, 2022. Noninterest-bearing deposits and interest-bearing accounts decreased $57.1 million, and $63.3 million, respectively, during the period. This decline was largely due to customer preference for money market deposits which carry higher interest rates than interest-bearing demand deposits. Time deposits grew $167.5 million, or 33.9%, from retail and wholesale efforts as customers prefer the higher term interest rates. Included in time deposits as of September 30, 2023, and December 31, 2022, are $401.3 million and $409.3 million of brokered deposits, respectively, which comprise 22.2% and 21.9% of total deposits as of these dates.
Capital
Consolidated stockholders’ equity of the Corporation was $155.1 million, or 7.0% of total assets as of September 30, 2023, as compared to $153.3 million, or 7.4% of total assets as of December 31, 2022. On October 26, 2023, the Board of Directors declared a quarterly cash dividend of $0.125 per common share payable November 20, 2023 to shareholders of record as of November 13, 2023.
In September, Meridian Corporation raised $9.7 million in subordinated debt at 8.00% with a term of 10 years. The issuance of this subordinated debt improved tier 2 capital, as well as tangible book value of the Corporation. The funds will be used for general corporate purposes, including providing capital to the Corporation's bank subsidiary, Meridian Bank, and supporting organic growth. The subordinated debt also helped to improve Meridian Bank's tier 1 capital.
The September 30, 2023 tangible common equity to tangible assets ratio (a non-GAAP measure) was 6.8% for the Corporation and 8.9% for the Bank, compared to 7.2% for the Corporation and 8.8% for the Bank at December 31, 2022. Tangible book value per share (a non-GAAP measure) was $13.53 as of September 30, 2023, compared with $13.01 as of December 31, 2022. A reconciliation of these non-GAAP measures is below.
The following table presents the Corporation’s capital ratios and the minimum capital requirements to be considered “well capitalized” by regulators at the periods indicated:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Corporation | | Bank | | Well-capitalized minimum |
| September 30, 2023 | | December 31, 2022 | | September 30, 2023 | | December 31, 2022 | |
Tier 1 leverage ratio | 7.52 | % | | 8.13 | % | | 9.65 | % | | 9.95 | % | | 5.00 | % |
Common tier 1 risk-based capital ratio | 8.43 | % | | 8.77 | % | | 10.82 | % | | 10.73 | % | | 6.50 | % |
Tier 1 risk-based capital ratio | 8.43 | % | | 8.77 | % | | 10.82 | % | | 10.73 | % | | 8.00 | % |
Total risk-based capital ratio | 11.96 | % | | 12.05 | % | | 11.85 | % | | 11.87 | % | | 10.00 | % |
Under the Community Bank Leverage Ratio framework, a community banking organization that is less than $10 billion in total consolidated assets, and has limited amounts of certain assets and off-balance sheet exposures, and a CBLR greater than 9% can elect to report a single regulatory capital ratio. The Corporation has elected to be measured under this framework for Bank capital adequacy and had ratios of 9.65% and 9.95% at September 30, 2023 and December 31, 2022, respectively. The Corporation is exempt from CBLR.
In December 2018, the Federal Reserve announced that a banking organization that experiences a reduction in retained earnings due to the CECL adoption as of the beginning of the fiscal year in which CECL is adopted may elect to phase in the regulatory capital impact of adopting CECL. Transitional amounts are calculated for the following items: retained earnings, temporary difference deferred tax assets and credit loss allowances eligible for inclusion in regulatory capital. When calculating regulatory capital ratios, 25% of the transitional amounts are phased in during the first year. An additional 25% of the transitional amounts are phased in over each of the next two years and at the beginning of the fourth year, the day-one effects of CECL are completely reflected in regulatory capital.
Liquidity
Management maintains liquidity to meet depositors’ needs for funds, to satisfy or fund loan commitments, and for other operating purposes. Meridian’s foundation for liquidity is a stable and loyal customer deposit base, cash and cash equivalents, and a marketable investment portfolio that provides periodic cash flow through regular maturities and amortization or that can be used as collateral to secure funding.
