ITEM 1A. RISK FACTORS
Risks Related to the COVID-19 Pandemic
The COVID-19 pandemic is adversely affecting the Company and its customers, counterparties, employees, and third-party service providers, and the full extent of the adverse impacts on the Company's business, financial position, results of operations, and prospects are unknown and could be significant.
The spread of COVID-19 has created a global public-health crisis that has resulted in widespread volatility and deterioration in business, economic, and market conditions and household incomes, including in the Commonwealth of Massachusetts where the Company conducts nearly all of its business. The extent of the impact of the COVID-19 pandemic on the Company's capital and liquidity, and on its business, results of operations, financial position and prospects generally will depend on a number of evolving factors, including:
The duration, extent, and severity of the pandemic and any resurgences. COVID-19 has not yet been contained and could affect significantly more households and businesses. The duration and severity of the pandemic, including recent resurgences and the potential for seasonal or other resurgences after any containment, continue to be impossible to predict. In addition, while the U.S. Food and Drug Administration has approved various COVID-19 vaccines, the timing of distribution and availability and efficacy of such vaccines remain uncertain. Following any containment, there is also substantial uncertainty surrounding the pace of economic recovery and the return of business and consumer confidence.
The response of governmental and nongovernmental authorities. Many of the actions intended to contain the spread of COVID-19 have been directed toward curtailing household and business activity while simultaneously deploying fiscal and monetary-policy measures to partially mitigate the adverse effects on individual households and businesses. These actions are not always coordinated or consistent across jurisdictions and, in general, have changed rapidly in scope and intensity, contributing to substantial market volatility.
The effect on the Company's customers, counterparties, employees, and third-party service providers. COVID-19 and its associated consequences and uncertainties, including increased unemployment rates, are affecting individuals, households, and businesses differently and unevenly. Many, however, have changed their behavior in response to governmental mandates and advisories to sharply restrain commercial and social interactions and discretionary spending. As a result, in the near term, the Company's credit, operational, and other risks have generally increased and, for the foreseeable future, may remain elevated or increase further.
The effect on economies and markets. Whether the actions of governmental and nongovernmental authorities will be successful in mitigating the adverse effects of COVID-19 is unclear. National, regional, and local economies (including the local economies in the markets areas which the Company serves) and markets have suffered disruptions and these disruptions could be long lasting. Governmental actions are meaningfully influencing the interest-rate environment and financial-market activity, which could adversely affect the Company's results of operations and financial condition.
During 2020, the most notable impact arising from the pandemic to the Company's results of operations was a higher provision expense for credit losses. The Company's provision expense was $52.5 million for the year ended December 31, 2020, compared to $6.0 million in the comparable year ago period. With the continued spread of COVID-19 in the United States, the Company's forecast of macroeconomic conditions and operating results including expected lifetime credit losses on the Company's loan portfolio, is subject to meaningful uncertainty.
Governments have taken unprecedented steps to partially mitigate the adverse effects of their containment measures. For example, on March 27, 2020, the Coronavirus, Aid, Relief and Economic Security Act ("CARES Act") was enacted to inject more than $2 trillion of financial assistance into the U.S. economy, and included the $349 billion PPP loan program administered through the SBA. The FRB has taken decisive and sweeping actions as well. Since March 15, 2020, these have included a reduction in the target range for the federal funds rate to 0 to 25 basis points, a program to purchase an indeterminate amount of Treasury securities and agency mortgage-backed securities, and numerous facilities to support the flow of credit to households and businesses. On December 27, 2020, the COVID-19 Economic Relief Bill was signed into law, creating a $900 billion COVID-relief and $1.4 trillion government funding package to provide additional financial assistance in the U.S., including an opportunity for certain businesses to seek a second PPP loan if they meet specified financial requirements.
The degree to which the Company's actions and those of governments and others will directly or indirectly assist the Company's customers, counterparties, and third-party service providers and advance the Company's business and the economy generally is not yet clear. For example, while the Company's loan-deferral programs may better position customers to resume their regular payments to the Company in the future and enhance the Company's brand and customer loyalty, these programs
21
Table of Contents
may negatively impact the Company's revenue and other results of operations at least in the near term, may produce a higher degree of enrollment and other requests for extensions and rewrites than the Company anticipated, and the Company may not be as successful as expected in managing credit risk. In addition, while the FRB’s accommodative monetary policy may benefit the Company to some degree by supporting economic activity among its customers, this policy and sudden shifts in it may inhibit the Company's ability to grow or sustain net interest income and effectively manage interest-rate risk.
Additional factors related to the credit quality of certain commercial real estate loans include the duration of moratoriums on evictions for non-payment of rent or other fees. The payment on these loans that are secured by income producing properties are typically dependent on the successful operation of the related real estate property and may subject the Company to risks from adverse conditions in the real estate market or the general economy, including decreases in collateral values associated with existing loans and the ability to liquidate the real estate collateral securing commercial real estate loans, or the acceleration in macroeconomic trends such as increased remote work arrangements and online shopping.Such trends could ultimately result in a shrinkage of the commercial real estate market to the extent that there is a reduced need for office and retail space as a result of changed operating preferences, which could materially impact the Company’s results of operations and financial condition and possibly the Company’s long-term business strategy because commercial real estate loans are the Company’s largest loan category.
The Company is unable to estimate the near-term and ultimate impacts of COVID-19 on the Company's business and operations at this time. The pandemic could cause the Company to experience higher credit losses in its lending portfolio, additional increases in the allowance for credit losses, impairment of goodwill and other financial assets, diminished access to capital markets and other funding sources, further reduced demand for the Company's products and services, and other negative impacts on the Company's financial position, results of operations, and prospects. In addition, while the Company continues to anticipate that its capital and liquidity positions will be sufficient, sustained adverse effects may impair these positions, prevent the Company from satisfying its minimum regulatory capital ratios and other supervisory requirements, and result in downgrades in its credit ratings.
The COVID-19 pandemic and related governmental mandates and advisories also have necessitated changes in the way the Company and its third party service providers continue operations, and the length of time that it may be required to operate under these circumstances, as well as the potential for conditions to worsen or for significant disruptions to occur, remains unpredictable. All of these risks and uncertainties can be expected to persist at least until the pandemic is demonstrably and sustainably contained, authorities cease curbing household and business activity, and consumer and business confidence recover. COVID-19 and the volatile economic conditions stemming from it could also precipitate or contribute to the other risk factors identified in this Report, which in turn could materially adversely affect the Company's business, financial position, results of operations, prospects, and its stock price, and may also affect the Company's business in a manner that is not presently known to it or that the Company currently does not consider to present significant risks to its business, financial position, results of operations or prospects.
As a participating lender in the SBA PPP, including the second round PPP commencing subsequent to December 31, 2020, the Company is subject to additional risks of litigation from its customers or other parties regarding the processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties, which could have a significant adverse impact on the Company's business, financial position, results of operations, and prospects.
The CARES Act included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. On April 16, 2020, the SBA notified lenders that the original $349.0 billion of funding under the PPP was exhausted, and on April 24, 2020, Congress allocated an additional $310.0 billion to the program. The Company participated as a lender in both rounds of the PPP. In 2020, the Company made over 6,100 PPP loans for approximately $810 million, with $791.9 million outstanding at December 31, 2020. Additionally in December 2020, the COVID-19 Economic Relief Bill provided an additional $284.5 billion to the PPP loan program.
The Company may be exposed to the risk of litigation, from both clients and non-clients that approached us regarding PPP loans, regarding its process and procedures used in processing applications for the PPP. If any such litigation is filed against the Company and is not resolved in a manner favorable to the Company, it may result in significant financial liability or adversely affect the Company's reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation could have a material adverse impact on the Company's business, financial position, results of operations and prospects.
22
Table of Contents
The Company may have a credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Company, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP, or as a result of a civil or criminal enforcement action against borrowers who obtained loans through fraud or other misconduct. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by the Company, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company, which could adversely impact the Company's business, financial position, results of operations and prospects.
The Company has a high concentration of commercial loan balances and exposures within industries negatively impacted by the COVID-19 pandemic and continued weaknesses in these sectors could result in additional credit losses in this portfolio.
The Company’s commercial loan portfolio is subject to greater credit risk as a result of the COVID-19 pandemic, and sustained weaknesses could result in an increased rate of delinquencies in, and increased losses from, this portfolio, which, accordingly, could have a material adverse effect on the Company’s business, financial condition and results of operations. Commercial real estate markets have been particularly impacted by the economic disruption resulting from the COVID-19 pandemic, and the federal banking regulatory agencies have expressed concerns about weaknesses in the current commercial real estate market. In addition, management identified approximately $1.3 billion of loans within highly impacted industries, including Accommodations, Food Services, Retail Trade, Other Services (except Public Administration), and Arts, Entertainment & Recreation. Although management enhanced monitoring of loan portfolios in these industries, management is unable to predict or estimate the full impact of all industries affected by the pandemic, which is dependent on factors outside of the Company’s control, including the extent and duration of the resulting economic disruption that has particularly impacted the commercial industries identified above. For more information about the credit risks posed by the Company’s commercial loan portfolio and management’s pandemic response, see Table 14 in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations.”
Risks Related to Changes in Interest Rates
Changes in interest rates and other factors could adversely impact the Company’s financial condition and results of operations. The Company’s ability to make a profit, like that of most financial institutions, substantially depends upon its net interest income, which is the difference between the interest income earned on interest-earning assets, such as loans and investment securities, and the interest expense paid on interest-bearing liabilities, such as deposits and borrowings. However, certain assets and liabilities may react differently to changes in market interest rates. Further, interest rates on some types of assets and liabilities may fluctuate prior to changes in broader market interest rates, while rates on other types of assets and liabilities may lag behind. Additionally, some assets such as adjustable-rate mortgages have features, such as rate caps and floors, which restrict changes in applicable interest rates. The Federal Reserve acted to decrease targeted short-term interest rates to 0% - 0.25% in March 2020, and it is anticipated that interest rates could remain near zero through 2023. Some foreign central banks have moved to a negative interest rate environment, which has exerted downward pressure on the profitability of banks in those regions and this interest rate trend could extend to the United States. Any substantial, unexpected, or prolonged change in market interest rates could have a material adverse effect on the Company's business, financial condition and results of operations.
Factors such as inflation, recession, unemployment, money supply, global disorder, instability in domestic and foreign financial markets, political uncertainty, and other factors beyond the Company’s control, may affect interest rates. Changes in market interest rates also affect the level of voluntary prepayments on loans and the receipt of payments on mortgage-backed securities, which can impact the expected timing of receipt of proceeds. Particularly in a decreasing interest rate environment, prepayments may result in proceeds having to be reinvested at a lower rate than the loan or mortgage-backed security being prepaid.
Potential sovereign debt defaults may severely impact global and domestic economies and may lead to significantly tighter liquidity and impact the availability of credit. Economic growth may slow down and the national or global economy may experience additional downturns, including recessionary periods. Market disruption, including potential disruption resulting from the United Kingdom's decision to exit the European Union known as "Brexit," government and central bank policy actions designed to counteract the effects of recession, changes in investor expectations regarding compensation for market risk, credit risk and liquidity risk and changing economic data could impact both the volatility and magnitude of the directional movements of interest rates. Although the Company pursues an asset/liability management strategy designed to manage its risk arising from changes in interest rates, the Company's strategy may not be fully effective, or may be effective in part, and changes in market interest rates can have a material adverse effect on the Company’s profitability.
23
Table of Contents
Risks Related to the Company's Lending Activities
If the Company experiences credit losses at a level higher than anticipated in the Company's models, its earnings could materially decrease. The Company’s loan customers may not repay loans according to their terms, and the collateral securing the payment of loans may be insufficient to assure repayment or cover losses. If loan customers fail to repay loans according to the terms of the loans, the Company may experience significant credit losses that could have a material adverse effect on its operating results and capital ratios. The Company makes various assumptions and judgments about the collectability of its loan portfolio, including the creditworthiness of borrowers, the value of the real estate and other assets serving as collateral for the repayment of loans, and the enforce ability of its loan documents. In determining the amount of the allowance for credit losses, the Company, in addition to assessing the collectability of its loan portfolio, relies on experience and evaluation of economic conditions. If the assumptions underlying the determination of its allowance for credit losses prove to be incorrect, the current allowance for credit losses may not be sufficient to cover losses inherent in the Company's loan portfolio and an adjustment may be necessary to allow for different economic conditions or adverse developments in its loan portfolio. A problem with one or more loans could require the Company to significantly increase the level of its allowance for credit losses. In addition, federal and state regulators periodically review the Company’s allowance for credit losses and may require it to increase its allowance for credit losses or recognize further loan charge-offs. Material additions to the allowance would materially decrease the Company’s net income.
A significant amount of the Company’s loans are concentrated in the Bank’s geographic footprint and adverse conditions in this geographic footprint could negatively impact its results of operations. Substantially all of the loans the Company originates are secured by properties located in, or are made to businesses that operate in, Massachusetts and, to a lesser extent, Rhode Island. Because of the current concentration of the Company’s loan origination activities in its geographic footprint, in the event of adverse economic conditions impacting the region (including, but not limited to, increased unemployment, downward pressure on the value of residential or commercial real estate, or political or business developments that may affect the ability of property owners and businesses to make payments of principal and interest on the underlying loans in the Bank’s geographic footprint), the Company would likely experience higher rates of loss and delinquency on its loans than if its loan portfolio were more geographically diversified, which could have an adverse effect on the Company's results of operations or financial condition.
