ITEM 1A. Risk Factors
The material risks that management believes affect the Company are described below. You should carefully consider the risks as described below, together with all of the information included herein. The risks described below are not the only risks the Company faces. Additional risks not presently known also may have a material adverse effect on the Company’s results of operations and financial condition.
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Risks Related to Covid-19
The COVID-19 pandemic has adversely affected our business, financial condition and results of operations, and the ultimate impacts of the pandemic on our business, financial condition and results of operations will depend on future developments and other factors that are highly uncertain and will be impacted by the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.
The ongoing COVID-19 global and national health emergency has caused significant disruption in the international and United States economies and financial markets and has had an adverse effect on our business, financial condition and results of operations. The spread of COVID-19 has caused illness, quarantines, cancellation of events and travel, business and school shutdowns, reduction in business activity and financial transactions, supply chain interruptions and overall economic and financial market instability. In response to the COVID-19 pandemic, the governments of the states in which we do business, and of most other states, have taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential. These restrictions and other consequences of the pandemic have resulted in significant adverse effects for many different types of businesses, including, among others, those in the travel, hospitality and food and beverage industries, and have resulted in a significant number of layoffs and furloughs of employees nationwide and in the regions in which we operate. It has also negatively affected individuals ability to work, which impacts the housing and multifamily rental markets.
The ultimate effects of COVID-19 on the broader economy and the markets that we serve are not known nor is the ultimate length of the restrictions described above. Additionally, it is not known when COVID-19 can be controlled and abated. Additional impacts of COVID-19 on our business could be widespread and material, and may include, or exacerbate, among other consequences, the following:
These factors, together or in combination with other events or occurrences that may not yet be known or anticipated, may materially and adversely affect our business, financial condition and results of operations.
Risks Related to Our Lending Activities
Because we intend to continue to increase our commercial loans, our credit risk may increase.
At December 31, 2021, our commercial loans totaled $432.1 million, or 55.0% of our total loans, including $383.4 million of Commercial Litigation-Related Loans, which represented 88.7% of our commercial loans. We intend to increase our originations of commercial loans, including our Commercial Litigation-Related Loans, which consist of working capital lines of credit, case cost lines of credit, term loans to law firms, and other commercial litigation-related loans. These loans generally have more risk than 1 – 4 family mortgage loans and commercial loans secured by real estate.
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Since repayment of commercial loans, including our Commercial Litigation-Related Loans, depends on the successful receipt of settlement proceeds or the successful management and operation of the borrower’s businesses, repayment of such loans can be affected by adverse court decisions and adverse conditions in the local and national economy. Commercial Litigation-Related Loans present unique credit risks in that attorney or law firm revenues can be volatile depending on the number of cases, the timing of court decisions, the timing of the overall judicial process, and the timing of those settlements as well as related payments on those settlements. In our experience, an average case can take two to four years to litigate and settle. Determining the value of an attorney’s or law firm’s case inventory (borrowing base) is also inherently an imprecise exercise. Though repayment of case lines is not dependent on a favorable case settlement, unfavorable outcomes can ultimately impact the cash flows of the borrower. An adverse development with respect to one loan or one Commercial Litigation-Related Loan credit relationship can expose us to significantly greater risk of loss compared to an adverse development with respect to a 1 – 4 family mortgage loan or a commercial real estate loan.
Because we plan to continue to increase our originations of these loans, commercial loans generally have a larger average size as compared with other loans such as commercial real estate loans, and the collateral for commercial loans is generally less readily-marketable, losses incurred on a small number of commercial loans could have a disproportionate and material adverse impact on our financial condition and results of operations.
A substantial portion of our loan portfolio consists of multifamily real estate loans and commercial real estate loans, which have a higher degree of risk than other types of loans.
At December 31, 2021, we had $254.9 million of multifamily loans and $48.6 million of commercial real estate loans. Multifamily and commercial real estate loans represented 38.7% of our total loan portfolio at December 31, 2021. Multifamily and commercial real estate loans are often larger and involve greater risks than other types of lending because payments on such loans are often dependent on the successful operation or development of the property or business involved. Repayment of such loans is often more sensitive than other types of loans to adverse conditions in the real estate market or the general business climate and economy. Accordingly, a downturn in the real estate market and a challenging business and economic environment may increase our risk related to multifamily and commercial real estate loans. Unlike 1 – 4 family mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from their employment and other income and which are secured by real property whose value tends to be more easily ascertainable, multifamily and commercial real estate loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the commercial venture. If the cash flow from business operations is reduced, the borrower’s ability to repay the loan may be impaired. Due to the larger average size of each multifamily and commercial real estate loan as compared with other loans such as 1 – 4 family loans, as well as collateral that is generally less readily-marketable, losses incurred on a small number of multifamily and commercial real estate loans could have a material adverse impact on our financial condition and results of operations.
We expect to increase our originations of consumer loans, including post-settlement consumer and structured settlement loans, and such loans generally carry greater risk than loans secured by owner-occupied, 1 – 4 family real estate, and these risks will increase as we continue to increase originations of these types of loans.
At December 31, 2021, our consumer held for investment loans totaled $8.7 million, or 1.1% of our total loan portfolio, of which $2.5 million, or 28.2%, were post-settlement consumer loans and $0.1 million, or 1.3%, were structured settlement loans. Consumer loans typically have shorter terms, lower balances, higher yields and higher risks of default than 1 – 4 family loans. Consumer loan collections are dependent on the borrower’s continuing financial stability and are therefore more likely to be affected by adverse personal circumstances, such as a loss of employment or unexpected medical costs. While our Consumer Litigation-Related Loans, which consist of post-settlement consumer and structured settlement loans, are typically well secured by the settlement amount, we can still be exposed to the financial stability of the borrower as a result of unforeseen rulings or administrative legal anomalies with a particular borrower’s settlement that eliminate or greatly reduce their settlement amount. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit our ability to recover on such loans. As we increase our originations of consumer loans, it may become necessary to increase our provision for loan losses in the event our losses on these loans increase, which would reduce our profits.
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Potential fraud by our post-settlement consumer loan customers who are claimants or others related to the NFL Concussion Settlement Program, revisions to qualifying physician requirements, ongoing effects of the pandemic and other administrative changes could increase our actual loan losses which would decrease earnings.
On December 10, 2018, the United States District Court for the Eastern District of Pennsylvania (the “Court”) appointed a special investigator in the NFL Concussion Injury Litigation (Case No. 12-md-2323) to ensure the integrity of the NFL Concussion Settlement Program, the efficient processing of valid claims, and impose appropriate sanctions if wrongdoing is found in response to allegations of fraudulent claims. Additionally, on May 8, 2019, the Court modified the rules regarding qualifying physicians by limiting NFL claimants to utilizing doctors in their immediate area (a range of 150 miles from the claimant’s home address). We believe that these Court rulings, including other administrative processes enacted by the claims administrator, have extended the duration of our assets which may increase our credit risk. Although we have not encountered any such fraud at this time within our portfolio, if it is determined that any of our NFL loan borrowers or others committed fraud when filing their application to the NFL Concussion Settlement Program or to Esquire Bank for the related loan, we may experience credit losses, which could have an adverse effect on our operating results.
Additionally, the current COVID-19 health crisis, may also extend the duration of our portfolio. Specifically, the uncertainty related to our borrowers’ (“claimants”) access to qualified testing, doctors, their attorneys and other administrative support, has introduced incremental duration risk which may further extend the settlement of claims and payoff of our NFL loans beyond the contractual maturity.
Moreover, in August 2020, certain former NFL players filed lawsuits with the Court challenging the use of “race norming” to systematically disfavor Black players who submitted claims in the NFL Concussion Settlement Program. In general, the lawsuits alleged that “race-norming” was being used in the claims administration process to artificially reduce estimates of Black players’ pre-concussion cognitive functioning levels thereby concluding that Black players suffered lesser impairments from their concussions than their medical diagnoses and tests otherwise indicated. As a result, the plaintiffs allege that Black claimants were determined not to qualify for settlement payments despite sustaining incapacitating injuries comparable to their white counterparts. In March 2021, the Court dismissed one of the lawsuits on procedural grounds. On June 2, 2021, the NFL and class counsel voluntarily pledged to abandon “race-norming” in the assessment of all settlement claims both prospectively and retrospectively. On October 23, 2021, there was further agreement that no race norms or race demographic estimates shall be used in the settlement program going forward and the NFL will not be able to appeal to settlement administrators to require race norms be applied. Revised claims assessment standards have yet to be finalized as of the filing of this report. Overall, we believe this represents a positive development for NFL claimants and should positively impact our borrowers but will again further extend the NFL portfolio duration as the claim settlement process is re-calibrated and new claims protocols are developed for retrospective and prospective claims.
As of December 31, 2021, we have received payoffs on approximately 31% of our NFL claimant loans as compared to the overall payoffs for claim registrations with the NFL claims administrator of approximately 8%. In the third quarter of 2021, we reclassified our legacy consumer NFL loan portfolio to loans held for sale where we incurred a $9.0 million charge-off. Subsequent payoffs and valuation adjustments totaling $0.5 million drove a carrying amount of $14.1 million as of December 31, 2021, which represents approximately 60% of our funded loan balance. If the processing of claims for our portfolio continues to extend beyond our maturity for these loans due to the aforementioned fraud, revisions to qualifying physician requirements, effects of the pandemic, revised protocols due to “race-norming” claims, or the additional administrative processes, portfolio delinquencies, credit downgrades and further losses as the result of possible write-downs of these loans could occur or increase in the future, which would negatively impact our earnings.
We may incur losses related to our NFL consumer loans held for sale if we are unable to exit at our current fair market value estimate, which is based on significant assumptions related to the timing and amount of cash flows we may receive.