In addition, Meridian maintains borrowing arrangements with various correspondent banks, the FHLB and the Federal Reserve Bank of Philadelphia to meet short-term liquidity needs and has access to approximately $1.0 billion in liquidity from these sources. Through its relationship at the Federal Reserve, Meridian had available credit of approximately $7.7 million at September 30, 2023. At September 30, 2023, Meridian had $33 million in borrowings from the Federal Reserve under the BTFP. As a member of the FHLB, we are eligible to borrow up to a specific credit limit, which is determined by the amount of our residential mortgages, commercial mortgages and other loans that have been pledged as collateral. As of September 30, 2023, Meridian’s maximum borrowing capacity with the FHLB was $637.6 million. At September 30, 2023, Meridian had borrowed $145.0 million and the FHLB had issued letters of credit, on Meridian’s behalf, totaling $112.7 million against its available credit lines. At September 30, 2023, Meridian also had available $15.0 million of unsecured federal funds lines of credit with other financial institutions as well as $137.5 million of available short or long term funding through the CDARS program and $379.4 million of available short or long term funding through brokered CD arrangements. Management believes that Meridian has adequate resources to meet its short-term and long-term funding requirements.
Discussion of Segments
As of September 30, 2023, the Corporation has three principal segments as defined by FASB ASC 280, “Segment Reporting.” The segments are Banking, Mortgage Banking and Wealth Management (see Note 10 in the accompanying Notes to Unaudited Consolidated Financial Statements).
The Banking Segment recorded income before tax of $6.3 million and $19.8 million for the three and nine months ended September 30, 2023 as compared to income before tax of $7.5 million and $22.5 million for the same periods in 2022. The Banking Segment provided
121.2% and 122.1% of the Corporation’s pre-tax profit for the three and nine month periods ended September 30, 2023, as compared to 100.7% and 101.5% for the same periods in 2022.
The Wealth Management Segment recorded income before tax of $417 thousand and $973 thousand for the three and nine months ended September 30, 2023 as compared to income before tax of $552 thousand and $1.8 million for the same periods in 2022. The decrease in income in this segment was the result of declines in market conditions over the period.
The Mortgage Banking Segment recorded a loss before tax of $1.5 million and $4.6 million for the three and nine months ended September 30, 2023 as compared to a loss before tax of $603 thousand and $2.2 million for the same periods in 2022. Mortgage Banking income and expenses related to loan originations and sales decreased due to lower origination volume in the higher rate environment. Originations have been significantly impacted by a lack of homes for sale.
Off Balance Sheet Risk
The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and loan repurchase commitments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the loan agreement. Total commitments to extend credit at September 30, 2023 were $517.7 million as compared to $506.2 million at December 31, 2022.
Standby letters of credit are conditional commitments issued by the Corporation to a customer for a third party. Such standby letters of credit are issued to support private borrowing arrangements. The credit risk involved in issuing standby letters of credit is similar to that involved in granting loan facilities to customers. The Corporation’s obligation under standby letters of credit at September 30, 2023 amounted to $10.7 million as compared to $19.0 million at December 31, 2022.
Estimated fair values of the Corporation’s off-balance sheet instruments are based on fees and rates currently charged to enter into similar loan agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. Since fees and rates charged for off-balance sheet items are at market levels when set, there is no material difference between the stated amount and the estimated fair value of off-balance sheet instruments.
In certain circumstances the Corporation may be required to repurchase residential mortgage loans from investors under the terms of loan sale agreements. Generally, these circumstances include the breach of representations and warranties made to investors regarding borrower default or early payment, as well as a violation of the applicable federal, state, or local lending laws. The Corporation agrees to repurchase loans if the representations and warranties made with respect to such loans are breached. Based on the obligations described above, the Corporation repurchased two loans totaling $730 thousand for the three and nine months ended September 30, 2023, while we repurchased one loan totaling $126 thousand for the three months ended September 30, 2022, and seven loans totaling $1.6 million for the nine months ended September 30, 2022.
Non-GAAP Financial Measures
Meridian believes that non-GAAP measures are meaningful because they reflect adjustments commonly made by management, investors, regulators and analysts to evaluate performance trends and the adequacy of common equity. This non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for performance and financial condition measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of Meridian’s results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.