A significant portion of the Company’s loan portfolio is secured by real estate, and events that negatively impact the real estate market could adversely affect the Company’s asset quality and the profitability of loans secured by real property and increase the number of defaults and the level of losses within the Company’s loan portfolio. The real estate collateral securing the Company's loans provides an alternate source of repayment in the event of default by the borrower. Should real estate values deteriorate during the time the credit is extended, the Company is potentially exposed to greater losses. A downturn in the real estate market in the Company’s primary market areas could result in an increase in the number of borrowers who default on loans and a reduction in the value of the collateral securing loans, which in turn could have an adverse effect on the Company’s profitability and asset quality. Further, if the Company is required to liquidate collateral securing a loan to satisfy the related debt during a period of reduced real estate values, the Company may experience higher credit losses than expected and its earnings and shareholders’ equity could be adversely affected. Any declines in real estate prices in the Company’s primary markets may also result in increases in delinquencies and losses in its loan portfolios. Unanticipated decreases in real estate prices coupled with a prolonged economic downturn and elevated levels of unemployment could drive credit losses beyond the level provided for in the Company’s allowance for credit losses. If this occurs, the Company’s earnings could be adversely affected.
The Company's emphasis on originating commercial loans may increase lending risks. At December 31, 2020, 74.8% of the Company's loan portfolio consisted of commercial loans. The Company's commercial loan portfolio includes commercial and industrial loans, commercial real estate loans, commercial constructions, and small business banking loans. Commercial and industrial loans may expose the Company to additional risks since their underwriting is typically based on the borrower's ability to make repayments from the cash flow of its business and are secured by non-real estate collateral that may depreciate over time. Commercial real estate loans and small business loans generally expose the Company to greater risk of non-payment and loss than residential mortgage loans because repayment of the loans often depends on the successful operation of the property and the continuity of tenant rental payments. Commercial real estate loans also typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential mortgage loans. Commercial construction loans are generally considered to involve a higher degree of credit risk than long-term financing on owner-occupied residential real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property's value at completion of construction as compared to estimated costs. Changes in economic conditions that are out of the control of the borrower and lender could impact the value of the future cash flow and value of the involved property that serves as loan collateral. Additionally, some commercial borrowers may have more than one outstanding loan with the Company and, as a result, an adverse development with respect to a commercial credit relationship may expose the Company to greater risk of loss
24
Table of Contents
as compared to an adverse development associated with a consumer loan borrower. At December 31, 2020, nonperforming commercial loans comprised 68.4% of total nonperforming loans.
The Company may experience losses and expenses if security interests granted for loans are not enforceable. When the Bank makes loans, it sometimes obtains liens, such as real estate mortgages or other asset pledges, to provide the Bank with a security interest in collateral. If there is a loan default the Bank may seek to foreclose upon collateral and enforce the security interests to obtain repayment and eliminate or mitigate the Company's loss. Drafting errors, recording errors, other defects or imperfections in the security interests granted to the Bank and/or changes in law may render liens granted to the Bank unenforceable. The Company may incur losses or expenses if security interests granted to the Bank are not enforceable.
Risks Related to Legal, Regulatory and Policy Matters
The Company operates in a highly regulated environment and may be adversely impacted by changes in law, regulations, and accounting policies. The Company is subject to extensive regulation, supervision and examination. See "Regulation" in Item 1 Business. Any change in the laws or regulations, including as a result of the change in the U.S. presidential administration, or failure by the Company to comply with applicable law and regulation, or a change in regulators’ supervisory policies or examination procedures, whether by the Massachusetts Commissioner of Banks, the FDIC, the Federal Reserve, other state or federal regulators, the U.S. Congress, or the Massachusetts legislature could have a material adverse effect on the Company’s business, financial condition, results of operations, and cash flows. Changes in accounting policies, practices and standards, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board, and other accounting standard setters, could also impact the Company’s financial results.
The Company is subject to heightened regulatory requirements and expectations, increased supervision and increased costs because the Company’s total assets exceed $10 billion. Because the Company’s total assets exceed $10 billion, the Company and the Bank are subject to heightened requirements under the Dodd-Frank Act and its implementing regulations. The Company is subject to additional regulatory requirements and expectations, increased supervision and increased costs, including: supervision, examination and enforcement by the Consumer Financial Protection Bureau with respect to consumer financial protection laws; annual stress testing using assumptions for baseline, adverse and severely adverse scenarios; a modified methodology for calculating FDIC insurance assessments and potentially higher assessment rates; enhanced supervision as a larger financial institution; and a cap on the interchange fees that may be charged in certain electronic debit and prepaid card transactions under the Durbin Amendment to the Dodd-Frank Act.
With respect to deposit-taking activities, banks with more than $10 billion in assets are subject to two primary requirements. The first is a deposit assessment based on a scorecard issued by the FDIC which considers, among other things, the Bank’s CAMELS rating, results of asset-related stress testing and funding-related stress, as well as the use of core deposits, among other things. Depending on performance results under that scorecard, the total base assessment rate is between 1.5 to 40 basis points. Any increase in the Bank’s deposit insurance assessments may result in an increased expense related to the use of deposits as a funding source. The second requirement eliminates the exemption from the requirements of the Federal Reserve’s rules on interchange transaction fees for debit cards. As a result, since July 1, 2020, the Bank has been limited to receiving no more than $0.21 plus 5 basis points of the transaction plus a $0.01 fraud adjustment for an interchange transaction fee for debit card transactions. This reduction in the amount of interchange fees received has reduced the Company's revenues.
The Company’s regulators may also consider compliance with heightened regulatory requirements when examining its operations generally or considering any request for regulatory approval made by the Company or Bank, which may delay or otherwise impact needed regulatory approvals.
The Company has hired additional personnel and implemented structural initiatives to address heightened regulatory requirements and expectations and in the future may need to hire additional personnel, design and implement additional internal controls and structural initiatives, or otherwise commit significant financial resources to regulatory compliance, any of which could have a significant impact on the Company's business, financial condition or results of operations.
The impact of changes to the Internal Revenue Code or federal, state or local taxes may adversely affect the Company’s financial results or business. The Company is subject to changes in tax law, including as a result of the change in the U.S. presidential administration, which could impact the Company's effective tax rate. Tax law changes may or may not be retroactive to previous periods and could negatively affect the current and future financial performance of the Company. Changes in enacted tax rates are recognized when promulgated and therefore could have a material impact on the Company's results.
25
Table of Contents
Changes to and replacement of the LIBOR Benchmark Interest Rate may adversely affect the Company’s business, financial condition, or results of operations. On July 27, 2017, the Financial Conduct Authority (FCA), a regulator of financial services firms in the United Kingdom, announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. The FCA and the submitting LIBOR banks have indicated they will support the LIBOR indices through 2021 to allow for an orderly transition to an alternative reference rate. Subsequently, on November 30, 2020, the ICE Benchmark Administration Limited announced its plan to extend the date that most U.S. dollar LIBOR values would cease being computed and announced from December 31, 2021 to June 30, 2023. On the same date, the Federal Reserve, the FDIC and the OCC issued a Joint Statement on LIBOR transition, which instructs banks to cease entering into new contracts that use U.S. dollar LIBOR as a reference rate by no later than December 31, 2021, and if practicable, as far in advance of that deadline as possible, notwithstanding its publication until June 30, 2023 In the United States, efforts to identify a set of alternative U.S. dollar reference interest rates include proposals by the Alternative Reference Rates Committee of the Federal Reserve. Other financial services regulators and industry groups are evaluating the possible phase-out of LIBOR and the development of alternate reference rate indices or reference rates. The Company has loans, derivative contracts, borrowings and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. Although the Company has incorporated LIBOR replacement language in many of its governing documents, the transition to a new rate could impact the Company's Market Risk profile and will require changes to risk and pricing models, valuation tools, product design and hedging strategies. The Company is evaluating the potential impact of the possible replacement of the LIBOR benchmark interest rate, but is not able to predict whether the alternative rates the Federal Reserve proposes to publish will become market benchmarks in place of LIBOR, or what the impact of such a transition will have on the Company’s business, financial condition, or results of operations.
Claims and litigation could result in losses and damage to the Company’s reputation. From time to time as part of the Company’s normal course of business, customers, bankruptcy trustees, former customers, contractual counterparties, third parties and former employees make claims and take legal action against the Company based on its actions or inactions. If such claims and legal actions are not resolved in a manner favorable to the Company, they may result in financial liability and/or adversely affect the market perception of the Company and its products and services. This may also impact customer demand for the Company’s products and services. Any financial liability could have a material adverse effect on the Company’s financial condition and results of operations. Any reputation damage could have a material adverse effect on the Company’s business.
Changes in U.S. trade policies and other global political factors beyond the Company’s control, including the imposition of tariffs and retaliatory tariffs, may adversely impact the Company's business, financial condition and results of operations. There have been changes and discussions with respect to U.S. trade policies, legislation, treaties and tariffs, including trade policies and tariffs affecting other countries, including China, the European Union, Canada and Mexico and retaliatory tariffs by certain of these countries, and there may be further changes as a result of the change in the U.S. presidential administration. Tariffs, retaliatory tariffs or other trade restrictions on products and materials that customers import or export, or a trade war or other governmental action related to tariffs or international trade agreements or policies have the potential to negatively impact the Company's and/or the Bank's customers' costs, demand for the Bank's customers' products, and/or the U.S. economy or certain sectors thereof and, thus, could adversely impact the Company's business, financial condition and results of operations. In addition, to the extent changes in the global political environment have a negative impact on the Company or on the markets in which the Company operates, business, results of operations and financial condition could be materially and adversely impacted in the future.
The Companymay not be able to detect money laundering and other illegal or improper activities fully or on a timely basis, which could expose it to additional liability and could have a material adverse effect on the Company. The Company is required to comply with anti-money laundering, anti-terrorism and other laws and regulations in the United States. These laws and regulations require the Company, among other things, to adopt and enforce "know-your-customer" policies and procedures and to report suspicious and large transactions to applicable regulatory authorities. These laws and regulations have become increasingly complex and detailed, require improved systems and sophisticated monitoring and compliance personnel and have become the subject of enhanced government supervision.
The policies and procedures the Company has adopted for the purposes detecting and preventing the use of its banking network for money laundering and related activities may not completely eliminate instances in which the Company may be used by customers to engage in money laundering and other illegal or improper activities. To the extent the Company fails to fully comply with applicable laws and regulations, banking agencies have the authority to impose fines and other penalties on the Company. In addition, the Company’s business and reputation could suffer if customers use its banking network for money laundering or illegal or improper purposes.
26
Table of Contents
Risks Related to the Company's Strategic Activities
Part of the Company’s business strategy is growth through acquisitions, and the failure to execute effectively on acquisitions could have an impact on its earnings and results of operations. While focusing on organic growth, the Company's strategy also includes, in part, growth through acquisitions. The Company may not be able to identify suitable acquisition candidates, or complete acquisitions. Further, the success of any acquisition depends on the ability to effectively integrate the acquired business, including integrating operations and achieving synergies and cost efficiencies. Acquisitions can be disruptive as they result in diversion of management's attention from other business activities and can consume significant executive and employee resources as the Company integrates the target's operations and functional business into its operations and business. The Company may experience complications or delays while integrating. In addition, once integrated, acquired businesses may not achieve levels of expected profitability or profitability comparable to those achieved by the Company’s existing operations, or otherwise may not perform as expected. Further acquisitions involve numerous risks, including lower than expected performance or higher than expected costs, potential dilution of stockholder value, changes in relationships with customers, and the potential loss of key employees. In addition, the Company may not be successful in mitigating deposit erosion or loan quality deterioration at acquired institutions. Competition for acquisitions can be highly competitive, and the Company may not be able to acquire other institutions on acceptable terms. The ability to grow may be limited if the Company is unable to successfully make acquisitions in the future.
The Company's ability to make opportunistic acquisitions is contingent on regulators granting any requisite approvals. Part of the Company's business strategy includes seeking to make opportunistic whole or partial acquisitions of other banks, branches, financial institutions, or related businesses from time to time. Any possible acquisition may be subject to regulatory approval, and there can be no assurance that the Company will be able to obtain any such approval in a timely manner or at all.
Risks Related to Financial and Accounting Matters
The Company’s securities portfolio performance in difficult market conditions could have adverse effects on the Company’s results of operations. Under U.S. Generally Accepted Accounting Principles ("GAAP"), the Company measures expected credit losses on its securities portfolios in accordance with the CECL methodology, taking into consideration current market conditions, the extent and nature of changes in fair value, issuer rating changes and trends, volatility of earnings, current analysts’ evaluations, the Company’s ability and intent to hold investments until a recovery of amortized cost, as well as other factors. Adverse developments with respect to one or more of these factors could require the Company to recognize an allowance for credit losses, with the credit related portion of the reduction in the value required to be recognized as a charge to the Company’s earnings. Market volatility can make it extremely challenging to accurately value certain securities the Company holds. Subsequent periodic valuations of securities, taking into consideration then prevailing factors, may result in changes to valuations. Significant negative changes to valuations could result in the recognition of an allowance for credit losses within the Company’s securities portfolio, which could have an adverse effect on the Company’s results of operations or financial conditions.