On September 29, 2021, we reclassified our legacy NFL consumer loan portfolio to loans held for sale due to the duration extension of these loans as a result of revisions to various claims administration protocols, the ongoing effects of the pandemic, revisions to qualifying physician requirements, and the controversial use of race-based norms. Our carrying amount of the portfolio is $14.1 million at December 31, 2021, is accounted for at lower of cost or market and based on
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significant assumptions related to the timing and amount of cash flows to be received from the borrower payments as well as a market discount rate. These assumptions can differ significantly from our estimate at the time of transfer due to the pending court approval of a new agreement which excludes race-based norms, potential for fraud by the borrowers or others, ongoing effects of the pandemic, other administrative changes and the interest rate environment. As a result, possible write-downs of these loans held for sale could occur which would negatively impact our earnings.
A substantial majority of our loans and operations are in New York, and therefore our business is particularly vulnerable to a downturn in the New York City economy.
Unlike larger financial institutions that are more geographically diversified, a large portion of our business is concentrated primarily in the state of New York, and in New York City in particular. As of December 31, 2021, 56.9% of our loan portfolio was in New York and our loan portfolio had concentrations of 45.5% in New York City. If the local economy, and particularly the real estate market, declines, the rates of delinquencies, defaults, foreclosures, bankruptcies and losses in our loan portfolio would likely increase. As a result of this lack of diversification in our loan portfolio, a downturn in the local economy generally and real estate market specifically could significantly reduce our profitability and growth and adversely affect our financial condition.
If the allowance for loan losses is not sufficient to cover actual loan losses, earnings could decrease.
Loan customers may not repay their loans according to the terms of their loans, and the collateral securing the payment of their loans may be insufficient to assure repayment. We may experience significant credit losses, which could have a material adverse effect on our operating results. Various assumptions and judgments about the collectability of the loan portfolio are made, including the creditworthiness of borrowers and the value of the real estate and other assets serving as collateral for the repayment of many loans. In determining the amount of the allowance for loan losses, management reviews the loans and the loss and delinquency experience and evaluates economic conditions.
At December 31, 2021, our allowance for loan losses as a percentage of total loans, net of unearned income, was 1.16%. The determination of the appropriate level of allowance is subject to judgment and requires us to make significant estimates of current credit risks and trends, all of which are subject to material changes. If assumptions prove to be incorrect, the allowance for loan losses may not cover probable incurred losses in the loan portfolio at the date of the financial statements. Significant additions to the allowance would materially decrease net income. We had $6 thousand in nonperforming loans at December 31, 2021. Nonperforming loans may increase and nonperforming or delinquent loans may adversely affect future performance. In addition, federal and state regulators periodically review the allowance for loan losses and may require an increase in the allowance for loan losses or recognize further loan charge-offs. Any significant increase in our allowance for loan losses or loan charge-offs as required by these regulatory agencies could have a material adverse effect on our results of operations and financial condition.
The FASB has adopted a new accounting standard that will be effective for our first fiscal year after December 15, 2022. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which may require us to increase our allowance for loan losses and increase the data we would need to collect and review to determine the appropriate level of the allowance for loan losses.
Bank regulators periodically review our allowance for loan losses and may require an increase to the provision for loan losses or further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our results of operations or financial condition.
Our loan portfolio is unseasoned.
With a growing and generally unseasoned loan portfolio, our credit risk may continue to increase and our future performance could be adversely affected. While we believe we have underwriting standards designed to manage normal lending risks, it is difficult to assess the future performance of our loan portfolio due to the recent origination of many of these loans. As a result, it is difficult to predict whether any of our loans will become nonperforming or delinquent loans,
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or whether we will have any nonperforming or delinquent loans that will adversely affect our future performance. At December 31, 2021, the weighted average age of our loans was 4.97 years, 2.08 years, 2.04 years, 3.07 years and 1.56 years for our 1 – 4 family loans, multifamily loans, commercial real estate loans, commercial loans and consumer loans, respectively. At December 31, 2021, the weighted average age of our loan portfolio was 2.77 years, however, the average customer relationship is of a longer term.
We may not be able to adequately measure and limit the credit risk associated with our loan portfolio, which could adversely affect our profitability.
As a part of the products and services that we offer, we make commercial, consumer and commercial real estate loans. The principal economic risk associated with each class of loans is the creditworthiness of the borrower, which is affected by the strength of the relevant business market segment, local market conditions, and general economic conditions. Additional factors related to the credit quality of commercial loans include the quality of the management of the business and the borrower’s ability both to properly evaluate changes in the supply and demand characteristics affecting their market for products and services, and to effectively respond to those changes. Additional factors related to the credit quality of consumer loans, particularly consumer post-settlement loans, include the quality of the post-settlement claim and unforeseen court rulings or administrative legal anomalies which could impact the final settlement amount. Additional factors related to the credit quality of commercial real estate loans include tenant vacancy rates and the quality of management of the property. A failure to effectively measure and limit the credit risk associated with our loan portfolio could have an adverse effect on our business, financial condition, and results of operations.
Changes in economic conditions could cause an increase in delinquencies and nonperforming assets, including loan charge-offs, which could depress our net income and growth.
Our loan portfolio includes many real estate secured loans, demand for which may decrease during economic downturns as a result of, among other things, an increase in unemployment, a decrease in real estate values and, a slowdown in housing. If we see negative economic conditions develop in the United States as a whole or our New York market, we could experience higher delinquencies and loan charge-offs, which would reduce our net income and adversely affect our financial condition. Furthermore, to the extent that real estate collateral is obtained through foreclosure, the costs of holding and marketing the real estate collateral, as well as the ultimate values obtained from disposition, could reduce our earnings and adversely affect our financial condition.
Risks Related to our Business
We have a limited operating history and have experienced significant growth, which makes it difficult to forecast our revenue and evaluate our business and future prospects.
We have only been in existence since 2006, and from 2016 through 2021, we experienced significant growth following our initial public offering, a capital raise and the conversion from a savings and loan holding company with a savings bank subsidiary to a bank holding company with a national bank subsidiary. As a result of our limited operating history and recent accelerated growth, in particular in our payment processing business, our ability to forecast our future results of operations and plan for and model future growth is limited and subject to a number of uncertainties. We have encountered and will continue to encounter risks and uncertainties frequently experienced by growing companies in the financial services industry, such as the risks and uncertainties described herein. Accordingly, we may be unable to prepare accurate internal financial forecasts and our results of operations in future reporting periods may be below the expectations of investors. If we do not address these risks successfully, our results of operations could differ materially from our estimates and forecasts or the expectations of our stockholders, causing our business to suffer and our stock price to decline.
A substantial portion of our business is dependent on the prospects of the legal industry and changes in the legal industry may adversely affect our growth and profitability.
We depend on our relationships within the legal community and our products and services tailored to the legal industry account for a significant source of our revenue. As we intend to focus our growth on our Litigation-Related Loan products, changes in the legal industry, including a significant decrease in the number of litigation cases in the United States, reform
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of the tort industry that reduces the ability of plaintiffs to bring cases or reduces the damages plaintiffs can receive, or a significant increase in the unemployment rate for attorneys, could, individually or in the aggregate, have a material adverse effect on our profitability, financial condition and growth of our business.
As a business operating in the financial services industry, our business and operations may be adversely affected in numerous and complex ways by weak economic conditions.
Our business and operations, which primarily consist of lending money to customers in the form of loans, borrowing money from customers in the form of deposits and investing in securities, are sensitive to general business and economic conditions in the United States. If the U.S. economy weakens, our growth and profitability from our lending, deposit and investment operations could be constrained. Uncertainty about the federal fiscal policymaking process, the medium and long-term fiscal outlook of the federal government, and future tax rates is a concern for businesses, consumers and investors in the United States. In addition, economic conditions in foreign countries could affect the stability of global financial markets, which could hinder U.S. economic growth. Weak economic conditions are characterized by deflation, fluctuations in debt and equity capital markets, a lack of liquidity and/or depressed prices in the secondary market for mortgage loans, increased delinquencies on mortgage, consumer and commercial loans, 1 – 4 family and commercial real estate price declines and lower home sales and commercial activity. The current economic environment is also characterized by interest rates at historically low levels, which impacts our ability to attract deposits and to generate attractive earnings through our investment portfolio. All of these factors are detrimental to our business, and the interplay between these factors can be complex and unpredictable. Our business is also significantly affected by monetary and related policies of the U.S. federal government and its agencies. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control. Inflation could also negatively impact us through rising costs and interest rates. Adverse economic conditions and government policy responses to such conditions could have a material adverse effect on our business, financial condition, results of operations and prospects.
We may not be able to grow, and if we do we may have difficulty managing that growth.
Our business strategy is to continue to grow our assets and expand our operations, including through potential strategic acquisitions. Our ability to grow depends, in part, upon our ability to expand our market share, successfully attract core deposits, and to identify loan and investment opportunities as well as opportunities to generate fee-based income. We can provide no assurance that we will be successful in increasing the volume of our loans and deposits at acceptable levels and upon terms acceptable to us. We also can provide no assurance that we will be successful in expanding our operations organically or through strategic acquisition while managing the costs and implementation risks associated with this growth strategy.
We expect to continue to experience growth in the number of our employees and customers and the scope of our operations. Our success will depend upon the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships, and to hire, train and manage our employees. In the event that we are unable to perform all these tasks and meet these challenges effectively, including continuing to attract core deposits, our operations, and consequently our earnings, could be adversely impacted.
Our ten largest deposit clients account for 19.3% of our total deposits.
As of December 31, 2021, our ten largest bank depositors accounted for, in the aggregate, 19.3% of our total deposits. As a result, a material decrease in the volume of those deposits by a relatively small number of our depositors could reduce our liquidity, in which event it could became necessary for us to replace those deposits with higher-cost deposits or FHLB borrowings, which would adversely affect our net interest income and, therefore, our results of operations.
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Risks Related to Market Interest Rates
Interest rate shifts may reduce net interest income and otherwise negatively impact our financial condition and results of operations.