Our management used the measure of the tangible common equity ratio to assess our capital strength. We believe that this non-GAAP financial measure is useful to investors because, by removing the impact of our goodwill and other intangible assets, it allows investors to more easily assess our capital adequacy. This non-GAAP financial measure should not be considered a substitute for any regulatory capital ratios and may not be comparable to other similarly titled measures used by other companies.
The table below provides the non-GAAP reconciliation for our tangible common equity ratio and tangible book value per common share:
| | | | | | | | | | | |
(dollars in thousands, except share data) | September 30, 2023 | | December 31, 2022 |
Total stockholders' equity (GAAP) | $ | 155,114 | | | $ | 153,280 | |
Less: Goodwill and intangible assets | 3,921 | | | 4,074 | |
Tangible common equity (non-GAAP) | 151,193 | | | 149,206 | |
| | | |
Total assets (GAAP) | 2,230,971 | | | 2,062,228 | |
Less: Goodwill and intangible assets | 3,921 | | | 4,074 | |
Tangible assets (non-GAAP) | $ | 2,227,050 | | | $ | 2,058,154 | |
| | | |
| | | | | | | | | | | |
(dollars in thousands, except share data) | September 30, 2023 | | December 31, 2022 |
Stockholders' equity to total assets (GAAP) | 6.95 | % | | 7.43 | % |
Tangible common equity to tangible assets (non-GAAP) | 6.79 | % | | 7.25 | % |
| | | |
Shares outstanding | 11,178 | | | 11,466 | |
| | | |
Book value per share (GAAP) | $ | 13.88 | | | $ | 13.37 | |
Tangible book value per share (non-GAAP) | $ | 13.53 | | | $ | 13.01 | |
The following is a reconciliation of the allowance for credit losses to total loans held for investment ratio at September 30, 2023. This is considered a non-GAAP measure as the calculation excludes the impact of loans held for investment that are fair valued and the impact of PPP loans as these loan types are not included in the allowance for credit losses calculation.
| | | | | | | | | | | |
(dollars in thousands) | September 30, 2023 | | December 31, 2022 |
Allowance for credit losses | $ | 19,683 | | | $ | 18,828 | |
| | | |
Loans, net of fees and costs (GAAP) | 1,885,629 | | | 1,743,682 | |
Less: PPP loans | (289) | | | (4,579) | |
Less: Loans fair valued | (13,231) | | | (14,502) | |
Loans, net of fees and costs, excluding PPP and fair valued loans (non-GAAP) | $ | 1,872,109 | | | $ | 1,724,601 | |
| | | |
Allowance for credit losses, net of fees and costs (GAAP) | 1.04 | % | | 1.08 | % |
Allowance for credit losses, net of fees and costs, excluding PPP and fair valued loans (non-GAAP) | 1.05 | % | | 1.09 | % |
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Simulations of Net Interest Income
We use a simulation model on a quarterly basis to measure and evaluate potential changes in our net interest income resulting from various hypothetical interest rate scenarios. Our model incorporates various assumptions that management believes to be reasonable, but which may have a significant impact on results such as:
•The timing of changes in interest rates;
•Shifts or rotations in the yield curve;
•Repricing characteristics for market rate sensitive instruments on the balance sheet;
•Differing sensitivities of financial instruments due to differing underlying rate indices;
•Varying timing of loan prepayments for different interest rate scenarios;
•The effect of interest rate floors, periodic loan caps and lifetime loan caps;
•Overall growth rates and product mix of interest-earning assets and interest-bearing liabilities.
Because of the limitations inherent in any approach used to measure interest rate risk, simulated results are not intended to be used as a forecast of the actual effect of a change in market interest rates on our results, but rather as a means to better plan and execute appropriate ALM strategies.
Potential increase (decrease) to our net interest income between a flat interest rate scenario and hypothetical rising and declining interest rate scenarios, measured over a one-year period as of the dates indicated, are presented in the following table which assuming rate shifts occur upward and downward on the yield curve in even increments over the first twelve months (ramp) followed by rates held constant thereafter.
| | | | | | | | | | | |
| September 30, |
Changes in Market Interest Rates | 2023 | | 2022 |
+300 basis points over next 12 months | (1.25) | % | | 0.13 | % |
+200 basis points over next 12 months | (0.74) | % | | 0.29 | % |
+100 basis points over next 12 months | (0.29) | % | | 0.15 | % |
No Change | | | |
-100 basis points over next 12 months | (1.33) | % | | (1.40) | % |
-200 basis points over next 12 months | (2.63) | % | | (3.19) | % |
The above interest rate simulation suggests that the Corporation’s balance sheet is asset sensitive as of September 30, 2023. In its current position, the table indicates that net interest income will fluctuate between (1.33%) and (0.29%) in an up or down 100 basis point environment over the next 12 months. The simulated exposure to a change in interest rates is manageable and well within policy guidelines. The results continue to drive our funding strategy of increasing relationship-based accounts (core deposits) and utilizing term deposits to fund short to medium duration assets.