Impairment of goodwill and/or intangible assets could require charges to earnings, which could result in a negative impact on the Company's results of operations. Goodwill arises when the Company acquires a business for an amount greater than the net fair value of the assets of the acquired business. The Bank has recognized goodwill as an asset on the balance sheet in connection with several acquisitions. Goodwill is an intangible asset. When an intangible asset is determined to have an indefinite useful life, it is not amortized, and instead is evaluated for impairment. The Company conducts goodwill impairment tests annually, or more frequently if necessary. The Company evaluates goodwill using a combined qualitative and quantitative impairment approach. A significant and sustained decline in the Company’s stock price and market capitalization, a significant decline in the Company’s expected future cash flows, a significant adverse change in the business climate, slower growth rates or other factors could result in a finding of impairment of goodwill or other intangible assets. If the Company were to conclude that a future write-down of goodwill or other intangible assets is necessary, then the Company would record the appropriate charge to earnings, which could have material adverse effect on the Company's results of operations or financial condition.
Deterioration in the performance or financial position of the Federal Home Loan Bank ("FHLB") of Boston might restrict the FHLB of Boston’s ability to meet the funding needs of its members, cause a suspension of its dividend, and cause its stock to be determined to be impaired. Significant components of the Bank’s liquidity needs are met through its access to funding pursuant to its membership in the FHLB of Boston. The FHLB of Boston is a cooperative that provides services to its member banking institutions. The primary reason for joining the FHLB of Boston is to obtain funding. The purchase of stock in the FHLB of Boston is a requirement for a member to gain access to funding. Any deterioration in the FHLB of Boston’s performance or financial condition may affect the Company’s ability to access funding and/or require the
27
Table of Contents
Company to deem the required investment in FHLB of Boston stock to be impaired. If the Company is not able to access funding, it may not be able to meet its liquidity needs, which could have an adverse effect on the results of operations or financial condition. Similarly, if the Company deems all or part of its investment in FHLB of Boston stock impaired, such action could have a material adverse effect on the Company's results of operations or financial condition.
Reductions in the value of the Company’s deferred tax assets could adversely affect the Company's results of operations. A deferred tax asset is created by the tax effect of the differences between an asset’s book value and its tax basis. The Company assesses the deferred tax assets periodically to determine the likelihood of the Company’s ability to realize the benefits. These assessments consider the performance of the associated business and its ability to generate future taxable income. If the information available to the Company at the time of assessment indicates there is a greater than 50% chance that the Company will not realize the deferred tax asset benefit, the Company is required to establish a valuation allowance for the deferred tax asset and reduce its future deferred tax assets to the amount the Company believes could be realized. Recording such a valuation allowance could have a material adverse effect on the Company's results of operations or financial condition. Additionally, the deferred tax assets are determined using effective tax rates expected to apply to the Company's taxable income in the years in which the temporary differences are expected to be recovered or settled. Accordingly, a change in statutory tax rates may result in a decrease or increase to the Company’s deferred tax assets. A decrease in the Company's deferred tax assets could have a material adverse effect on the Company's results of operations or financial condition.
Some of the Company's accounting policies require the use of estimates and assumptions that affect the value of the Company's assets and liabilities and results of operations and if actual events differ from the Company's estimates and assumptions, the Company's results of operations and financial condition could be materially adversely affected. Certain accounting policies require the use of estimates and assumptions that may affect the value of the Company’s assets and liabilities and results of operations. The Company identified the accounting policies regarding the allowance for credit losses, security valuations and allowance for credit losses, goodwill and other intangible assets, and income taxes to be critical because these policies require management to make difficult, subjective and complex judgments, estimates and assumptions about matters that are inherently uncertain. Under each of these policies, it is possible that materially different values and results of operations would be reported under different conditions, different judgments, or different estimates or assumptions. Further, as new information becomes available, the Company may make a determination to refine or change its judgments, estimates and assumptions, any of which could materially adversely affect the value of the Company's assets and liabilities or its results of operations.
From time to time, the FASB and the SEC change applicable guidance governing the form and content of the Company’s financial statements. In addition, accounting standard setters and those who interpret U.S. GAAP, such as the FASB, SEC, and banking regulators, may change or even reverse their previous interpretations or positions on how these standards should be applied. Such changes are expected to continue, and may accelerate, dependent upon the FASB and International Accounting Standards Boards commitment to achieving convergence between U.S. GAAP and International Financial Reporting Standards. Changes in U.S. GAAP and current interpretations are beyond the Company’s control, can be hard to predict and could materially impact how the Company reports its financial results and condition. In certain cases, the Company could be required to apply new or revised guidance retroactively or apply existing guidance differently (also retroactively), which may result in the Company restating prior period financial statements for material amounts. Additionally, significant changes to U.S. GAAP may require costly technology changes, additional training and personnel, and other expenses that could materially adversely affect the Company’s results of operations.
Changes in debt and equity markets or economic downturns could affect the level of assets under management and the demand for other fee-based services. Economic downturns could affect the volume of income earned from and demand for fee-based services. Revenues from the investment management business depend in large part on the level of assets under management and administration. Market volatility that results in customers liquidating investments, as well as lower asset values, can reduce the level of assets under management and administration and decrease the Company's investment management and administration revenues, which could materially adversely affect the Company's results of operations.
Risks Related to Information Security and Technology
Evolving information technologies, the need to mitigate against and react to cyber-security risks, and electronic fraud risks require significant resources, and the Company remains subject to cyber-security risks and electronic fraud. The risk of electronic fraudulent activity within the financial services industry, especially in the commercial banking sector, due to cyber-attacks (crime committed through or involving the internet, such as phishing, hacking, denial of service attacks, stealing information, unauthorized intrusions into internal systems or the systems of the Company's third party vendors) could adversely impact the Company’s operations or damage its reputation. The Company's information technology infrastructure and systems may be vulnerable to cyber-terrorism, computer viruses, system failures and other intentional or unintentional interference, fraud and other unauthorized attempts to access or interfere with the systems.
28
Table of Contents
The Company regularly collects, processes, transmits and stores confidential information regarding its customers and employees. In some cases, this confidential or proprietary information is collected, compiled, processed, transmitted or stored by third parties on the Company’s behalf.
Information security risks have increased because of the proliferation of new technologies and the increased sophistication and activities of perpetrators of cyber-attacks. Many financial institutions and service providers to financial institutions have reported significant breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, denial-of-service, or sabotage systems, often through the introduction of computer viruses or malware, cyber-attacks and other means. The Company frequently experiences attempted cyber-security attacks against its systems, and expects such attacks will continue, and may intensify, in the future.
The Company expects risk exposure to cyber-attacks will remain elevated or increase in the future due to, among other things, the increasing size and prominence of the Company in the financial services industry, its expansion of Internet and mobile banking tools and products based on customer needs, and its increasing use of operational software hosted on the Internet as more and more software solutions used in the Company’s operations migrate from solutions hosted within the Company’s firewalls to internet-hosted solutions at third party locations.
To help manage the Company’s cyber-risks, when entering a new vendor relationship, the Company reviews and assesses the cyber-security risk of third-party service providers. A successful cyber-security attack on one of the Company’s third-party service providers could disrupt operations, adversely affect the Company’s business, or result in the disclosure or misuse of the Company’s confidential information, including customer confidential information. There can be no assurance that the precautions the Company takes to seek to manage cyber risk related to third party service providers will be effective or prevent a cyber-attack that could expose the Company to significant operational costs and damages or reputational harm.
The Company’s risk-based technology and systems or the personnel who monitor such technology and systems may not identify and prevent or effectively mitigate successful cyber-attacks when they occur. Significant operational costs and damages or reputational harm may occur if the Company fails to identify and prevent or effectively mitigate, or there is a delay in identifying, a cyber-attack on its systems, or those of its third-party service providers.
The Company relies on its systems, employees and certain service providers, and if the Company experiences a system failure or if the Company's security measures are compromised or inadequate, the operations could be disrupted or the customer data could be improperly divulged. The Company faces the risk that the design of its controls and procedures, including those designed to mitigate the risk of fraud by employees or outside third parties, may be inadequate or be circumvented, thereby causing delays or failures in detection of errors or inaccuracies in data and information. The Company regularly reviews and updates the Company's internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is 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 the Company's controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company's business, results of operations and financial condition. Since the onset of the COVID-19 pandemic, certain of the Company’s employees have been working remotely, which arrangements contribute to heightened cybersecurity, information security and operational risks. The Company has not experienced any material impact to the Company’s internal control over financial reporting due to the fact that most of the Company’s employees responsible for financial reporting are working remotely during the COVID-19 pandemic, but the Company is continually monitoring and assessing the impact of the COVID-19 pandemic on the Company’s internal control over financial reporting to minimize any impact on the design and operating effectiveness. The Company may also be subject to disruptions of the systems arising or originating from third party services providers or from events that are wholly or partially beyond the Company's control (including, for example, electrical, internet or telecommunications outages), which may adversely impact the Company's ability to provide service to customers and result in loss, cost and expense or liability. Additionally, the Company's risk exposure to security matters may increase in the future if the Company increases in size and prominence in the financial services industry, as the Company expands internet based and mobile banking tools and products and services, and as a consequence of the risk inherent in system and customer account conversions associated with the integration of acquisition targets. The Company is further exposed to the risk that external service providers may be unable to fulfill their contractual obligations on matters of internet security and adequacy of services. (The Company's third party service providers are subject to many, if not all, of the same risks, including internet vulnerability and fraud operational errors by their respective employees.) The Company's due diligence on service providers and other vendor management risk migration activities designed to mitigate service provider risk may not provide full protection against all risks, and the Company's (or service providers) business continuity plans, risk management processes and procedures or security systems (including security against cyber-crime) could be inadequate. While the Company maintains a control framework designed to monitor service provider risks, the failure of a service provider to perform in accordance with the contracted arrangements and, if applicable, under
29
Table of Contents
service level agreements could be disruptive to the Company's operations, which could have a material adverse impact on the Company's financial condition or results of operations.
Risks Related to Liquidity
The Company may be unable to adequately manage its liquidity risk, which could affect its ability to meet its obligations as they become due, capitalize on growth opportunities, or pay dividends on its common stock. Liquidity risk refers to managing the Company's liquidity so that it can meet its obligations as the obligations become due, opportunistically capitalize on potential growth opportunities as they arise, or pay dividends on its common stock. The Company's liquidity arises from its ability to liquidate assets or obtain adequate funding in a timely basis, at a reasonable cost and within acceptable risk tolerances. Liquidity is required to fund various obligations, including credit commitments to borrowers, mortgage and other loan originations, withdrawals by depositors, repayment of borrowings, dividends to shareholders, operating expenses and capital expenditures. The Company's liquidity is derived primarily from funding obtained from the FHLB of Boston; retail deposit growth and retention; principal and interest payments on loans; principal and interest payments on investment securities the Company issues; sale, maturity and prepayment of investment securities the Company holds; net cash provided from operations; and access to other funding sources. Any substantial, unexpected or prolonged changes in the level or cost of liquidity could have a material adverse effect on the Company's business. Factors that could detrimentally impact the Company’s access to liquidity sources include a decrease in the level of business activity as a result of a downturn in the markets in which the Company's loans are concentrated or an adverse regulatory action against the Company.The Company’s ability to borrow could also be impaired by factors that are not specific to the Company, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry generally.
Risks Related to Environmental and Social Matters
The Company is subject to environmental liability risk associated with lending activities which could have a material adverse effect on its financial condition and results of operations. A significant portion of the Company’s loan portfolio is secured by real property. During the ordinary course of business, the Company may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Company may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Company to incur substantial expenses and may materially reduce the affected property’s value or limit the Company’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase the Company’s exposure to environmental liability. Environmental reviews conducted prior to originating certain commercial real estate loans, as well as before initiating any foreclosure action on real property, as required by Company policies and procedures, may not detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on the Company’s financial condition or results of operations.
Societal responses to climate change could adversely affect the Company's business and performance, including indirectly through impacts on its customers. Concerns over the long-term impacts of climate change have led and will continue to lead to governmental efforts around the world to mitigate those impacts. Consumers and businesses also may change their behavior on their own as a result of these concerns. The Company and its customers will need to respond to new laws and regulations as well as consumer and business preferences resulting from climate change concerns. The Company and its customers may face cost increases, asset value reductions, operating process changes, and the like. Among the impacts to the Company could be a drop in demand for its products and services, particularly in certain sectors. In addition, the Company could face reductions in creditworthiness on the part of some customers or in the value of assets securing loans.
Risks Related to the Company's Business and Industry Generally
The Company’s business depends on maintaining the trust and confidence of customers and other market participants, and the Company's reputation is critical to its business. The Company’s ability to originate and maintain accounts and business is highly dependent upon the perceptions of borrowers and deposit holders and other external perceptions of the Company’s business practices and financial health. The Company’s reputation is vulnerable to threats that can be difficult or impossible to control, and costly or impossible to remediate. Regulatory inquiries, actual or alleged incidents of employee misconduct and rumors, among other things, can substantially damage the Company’s reputation, even if the inquiries, allegations, or rumors are baseless or satisfactorily addressed. Adverse perceptions regarding the Company’s reputation in the consumer, commercial and funding markets could result in difficulties in generating and maintaining accounts
30
Table of Contents
and business, as well as in financing accounts and the Company's business. Further, adverse perceptions can result in decreases in the levels of deposits that customers and potential customers choose to maintain with the Company, any of which could have a material adverse effect on the Company’s results of operations or financial condition.