The majority of our banking assets are monetary in nature and subject to risk from changes in interest rates. Like most financial institutions, our earnings and cash flows depend to a great extent upon the level of our net interest income, or the difference between the interest income we earn on loans, investments and other interest earning assets, and the interest we pay on interest bearing liabilities, such as deposits and borrowings. Changes in interest rates can increase or decrease our net interest income, because different types of assets and liabilities may react differently, and at different times, to market interest rate changes.
When interest bearing liabilities mature or reprice more quickly, or to a greater degree than interest earning assets in a period, an increase in interest rates could reduce net interest income. Similarly, when interest earning assets mature or reprice more quickly, or to a greater degree than interest bearing liabilities, falling interest rates could reduce net interest income. Additionally, an increase in interest rates may, among other things, reduce the demand for loans and our ability to originate loans and decrease loan repayment rates. A decrease in the general level of interest rates may affect us through, among other things, increased prepayments on our loan portfolio and increased competition for deposits. Accordingly, changes in the level of market interest rates affect our net yield on interest earning assets, loan origination volume and our overall results. Although our asset-liability management strategy is designed to control and mitigate exposure to the risks related to changes in market interest rates, those rates are affected by many factors outside of our control, including governmental monetary policies, inflation, deflation, recession, changes in unemployment, the money supply, international disorder and instability in domestic and foreign financial markets.
Risks Related to Operations
We are exposed to the risks of natural disasters and global market disruptions.
We handle a substantial volume of customer and other financial transactions every day. Our financial, accounting, data processing, check processing, electronic funds transfer, loan processing, online and mobile banking, automated teller machines, backup or other operating or security systems and infrastructure may fail to operate properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control. This could adversely affect our ability to process these transactions or provide these services. There could be a sudden change in customer transaction volume, electrical, telecommunications or other major physical infrastructure outages, natural disasters, events arising from local or larger scale political or social matters, including terrorist acts, pandemics, and cyber attacks. We continuously update these systems to support our operations and growth. This updating entails significant costs and creates risks associated with implementing new systems and integrating them with existing ones. Operational risk exposures could adversely impact our results of operations, liquidity and financial condition, and cause reputational harm.
Additionally, global markets may be adversely affected by natural disasters, the emergence of widespread health emergencies or pandemics, cyber attacks or campaigns, military conflict, including escalating military tension between Russia and Ukraine, terrorism or other geopolitical events. Global market disruptions may affect our business liquidity. Also, any sudden or prolonged market downturn in the United States or abroad, as a result of the above factors or otherwise could result in a decline in revenue and adversely affect our results of operations and financial condition, including capital and liquidity levels.
We rely heavily on our management team and our business could be adversely affected by the unexpected loss of one or more of our officers.
We are led by a management team with substantial experience in the markets that we serve and the financial products that we offer. Our operating strategy focuses on providing products and services through long-term relationship managers. Accordingly, our success depends in large part on the performance of our key officers, as well as on our ability to attract, motivate and retain highly qualified senior and middle management. Competition for employees is intense, and the process
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of identifying key personnel with the combination of skills and attributes required to execute our business plan may be lengthy. We may not be successful in retaining our key employees and the unexpected loss of services of one or more of our officers could have a material adverse effect on our business because of their skills, knowledge of our market and financial products, years of industry experience, long-term business and customer relationships and the difficulty of finding qualified replacement personnel. If the services of any of our key personnel should become unavailable for any reason, we may not be able to identify and hire qualified persons on terms acceptable to us, which could have an adverse effect on our business, financial condition and results of operations.
We are subject to certain operational risks, including, but not limited to, customer or employee fraud and data processing system failures and errors.
Employee errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence.
We maintain a system of internal controls and insurance coverage to mitigate against operational risks, including data processing system failures and errors and customer or employee fraud. If our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial condition and results of operations.
We face risks related to our operational, technological and organizational infrastructure.
Our ability to grow and compete is dependent on our ability to build or acquire the necessary operational and technological infrastructure and to manage the cost of that infrastructure as we expand. Similar to other large corporations, operational risk can manifest itself in many ways, such as errors related to failed or inadequate processes, faulty or disabled computer systems, fraud by employees or outside persons and exposure to external events. As discussed below, we are dependent on our operational infrastructure to help manage these risks. In addition, we are heavily dependent on the strength and capability of our technology systems which we use both to interface with our customers and to manage our internal financial and other systems. Our ability to develop and deliver new products that meet the needs of our existing customers and attract new ones depends on the functionality of our technology systems. Additionally, our ability to run our business in compliance with applicable laws and regulations is dependent on these infrastructures.
We continuously monitor our operational and technological capabilities and make modifications and improvements when we believe it will be cost effective to do so. In some instances, we may build and maintain these capabilities ourselves. We also outsource some of these functions to third parties. Specifically, we depend on third parties to provide our core systems processing, essential web hosting and other internet systems, deposit processing and other processing services. In connection with our payment processing business, we (and our ISOs) rely on various third parties to provide processing and clearing and settlement services to us in connection with card transactions. If these third-party service providers experience difficulties, fail to comply with banking regulations or terminate their services and we are unable to replace them with other service providers, our operations could be interrupted. If an interruption were to continue for a significant period of time, our business, financial condition and results of operations could be adversely affected, perhaps materially. Even if we are able to replace them, it may be at a higher cost to us, which could adversely affect our business, financial condition and results of operations. We also face risk from the integration of new infrastructure platforms and/or new third party providers of such platforms into its existing businesses.
A failure in our operational systems or infrastructure, or those of third parties, could impair our liquidity, disrupt our businesses, result in the unauthorized disclosure of confidential information, damage our reputation and cause financial losses.
Our business, and in particular, our payment processing business, is partially dependent on our ability to process and monitor, on a daily basis, a large number of transactions, many of which are highly complex, across numerous and diverse markets. These transactions, as well as the information technology services we provide to clients, often must adhere to
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client-specific guidelines, as well as legal and regulatory standards. Due to the breadth of our client base and our geographical reach, developing and maintaining our operational systems and infrastructure is challenging, particularly as a result of rapidly evolving legal and regulatory requirements and technological shifts. Our financial, accounting, data processing or other operating systems and facilities, and, as discussed above, those the third-party service providers upon which we depend, may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, such as a spike in transaction volume, cyber-attack or other unforeseen catastrophic events, which may adversely affect our ability to process these transactions or provide services.
The occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents could have a material adverse effect on our business, financial condition and results of operations.
Our operations rely on the secure processing, storage and transmission of confidential and other sensitive business and consumer information on our computer systems and networks, as well as those of our ISOs and processors. Under the card network rules and various federal and state laws, we are responsible for safeguarding such information. Although we take protective measures to maintain the confidentiality, integrity and availability of information across all geographic and product lines, and endeavor to modify these protective measures as circumstances warrant, the nature of the threats continues to evolve. As a result, our computer systems, software and networks are vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events that could have an adverse security impact. Despite the defensive measures we take to manage our internal technological and operational infrastructure, these threats have in the past and may in the future originate externally from third parties such as foreign governments, organized crime and other hackers, and outsource or infrastructure-support providers and application developers, or may originate internally from within our organization. Given the increasingly high volume of our transactions, certain errors may be repeated or compounded before they can be discovered and rectified. In addition, security breaches or failures could result in the bank incurring liability to ISOs, members of the card network and card issuers in relation to our payment processing business.
In particular, information pertaining to us and our customers is maintained, and transactions are executed, on the networks and systems of us, our customers and certain of our third-party partners, such as our online banking or reporting systems, ISO’s customers and merchants who are part of our payment processing business. The secure maintenance and transmission of confidential information, as well as execution of transactions over these systems, are essential to protect us and our customers against fraud and security breaches and to maintain our clients’ confidence. Breaches of information security also may occur, and in infrequent cases have occurred, through intentional or unintentional acts by those having access or gaining access to our systems or our customers’ or counterparties’ confidential information, including employees. In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our customers and underlying transactions, as well as the technology used by our customers to access our systems. We cannot be certain that the security measures we or our ISOs or processors have in place to protect this sensitive data will be successful or sufficient to protect against all current and emerging threats designed to breach our systems or those of our ISOs or processors. Although we have developed, and continue to invest in, systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, a breach of our systems, or those of our ISOs or processors, could result in losses to us or our customers; loss of business and/or customers; damage to our reputation; the incurrence of additional expenses (including the cost of notification to consumers, credit monitoring and forensics, and fees and fines imposed by the card networks); disruption to our business; our inability to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil litigation and possible financial liability — any of which could have a material adverse effect on our business, financial condition and results of operations.
If our enterprise risk management framework is not effective at mitigating risk and loss to us, we could suffer unexpected losses and our results of operations could be materially adversely affected.
Our enterprise risk management framework seeks to achieve an appropriate balance between risk and return, which is critical to optimizing stockholder value. We have established processes and procedures intended to identify, measure, monitor, report and analyze the types of risk to which we are subject, including credit, liquidity, operational, regulatory
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compliance and reputational. However, as with any risk management framework, there are inherent limitations to our risk management strategies as there may exist, or develop in the future, risks that we have not appropriately anticipated or identified. If our risk management framework proves ineffective, we could suffer unexpected losses and our business and results of operations could be materially adversely affected.
Risks Related to Competitive Matters
Our small size makes it more difficult for us to compete.
Our small size makes it more difficult to compete with other financial institutions which are generally larger and can more easily afford to invest in the marketing and technologies needed to attract and retain customers. Because our principal source of income is the net interest income we earn on our loans and investments after deducting interest paid on deposits and other sources of funds, our ability to generate the revenues needed to cover our expenses and finance such investments is limited by the size of our loan and investment portfolios. In addition, we compete with many larger financial institutions and other financial companies who operate in the payment processing business. Accordingly, we are not always able to offer new products and services as quickly as our competitors. As a smaller institution, we are also disproportionately affected by the continually increasing costs of compliance with new banking and other regulations.
We operate in a highly competitive industry and face significant competition from other financial institutions and financial services providers, which may decrease our growth or profits.