Simulation of economic value of equity
To quantify the amount of capital required to absorb potential losses in value of our interest-earning assets and interest-bearing liabilities resulting from adverse market movements, we calculate economic value of equity on a quarterly basis. We define economic value of equity as the net present value of our balance sheet’s cash flow, and we calculate economic value of equity by discounting anticipated principal and interest cash flows under the prevailing and hypothetical interest rate environments. Potential changes to our economic value of equity between a flat rate scenario and hypothetical rising and declining rate scenarios are presented in the following table. The projections assume shifts upward and downward in the yield curve of 100, 200 and 300 basis points occurring immediately.
| | | | | | | | | | | |
| September 30, |
Changes in Market Interest Rates | 2023 | | 2022 |
+300 basis points | (10) | % | | 5 | % |
+200 basis points | (6) | % | | 6 | % |
+100 basis points | (2) | % | | 4 | % |
No Change | | | |
-100 basis points | — | % | | (9) | % |
-200 basis points | (5) | % | | (25) | % |
This economic value of equity profile at September 30, 2023 suggests that we would experience a negative effect from an increase or decrease in rates, and the impact would worsen as rates continued to move in either direction. While an instantaneous shift in interest rates is used in this analysis to provide an estimate of exposure, we believe that a gradual shift in interest rates would have a much more modest impact. Since economic value of equity measures the discounted present value of cash flows over the estimated lives of instruments, the change in economic value of equity does not directly correlate to the degree that earnings would be impacted over a shorter time horizon.
The results of our net interest income and economic value of equity simulation analysis are purely hypothetical, and a variety of factors might cause actual results to differ substantially from what is depicted. For example, if the timing and magnitude of interest rate changes differ from that projected, our net interest income might vary significantly. Non-parallel yield curve shifts or changes in interest rate spreads would also cause net interest income to be different from that projected. An increasing interest rate environment could reduce projected net interest income if deposits and other short-term interest-bearing liabilities reprice faster than expected or faster than our interest-earning assets. Actual results could differ from those projected if interest-earning assets and interest-bearing liabilities grow faster or slower than estimated, or otherwise change its mix of products. Actual results could also differ from those projected if actual repayment speeds in the loan portfolio are substantially different than those assumed in the simulation model. Furthermore, the results do not take into account the impact of changes in loan prepayment rates on loan discount accretion. If loan prepayment rates were to increase, any remaining loan discounts would be recognized into interest income. This would result in a current period offset to declining net interest income caused by higher rate loans prepaying. Finally, these simulation results do not contemplate all the actions that management may undertake in response to changes in interest rates, such as changes to loan, investment, deposit, funding or other strategies.
Management has and continues to employ strategies to mitigate risk in the Net Interest Income and Economic Value simulations.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our CEO and CFO, has evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a- 15(e) and 15d- 15(e) under the Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, the Corporation’s CEO and CFO have concluded that the Corporation’s disclosure controls and procedures were effective as of September 30, 2023 to ensure that the information required to be disclosed by the
Corporation in the reports that the Corporation files or submits under the Exchange Act is recorded, processed, summarized, and reported completely and accurately within the time periods specified in SEC rules and forms.
Changes in Internal Control Over Financial Reporting
Effective January 1, 2023, the Corporation adopted CECL. The Corporation designed new controls and modified existing controls as part of this adoption. These additional controls over financial reporting included controls over model creation and design, model governance, assumptions, and expanded controls over loan level data. There were no other changes in the Corporation's internal control over financial reporting (as defined in Rule 13a-15(f)) during the quarter ended September 30, 2023 that materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
PART II–OTHER INFORMATION
Item 1. Legal Proceedings.