If the Company’s risk management framework does not effectively identify or mitigate the Company’s risks, the Company could suffer unexpected losses and the results of operations and financial condition could be materially adversely affected. The Company’s risk management framework seeks to mitigate risk and appropriately balance risk and return. The Company has established processes and procedures intended to identify, measure, monitor and report the types of risk to which it is subject, including credit risk, operations risk, compliance risk, reputation risk, strategic risk, market risk and liquidity risk. The Company seeks to monitor and control its risk exposure through a framework of policies, procedures and reporting requirements. Management of the Company’s risks in some cases depends upon the use of analytical and/or forecasting models, which, in turn, rely on assumptions and estimates. If the models used to mitigate these risks are inadequate, or the assumption or estimates are inaccurate or otherwise flawed, the Company may fail to adequately protect against risks and may incur losses. In addition, there may be risks that exist, or that develop in the future, that the Company has not appropriately anticipated, identified or mitigated, which could lead to unexpected losses and the Company's results of operations or financial condition could be materially adversely affected.
The Company has strong competition within its market area which may constrain the Company’s ability to grow and achieve profitability. The Company faces significant competition both in attracting deposits and in the origination of loans. See "Market Area and Competition" in Item 1. Business of this Report. Mergers and acquisitions of financial institutions within the Company’s market area may occur, which could add more competitive pressure as the Company would be competing with the resultant larger financial institutions with greater financial resources on a combined basis. Additionally, the Company's market share and income may be adversely affected by its inability to successfully compete against larger and more diverse financial service providers. If the Company is unable to compete effectively, it may lose market share or fail to maintain its market share, and income generated from loans, deposits, and other financial products may decline.
The Company continually encounters technological change. The failure to understand and adapt to these changes could negatively impact the Company's business.Financial services industries continually experience rapid technological change with frequent introductions of new technology-driven products and services. An effective use of technology can increase efficiency, enable financial institutions to better serve customers, and reduce costs. However, some new technologies needed to compete effectively result in incremental operating costs and capital investments. The Company's future success depends in part upon its ability to continue to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in operations. Many of the Company's competitors, because of their larger size and available capital, have substantially greater resources to invest in technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers within the same time frame as its large competitors. Failure to successfully keep pace with technological change affecting the financial services industry could lead to loss of customers and could have a material adverse impact on the Company's business and, in turn, its financial condition and results of operations.
The success of the Company is dependent on the Company's ability to attract, hire and retain certain key personnel. The Company’s business is complex and specialized and performance is largely dependent on the knowledge, talents and efforts of highly skilled individuals. The Company relies on key personnel to manage and operate its business, including major revenue producing functions, such as loan and deposit generation. The loss of key personnel could adversely affect the Company’s ability to maintain and manage these functions effectively, which could negatively affect the Company’s net income. In addition, loss of key personnel could result in increased recruiting and hiring expenses, which could adversely impact the Company’s net income. The Company’s continued ability to compete effectively depends on its ability to attract new employees and to retain and motivate its existing key employees.
Adverse weather, changes in climate, natural disasters, public health crises or man-made events could negatively affect the Company's local economies or disrupt operations, which would have an adverse effect on the Company's business or results of operations. The Company's market area includes coastal regions that are susceptible natural disasters including, but not to limited to, hurricanes, blizzards and northeasters and related flooding and wind damage. The nature and level of such natural disasters, public health crises, such as pandemics or epidemics, or man-made events, including political events such as war, civil unrest or terrorist attacks, cannot be predicted and may be exacerbated by global climate change. Such events can disrupt operations, result in damage to properties and negatively affect the local economies in the markets where the Company operates. The Company's borrowers may suffer property damage, experience interruption of their businesses or lose their jobs, which may negatively impact the ability of these borrowers to make deposits with the Company or repay their loans or negatively impact values of collateral securing loans, any of which could result in losses and increased provisions for credit
31
Table of Contents
losses. Additionally, the occurrence of natural disasters could harm the Company's operations thorough interference with communications, including the interruption or loss of its computer systems which could prevent the gathering of deposits, originating loans and processing and controlling business flow, as well as through the destruction of facilities and operational, financial and management information systems.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2. PROPERTIES
At December 31, 2020, the Bank conducted its business from its main office located at 288 Union Street, Rockland, Massachusetts, ninety-five retail branches, and two limited service branches located within Barnstable, Bristol, Dukes, Middlesex, Nantucket, Norfolk, Plymouth, Suffolk and Worcester counties in Eastern Massachusetts. In addition to its main office, the Bank leased sixty-two of its branches (including two limited service branches) and owned the remaining thirty-five branches. In addition to these branch locations, the Bank had twenty-three remote ATM locations, all of which are leased.
The Bank’s executive administration offices are located in Hanover, Massachusetts while the remaining administrative and operations locations are housed in several different campuses. Additionally, there are a number of sales offices not associated with a branch location throughout the Bank’s footprint.
For additional information regarding the Bank’s premises and equipment and lease obligations, see Notes 6, "Bank Premises and Equipment" and 19"Leases,"respectively, within the Notes to Consolidated Financial Statements included in Item 8 of this Report.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 2020, Rockland Trust was involved in pending lawsuits that arose in the ordinary course of business. Management has reviewed these pending lawsuits with legal counsel and has taken into consideration the view of counsel as to their outcome. In the opinion of management, the final disposition of such pending lawsuits is not expected to have a material adverse effect on the Company’s financial position or results of operations.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable
PART II
ITEM 5. MARKET FOR INDEPENDENT BANK CORP.'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
(a.) Independent Bank Corp.’s common stock trades on the NASDAQ Global Select Market under the symbol INDB. The Company declared aggregate cash dividends of $1.84 and $1.76 per share in 2020 and in 2019, respectively. The ratio of dividends paid to earnings in 2020 and 2019 was 50.21% and 32.25%, respectively.
Payment of dividends by the Company on its common stock is subject to various regulatory restrictions and guidelines. Since substantially all of the funds available for the payment of dividends are derived from the Bank, future dividends will depend on the earnings of the Bank, its financial condition, its need for funds, applicable governmental policies and regulations, and other such matters as the Board of Directors deems appropriate. Management believes that the Bank will continue to generate adequate earnings to continue to pay comparable common dividends on a quarterly basis.
32
Table of Contents
The following schedule summarizes the closing price range of common stock and the cash dividends paid for the fiscal years 2020 and 2019:
High Low Dividend
High Low Dividend
As of February 24, 2021, there were 33,018,461 shares of common stock outstanding which were held by approximately 2,935 holders of record. The number of record-holders may not reflect the number of persons or entities holding stock in nominee name through banks, brokerage firms, and other nominees. The closing price of the Company’s common stock on December 31, 2020 was $73.04.
The information required by S-K Item 201(d) is incorporated by reference from Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters of this Report.
Comparative Stock Performance Graph
The stock performance graph below and associated table compare the cumulative total shareholder return of the Company’s common stock from December 31, 2015 to December 31, 2020 to the cumulative total return of the NASDAQ Composite Index (U.S. Companies) and the SNL Bank NASDAQ Index. The lines in the graph and the numbers in the table below represent yearly index levels derived from compounded daily returns that include reinvestment or retention of all dividends. If the yearly interval, based on the last day of a fiscal year, was not a trading day, the preceding trading day was used. The index value for all of the series was set to 100.00 on December 31, 2015 (which assumes that $100.00 was invested in each of the series on December 31, 2015).
The following information in this Item 5 of this Report is not deemed to be "soliciting material" or to be "filed" with the SEC or subject to Regulation 14A or 14C under the Exchange Act or to the liabilities of Section 18 of the Exchange Act and will not be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent the Company specifically incorporates it by reference into such a filing. The stock price performance shown on the stock performance graph and associated table below is not necessarily indicative of future price performance. Information used in the graph and table was obtained from a third party provider, a source believed to be reliable, but the Company is not responsible for any errors or omissions in such information.
33
Table of Contents
The following chart depicts the total return performance of the Company:
Source: S&P Global Market Intelligence
© 2021
(b.) Not applicable
34
Table of Contents
(c.) The following table sets forth information regarding the Company’s repurchases of its common stock during the three months ended December 31, 2020:
Issuer Purchases of Equity Securities
October 1 to October 31, 2020 — $ — — —
December 1 to December 31, 2020 — — — —
(1)Shares purchased relate to the surrendering of mature shares for the exercise and/or vesting of stock compensation grants and related tax withholding.
(2)On October 17, 2019 the Company announced that its Board of Directors authorized a share repurchase program up to 1.5 million shares of the Company's common stock. All 1.5 million shares were repurchased under the program between January and April of 2020. Accordingly, the October 2019 share repurchase program is no longer in effect.
35
Table of Contents
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial and other data of the Company set forth below does not purport to be complete and should be read in conjunction with, and is qualified in its entirety by, the more detailed information, including the Consolidated Financial Statements and related notes, appearing elsewhere herein.
As of or for the Years Ended December 31
(Dollars in thousands, except per share data)
Financial condition data
Operating data
Per share data
Performance ratios
Asset quality ratios
Capital ratios
(1) Represents a non-GAAP measurement. For reconciliation to GAAP measurement, see Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Level Overview - Non-GAAP Measures".
36
Table of Contents
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company is a state chartered, federally registered bank holding company, incorporated in 1985. The Company is the sole stockholder of Rockland Trust, a Massachusetts trust company chartered in 1907. For a full list of corporate entities see Item 1 "Business — General."
All material intercompany balances and transactions have been eliminated in consolidation. When necessary, certain amounts in prior year financial statements have been reclassified to conform to the current year’s presentation. The following should be read in conjunction with the Consolidated Financial Statements and related notes.
Executive Level Overview
Management evaluates the Company's operating results and financial condition using measures that include net income, earnings per share, return on assets and equity, return on tangible common equity, net interest margin, tangible book value per share, asset quality indicators, and many others. These metrics are used by management to make key decisions regarding the Company's balance sheet, liquidity, interest rate sensitivity, and capital resources and assist with identifying opportunities for improving the Company's financial position or operating results.
Results for the year ended December 31, 2020 were significantly impacted by the ongoing COVID-19 pandemic, resulting in $52.5 million of loan provisioning during the year. The full macroeconomic impacts of the pandemic remain unclear and are continuing to evolve; however, the stay-at-home orders, business closures, social distancing measures, limitations on travel and restrictions on gatherings that have been put in place for public health and safety have led to a decline in consumer spending and historically high levels of unemployment as workplaces have been forced to shut down or severely limit operations. The duration of these restrictions has varied, and restrictions have been and may continue to be tightened or re-instituted in light of resurgences of COVID-19 in particular areas. In addition, the effectiveness of recently approved vaccines, as well as their availability and the timing of their distribution to the public remain largely unknown at this time. As a result, the Company is not able to provide any assurances that the Company’s earnings, asset quality, regulatory capital ratios and economic condition will not be materially adversely impacted on a short term or long term basis.
The Company has been and remains committed to supporting and working with its customers as they navigate these unprecedented times. The Company has abided by government mandates requiring temporary moratorium on foreclosures, and has offered a variety of relief measures to its customers consistent with prudent banking principles and regulatory guidance. These relief measures have included temporary deferrals of loan payments, waiving certain fees and permitting customers easier access to their deposits. The Company’s charitable foundations have engaged and will continue to engage in outreach to local communities during this difficult time and have committed funds to be made available to key nonprofits with urgent needs, such as local food banks. The Company has been an active participant in the government-sponsored Paycheck Protection Program ("PPP") designed to help deploy stimulus funds in the form of loans to businesses within the community, funding approximately 6,100 loans during the year, with a total balance of $791.9 million outstanding as of December 31, 2020. The Company received fee revenue of $27.1 million for the origination of these PPP loans, which is deferred and amortized over the life of the loan. As of December 31, 2020, $9.1 million in fee revenue has been amortized into income, with the remaining amount to be amortized over the remaining loan maturity. Subsequent to year end, the Company has been participating in the second round of PPP funding, continuing to offer its customers access to much needed relief funds.
37
Table of Contents
Interest-Earning Assets
Management’s asset strategy typically emphasizes loan growth, primarily in the commercial and home equity portfolios. The results depicted in the following table reflect the trend of the Company's interest-earning assets over the past five years. For 2020, the increase in interest-earning assets was driven primarily by an increase in commercial loan balances, reflecting the Company's PPP loan funding activity, as well as growth in cash balances attributable to elevated deposits from PPP loans and other government stimulus payments, partially offset by decreases in the residential and home equity loan portfolios.
Management strives to be disciplined about loan pricing and considers interest rate sensitivity when generating loan assets. In addition, management takes a disciplined approach to credit underwriting, seeking to avoid undue credit risk and credit losses.
38
Table of Contents
Funding and the Net Interest Margin
The Company's overall sources of funding reflect strong business and retail deposit growth with a management emphasis on core deposit growth to fund loans. During 2020, the Company realized growth in deposits, which increased $1.8 billion or 20.2% from December 31, 2019 to $11.0 billion, which was attributable to a combination of funds received for PPP loans and from other government stimulus programs and an overall customer focus on retaining liquidity. The following chart shows the sources of funding and the percentage of core deposits to total deposits for the trailing five years:
The cost of deposits at December 31, 2020 was 0.27%, a 20 basis point decrease compared to December 31, 2019 due primarily to deposit rate reductions across all products. The Company's net interest margin was 3.29% for the year ended December 31, 2020, representing a 75 basis point decrease from the comparative 2019 period, primarily reflective of the lower interest-rate environment, along with other factors, such as increases in low yielding cash balances and PPP loans.