Consumer and commercial banking as well as payment processing are highly competitive industries. Our market area contains not only a large number of community and regional banks, but also a significant presence of the country’s largest commercial banks. We compete with other state and national financial institutions, as well as savings and loan associations, savings banks, and credit unions, for deposits and loans. In addition, we compete with financial intermediaries, such as consumer finance companies, specialty finance companies, commercial finance companies, mortgage banking companies, insurance companies, securities firms, mutual funds, and several government agencies, as well as major retailers, all actively engaged in providing various types of loans and other financial services, including payment processing. Competition for Litigation-Related Loans is derived primarily from a small number of nationally-oriented financial companies that specialize in this market as well as local community banks. Some of these companies are focused exclusively on loans to law firms, while others offer loans to plaintiffs as well. We also face significant competition from many larger institutions, including large commercial banks and third party processors that operate in the payment processing business, and our ability to grow that portion of our business depends on us being able to continue to attract and retain ISOs and merchants. Some of these competitors may have a long history of successful operations nationally as well as in our market area and greater ties to businesses or the legal community and more expansive banking relationships, as well as more established depositor bases, fewer regulatory constraints, and lower cost structures than we do. Competitors with greater resources may possess an advantage through their ability to maintain numerous banking locations in more convenient sites, to conduct more extensive promotional and advertising campaigns, or to operate a more developed technology platform. Due to their size, many competitors may offer a broader range of products and services, as well as better pricing for certain products and services than we can offer. For example, in the current low interest rate environment, competitors with lower costs of capital may solicit our customers to refinance their loans with a lower interest rate. Further, increased competition among financial services companies due to the recent consolidation of certain competing financial institutions may adversely affect our ability to market our products and services. Technology has lowered barriers to entry and made it possible for banks and specifically finance companies to compete in our market area and for non-banks to offer products and services traditionally provided by banks.
The financial services industry could become even more competitive as a result of legislative, regulatory, and technological changes and continued consolidation. Banks, securities firms, and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and payment processing.
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Our ability to compete successfully depends on a number of factors, including:
● our ability to expand our market position;
● customer satisfaction with our level of service; and
● industry and general economic trends.
Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could harm our business, financial condition, and results of operations.
Risks Related to our Payment Processing Business
Our merchants or ISOs may be unable to satisfy obligations for which we may ultimately be liable.
We are subject to the risk of our merchants or ISOs being unable to satisfy obligations for which we may ultimately be liable. If we are unable to collect amounts due from a merchant or ISO because of insolvency or other reasons, we may bear the loss for those full amounts. We manage our credit risk and attempt to mitigate our risk by obtaining cash reserves, both from merchants and ISOs, and through other contractual remedies. It is possible, however, that a default on such obligations by one or more of our ISOs or merchants, could, individually or in the aggregate, have a material adverse effect on our business, financial condition and results of operations.
Fraud by merchants or others could have a material adverse effect on our business and financial condition.
We may be subject to liability for fraudulent transactions initiated by merchants or others. Examples of such fraud include when a merchant or other party knowingly uses a stolen or counterfeit card to make a transaction, or if a merchant intentionally fails to deliver the merchandise or services sold in an otherwise valid transaction. Criminals are using increasingly sophisticated methods to engage in illegal activities such as counterfeiting and fraud. It is possible that incidents of fraud could increase in the future. Failure to effectively manage risk and prevent fraud would increase our chargeback liability or other liability. Increases in chargebacks or other liability could have a material adverse effect on our business, financial condition, and results of operations.
Changes in card network rules or standards could adversely affect our business.
In order to provide our payment processing services, we are members of the Visa and MasterCard networks. As such, we are subject to card network rules that could subject us or our ISOs and merchants to a variety of fines or penalties that may be assessed on us, our ISOs, and our merchants. The termination of our membership, or the revocation of registration of any of our ISOs, or any changes in card network rules or standards could increase the cost of operating our payment processor business or limit our ability to provide payment processing to or through our customers, and could have a material adverse effect on our business, financial condition and results of operations.
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Changes in card network fees could impact our operations.
From time to time, the card networks increase the fees (known as interchange fees) that they charge to acquirers and we charge to our merchants. It is possible that competitive pressures will result in us absorbing a portion of such increases in the future, which would increase our costs, reduce our profit margin and adversely affect our business and financial condition. In addition, the card networks require certain capital requirements. An increase in the required capital level would further limit our use of capital for other purposes.
Risks Related to Laws and Regulation and Their Enforcement
As a bank holding company, the sources of funds available to us are limited.
Any future constraints on liquidity at the holding company level could impair our ability to declare and pay dividends or repurchase our common stock. In some instances, notice to, or approval from, the FRB may be required prior to our declaration or payment of dividends or repurchase of common stock. Further, our operations are primarily conducted by our subsidiary, Esquire Bank, which is subject to significant regulation. Federal banking laws restrict the payment of dividends by banks to their holding companies, and Esquire Bank will be subject to these restrictions in paying dividends to us. Because our ability to receive dividends or loans from Esquire Bank is restricted, our ability to pay dividends to our stockholders and repurchase our common stock is also restricted.
Additionally, the right of a bank holding company to participate in the assets of its subsidiary bank in the event of a bank-level liquidation or reorganization is subject to the claims of the bank’s creditors, including depositors, which take priority, except to the extent that the holding company may be a creditor with a recognized claim.
Our business, financial condition, results of operations and future prospects could be adversely affected by the highly regulated environment and the laws and regulations that govern our operations, corporate governance, executive compensation and accounting principles, or changes in any of them.
As a bank holding company, we are subject to extensive examination, supervision and comprehensive regulation by various federal and state agencies that govern almost all aspects of our operations. These laws and regulations are not intended to protect our stockholders. Rather, these laws and regulations are intended to protect customers, depositors, the DIF and the overall financial stability of the U.S. These laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on the business activities in which we can engage, limit the dividend or distributions that Esquire Bank can pay to us, restrict the ability of institutions to guarantee our debt, and impose certain specific accounting requirements on us that may be more restrictive and may result in greater or earlier charges to earnings or reductions in our capital than generally accepted accounting principles would require. Compliance with these laws and regulations is difficult and costly, and changes to these laws and regulations often impose additional compliance costs. Our failure to comply with these laws and regulations, even if the failure follows good faith effort or reflects a difference in interpretation, could subject us to restrictions on our business activities, fines and other penalties, any of which could adversely affect our results of operations, capital base and the price of our securities. Further, any new laws, rules and regulations could make compliance more difficult or expensive.
Likewise, the Company operates in an environment that imposes income taxes on its operations at both the federal and state levels to varying degrees. Strategies and operating routines have been implemented to minimize the impact of these taxes. Consequently, any change in tax legislation could significantly alter the effectiveness of these strategies.
The net deferred tax asset reported on the Company’s balance sheet generally represents the tax benefit of future deductions from taxable income for items that have already been recognized for financial reporting purposes. The bulk of these deferred tax assets consists of deferred loan loss deductions and deferred compensation deductions. The net deferred tax asset is measured by applying currently-enacted income tax rates to the accounting period during which the tax benefit is expected to be realized.
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Federal regulators periodically examine our business, and we may be required to remediate adverse examination findings.
The FRB, the OCC and the FDIC, periodically examine our business, including our compliance with laws and regulations. If, as a result of an examination, a federal banking agency were to determine that our financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of any of our operations had become unsatisfactory, or that we were in violation of any law or regulation, it may take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to assess civil monetary penalties against our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance and place us into receivership or conservatorship. If we become subject to any regulatory actions, it could have a material adverse effect on our business, results of operations, financial condition and growth prospects.
We are subject to the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to material penalties.
The Community Reinvestment Act (“CRA”), the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The Consumer Financial Protection Bureau, the United States Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. A successful challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on mergers and acquisitions activity and restrictions on expansion activity. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation.
Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.
In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the FRB. An important function of the FRB is to regulate the money supply and credit conditions. Among the instruments used by the FRB to implement these objectives are open market purchases and sales of U.S. government securities, adjustments of the discount rate and changes in banks’ reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits.
The monetary policies and regulations of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon our business, financial condition and results of operations cannot be predicted.
We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.
The Bank Secrecy Act, the USA Patriot Act and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and to file reports such as suspicious activity reports and currency transaction reports. We are required to comply with these and other anti-money laundering requirements. The federal banking agencies and Financial Crimes Enforcement Network are authorized to impose significant civil money penalties for violations of those requirements and have recently engaged in coordinated enforcement efforts against banks and other financial services providers with the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. We are also subject to increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to
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pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans.
Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
We could be adversely affected by the soundness of other financial institutions and other third parties we rely on.
Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and other institutional customers. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when our collateral cannot be foreclosed upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due. Furthermore, successful operation of our payment processing business depends on the soundness of ISOs, third party processors, payment facilitators, clearing agents and others that we rely on to conduct our payment processing business. Any losses resulting from such third parties could adversely affect our business, financial condition and results of operations.
Risks Related to Accounting Matters
Changes in accounting standards could materially impact our financial statements.
From time to time, the Financial Accounting Standards Board or the SEC may change the financial accounting and reporting standards that govern the preparation of our financial statements. Such changes may result in us being subject to new or changing accounting and reporting standards. In addition, the bodies that interpret the accounting standards (such as banking regulators, outside auditors or management) may change their interpretations or positions on how these standards should be applied. These changes may be beyond our control, can be hard to predict, and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retrospectively, or apply an existing standard differently, also retrospectively, in each case resulting in our needing to revise or restate prior period financial statements.
Our accounting estimates and risk management processes and controls rely on analytical techniques and models and assumptions, which may not accurately predict events.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with GAAP and reflect management’s judgment of the most appropriate manner to report our financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet which may result in our reporting materially different results than would have been reported under a different alternative.