None
Item 1A. Risk Factors.
In addition to the other information contained in this Quarterly Report on Form 10-Q, the following risk factors represent material updates and additions to the risk factors previously disclosed in the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022 as filed with the SEC. Additional risks not presently known to the Corporation, or that are currently deemed immaterial, may also adversely affect business, financial condition or results of operations of the Corporation. Further, to the extent that any of the information contained in this Quarterly Report on Form 10-Q constitutes forward-looking statements, the risk factor set forth below also is a cautionary statement identifying important factors that could cause the Corporation’s actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of it.
Adverse developments affecting the financial services industry, such as recent bank failures or concerns involving liquidity, may have a material effect on our operations.
The rapid rise in interest rates starting in 2022; the resulting industry-wide reduction in the fair value of securities portfolios and capital; and several bank runs resulting in high profile bank failures, have caused a current state of volatility in the financial services industry with respect to liquidity and the health of the U.S. banking system. A financial institution's liquidity reflects its ability to meet customer demand for loans, accommodating possible outflows in deposits and accessing alternative sources of funds when needed, while at the same time taking advantage of interest rate market opportunities. The ability to manage liquidity is fundamental to a financial institution's business and success. These recent events have, and could continue to adversely impact earnings as well as the market price and volatility of the Corporation's common stock. Additionally, the cost of resolving recent bank failures prompted the FDIC to announce plans to collect additional special assessments. These recent events may also result in potentially adverse changes to laws or regulations applicable to the Corporation, which could have a material impact on the Corporation's business and result in increased costs necessary to comply with any such changes.
Weakness in the secondary residential mortgage loan markets or demand for mortgage loans may adversely affect income.
Our mortgage banking segment can provide a significant portion of our non-interest income. Mortgage activity throughout the industry decreased significantly in 2022 and our mortgage activity decreased as well. Residential mortgage lending is subject to substantial volatility due to changes in interest rates, the continued lack of housing inventory, housing demand, inflation, cash buyers, new mortgage lending regulations and other market conditions, such as the number of third-party investors and their demand to purchase mortgage loans. These factors have a direct effect on loan originations across the industry. In particular, in the current higher interest rate environment compounded by a sustained lack of housing inventory, our originations of mortgage loans decreased resulting in fewer loans available to be sold to investors, which has resulted in a decrease in non-interest income that may continue into future periods, and which may occur during other periods of rising interest rates.
Based on the above factors we may not be able to return our mortgage business to the rates of growth achieved in recent years or even grow our mortgage business from current levels. The success of our mortgage segment is dependent upon our ability to originate a high volume of loans and sell them in the secondary market to investors at a gain. In addition, our results of operations are affected by the amount of non-interest expenses (including for personnel and systems infrastructure) associated with mortgage banking activities. During periods of reduced loan demand, our results of operations are adversely affected if we are unable to reduce expenses commensurate with the decline in mortgage loan origination activity.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
Item 6. Exhibits.
EXHIBIT INDEX
| | | | | | | | |
Exhibit Number | | Description |
2.1 | | |
3.1 | | |
3.2 | |
|
4.2 | |
|
4.3 | |
|
31.1 | | |
31.2 | | |
32 | | |
101.INS | | XBRL Instance Document – The instance document does not appear in the interactive Data File because its XBRL tags are embedded within the Inline XBRL document |
101.SCH | | Inline XBRL Taxonomy Extension Schema Document |
101.CAL | | Inline XBRL Taxonomy Extension Calculation Linkbase Document |
101.LAB | | Inline XBRL Taxonomy Extension Label Linkbase Document |
101.PRE | | Inline XBRL Taxonomy Extension Presentation Linkbase Document |
101.DEF | | Inline XBRL Taxonomy Extension Definition Linkbase Document |
Exhibit 104 | | Cover Page Interactive Data File – The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document |
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.
| | | | | | | | | | | |
Date: | November 9, 2023 | Meridian Corporation |
| | |
| | By: | /s/ Christopher J. Annas |
| | | Christopher J. Annas President and Chief Executive Officer (Principal Executive Officer) |
| | | |
| | By: | /s/ Denise Lindsay |
| | | Denise Lindsay Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) |