The following table shows the net interest margin and cost of deposits trends for the trailing five year period:
39
Table of Contents
Noninterest Income
Management continues to focus on noninterest income, which is primarily comprised of deposit account fees, interchange and ATM fees, investment management fees and mortgage banking income. The following chart shows the components of noninterest income over the past five years:
Expense Control
Management seeks to take a balanced approach to noninterest expense control by monitoring ongoing operating expenses while making needed capital expenditures and prudently investing in growth initiatives. The Company’s primary expenses arise from Rockland Trust’s employee salaries and benefits, as well as expenses associated with buildings and equipment. During 2020, the Company incurred additional expenses due to the COVID-19 pandemic relating to cleaning costs, the purchase of office supplies and protective equipment, such as face masks, plexiglass dividers and other protective measures, as well as increased equipment expense related to setting up employees with remote capabilities. Additionally, the 2020 results included a $4.2 million lease impairment charge in connection with the decision to exit two branch locations.
40
Table of Contents
The following chart depicts the Company's efficiency ratio on a GAAP basis (calculated by dividing noninterest expense by the sum of noninterest income and net interest income), as well as the Company's efficiency ratio on a non-GAAP operating basis, (calculated by dividing noninterest expense, excluding certain noncore items, by the sum of noninterest income, excluding certain noncore items, and net interest income) over the past five years:
*See "Non-GAAP Measures" below for a reconciliation to GAAP financial measures.
Capital
The Company's approach with respect to revenue and expense is designed to promote long-term earnings growth, which in turn contributes to capital growth. During the first half of 2020, the Company completed its previously announced stock repurchase program, repurchasing all 1.5 million shares available under the program at a total cost of $95.1 million and an average cost per share of $63.39. The following chart shows the Company's book value and tangible book value per share over the past five years:
*See "Non-GAAP Measures" below for a reconciliation to GAAP financial measures.
41
Table of Contents
Cash dividends declared by the Company increased from an aggregate of $1.76 per share in 2019 to $1.84 per share in 2020, representing an increase of 4.5%.
2020 Results
Net income for 2020 computed in accordance with GAAP was $121.2 million, or $3.64 on a diluted earnings per share basis, as compared to $165.2 million, or $5.03 per diluted share, for the prior year. Net income for 2020 and 2019 included items that are considered noncore, which are excluded for purposes of assessing operating earnings. Net operating earnings for 2020 were $121.7 million, or $3.66 on a diluted earnings per share basis, a decrease of 34.1% and 34.9%, respectively, when compared to net operating earnings of $184.6 million, or $5.62 per diluted share, for the year ended December 31, 2019. See "Non-GAAP Measures" below for a reconciliation of net operating earnings and diluted earnings per share to GAAP net income and earnings per share, respectively.
2021 Outlook
During the Company's fourth quarter 2020 earnings call, the Company provided the following key expectations regarding business activity to serve as near term guidance into the year 2021:
•excluding PPP activity, the Company anticipates modest net growth in total commercial loan balances;
•while loan closing activity is expected to remain strong heading into 2021, the anticipated persistence of pay-down activity will continue to challenge any meaningful growth in the consumer loan portfolios;
•excess liquidity and the timing on PPP fee income recognition will continue to create some level of volatility in net interest margin. Excluding these factors, the core margin will continue to be impacted by expected asset yield compression as assets continue to reprice into an anticipated low interest rate environment. However, the Company believes there is still some level of further reductions in the deposit base at December 31, 2020 that should continue to mitigate the asset yield compression in the near term, resulting in a modest net core margin compression;
•assuming no material changes to the overall macroeconomic forecast, the Company anticipates that the build of the allowance for credit losses in 2020 should cause the provision for credit losses to more closely correlate to charge-off activity, with some element of loss reserve reductions if the economic environment stabilizes;
•the Company expects mortgage demand to remain strong with gain on sale margins expected to normalize down from 2020 levels, while swap fee income is expected to return to historical levels;
•a continued stabilization of the economy should reflect positive increases to deposit fees that were negatively impacted for much of 2020, and continued growth in investment management results are expected; and,
•the Company's effective tax rate is expected to be approximately 24% in 2021 assuming no change in tax laws.
Non-GAAP Measures
When management assesses the Company’s financial performance for purposes of making day-to-day and strategic decisions, it does so based upon the performance of its core banking business, which is primarily derived from the combination of net interest income and noninterest or fee income, reduced by operating expenses, the provision for credit losses, and the impact of income taxes and other noncore items shown in the table that follows. There are items that impact the Company's results that management believes are unrelated to its core banking business such as gains or losses on the sales of securities, merger and acquisition expenses, loss on extinguishment of debt, impairment, and other items, such as one-time adjustments as a result of changes in laws and regulations. Management, therefore, excludes items management considers to be noncore when computing the Company’s non-GAAP operating earnings and operating EPS, noninterest income on an operating basis and efficiency ratio on an operating basis. Management believes excluding these items facilitates greater visibility into the Company’s core banking business and underlying trends that may, to some extent, be obscured by inclusion of such items.
Management also supplements its evaluation of financial performance with an analysis of tangible book value per share (which is computed by dividing stockholders' equity less goodwill and identifiable intangible assets, or tangible common equity, by common shares outstanding) and with the Company's tangible common equity ratio (which is computed by dividing tangible common equity by tangible assets) which are non-GAAP measures. The Company has included information on these
42
Table of Contents
tangible ratios because management believes that investors may find it useful to have access to the same analytical tools used by management to assess performance and identify trends. The Company has recognized goodwill and other intangible assets in conjunction with merger and acquisition activities. Excluding the impact of goodwill and other intangibles in measuring asset and capital values for the ratios provided, along with other bank standard capital ratios, facilitates comparison of the capital adequacy of the Company to other companies in the financial services industry.
These non-GAAP measures should not be viewed as a substitute for financial results determined in accordance with GAAP. An item which management deems to be noncore and excludes when computing these non-GAAP measures can be of substantial importance to the Company’s results for any particular period. The Company’s non-GAAP performance measures are not necessarily comparable to similarly named non-GAAP performance measures which may be presented by other companies.
The following table summarizes the impact of noncore items on net income and reconciles non-GAAP net operating earnings to net income available to common shareholders:
Net Income Diluted Earnings Per Share
(Dollars in thousands, except per share data)
Non-GAAP adjustments
Noninterest income components
Less: gain on sale of loans — 951 — 0.03
Noninterest expense components
Add: loss on termination of derivatives 684 — 0.03 —
Add: merger and acquisition expenses — 26,433 — 0.80
Net tax benefit associated with noncore items (1) (192) (6,686) (0.01) (0.20)
(1)The net tax benefit associated with noncore items is determined by assessing whether each noncore item is included or excluded from net taxable income and applying the Company's combined marginal tax rate only to those items included in net taxable income.
43
Table of Contents
The following table summarizes the impact of noncore items with respect to the Company's total revenue, noninterest income as a percentage of total revenue, and the efficiency ratio for the periods indicated:
Years Ended December 31
(Dollars in thousands)
Less:
Gain on sale of loans — 951 — — —
Less:
Loss on extinguishment of debt — — — — 437
Loss on termination of derivatives 684 — — — —
Ratios
44
Table of Contents
The following table summarizes the calculation of the Company's tangible common equity ratio and tangible book value per share for the periods indicated:
Years Ended December 31
(Dollars in thousands, except per share data)
Tangible common equity
Tangible assets
45
Table of Contents
Financial Position
Securities Portfolio The Company’s securities portfolio consists of trading securities, equity securities, securities available for sale and securities which management intends to hold until maturity. Securities decreased by $28.4 million, or 2.4%, at December 31, 2020 as compared to December 31, 2019. The ratio of securities to total assets at December 31, 2020 was 8.80%, compared to 10.45% at December 31, 2019. The Company estimates expected credit losses for its available for sale and held to maturity securities in accordance with the current expected credit loss ("CECL") methodology. Further details regarding the Company's measurement of expected credit losses can be found in Note 1, "Summary of Significant Accounting Policies" within the Notes to Consolidated Financial Statements included in Item 8 of this Report.
The following table sets forth the fair value of available for sale securities and the amortized cost of held to maturity securities along with the percentage distribution:
Table 1 - Securities Portfolio Composition
December 31
Amount Percent Amount Percent Amount Percent
(Dollars in thousands)
Fair value of securities available for sale
Amortized cost of securities held to maturity
U.S. government agency securities — — % 12,874 1.7 % — — %
The Company’s available for sale securities are carried at fair value and are categorized within the fair value hierarchy based on the observability of model inputs. Securities which require inputs that are both significant to the fair value measurement and unobservable are classified as level 3 within the fair value hierarchy. At December 31, 2020, and 2019, the Company had $1.1 million of securities categorized as level 3 within the fair value hierarchy. At December 31, 2018, the Company had $1.3 million of securities categorized as level 3 within the fair value hierarchy.
46
Table of Contents
The following tables set forth contractual maturities of the Bank’s securities portfolio at December 31, 2020. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Weighted average yields in the table below have been calculated based on the amortized cost of the security.
Table 2 - Securities Portfolio, Amounts Maturing
(Dollars in thousands)
Fair value of securities available for sale
Agency collateralized mortgage obligations — — — — — — 91,683 2.0 % 91,683 2.0 %
State, county and municipal securities 601 3.2 % — — 206 3.0 % — — 807 3.1 %
Amortized cost of securities held to maturity
As of December 31, 2020, the weighted average life of the securities portfolio was 3.00 years and the modified duration was 2.90 years.
At December 31, 2020, the aggregate book value of securities issued by Fannie Mae and Freddie Mac exceeded 10% of stockholders' equity. The aggregate book value and market value of securities issued by Fannie Mae at December 31, 2020 was $674.9 million and $700.3 million, respectively. The aggregate book value and market value of securities issued by Freddie Mac at December 31, 2020 was $276.6 million and $286.8 million, respectively.
Residential Mortgage Loan Sales The Company’s primary loan sale activity arises from the sale of government sponsored enterprise eligible residential mortgage loans. The Company originates residential loans with the intention of selling them in the secondary market or to hold in the Company's residential portfolio. When a loan is sold, the Company enters into agreements that contain representations and warranties about the characteristics of the loans sold and their origination. The Company may be required to either repurchase mortgage loans or to indemnify the purchaser from losses if representations and warranties are breached. The Company incurred no material losses related to mortgage repurchases during the years ended December 31, 2020, 2019, and 2018.
47
Table of Contents
The following table shows the total residential loans that were closed and whether the amounts were held in the portfolio or sold/held for sale in the secondary market for the periods indicated:
Table 3 - Closed Residential Real Estate Loans
Years Ended December 31
(Dollars in thousands)
The table below reflects additional information related to loans which were sold during the periods indicated:
Table 4 - Residential Mortgage Loan Sales
Years Ended December 31
(Dollars in thousands)
(1)The Company had recourse on all loans sold with servicing rights retained.
When a loan is sold, the Company may decide to also sell the servicing of sold loans for a servicing release premium, simultaneously with the sale of the loan, or the Company may opt to sell the loan and retain the servicing. In the event of a sale with servicing rights retained, a mortgage servicing asset is established, which represents the then current estimated fair value based on market prices for comparable mortgage servicing contracts, when available, or alternatively is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Servicing rights are recorded in other assets in the consolidated balance sheets, are amortized in proportion to and over the period of estimated net servicing income, and are assessed for impairment based on fair value at each reporting date. Impairment is determined by stratifying the rights based on predominant characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance, to the extent that fair value is less than the capitalized amount. If the Company later determines that all or a portion of the impairment no longer exists, a reduction of the allowance may be recorded as an increase to income. The principal balance of loans serviced by the Bank on behalf of investors was $453.7 million at December 31, 2020 and $656.4 million at December 31, 2019.
48
Table of Contents
The following table shows the adjusted cost of the servicing rights associated with these loans and the changes for the periods indicated:
Table 5 - Mortgage Servicing Asset
(Dollars in thousands)
Acquired portfolio — 3,198
Change in valuation allowance (1,934) (59)
See Note 12, "Derivatives and Hedging Activities," within the Notes to Consolidated Financial Statements included in Item 8 of this Report for more information on mortgage activity and mortgage related derivatives.
Loan Portfolio The Company’s loan portfolio increased by $519.2 million during 2020. The overall increase is primarily attributable to the Company's participation in the PPP. There were approximately 6,100 PPP loans funded during the year with a total outstanding balance of $791.9 million at December 31, 2020. When excluding PPP activity, loans declined by $272.7 million, or 3.07%, compared to December 31, 2019. During 2020, growth across most commercial loan categories was outpaced by runoff in the consumer loan portfolios. Growth across commercial loan categories generally reflects strong closing activity diversified across a number of industries and property types. Within the consumer portfolios, the low interest rate environment has driven record mortgage banking volumes and results, while portfolio balances further declined as the majority of residential mortgage production continues to be sold into the secondary market. Similarly, on the home equity side, despite strong closing activity, loan growth continues to be challenged by attrition.
49
Table of Contents
The following table sets forth information concerning the composition of the Bank’s loan portfolio by loan type at the dates indicated:
Table 6 - Loan Portfolio Composition
December 31
(Dollars in thousands)
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
The following table sets forth the scheduled contractual amortization of the Bank’s loan portfolio at December 31, 2020. Loans having no schedule of repayments or no stated maturity are reported as being due in greater than five years. The following table also sets forth the rate structure of loans scheduled to mature after one year:
Table 7 - Scheduled Contractual Loan Amortization
(Dollars in thousands)
Amounts due in:
Interest rate terms on amounts due after one year:
(1)Includes certain construction loans that will convert to commercial mortgages and will be reclassified to commercial real estate upon the completion of the construction phase.