Certain accounting policies are critical to presenting our financial condition and results of operations. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. Management considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy. Because of the uncertainty of estimates involved in these matters, we may be required to do one or more of the following: significantly increase the allowance for loan losses or sustain loan losses that are significantly higher than the reserve provided. These could have a material adverse effect on our business, financial condition or results of operations. See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
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Our internal controls, disclosure controls, processes and procedures, and corporate governance policies and procedures are based in part on certain assumptions and can provide only reasonable (not absolute) assurances that the objectives of the system are met. Any failure or circumvention of our controls, processes and procedures or failure to comply with regulations related to controls, processes and procedures could necessitate changes in those controls, processes and procedures, which may increase our compliance costs, divert management attention from our business or subject us to regulatory actions and increased regulatory scrutiny. Any of these could have a material adverse effect on our business, financial condition or results of operations.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 2. Properties
At December 31, 2021, we conducted business through our corporate headquarters and full service branch in Jericho, New York (Nassau County) and one administrative office in Boca Raton, Florida. All the current locations are leased properties. At December 31, 2021, the total net book value of our leasehold improvements, furniture, fixtures and equipment was approximately $3.3 million.
ITEM 3. Legal Proceedings
Periodically, we are involved in claims and lawsuits, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. At December 31, 2021, we are not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.
ITEM 4. Mine Safety Disclosures
Not applicable.
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PART II
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our shares of common stock are traded on the NASDAQ Capital Market under the symbol “ESQ”. The approximate number of holders of record of Esquire Financial Holding, Inc.’s common stock as of March 1, 2022 was 1,516. The Company’s common stock began trading on the NASDAQ Capital Market on June 27, 2017.
We have not historically declared or paid cash dividends on our common stock, but may elect to pay cash dividends on our common stock in the future. Any future determination to pay cash dividends on our common stock will be made by our board of directors and will depend on a number of factors, including:
● our capital levels and requirements;
● statutory and regulatory prohibitions and other limitations;
● our business strategy;
● tax considerations;
● any acquisitions or potential acquisitions that we may examine;
● general economic conditions; and
● other factors deemed relevant by our board of directors.
The following table summarizes information as of December 31, 2021 relating to equity compensation plans of the Company pursuant to which grants of options, restricted stock awards or other rights to acquire shares may be granted from time to time.
Number of securities
Number of securities remaining available for
to be issued upon Weighted-average future issuance under
exercise of exercise price of equity compensation
outstanding options, outstanding options, plans (excluding securities
warrants and rights warrants and rights reflected in column (a))
Plan Category (a) (b) (c)
Equity Compensation Plans Not Approved by Security Holders — — —
In June 2021, we filed a shelf registration statement on Form S-3 with the United States Securities and Exchange Commission (the “SEC”). While the Company has no current plans to issue securities under the new registration statement, the Company believes it will provide more timely and efficient access to the capital markets if the Company decides to issue securities in the future. The Company also believes the registration statement will provide increased financial flexibility and streamline the offering process for general corporate purposes and possible strategic and other opportunities
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that may require additional capital. Under the registration statement, the Company may from time to time issue various types of securities, including common stock, preferred stock, debt securities, depositary shares, warrants, purchase contracts, units and subscription rights, or any combination of such securities, up to an aggregate amount of $100.0 million, through one or more methods of distribution. The terms of any offering under the registration statement will be established at the time of such offering and will be made solely by means of a prospectus and an accompanying prospectus supplement relating to that offering.
On January 9, 2019, the board of directors approved a stock repurchase program which authorized the repurchase of up to 300,000 shares of its common stock, or approximately 4.0% of its outstanding shares. There is no expiration for the stock repurchase plan. As of December 31, 2021, 34,306 shares have been repurchased under the plan.
The following table presents information regarding purchase of our common stock during the quarter ended December 31, 2021 and the stock repurchase program approved by our Board of Directors.
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ITEM 6. [Reserved]
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis reflects our financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the financial statements, which appear elsewhere in this Annual Report. You should read the information in this section in conjunction with the other business and financial information provided in this annual report.
Overview
We are a financial holding company headquartered in Jericho, New York and registered under the BHC Act. Through our wholly owned bank subsidiary, Esquire Bank, National Association, we are a full service commercial bank dedicated to serving the financial needs of the legal and small business communities on a national basis, as well as commercial and retail customers in the New York metropolitan market. We offer tailored products and solutions to the legal community and their clients as well as dynamic and flexible payment processing solutions to small business owners, both on a national basis. We also offer traditional banking products for businesses and consumers in our local market area.
Our results of operations depend primarily on our net interest income which is the difference between the interest income we earn on our interest-earning assets and the interest we pay on our interest-bearing liabilities. Our results of operations also are affected by our provisions for loan losses, noninterest income and noninterest expense. Noninterest income currently consists primarily of payment processing income and customer related fees and charges. Noninterest expense currently consists primarily of employee compensation and benefits and professional and consulting services. Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies, the litigation market and actions of regulatory authorities.
Critical Accounting Policies
A summary of our accounting policies is described in Note 1 to the Consolidated Financial Statements included in this annual report. Critical accounting estimates are necessary in the application of certain accounting policies and procedures and are particularly susceptible to significant change. Critical accounting policies are defined as those involving significant judgments and assumptions by management that could have a material impact on the carrying value of certain assets or on income under different assumptions or conditions. Management believes that the most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows:
Allowance for Loan Losses. Management considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the inherent subjectivity and uncertainty in estimating the levels of the allowance required to cover credit losses in the portfolio and the material effect that such judgments can have on the results of operations. The determination of the appropriate level of allowance is subject to judgment and requires us to make significant estimates of current credit risks and trends, all of which are subject to material changes. In particular, because of a low charge off history, a significant portion of the allowance for loan losses is determined using qualitative factors on loans with similar risk characteristics, which involve significant judgment and subjective measurement on part of management. For loans that do not share risk characteristics, the Company evaluates the loan on an individual basis based on various factors. Factors that may be considered are borrower delinquency trends and nonaccrual status, probability of foreclosure or note sale, changes in the borrower’s circumstances or cash collections, borrower’s industry, or other facts and circumstances of the loan or collateral.
If such judgments and/or assumptions prove to be incorrect, the allowance for loan losses may not cover probable incurred losses in the loan portfolio at the date of the financial statements. In addition, various regulatory agencies, as an integral part of the examination process, periodically review the allowance for credit losses. Such agencies may require the Bank to recognize adjustments to the allowance based on their judgments of the information available to them at the time of their examination. Significant additions to the allowance would materially decrease net income. Additional information can be found in Note 1 of the Notes to the Consolidated Financial Statements.
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Emerging Growth Company. Pursuant to the JOBS Act, an emerging growth company is provided the option to adopt new or revised accounting standards that may be issued by the Financial Accounting Standards Board (“FASB”) or the SEC either (i) within the same periods as those otherwise applicable to non-emerging growth companies or (ii) within the same time periods as private companies. We have irrevocably elected to adopt new accounting standards within the public company adoption period.
We have taken advantage of some of the reduced regulatory and reporting requirements that are available to it so long as we qualify as an emerging growth company, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation, and exemptions from the requirements of holding non-binding advisory votes on executive compensation and golden parachute payments.
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Selected Financial Data
The following information is derived in part from the consolidated financial statements of Esquire Financial Holdings, Inc.
At or For the Years Ended December 31,
(Dollars in thousands, except share and per share data)
Balance Sheet Data:
Income Statement Data:
Per Share Data:
Earnings per share:
Selected Performance Ratios:
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At or For the Years Ended December 31,
Asset Quality Ratios (Loans Held for Investment):
Capital Ratios (Esquire Bank):
Other:
Number of offices 3 3 3 3 3
Number of full-time equivalent employees 110 99 86 74 61
Non-GAAP Financial Measure Reconciliation
The efficiency ratio is a non-GAAP measure of expense control relative to recurring revenue. We calculate the efficiency ratio by dividing total noninterest expenses excluding non-recurring items by the sum of total net interest income and total noninterest income as determined under GAAP, but excluding net gains on securities from this calculation and other non-recurring income sources, if applicable, which we refer to below as recurring revenue. We believe that this provides one reasonable measure of recurring expenses relative to recurring revenue.
We believe that this non-GAAP financial measure provides information that is important to investors and that is useful in understanding our financial position, results and ratios. However, this non-GAAP financial measure is supplemental and is not a substitute for an analysis based on GAAP measures. As other companies may use different calculations for this measure, this presentation may not be comparable to other similarly titled measures by other companies.
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At December 31,
(Dollars in thousands)
Efficiency Ratio
Less: nonrecurring compensation charge — — — 1,173 —
Discussion and Analysis of Financial Condition for the Years Ended December 31, 2021 and 2020
Assets. Our total assets were $1.2 billion at December 31, 2021, an increase of $242.1 million from $936.7 million at December 31, 2020. The increase was primarily due to growth in our loan portfolio, cash and securities available-for-sale.
Loan Portfolio Analysis. At December 31, 2021, loans were $785.0 million, or 66.6% of total assets, compared to $672.7 million, or 71.8% of total assets, at December 31, 2020. Commercial loans increased $73.7 million, or 20.6%, to $432.1 million at December 31, 2021 from $358.4 million at December 31, 2020. Multifamily loans increased $85.0 million, or 50.1%, to $254.9 million at December 31, 2021 from $169.8 million at December 31, 2020. Commercial real estate loans decreased $6.1 million, or 11.2%, to $48.6 million at December 31, 2021 from $54.7 million at December 31, 2020. 1 – 4 family loans decreased $7.7 million, or 15.9%, to $40.8 million at December 31, 2021 from $48.4 million at December 31, 2020. Consumer loans decreased $32.7 million or 79.0%, to $8.7 million at December 31, 2021 from $41.4 million at December 31, 2020, primarily due to the company reclassifying its legacy consumer NFL loan portfolio totaling $25.4 million to loans held for sale. We had no construction loans as of December 31, 2021 and 2020.
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated.
At December 31,
Amount Percent Amount Percent
(Dollars in thousands)
Real estate:
Construction — — — —
Deferred loan costs and unearned premiums, net (466) (318)
Allowance for loan losses (9,076) (11,402)
Loans held for sale, net (Other assets) $ 14,100 $ —
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The following table sets forth the composition of our held for investment Litigation-Related Loan portfolio by type of loan at the dates indicated.