At December 31, 2020, $18.8 million of loans scheduled to mature within one year were nonperforming.
Generally, the actual maturity of loans is substantially shorter than their contractual maturity due to prepayments and, in the case of real estate loans, due-on-sale clauses, which generally give the Bank the right to declare a loan immediately due and payable in the event that, among other things, the borrower sells the property subject to the mortgage and the loan is not repaid. The average life of real estate loans tends to increase when current real estate loan rates are higher than rates on mortgages in the portfolio and, conversely, tends to decrease when rates on mortgages in the portfolio are higher than current real estate loan rates. Due to the fact that the Bank may, consistent with industry practice, renew a significant portion of commercial and commercial real estate loans at or immediately prior to their maturity by renewing the loans on substantially similar or revised terms, the principal repayments actually received by the Bank are anticipated to be significantly less than the amounts
50
Table of Contents
contractually due in any particular period. In other circumstances, a loan, or a portion of a loan, may not be repaid due to the borrower’s inability to satisfy the contractual obligations of the loan.
Asset Quality The Company continually monitors the asset quality of the loan portfolio using all available information. Based on this assessment, loans demonstrating certain payment issues or other weaknesses may be categorized as delinquent, nonperforming and/or put on nonaccrual status. In the course of resolving such loans, the Company may choose to restructure the contractual terms of certain loans to match the borrower’s ability to repay the loan based on their current financial condition. If a restructured loan meets certain criteria, it may be categorized as a troubled debt restructuring ("TDR"). In addition, the Company has been offering needs based payment relief options for commercial and small business loans, residential mortgages, and home equity loans and lines of credit in response to the COVID-19 pandemic. In accordance with the CARES Act, these modifications will not be accounted for as TDRs or be reflected as delinquent or non-accrual loans if the borrower was in compliance with the loan terms as of December 31, 2019.
DelinquencyThe Company’s philosophy toward managing its loan portfolios is predicated upon careful monitoring, which stresses early detection and response to delinquent and default situations. The Company seeks to make arrangements to resolve any delinquent or default situation over the shortest possible time frame. Generally, the Company requires that a delinquency notice be mailed to a borrower upon expiration of a grace period (typically no longer than 15 days beyond the due date). Reminder notices may be sent and telephone calls may be made prior to the expiration of the grace period. If the delinquent status is not resolved within a reasonable time frame following the mailing of a delinquency notice, the Bank’s personnel charged with managing its loan portfolios contacts the borrower to ascertain the reasons for delinquency and the prospects for payment. Any subsequent actions taken to resolve the delinquency will depend upon the nature of the loan and the length of time that the loan has been delinquent. The borrower’s needs are considered as much as reasonably possible without jeopardizing the Bank’s position. A late charge is usually assessed on loans upon expiration of the grace period.
Nonaccrual Loans As a general rule, loans 90 days or more past due with respect to principal or interest are classified as nonaccrual loans. However, certain loans that are 90 days or more past due may be kept on an accruing status if the loans are well secured and in the process of collection. The Company may also put a junior lien mortgage on nonaccrual status as a result of delinquency with respect to the first position, which is held by another financial institution, while the junior lien is currently performing. Income accruals are suspended on all nonaccrual loans and all previously accrued and uncollected interest is reversed against current income. A loan remains on nonaccrual status until it becomes current with respect to principal and interest (and in certain instances remains current for up to six months), the loan is liquidated, or when the loan is determined to be uncollectible and is charged-off against the allowance for credit losses.
Troubled Debt RestructuringsIn the course of resolving problem loans, the Company may choose to restructure the contractual terms of certain loans. The Company attempts to work out an alternative payment schedule with the borrower in order to avoid or cure a default. Loans that are modified are reviewed by the Company to identify if a TDR has occurred, which is when, for economic or legal reasons related to a borrower’s financial difficulties, the Bank grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status and the restructuring of the loan may include adjustments to interest rates, extensions of maturity, consumer loans where the borrower's obligations have been effectively discharged through Chapter 7 Bankruptcy and the borrower has not reaffirmed the debt to the Bank, and other actions intended to minimize economic loss and avoid foreclosure or repossession of collateral. If such efforts by the Bank do not result in satisfactory performance, the loan is referred to legal counsel, at which time foreclosure proceedings are initiated. At any time prior to a sale of the property at foreclosure, the Bank may terminate foreclosure proceedings if the borrower is able to work out a satisfactory payment plan.
It is the Company’s policy to have any restructured loans which are on nonaccrual status prior to being modified remain on nonaccrual status for six months, subsequent to being modified, before management considers their return to accrual status. If the restructured loan is on accrual status prior to being modified, it is reviewed to determine if the modified loan should remain on accrual status. Loans that are considered TDRs are classified as performing, unless they are on nonaccrual status or are delinquent for 90 days or more. Loans classified as TDRs remain classified as such for the life of the loan, except in limited circumstances, when it may be determined that the borrower is performing under modified terms and the restructuring agreement specified an interest rate greater than or equal to an acceptable market rate for a comparable new loan at the time of the restructuring.
Purchased Credit Deteriorated LoansPurchased Credit Deteriorated ("PCD") loans are acquired loans which have shown a more-than-insignificant deterioration in credit quality since origination. PCD loans are recorded at amortized cost with an allowance for credit losses recorded upon purchase, as appropriate.
51
Table of Contents
Nonperforming Assets Nonperforming assets are typically comprised of nonperforming loans and other real estate owned ("OREO"). Nonperforming loans consist of nonaccrual loans and loans that are 90 days or more past due but still accruing interest. OREO consists of real estate properties, which have primarily served as collateral to secure loans, that are controlled or owned by the Bank. These properties are recorded at fair value less estimated costs to sell at the date control is established, resulting in a new cost basis. The amount by which the recorded investment in the loan exceeds the fair value (net of estimated costs to sell) of the foreclosed asset is charged to the allowance for credit losses. Subsequent declines in the fair value of the foreclosed asset below the new cost basis are recorded through the use of a valuation allowance. Subsequent increases in the fair value are recorded as reductions in the valuation allowance, but not below zero. All costs incurred thereafter in maintaining the property are generally charged to noninterest expense. In the event the real estate is utilized as a rental property, net rental income and expenses are recorded as incurred within noninterest expense.
The following table sets forth information regarding nonperforming assets held by the Bank at the dates indicated:
Table 8 - Nonperforming Assets
December 31
(Dollars in thousands)
Loans accounted for on a nonaccrual basis
Loans past due 90 days or more but still accruing
Commercial real estate (2) — $ 218 — — —
Residential real estate (2) — 1,652 — — —
Home equity (2) — 265 — — —
Other real estate owned — — — 612 4,173
(1)Included in these amounts were nonaccrual TDRs of $22.2 million at December 31, 2020, $24.8 million at December 31, 2019, $29.3 million at December 31, 2018, $6.1 millionat December 31, 2017, and $5.2 million at December 31, 2016. The increase in nonaccrual TDRs in 2018 was due to nonaccrual loans associated with a large commercial loan customer that had previously declared bankruptcy which were modified when a court confirmed the customer's bankruptcy reorganization plan. That revision to loan terms required the Company to deem loans associated with the customer as TDRs at December 31, 2018 which amounted to $25.9 million.
(2)Represents purchased credit impaired ("PCI") loans that were accruing interest due to the expectation of future cash collections. Under CECL guidance, the concept of PCI loans was eliminated (and was replaced with classification as PCD loans) and is therefore not applicable for periods subsequent to the Company's adoption of CECL on January 1, 2020.
52
Table of Contents
The following table summarizes the changes in nonperforming assets for the periods indicated:
Table 9 - Activity in Nonperforming Assets
(Dollars in thousands)
Nonperforming assets beginning balance $ 48,049 $ 45,418
Acquired nonperforming loans — 2,317
Loans restored to accrual status (12,692) (2,603)
Acquired other real estate owned — 2,818
Valuation write down — (389)
Sale of other real estate owned — (2,500)
Nonperforming assets ending balance $ 66,861 $ 48,049
The following table sets forth information regarding TDR loans at the dates indicated:
Table 10 - Troubled Debt Restructurings
December 31
(Dollars in thousands)
(1) During the fourth quarter of 2018 nonaccrual loans associated with a large commercial loan customer that had previously declared bankruptcy were modified when a court confirmed the customer's bankruptcy reorganization plan. That revision to loan terms required the Company to deem $25.9 million of loans associated with the customer as TDRs at December 31, 2018.
The following table summarizes changes in TDRs for the periods indicated:
Table 11 - Activity in Troubled Debt Restructurings
(Dollars in thousands)
Charge-offs (22) (38)
53
Table of Contents
Income accruals are suspended on all nonaccrual loans and all previously accrued and uncollected interest is reversed against current income. The table below shows interest income that was recognized or collected on all nonaccrual loans and TDRs as of the dates indicated:
Table 12 - Interest Income - Nonaccrual Loans and Troubled Debt Restructurings
Years Ended December 31
(Dollars in thousands)
Potential problem loans are any loans which are not included in nonaccrual or nonperforming loans, where known information about possible credit problems of the borrowers causes management to have concerns as to the ability of such borrowers to comply with present loan repayment terms. At December 31, 2020, there were 83 relationships, with an aggregate balance of $145.6 million, deemed to be potential problem loans. These potential problem loans continued to perform with respect to payments. Management actively monitors these loans and strives to minimize any possible adverse impact to the Company. A portion of the potential problem loans identified by management have been granted a deferral during 2020 in accordance with the relief options offered in response to the COVID-19 pandemic. If applicable, these potential problem loans with an active deferral as of December 31, 2020 have been included in the table below.
As ntoed above, as a result of the COVID-19 pandemic, the Company has been offering needs based payment relief options to its customers in response to the COVID-19 pandemic. These modifications will not be accounted for as TDRs or reflected as delinquent or nonaccrual loans if the borrower was in compliance with their loan terms as of December 31, 2019. The following table summarizes active deferrals by modification type as of December 31, 2020:
Table 13 - Deferrals by Modification Type
(Dollars in thousands)
Consumer — — — — 21,862 — %
(1)Balances include commercial construction deferrals.
Additionally, as a result of the COVID-19 pandemic, management has also enhanced monitoring of loan portfolios in certain industries that have been or could be highly impacted. While management is unable to predict the full impact of all industries affected by the pandemic, there are assumptions as to which industries will be more greatly impacted due to social distancing and other protective measures and restrictions put in place by government and private businesses, as well as the duration of these measures and restrictions. Management has identified approximately $1.3 billion of loans within highly impacted industries, such as Accommodations, Food Services, Retail Trade, Other Services (except Public Administration), and Arts, Entertainment & Recreation. Loss exposure within these industries is mitigated by a number of factors such as collateral values, loan-to-value ratios, and other key indicators, however, some degree of credit loss is expected and has been incorporated into the allowance for credit loss recognition under the CECL model.
54
Table of Contents
The table below provides total outstanding balances of commercial loans at December 31, 2020 within industries that management has deemed to be highly impacted by the COVID-19 pandemic:
Table14 - Highly Impacted COVID-19 Industries - Details
(Dollars in thousands)
Accommodations
Average borrower loan size $ 4,055
% secured by real estate 99.7 %
Weighted average loan to value 54.4 %
Other information:
Food Services
Average borrower loan size $ 374
% secured by real estate 65.6 %
Weighted average loan to value 51.2 %
Other information:
Retail Trade
Average borrower loan size $ 490
% secured by real estate 42.2 %
Weighted average loan to value 55.5 %
Other information:
Other Services (except Public Administration)
Average borrower loan size $ 257
% secured by real estate 51.0 %
Weighted average loan to value 50.8 %
Other information:
55
Table of Contents
Arts, Entertainment, and Recreation
Average borrower loan size $ 807
% secured by real estate 84.1 %
Weighted average loan to value 52.9 %
Other information:
Allowance for Credit Losses The allowance for credit losses is maintained at a level that management considers appropriate to provide for the Company's current estimate of expected lifetime credit losses on loans measured at amortized cost. The allowance is increased by providing for credit losses through a charge to expense and by credits for recoveries of loans previously charged-off and is reduced by loans being charged-off.
In accordance with the CECL methodology, adopted January 1, 2020, the Company estimates credit losses for financial assets on a collective basis for loans sharing similar risk characteristics using a quantitative model combined with an assessment of certain qualitative factors designed to address forecast risk and model risk inherent in the quantitative model output. The model estimates expected credit losses using loan level data over the contractual life of the exposure, considering the effect of prepayments. Economic forecasts are incorporated into the estimate over a reasonable and supportable forecast period of one year, beyond which is a reversion to the Company's historical long-run average for a period of 6 months. The Company's qualitative assessment is structured based upon nine environmental factors impacting the expected risk of loss within the loan portfolio. Loans that do not share similar risk characteristics with any pools of assets are subject to individual assessment and are removed from the collectively assessed pools to avoid double counting. For the loans that will be individually assessed, the Company uses either a discounted cash flow (“DCF”) approach or a fair value of collateral approach. The latter approach is used for loans deemed to be collateral dependent or when foreclosure is probable. The Company's adoption of CECL had a minimal impact on the allowance for credit losses as compared to the incurred loss methodology prescribed by previously applicable accounting guidance.
The allowance for credit losses of $113.4 million at December 31, 2020 represents an increase of $45.6 million, or 67.3%, in comparison to the implementation balances at January 1, 2020. This increase in the allowance was primarily driven by anticipated credit deterioration caused by the COVID-19 pandemic, which resulted in an elevated provision for credit losses of $52.5 million for the year ended December 31, 2020.
While management is unable to know with certainty the direct, indirect, and future impacts of the COVID-19 pandemic, it is expected that the pandemic will have a material adverse impact on future losses across a broad range of loan segments. Accordingly, the forecast used by the model was adjusted to use a more severe outlook as compared to the baseline forecast used to calculate the opening balances on January 1, 2020 as a result of the uncertainty in the outlook due to the ongoing pandemic. Additionally, the provision for credit loss recognized for the year ended December 31, 2020 reflects increased reserve allocations to loan segments identified as having an elevated loss exposure associated with the COVID-19 pandemic. The underlying assumptions related to the Company's economic forecast included items such as, unemployment increasing through mid-2022, federal funds rates holding steady near 0% until 2022 and an expectation that no sustained economic recovery will occur until 2022.
The provision for credit losses was qualitatively adjusted upward for the year ended December 31, 2020 in order to ensure coverage for highly impacted relationships as management performed detailed analysis consisting of a review of maximum levels of historic loss given default ("LGD") and stressed probability of default ("PD") scenarios for loans that were deemed to be more at risk within the industries that are highly impacted by the COVID-19 pandemic. In addition to these industry exposures, qualitative adjustments were also made in order to provide coverage over the additional risk of loss attributable to collateral values associated with non-owner occupied real estate with significant retail tenant exposure, as well as home equity loans within a junior lien position. Refer to Note 4, "Loans, Allowance for Credit Losses and Credit Quality" within the Notes to the Consolidated Financial Statements included in Item 8 of this Report for further details regarding the Company's adoption of CECL and full disclosures under the new standard.
56
Table of Contents
The following table summarizes changes in the allowance for credit losses and other selected statistics for the periods presented:
Table 15 - Summary of Changes in the Allowance for Credit Losses
December 31
(Dollars in thousands)
Cumulative effect accounting adjustment (1) (1,137) — — — —
Cumulative effect accounting adjustment (2) 1,157 — — — —
Charged-off loans:
Recoveries on loans previously charged-off
Net loans charged-off (recoveries)
(1)Represents adjustment needed to reflect the cumulative day one impact pursuant to the Company's adoption of Accounting Standards Update 2016-13. The adjustment represents a $1.1 million decrease to the allowance attributable to the change in accounting methodology for estimating the allowance for credit losses resulting from the Company's adoption of the standard.
(2)Represents adjustment needed to reflect the day one reclassification of the Company's PCI loan balances to PCD and the associated gross-up, pursuant to the adoption of Accounting Standards Update 2016-13. The adjustment represents a $1.2 million increase to the allowance resulting from the day one reclassification.
57
Table of Contents
For purposes of the allowance for credit losses, management segregates the loan portfolio into the portfolio segments detailed in the table below. The allocation of the allowance for credit losses is made to each loan category using the analytical techniques and estimation methods described in this Report. While these amounts represent management’s best estimate of credit losses at the evaluation dates, they are not necessarily indicative of either the categories in which actual losses may occur or the extent of such actual losses that may be recognized within each category. Each of these loan categories possess unique risk characteristics that are considered when determining the appropriate level of allowance for each segment. The Company began estimating its allowance for credit losses in accordance with the CECL methodology as of January 1, 2020, while prior period amounts were estimated using the incurred loss methodology prescribed by previously applicable accounting guidance. The total allowance is available to absorb losses from any segment of the loan portfolio.
The following table sets forth the allocation of the allowance for credit losses by loan category at the dates indicated:
Table 16 - Summary of Allocation of Allowance for Credit Losses
December 31
(Dollars in thousands)
Allocated Allowance
(1)Total loans in this category increased during 2020 due to loans originated as part of the PPP established by the CARES Act. These loans have been excluded from the credit loss calculations as these loans are 100% guaranteed by the U.S. Government.
To determine if a loan should be charged-off, all possible sources of repayment are analyzed. Possible sources of repayment include the potential for future cash flows, the value of the Bank’s collateral, and the strength of co-makers or guarantors. When available information confirms that specific loans or portions thereof are uncollectible, these amounts are promptly charged-off against the allowance for credit losses and any recoveries of such previously charged-off amounts are credited to the allowance.
Regardless of whether a loan is unsecured or collateralized, the Company charges off the amount of any confirmed loan loss in the period when the loans, or portions of loans, are deemed uncollectible. For troubled, collateral-dependent loans, loss-confirming events may include an appraisal or other valuation that reflects a shortfall between the value of the collateral and the carrying value of the loan or receivable, or a deficiency balance following the sale of the collateral.
For additional information regarding the Bank’s allowance for credit losses, see Note 1, "Summary of Significant Accounting Policies" and Note 4, "Loans, Allowance for Credit Losses and Credit Quality" within the Notes to the Consolidated Financial Statements included in Item 8 of this Report.
Federal Home Loan Bank Stock The Bank held an investment in Federal Home Loan Bank ("FHLB") of Boston, of $10.3 million and $14.4 million at December 31, 2020 and December 31, 2019, respectively. The FHLB is a cooperative that provides services to its member banking institutions. The primary reason for the FHLB of Boston membership is to gain access to a reliable source of wholesale funding as a tool to manage liquidity and interest rate risk. The purchase of stock in the FHLB is a requirement for a member to gain access to funding. The Company either purchases additional FHLB stock or is subject to redemption of FHLB stock proportional to the volume of funding received. The Company views the holdings as a necessary long-term investment for the purpose of balance sheet liquidity and not for investment return.
58
Table of Contents
Goodwill and Other Intangible Assets Goodwill and Other Intangible Assets were $529.3 million and $535.5 million at December 31, 2020 and December 31, 2019, respectively. The decrease in 2020 is due to primarily to the amortization of definite-lived intangibles.
The Company typically performs its annual goodwill impairment testing during the third quarter of the year, unless certain indicators suggest earlier testing to be warranted. The COVID-19 pandemic resulted in significant levels of volatility in the capital markets and presents heightened uncertainty surrounding the future impact to operations of the Company and its customers. Given these conditions, the Company identified the impact of the pandemic as a triggering event warranting interim tests for impairment as of March 31, June 30, and September 30, 2020. Accordingly, the Company performed impairment tests as of each date and determined that there was no impairment of its goodwill. No additional test for impairment was deemed warranted as of the year ended December 31, 2020. Although the Company utilizes quoted market prices when estimating fair value of the reporting unit for purposes of the quantitative impairment tests, it also considers certain qualitative factors, including the concept of a control premium, which increases the fair value as compared to market capitalization. Other intangible assets are also reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company also considered the impact of the COVID-19 pandemic on other intangible assets and determined that there was no indication of impairment related to other intangible assets as of December 31, 2020. For additional information regarding the goodwill and other intangible assets, see Note 7, "Goodwill and Other Intangible Assets" within the Notes to Consolidated Financial Statements included in Item 8 hereof.
Cash Surrender Value of Life Insurance Policies The Bank holds life insurance policies for the purpose of offsetting its future obligations to its employees under its retirement and benefits plans. The cash surrender value of life insurance policies was $200.5 million and $197.4 million at December 31, 2020 and December 31, 2019, respectively. The Company recorded tax exempt income from life insurance policies in the amounts of $5.4 million, $5.0 million, and $4.1 million for the years ended December 31, 2020, 2019 and 2018, respectively. The Company also recorded gains on life insurance benefits of $1.0 million, $434,000, and $1.5 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Deposits At December 31, 2020, total deposits were $11.0 billion, representing a $1.8 billion, or 20.2%, increase from the prior year-end. The increase is due primarily to a combination of funds received for PPP loans and from other government stimulus programs and a customer focus on retaining liquidity, which fueled strong growth during the twelve months ended December 31, 2020. Core deposits represented 89.6% of total deposits at December 31, 2020, and the total cost of deposits was 0.27% for the year ended December 31, 2020, representing a decrease from the prior year of 20 basis points.
The Company also participates in the IntraFi Network, allowing the Bank to provide easy access to multi-million dollar Federal Deposit Insurance Corporation ("FDIC") deposit insurance protection on certificate of deposit and money market investments for consumers, businesses and public entities. This channel allows the Company to seek additional funding in potentially large quantities by attracting deposits from outside the Bank’s core market and amounted to $237.9 million and $211.2 million, at December 31, 2020 and December 31, 2019, respectively. In addition, the Company may occasionally raise funds through the use of brokered deposits outside of the IntraFi Network, which amounted to $8.5 million and $281.8 million, at December 31, 2020 and December 31, 2019, respectively. The decline is due primarily to the maturity of brokered certificates of deposit during 2020.
The following table sets forth the maturities of the Bank’s time certificates of deposits in the amount of $100,000 or more as of December 31, 2020:
Table 17 - Maturities of Time Certificates of Deposits $100,000 and Over
Balance Percentage
(Dollars in thousands)
59
Table of Contents
Borrowings The Company's borrowings consist of both short-term and long-term borrowings and provide the Bank with one of its primary sources of funding. Maintaining available borrowing capacity provides the Bank with a contingent source of liquidity. Borrowings decreased by $122.0 million, or 40.3%, at December 31, 2020, as compared to December 31, 2019. In relation to its funding strategy, and in light of the steady buildup of its liquidity position, the Bank used excess cash to pay down various forms of borrowings during the year, including short term borrowings held with the FHLB as well a $37.5 million pay down on a long-term line of credit.
The following table presents balances within each of the Company's major borrowing categories as of the periods indicated:
Table 18 - Components of Borrowings by Category
December 31
(Dollars in thousands)
See Note 9, "Borrowings" within the Notes to Consolidated Financial Statements included in Item 8 of this Report for more information regarding borrowings.
Capital Resources The Federal Reserve Board ("Federal Reserve"), the FDIC, and other regulatory agencies have established risk-based capital guidelines for banks and bank holding companies that require banks to meet a minimum Common Equity Tier 1 capital ratio of 4.5%, a Tier 1 capital ratio of 6.0% and a total capital ratio of 8.0%. A minimum requirement of 4.0% Tier 1 leverage capital is also mandated. In addition, the Company is required to maintain a minimum capital conservation buffer of 2.5%, in the form of common equity, in order to avoid restrictions on capital distributions and discretionary bonuses. At December 31, 2020, the Company and the Bank exceeded the minimum requirements for Common Equity Tier 1 capital, Tier 1 capital, total capital, and Tier 1 leverage capital, inclusive of the capital conservation buffer. See Note 21, "Regulatory Matters" within the Notes to Consolidated Financial Statements included in Item 8 of this Report for more information regarding capital requirements.
Results of Operations
Table 19 - Summary of Results of Operations
Years Ended December 31
(Dollars in thousands, except per share data)
Diluted earnings per share $ 3.64 $ 5.03
Return on average assets 0.96 % 1.52 %
Return on average equity 7.13 % 10.85 %
Stockholders' equity as % of assets 12.89 % 14.99 %
Net interest margin 3.29 % 4.04 %
Net Interest Income The amount of net interest income is affected by changes in interest rates and by the volume, mix, and interest rate sensitivity of interest-earning assets and interest-bearing liabilities.
On a fully tax-equivalent basis, net interest income was $368.7 million for the year ended December 31, 2020, representing a 6.5% decrease from net interest income of $394.1 million for the year ended December 31, 2019. The overall decrease in net interest income is due primarily to the negative impact of a lower interest rate environment and mix of interest earnings assets, partially offset by the full year impact of the BHB acquisition, which closed in the second quarter of 2019.
The following table presents the Company’s average balances, net interest income, interest rate spread, and net interest margin for the years ended December 31, 2020, 2019 and 2018. Nontaxable income from loans and securities is presented on a
60
Table of Contents
fully tax-equivalent basis by adjusting tax-exempt income upward by an amount equivalent to the prevailing federal income taxes that would have been paid if the income had been fully taxable.
Table 20 - Average Balance, Interest Earned/Paid & Average Yields
Years Ended December 31
(Dollars in thousands)
Interest-earning assets
Securities
Loans (2)
Interest-bearing liabilities
Deposits
Borrowings
61
Table of Contents
Supplemental Information
Cost of total funding liabilities 0.32 % 0.59 % 0.35 %
(1)The total amount of adjustment to present interest income and yield on a fully tax-equivalent basis is $927,000, $963,000 and $724,000 for 2020, 2019 and 2018, respectively. The FTE adjustment relates to nontaxable investment securities with average balances of $1.1 million, $1.7 million, and $2.1 million in 2020, 2019, and 2018, respectively, and tax exempt income relating to loans with average balances of $80.1 million, $80.0 million and $55.7 million at 2020, 2019 and 2018, respectively.
(2)Includes average nonaccruing loans.
(3)Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average costs of interest-bearing liabilities.
(4)Net interest margin represents net interest income as a percentage of average interest-earning assets.
62
Table of Contents
The following table presents certain information on a fully-tax equivalent basis regarding changes in the Company’s interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to (1) changes in rate (change in rate multiplied by prior year volume), (2) changes in volume (change in volume multiplied by prior year rate) and (3) changes in volume/rate (change in rate multiplied by change in volume) which is allocated to the change due to rate column:
Table 21 - Volume Rate Analysis
Years Ended December 31
(Dollars in thousands)
Income on interest-earning assets
Securities
Loans
Expense of interest-bearing liabilities
Deposits
Borrowings
(1)The table above reflects income determined on a fully tax equivalent basis. See footnotes to Table 20 above for the related adjustments.