Amount Percent Amount Percent
(Dollars in thousands)
Litigation-Related Loans
Commercial Litigation-Related:
Consumer Litigation-Related:
Post-settlement consumer loans 2,451 0.7 29,342 8.9
Structured settlement loans 116 0.0 236 0.1
Total Consumer Litigation-Related 2,567 0.7 29,578 9.0
At December 31, 2021, our Litigation-Related Loans, which include commercial and consumer lending to attorneys, law firms and plaintiffs/claimants, totaled $386.0 million, or 49.2% of our total loan portfolio, compared to $329.2 million at December 31, 2020. We also had Commercial Litigation-Related uncommitted undrawn lines of credit totaling $234.0 million at December 31, 2021. In addition, we had $2.1 million in PPP loans as of December 31, 2021 to litigation related customers which are excluded from the table above.
Litigation-Related post-settlement consumer loans held for investment decreased $26.9 million to $2.5 million as of December 31, 2021, from $29.3 million as of December 31, 2021. In the third quarter of 2021, we reclassified our legacy consumer NFL loan portfolio with a balance of $25.4 million to loans held for sale where we incurred a $9.0 million charge-off. Subsequent payoffs and valuation adjustments totaling $0.5 million resulted in a carrying amount of $14.1 million as of December 31, 2021. This accounting reclassification to held for sale is reflective of management’s intent to sell these assets to a third party in the near term. As this loan portfolio’s duration has extended over the years as a result of revisions to various claims administration protocols, the ongoing effects of the pandemic, revisions to qualifying physician requirements and now the recent controversial use of race-based norms on former NFL players’ concussion claims, we have elected to sell our NFL assets while retaining a noncontrolling economic interest in an attempt to match the extended duration of our NFL borrowers’ concussion claims with that of their loans. See “Item 1A—Risk Factors—Potential fraud by our post-settlement consumer loan customers who are claimants or others related to the NFL Concussion Settlement Program, revisions to qualifying physician requirements, ongoing effects of the pandemic and other administrative changes could increase our actual loan losses which would decrease earnings” for additional discussion.
In the fourth quarter, we entered into a term sheet, subject to agreement on final legal documents, to sell the loans to a third party sponsored entity or Fund, while retaining approximately 90% of a noncontrolling economic interest in the Fund. We intend to pay the independent sponsor of the Fund or its designated manager a fee for the management of the Fund. It is anticipated that the Fund’s existence will terminate within 7 years.
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Loan Maturity. The following table sets forth certain information at December 31, 2021 regarding the contractual maturity of our held for investment loan portfolio. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. The table does not include any estimate of prepayments that could significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below.
Commercial
(In thousands)
Amounts due in:
The following table sets forth fixed and adjustable-rate held for investment loans at December 31, 2021 that are contractually due after December 31, 2022.
Due After December 31, 2022
Fixed Adjustable Total
(In thousands)
Real estate
Construction — — —
At December 31, 2021, $388.4 million, or 89.8% of our adjustable interest rate loans were at their interest rate floor.
Nonperforming Assets
Nonperforming assets include loans that are 90 or more days past due or on nonaccrual status, including troubled debt restructurings on nonaccrual status, and real estate and other loan collateral acquired through foreclosure and repossession. Loans 90 days or greater past due may remain on an accrual basis if adequately collateralized and in the process of collection. At December 31, 2021 and 2020, we did not have any accruing loans past due 90 days or greater.
Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as foreclosed real estate until it is sold. When property is acquired, it is initially recorded at the fair value less costs to sell at the date of foreclosure, establishing a new cost basis. Holding costs and declines in fair value after acquisition of the property result in charges against income. At December 31, 2021 and 2020, we have not had any foreclosed assets.
Troubled debt restructurings include loans for economic or legal reasons related to the borrower’s financial difficulties, for which we grant a concession to the borrower that we would not consider otherwise. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, we determine the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
In 2020, the Company implemented a customer payment deferral program in response to the COVID-19 crisis and elected to evaluate the modified loan population under the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) which allows for troubled debt restructuring categorization to be suspended. The Company had no loans
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identified as troubled debt restructurings at December 31, 2021 and 2020. Further, there were no loan modifications during 2021, 2020, and 2019 that were troubled debt restructurings.
The implemented customer payment deferral program (principal and interest) is designed to assist business borrowers and certain consumers that may be experiencing financial hardship due to COVID-19 related challenges. These loans will continue to accrue interest during the deferral period unless otherwise classified as nonperforming. Consistent with regulatory guidance and the provisions of the CARES Act, borrowers that were otherwise current on loan payments that were granted COVID-19 related financial hardship payment deferrals will continue to be reported as current loans during the deferral period and not evaluated as to whether they are troubled debt restructurings (“TDR”). There were no delinquent loans upon adoption of our payment deferral program. As of December 31, 2021, there were no participants in our payment deferral program.
The following table sets forth information regarding our nonperforming assets at the dates indicated.
At December 31,
(Dollars in thousands)
Nonaccrual loans:
1 – 4 family $ — $ —
Multifamily — —
Commercial real estate — —
Construction — —
Commercial — —
Total nonaccrual loans $ 6 $ 2,303
Other real estate owned — —
Loans past due 90 days and still accruing — —
Troubled debt restructurings — —
Total nonperforming assets $ 6 $ 2,303
Allowance for loan losses $ 9,076 $ 11,402
Total nonaccrual loans to total loans 0.00 % 0.34 %
Total nonperforming assets to total assets 0.00 % 0.25 %
Allowance for loan losses to nonaccrual loans 157,180 % 495 %
Allowance for loan losses to nonperforming loans 157,180 % 495 %
Allowance for loan losses to total loans at end of the period(1) 1.16 % 1.70 %
Allowance for Loan Losses
Please see “— Critical Accounting Policies — Allowance for Loan Losses” for additional discussion of our allowance policy.
The allowance for loan losses is maintained at levels considered adequate by management to provide for probable loan losses inherent in the loan portfolio as of the Consolidated Statements of Financial Condition reporting dates. The allowance for loan losses is based on management’s assessment of various factors affecting the loan portfolio, including portfolio composition, delinquent and nonaccrual loans, national and local business conditions and loss experience and an overall evaluation of the quality of the underlying collateral.
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The following table sets forth activity in our allowance for loan losses for the periods indicated.
For the years ended December 31,
(In thousands)
Charge-offs:
1 – 4 family — — —
Multifamily — — 63
Commercial real estate — — —
Construction — — —
Recoveries:
1 – 4 family — — —
Multifamily — — —
Commercial real estate — — —
Construction — — —
Commercial — — —
Consumer — — —
Total recoveries — — —
The following table presents average loans and loan loss experience for the periods indicated.
For the years ended December 31,
Net Net
Net Charge-offs Net Charge-offs
(Dollars in thousands)
1 – 4 family $ 44,733 $ — — % $ 49,732 $ — — %
Multifamily 208,363 — — % 157,271 — — %
Commercial real estate 52,155 — — % 52,542 — — %
Construction — — NA 965 — — %
Net charge-offs (recoveries) to average outstanding loans increased to 1.29% for the year ended December 31, 2021 as compared to 0.30% in 2020, primarily due to the reclassification of the NFL consumer post settlement loan portfolio from held for investment to held for sale, which resulted in a $9.0 million charge-off.
Allocation of Allowance for Loan Losses. The following tables set forth the allowance for loan losses allocated by loan category and the percent of the allowance in each category to the total allocated allowance at the dates indicated. The
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allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
At December 31,
Percent of Percent of Percent of Percent of
Allowance Loans in Allowance Loans in
for Loan Each for Loan Each
Allowance Losses to Category Allowance Losses to Category
for Loan Total to Total for Loan Total to Total
Losses Allowance Loans Losses Allowance Loans
(Dollars in thousands)
Construction — — — — — —
Loans rated special mention increased $16.9 million to $24.8 million as of December 31, 2021 from $7.9 million as of December 31, 2020, driven by our commercial, CRE and 1-4 family loan portfolios. Loans rated substandard increased $1.9 million to $4.3 million as of December 31, 2021, from $2.4 million at December 31, 2020. Our special mention and substandard loans as a percentage of loans was 3.7% and 1.5% as of December 31, 2021 and 2020, respectively. The allowance for loan losses as a percentage of loans was 1.16% and 1.70% as of December 31, 2021 and 2020, respectively. The decrease in the allowance as a percent of loans was primarily due to the charge-off of $9.0 million upon reclassification of the legacy NFL consumer post settlement loan portfolio from held for investment to held for sale.
Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and our results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with generally accepted accounting principles in the United States of America, there can be no assurance that regulators, in reviewing our loan portfolio, will not require us to increase our allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.
Payment Processing Credit Risk
From a payment processing perspective, we have taken action to identify and assess our COVID-19 related credit exposure, primarily defined as merchant returns and chargebacks, by merchant industry type and category. These industry types include, but are not limited to, restaurants, hospitality, travel, and entertainment. We have also assessed the level and adequacy of our ISO and merchant reserves held on deposit at Esquire Bank. Currently, based on our assessments, we have not identified any elevated credit risk in these affected industry types and other categories and our returns and chargeback ratios remain relatively consistent with pre-COVID-19 levels and commensurate to the merchant portfolio risk profile.
Debt Securities Portfolio
At December 31, 2021 and 2020, all debt securities were carried at fair value and we had no investments in a single company or entity, other than government and government agency securities, which had an aggregate book value in excess of 10% of our equity.
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We review the investment portfolio on a quarterly basis to determine the cause, magnitude and duration of declines in the fair value of each security. In estimating other-than-temporary impairment (OTTI), we consider many factors including: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether we have the intent to sell the security or more likely than not will be required to sell the security before its anticipated recovery. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) OTTI related to credit loss, which must be recognized in the income statement and (2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. The assessment of whether any other than temporary decline exists may involve a high degree of subjectivity and judgment and is based on the information available to management at a point in time. We evaluate securities for OTTI at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.
At December 31, 2021 and December 31, 2020, securities in unrealized loss positions were issuances from government sponsored entities. The decline in fair value is attributable to changes in interest rates and illiquidity, not credit quality and because we do not have the intent to sell the securities and it is likely that we will not be required to sell the securities before their anticipated recovery, we do not consider the securities to be other-than-temporarily impaired at December 31, 2021 and 2020.
No impairment charges were recorded for the years ended December 31, 2021, 2020 and 2019.
Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at December 31, 2021, are summarized in the following table. Maturities are based on the final contractual payment dates and do not reflect the impact of prepayments or early redemptions that may occur. No tax-equivalent yield adjustments have been made, as we have no tax free interest earning assets.
More Than One Year More Than Five Years
Weighted Weighted Weighted Weighted Weighted
Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield
(Dollars in thousands)
Deposits
Total deposits increased $224.4 million, or 27.9%, to $1.0 billion at December 31, 2021 from $804.1 million at December 31, 2020. We continue to focus on the acquisition and expansion of core deposit relationships, which we define as all deposits except for certificates of deposit. Core deposits totaled $1.0 billion at December 31, 2021, or 98.1% of total deposits at that date.
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The following tables set forth the distribution of average deposits by account type at the dates indicated.
For the Year Ended December 31,
Average Average Average Average
Balance Percent Cost Balance Percent Cost
(Dollars in thousands)
As of December 31, 2021 and 2020, the aggregate amount of uninsured deposits (deposits in amounts greater than or equal to $250,000, which is the maximum amount for federal deposit insurance)was $703.6 million and $579.8 million, respectively. These uninsured balances disclosed do not consider that FDIC insurance can be further extended by claimant within certain law firm deposit accounts. In addition, as of December 31, 2021, the aggregate amount of all our uninsured certificates of deposit was $6.9 million. We have no deposits that are uninsured for any reason other than being in excess of the maximum amount for federal deposit insurance. The following table sets forth the maturity of the uninsured certificates of deposit as of December 31, 2021.
At
(In thousands)
Maturing period:
Three months or less $ —
Over three months through six months —
Over six months through twelve months 6,828
Over twelve months 38
Borrowings
At December 31, 2021, we had the ability to borrow a total of $141.4 million from the Federal Home Loan Bank of New York. We also had a borrowing capacity with the Federal Reserve Bank of New York discount window of $26.1 million. At December 31, 2021, we also had lines of credit with other financial institutions totaling $67.5 million. No amounts were outstanding on any of the aforementioned lines as of December 31, 2021.
Stockholders’ Equity
Total stockholders’ equity increased $17.7 million, or 14.0%, to $143.7 million at December 31, 2021, from $126.1 million at December 31, 2020. The increase for the year ended December 31, 2021 was primarily due to net income and amortization of share based compensation, partially offset by unrealized losses on our available-for-sale portfolio.
Average Balance Sheets and Related Yields and Rates
The following tables present average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the years ended December 31, 2021, 2020 and 2019. The average balances are daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of discount accretion and net deferred loan origination costs accounted for as yield adjustments. No tax-equivalent adjustments have been made.
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For the Years Ended December 31,
Average Average Average Average Average Average
(Dollars in thousands)
INTEREST EARNING ASSETS
INTEREST BEARING LIABILITIES
NONINTEREST BEARING LIABILITIES
Net interest spread 4.40 % 4.34 % 4.56 %
Net interest margin 4.49 % 4.47 % 4.86 %
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The following table presents the dollar amount of changes in interest income and interest expense for major components of interest earning assets and interest bearing liabilities for the periods indicated. The table distinguishes between: (1) changes attributable to volume (changes in volume multiplied by the prior period’s rate); (2) changes attributable to rate (change in rate multiplied by the prior year’s volume) and (3) total increase (decrease) (the sum of the previous columns). Changes attributable to both volume and rate are allocated ratably between the volume and rate categories.
For the Years Ended
December 31,
Increase Total
(Decrease) due to Increase
Volume Rate (Decrease)
(Dollars in thousands)
Interest earned on:
Securities, includes restricted stock 150 (532) (382)
Securities purchased under agreements to resell 529 (4) 525
Interest earning cash and other (97) (102) (199)
Interest paid on:
Savings, NOW, Money Markets 37 (179) (142)
Borrowings (1) (1) (2)
Total interest expense (42) (320) (362)
Change in net interest income $ 7,139 $ (876) $ 6,263
For the Years Ended
December 31,
Increase Total
(Decrease) due to Increase
Volume Rate (Decrease)
(Dollars in thousands)
Interest earned on:
Securities, includes restricted stock (519) (834) (1,353)
Securities purchased under agreements to resell 94 — 94
Interest earning cash and other 566 (1,134) (568)
Interest paid on:
Borrowings — — —
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Results of Operations for the Years Ended December 31, 2021 and 2020
General. Net income increased $5.3 million or 42.1%, to $17.9 million for the year ended December 31, 2021 from $12.6 million for the year ended December 31, 2020. The increase resulted from a $6.4 million increase in noninterest income and a $6.3 million increase in net interest income, partially offset by an increase in noninterest expense of $6.4 million.
Net Interest Income. Net interest income increased $6.3 million, or 16.7%, to $43.7 million for the year ended December 31, 2021 from $37.4 million for the year ended December 31, 2020, due to a $5.9 million net increase in interest income and a $362 thousand decrease in interest expense.
Our net interest margin increased 2 basis points to 4.49% for the year ended December 31, 2021 from 4.47% for the year ended December 31, 2020. The increase in net interest margin was due to a 9 basis point decrease in the cost of interest bearing deposits, offset by the decrease in interest earning asset yields of 3 basis points, primarily due to the historically low interest rate environment. Our asset and liability management model allows us to maintain our net interest margin at this level as the growth in our interest earning assets was primarily funded by a $114.3 million, or 37.9%, increase in average noninterest bearing demand deposits to $415.7 million for the year ended December 31, 2021 from $301.4 million for the year ended December 31, 2020.
Interest Income. Interest income increased $5.9 million or 15.3%, to $44.5 million for the year ended December 31, 2021 from $38.6 million for the year ended December 31, 2020 and was attributable to an increase in loan and reverse repurchase interest income offset by a decrease in interest income on securities and interest earning cash and other.
Loan interest income increased $6.0 million, or 16.7%, to $41.5 million for the year ended December 31, 2021 from $35.6 million for the year ended December 31, 2020. This increase was attributable to a $112.4 million, or 18.6%, increase in the average loan balance from our litigation-related and multifamily loan portfolios offset by a 9 basis point decrease in loan yields. The decrease in loan yields is primarily due to the impact of the historically low interest rate environment and its effect on our real estate loan portfolio pricing. The impact of the decline in loan yields on interest income was primarily offset by a 9 basis point decrease in rates on interest bearing deposits as part of the Company’s overall asset/liability management strategy.
Securities interest income decreased $382 thousand, or 14.9%, to $2.2 million for the year ended December 31, 2021 from $2.6 million for the year ended December 31, 2020. This decrease was attributable to a 41 basis point decrease in yields, driven by accelerated prepayments due to the current interest rate environment, offset by a $7.8 million, or 6.2%, increase in average securities balances at a lower rate.
Securities purchased under agreements to resell interest income increased $525 thousand to $619 thousand for the year ended December 31, 2021 from $94 thousand for the year ended December 31, 2020 as this program commenced in the fourth quarter of 2020.
Interest earning cash and other interest income decreased $199 thousand, or 50.8%, to $193 thousand for the year ended December 31, 2021 from $392 thousand for the year ended December 31, 2020. This decrease was attributable to a 12 basis point decrease in yields driven by the current interest rate environment as well as a $28.9 million, or 29.2%, decrease in average cash balance primarily due to the investment of cash into higher yielding loans.
Interest Expense. Interest expense decreased $362 thousand, or 30.4%, to $828 thousand for the year ended December 31, 2021 from $1.2 million for the year ended December 31, 2020, primarily attributable to rate reductions on deposits. Interest rates we paid on interest bearing deposits decreased 9 basis points to 0.18% for the year ended December 31, 2021 from 0.27% for the year ended December 31, 2020. Our average balance of interest bearing deposits increased $12.6 million, or 2.9%, to $450.9 million for the year ended December 31, 2021 from $438.3 million for the year ended December 31, 2020 attributable primarily to litigation related deposit growth.
Provision for Loan Losses. Our provision for loan losses was $7.0 million for the year ended December 31, 2021 compared to $6.3 million for the year ended December 31, 2020. The 2021 provision included approximately $5.1 million
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for the NFL portfolio, which was reclassified to held for sale in the third quarter. The remaining provision of approximately $1.9 million was primarily related to growth experienced in the loan portfolio.
Noninterest Income. Noninterest income information is as follows:
For the Year Ended
December 31, Change
(Dollars in thousands)
Payment processing fees
Customer related fees, service charges and other
Administrative service income 29 183 (154) (84.2)
Loss on loans held for sale (295) — (295) NA
Payment processing income increased due to the expansion of our sales channels through ISOs, merchants and additional fee allocation arrangements, with annual volumes increasing 59.4% to $23.7 billion for 2021 compared to $14.8 billion for 2020. Customer related fees and service charges have decreased due to decreases in administrative service income due to reductions in short term rates offset by an increase in off balance sheet funds. Our off balance sheet funds increased $157.3 million, or 41.4%, to $537.5 million as of December 31, 2021 as compared to $380.2 million as of December 31, 2020. These administrative service fees are impacted by the volume of off-balance sheet funds, the duration of these funds and short-term interest rates.