63
Table of Contents
Provision For Credit Losses The provision for credit losses represents the charge to expense that is required to maintain an appropriate level of allowance for credit losses. The provision for credit losses totaled $52.5 million for the year ended December 31, 2020, compared with $6.0 million for the year ended December 31, 2019. The elevated provision for credit losses for the year ended December 31, 2020 was calculated under the new CECL methodology, which was adopted as of January 1, 2020, and was driven primarily by anticipated credit losses related to the COVID-19 pandemic. The Company’s allowance for credit losses, as a percentage of total loans, was 1.21% at December 31, 2020, as compared to 0.76% at December 31, 2019. Net charge-offs for the years ended December 31, 2020 and 2019 totaled $6.9 million and $2.6 million, respectively. The increase in net charge-offs for the year ended December 31, 2020 was due primarily to charge-offs recorded on two large commercial relationships. See Note 4, "Loans, Allowance for Credit Losses and Credit Quality" within the Notes to Consolidated Financial Statements included in Part I. Item 1 of this Report, for further details surrounding the primary drivers of the provision for credit losses during the period.
Noninterest Income The following table sets forth information regarding noninterest income for the periods shown:
Table 22 - Noninterest Income
Years Ended December 31
Change
(Dollars in thousands)
The primary reasons for significant variances in the noninterest income categories shown in the preceding table are noted below:
Deposit account fees decreased year over year primarily due to reductions in overdraft fees as customers benefited from government stimulus payments disbursed during 2020.
Interchange and ATM fees decreased during the year reflective of the negative impact of the Durbin Amendment, which the Company became subject to effective July 1, 2020 as a result of crossing the $10 billion asset threshold. In addition there was an overall decrease in consumer spending as customers focused on retaining liquidity during the COVID-19 pandemic leading to further reduced fees.
Investment management revenue increased primarily due to growth in overall assets under administration, which grew from $4.6 billion at December 31, 2019 to $4.9 billion at December 31, 2020.
Mortgage banking income increased in comparison to the prior year primarily due to increased volume and strong demand driven by the low interest rate environment.
The increase in cash surrender value of life insurance policies was primarily due to policies obtained from the BHB acquisition, which closed in the second quarter of 2019.
The Company received proceeds on life insurance policies during 2020, resulting in gains of $1.0 million for the year ended December 31, 2020, compared to gains of $434,000 for the year ended December 31, 2019.
Loan level derivative income increased primarily as a result of higher customer demand during the year.
64
Table of Contents
Other noninterest income decreased during the year, largely attributable to a one-time $3.1 million insurance recovery and a gain on the sale of residential loans of $1.4 million, each recognized in 2019. Gain on sale of fixed assets and FHLB dividend income also decreased in 2020.
Noninterest Expense The following table sets forth information regarding noninterest expense for the periods shown:
Table 23 - Noninterest Expense
Years Ended December 31
Change
(Dollars in thousands)
Data processing and facilities management 6,265 6,516 (251) (3.9) %
Loss on sale of other equity investments 1,033 — 1,033 nm
Loss on termination of derivatives 684 — 684 nm
The use of "nm" indicated that the percentage was not meaningful.
The primary reasons for significant variances in the noninterest expense categories shown in the preceding tables are noted below:
The increase in salaries and employee benefits reflects overall increases in the employee base, primarily due to the BHB acquisition which occurred on April 1, 2019, along with increases in retirement benefit costs and medical insurance costs, partially offset by decreases in incentive compensation.
Occupancy and equipment expense increases were primarily attributable to the full year impact of the acquired BHB branch network and costs attributable to the Company's infrastructure in response to the COVID-19 pandemic.
FDIC assessment expense increased during 2020 primarily due to an increase in the assessment base driven by the Company's crossing the $10 billion asset threshold. Additionally, the Company benefited from the small bank assessment credits allocated in conjunction with the Deposit Insurance Fund's attainment of a 1.38 percent reserve ratio, which resulted in no expense during the second half of 2019 and reduced expense during the first half of 2020.
Advertising expense in 2020 decreased in comparison to the prior year due primarily to the timing and scope of various marketing campaigns.
Consulting expense increased in 2020 in conjunction with the Company's overall growth, implementation of strategic initiatives and COVID-19 related projects.
During the fourth quarter of 2020, the Company recorded an impairment charge of $4.2 million reflecting accelerated lease termination costs and the write-off of leasehold improvements related to two branch closure decisions made during the quarter. There were no such impairment charges recorded during the prior year.
For the fourth quarter of 2020, the Company recognized a loss of $1.0 million on the sale of certain Small Business Investment Company ("SBIC") investment holdings that were acquired in the BHB merger in 2019. No such losses were recognized during the prior year.
65
Table of Contents
In 2020, the Company recorded a $684,000 loss on the termination of a swap derivative contract with a notional amount of $100.0 million. There were no such charges recorded during the prior year.
Merger and acquisition expense in 2019 was primarily attributable to the BHB acquisition. The majority of these costs include legal, professional fees and integration costs. There were no merger and acquisition costs incurred during 2020.
Software maintenance expense increased during 2020 reflecting the Company's continued investment in its technology infrastructure.
Other noninterest expenses increased in 2020 in comparison to the prior year, primarily due to increased consultant fees, retail branch traffic control, subscription fees, defined benefit plan costs, recruitment expenses, prepayment fees on borrowings, COVID-19 related office supplies and protective equipment, which were partially offset by a reduction in the provision for unfunded commitments and sponsorships.
Income Taxes The tax effect of all income and expense transactions is recognized by the Company in each year’s consolidated statements of income, regardless of the year in which the transactions are reported for income tax purposes. The following table sets forth information regarding the Company’s tax provision and applicable tax rates for the periods indicated:
Table 24 - Tax Provision and Applicable Tax Rates
Years Ended December 31
(Dollars in thousands)
The Company’s effective tax rate for 2020 is lower as compared to the year ago period primarily due to lower pre-tax net income, as well as the impact of discrete items, which are subject to fluctuation year over year. The discrete tax amounts for the year ended December 31, 2020 include a benefit of $4.8 million associated with the net operating loss (NOL) carryback provision of the CARES Act. This NOL was generated in relation to the BHB acquisition. The effective tax rates reported in the table above are lower than the blended statutory tax rates due to the aforementioned discrete items as well as certain tax preference assets such as life insurance policies, tax exempt bonds, and federal tax credits. The Company’s blended statutory tax rate for the year ended December 31, 2020 is comparable to the year ago period.
The Company invests in various low-income housing projects which are real estate limited partnerships that acquire, develop, own and operate low and moderate-income housing developments. As a limited partner in these operating partnerships, the Company receives tax credits and tax deductions for losses incurred by the underlying properties. The investments are accounted for using the proportional amortization method and will be amortized over various periods through 2039, which represents the period that the tax credits and other tax benefits will be utilized. The total committed investment in these partnerships at December 31, 2020 was $128.8 million, of which $79.2 million has been funded. The Company recognized a net tax benefit of approximately $1.9 million for 2020 and anticipates additional net tax benefits of $18.8 million over the remaining life of the investments from the combination of tax credits and operating losses.
For additional information related to the Company's income taxes see Note 13, "Income Taxes" and Note 14, "Low Income Housing Project Investments" within the Notes to the Consolidated Financial Statements included in Item 8 of this Report.
Dividends The Company declared quarterly cash dividends totaling $1.84 per common share in 2020 and $1.76 per common share in 2019. The 2020 and 2019 ratio of dividends paid to earnings was 50.21% and 32.25%, respectively.
Since substantially all of the funds available for the payment of dividends are derived from the Bank, future dividends of the Company will depend on the earnings of the Bank, its financial condition, its need for funds, applicable governmental policies and regulations, and other such matters as the Board of Directors deems appropriate.
Comparison of 2019 vs. 2018 For a discussion of our results for the year ended December 31, 2019 compared to the year ended December 31, 2018, please see Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K filed with the SEC on February 27, 2020.
66
Table of Contents
Risk Management
The Board of Directors and management have identified significant risks which affect the Company, including credit risk, market risk, liquidity risk, price risk, operations risk, cybersecurity risk, consumer compliance risk, reputation risk, and strategic risk. The Board of Directors has approved an Enterprise Risk Management Policy, and management has adopted a Risk Appetite Statement that addresses each risk category. Management reviews key risks and their mitigation on an ongoing basis and provides regular enterprise risk management reports to the Board of Directors. The Board of Directors, with the assistance of the Board’s Risk Committee, oversees management’s enterprise risk assessment and management.
Credit Risk Credit risk is the possibility that customers or other counterparties may not repay loans or other contractual obligations according to their terms. While the collateral securing loans may be sufficient in some cases to recover the amount due, in other cases the Company may experience significant credit losses which could have an adverse effect on its operating results. The Company makes assumptions and judgments about the collectability of its loan portfolio, including the creditworthiness of its borrowers and counterparties and the value of collateral for the repayment of loans. For further discussion regarding the credit risk and the credit quality of the Company’s loan portfolio, see Note 4, "Loans, Allowance for Credit Losses and Credit Quality" within Notes to Consolidated Financial Statements included in Item 8 of this Report.
Operational Risk Operational risk is the risk of loss from the Company’s operations due to human behavior, inadequate or failed internal systems and controls, and external influences such as market conditions, fraudulent activities, natural disasters, and security risks. Potential operational risk exposure exists throughout the Company. The continued effectiveness of colleagues, technical systems, operational infrastructure, and relationships with key third party service providers are integral to mitigating operations risk, and any shortcomings subject the Company to risks that vary in size, scale and scope. Operational risks include, but are not limited to, operational or technical failures, unlawful tampering with technical systems, cyber security, terrorist activities, ineffectiveness or exposure due to interruption in third party support, as well as the loss of key individuals or failure on the part of the key individuals to perform properly. Management maintains an Operational Risk Committee to assess and mitigate operational risk which contributes to periodic enterprise risk management reporting to the Board of Directors.
Compliance Risk Compliance risk is the risk of regulatory sanctions or financial loss resulting from the failure to comply with rules and regulations issued by the various banking agencies, the SEC, the NASDAQ Stock Market, and good banking practices. Activities which may expose the Company to compliance risk include money laundering, privacy and data protection, adherence to laws and regulations, community reinvestment initiatives, and employment and tax matters. Compliance risk is mitigated through the use of written policies and procedures, staff training, and continuous monitoring of activities for adherence to policies and procedures. Management maintains a Consumer Compliance Advisory team to assess and mitigate compliance risk that contributes to periodic enterprise risk management reporting to the Board of Directors.
Strategic and Reputation Risk Strategic and reputation risk is the risk of loss due to impairment of reputation, failure to fully develop and execute business plans, and failure to assess current and new opportunities and threats in business, markets, and products. Management seeks to mitigate strategic and reputational risk through annual strategic planning, frequent executive review of strategic plan progress, ongoing competitive and technological observation, assessment processes of new products, new branches, and new business initiatives, adherence to ethical standards, a philosophy of customer advocacy, a structured process of customer complaint resolution, and ongoing reputational monitoring, crisis management planning, and management tools.
Market Risk Market risk is the sensitivity of income to changes in interest rates, equity prices, foreign exchange rates, commodity prices, and other market-driven rates or prices. The Company’s most significant market risk exposure is interest rate risk.
Interest rate risk is the sensitivity of income due to changes in interest rates. Interest rate changes, as well as fluctuations in the level and duration of assets and liabilities, affect net interest income, the Company’s primary source of revenue. Interest rate risk arises directly from the Company’s core banking activities. In addition to directly impacting net interest income, changes in the level of interest rates can also affect the amount of loans originated, the timing of cash flows on loans and securities, and the fair value of securities and derivatives, and have other effects.
Management maintains an Asset Liability Committee to manage interest rate risk, which strives to control interest rate risk within limits approved by the Board of Directors that reflect the Company’s tolerance for interest rate risk over short-term and long-term horizons. The Company attempts to manage interest rate risk by identifying, quantifying, and, where appropriate, hedging exposure. If assets and liabilities do not re-price simultaneously and in equal volume, the potential for interest rate exposure exists. It is the Company's objective to maintain stability in the growth of net interest income through the maintenance of an appropriate mix of interest-earning assets and interest-bearing liabilities and, when necessary, within limits
67
Table of Contents
management determines to be prudent, through the use of off-balance sheet hedging instruments such as interest rate swaps, floors, and caps.
The Company quantifies its interest rate exposures using net interest income simulation models, as well as simpler gap analysis, and an Economic Value of Equity analysis. Key assumptions in these simulation analyses relate to changes in interest rates and the behavior of the Company’s deposit and loan customers. The most material assumptions relate to the prepayment of mortgage assets (including mortgage loans and mortgage-backed securities) and the life and sensitivity of non-maturity deposits (e.g., demand deposit, negotiable order of withdrawal, savings, and money market accounts). In the case of prepayment of mortgage assets, assumptions are derived from published dealer median prepayment estimates for comparable mortgage loans. The risk of prepayment tends to increase when interest rates fall. Since future prepayment behavior of loan customers is uncertain, interest rate sensitivity of loans cannot be determined exactly and actual behavior may differ from assumptions.