Noninterest Expense. Noninterest expense information is as follows:
For the Year Ended
December 31, Change
(Dollars in thousands)
Noninterest expense
Professional and consulting services 2,922 3,229 (307) (9.5)
FDIC and regulatory assessments 447 375 72 19.2
Travel and business relations 327 210 117 55.7
Employee compensation and benefits costs increased due to increases in staff and officer level employees to primarily support our growth, investment in digital platforms and related sales/marketing divisions, and the impact of salary, bonus and stock-based compensation increases. Professional and consulting services costs decreased and partially offset the increase in employee compensation and benefits as previously contracted consultants were hired, primarily in our technology development and digital marketing departments. Advertising and marketing costs increased as we purposefully enhanced our brand and sales channels through our new digital marketing efforts and thought leadership in our national verticals. We also re-engaged in our traditional high touch marketing and sales efforts to complement our digital marketing efforts. Data processing costs increased due to increased processing volume, primarily driven by our core banking platform, and additional costs related to our technology implementations. Occupancy and equipment costs increased primarily due to amortization of our investments in internally developed software to support our new digital platforms, precautionary office cleaning costs related to COVID-19 and additional office space to support our continued growth.
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Income Tax Expense. We recorded income tax expense of $4.8 million for the year ended December 31, 2021, reflecting an effective tax rate of 21.1%, compared to $4.5 million, or an effective tax rate of 26.5%, for the year ended December 31, 2020. The decrease in the effective tax rate is a result of certain discrete tax benefits totaling approximately $1.4 million related to share-based compensation recognized in 2021.
Results of Operations for the Years Ended December 31, 2020 and 2019
General. Net income decreased $1.5 million or 10.8%, to $12.6 million for the year ended December 31, 2020 from $14.1 million for the year ended December 31, 2019. The decrease resulted from a $4.4 million increase in provision for loan losses as a result of the effects of the pandemic on the economic and non-economic risk factors associated with the allowance for loan losses, a $3.7 million increase in noninterest expense, partially offset by an increase in net interest income of $3.3 million and a $2.8 million increase in noninterest income.
Net Interest Income. Net interest income increased $3.3 million, or 9.8%, to $37.4 million for the year ended December 31, 2020 from $34.1 million for the year ended December 31, 2019, due to a $2.0 million net increase in interest income and a $1.4 million decrease in interest expense.
Our net interest margin decreased 39 basis points to 4.47% for the year ended December 31, 2020 from 4.86% for the year ended December 31, 2019. The decrease in net interest margin was due to a 61 basis point decrease in the yields on interest earning assets, primarily due to the historically low interest rate environment caused by the pandemic and changing composition of our interest earning assets. This decrease was offset by a 39 basis point decrease in our cost of funds on average interest bearing liabilities.
Interest Income. Interest income increased $2.0 million or 5.4%, to $38.6 million for the year ended December 31, 2020 from $36.7 million for the year ended December 31, 2019 and was attributable to an increase in loan and reverse repurchase interest income offset by a decrease in interest income on securities and interest earning cash and other.
Loan interest income increased $3.8 million, or 11.9%, to $35.6 million for the year ended December 31, 2020 from $31.8 million for the year ended December 31, 2019. This increase was attributable to a $97.7 million, or 19.3%, increase in the average loan balance from our litigation-related, multifamily, and commercial real estate portfolios offset by a 38 basis point decrease in loan yields. The decrease in loan yields is due to the historically low interest rate environment caused by the pandemic and its effects on the overall economy. The impact of the decline in loan yields on interest income was primarily offset by a 39 basis point decrease in rates on interest bearing deposits as part of the Company’s overall asset/liability management strategy.
Securities interest income decreased $1.4 million, or 34.6%, to $2.6 million for the year ended December 31, 2020 from $3.9 million for the year ended December 31, 2019. This decrease was attributable to a $21.6 million, or 14.6%, decrease in average securities balances and a 62 basis point decrease in yields, both driven by accelerated prepayments due to the current interest rate environment.
Interest earning cash and other interest income decreased $568 thousand, or 59.2%, to $392 thousand for the year ended December 31, 2020 from $960 thousand for the year ended December 31, 2019. This decrease was attributable to a 164 basis point decrease in yields driven by the current interest rate environment offset by a $52.0 million, or 110.5%, increase in average cash balance primarily due to growth in our payment processing volumes as well as increases in our core deposits.
Interest Expense. Interest expense decreased $1.4 million, or 53.3%, to $1.2 million for the year ended December 31, 2020 from $2.5 million for the year ended December 31, 2019, primarily attributable to rate reductions on deposits. Interest rates we paid on interest bearing deposits decreased 39 basis points to 0.27% for the year ended December 31, 2020 from 0.66% for the year ended December 31, 2019. Our average balance of interest bearing deposits increased $51.9 million, or 13.4%, to $438.3 million for the year ended December 31, 2020 from $386.4 million for the year ended December 31, 2019 attributable primarily to litigation related deposit growth.
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Provision for Loan Losses. Our provision for loan losses was $6.3 million for the year ended December 31, 2020 compared to $1.9 million for the year ended December 31, 2019. The increase from the prior year was primarily related to the effects of the pandemic on economic and non-economic risk factors associated with the allowance for loan losses, loan growth and consumer loan charge-offs related to our legacy NFL portfolio and increased duration risk in our legacy NFL portfolio.
Noninterest Income. Noninterest income information is as follows:
For the Year Ended
December 31, Change
(Dollars in thousands)
Payment processing fees
Customer related fees and service charges
Administrative service income 183 491 (308) (62.7)
Payment processing income increased due to the expansion of our sales channels through ISOs, merchants and additional fee allocation arrangements, with annual volumes increasing 25.2% to $14.8 billion for 2020 compared to $11.9 billion for 2019. For the month ended December 2020 volumes increased 37.4% to $1.5 billion compared to $1.1 billion for the month ended December 2019. Customer related fees and charges have decreased due to decreases in administrative service income due to reductions in short term rates offset by an increase in off balance sheet funds. Our off balance sheet funds increased $120.9 million, or 46.6%, to $380.3 million as of December 31, 2020 as compared to $259.3 million as of December 31, 2019. These administrative service fees are impacted by the volume of off-balance sheet funds, the duration of these funds and short-term interest rates.
Noninterest Expense. Noninterest expense information is as follows:
For the Year Ended
December 31, Change
(Dollars in thousands)
Noninterest expense
Professional and consulting services 3,229 2,919 310 10.6
FDIC and regulatory assessments 375 242 133 55.0
Advertising and marketing 584 518 66 12.7
Travel and business relations 210 548 (338) (61.7)
Employee compensation and benefits costs increased due to increases in staffing to support our continued growth, investment in our digital platform and the impact of salary and stock-based compensation increases. Data processing costs increased due to increased processing volume, primarily driven by our core banking platform, as well as additional costs related to our technology implementations. Occupancy and equipment costs increased primarily due to our investment in internally developed software to support our digital platform, precautionary office cleaning costs related to COVID-19 and additional office space to support growth. Professional and consulting fees increased due to the expansion of our technology initiatives tied to our digital platform. Other operating expenses increased due to donations to charitable organizations as we focused on our corporate responsibility to support those impacted by the current crisis. Travel and
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sales related costs decreased due to a freeze on travel and a transition to webcast-based business development and digital marketing.
Income Tax Expense. We recorded income tax expense of $4.5 million for the year ended December 31, 2020, reflecting an effective tax rate of 26.5%, compared to $5.0 million, or an effective tax rate of 26.1%, for the year ended December 31, 2019.
Management of Market Risk
General. The principal objective of our asset and liability management function is to evaluate the interest rate risk within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing net income and preserving adequate levels of liquidity and capital. The board of directors of our bank has oversight of our asset and liability management function, which is managed by our Asset/Liability Management Committee. Our Asset/Liability Management Committee meets regularly to review, among other things, the sensitivity of our assets and liabilities to market interest rate changes, local and national market conditions and market interest rates. That group also reviews our liquidity, capital, deposit mix, loan mix and investment positions.
As a financial institution, our primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and the fair value of all interest earning assets and interest bearing liabilities, other than those which have a short term to maturity. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income.
We manage our exposure to interest rates primarily by structuring our balance sheet in the ordinary course of business. We do not typically enter into derivative contracts for the purpose of managing interest rate risk, but we may do so in the future. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.
Net Interest Income Simulation. We use an interest rate risk simulation model to test the interest rate sensitivity of net interest income and the balance sheet. Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest margin. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates and use various assumptions, including, but not limited to, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows.
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The following table presents the estimated changes in net interest income of Esquire Bank, National Association, calculated on a bank-only basis, which would result from changes in market interest rates over twelve-month periods beginning December 31, 2021. The tables below demonstrate that we are asset-sensitive in a rising interest rate environment.
At December 31,
Estimated
Changes in 12-Months
Interest Rates Net Interest
(Basis Points) Income Change
(Dollars in thousands)
Economic Value of Equity Simulation. We also analyze our sensitivity to changes in interest rates through an economic value of equity (“EVE”) model. EVE represents the present value of the expected cash flows from our assets less the present value of the expected cash flows arising from our liabilities adjusted for the value of off-balance sheet contracts. EVE attempts to quantify our economic value using a discounted cash flow methodology. We estimate what our EVE would be as of a specific date. We then calculate what EVE would be as of the same date throughout a series of interest rate scenarios representing immediate and permanent, parallel shifts in the yield curve. We currently calculate EVE under the assumptions that interest rates increase 100, 200, 300 and 400 basis points from current market rates, and under the assumption that interest rates decrease 100 and 200 basis points from current market rates.
The following table presents the estimated changes in EVE of Esquire Bank, National Association, calculated on a bank-only basis, that would result from changes in market interest rates as of December 31, 2021.
At December 31,
Changes in Economic
Interest Rates Value of
(Basis Points) Equity Change
(Dollars in thousands)
Many assumptions are used to calculate the impact of interest rate fluctuations. Actual results may be significantly different than our projections due to several factors, including the timing and frequency of rate changes, market conditions and the shape of the yield curve. The computations of interest rate risk shown above do not include actions that our management may undertake to manage the risks in response to anticipated changes in interest rates, and actual results may also differ due to any actions taken in response to the changing rates.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments and maturities and sales of securities. While maturities and scheduled
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