ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K. The following discussion contains "forward-looking statements" that reflect our future plans, estimates, beliefs and expected performance. We caution that assumptions, expectations, projections, intentions or beliefs about future events may, and often do, vary from actual results and the differences can be material. See "Cautionary Statement Regarding Forward-Looking Statements." Also, see the risk factors and other cautionary statements described under the heading "Item 1A – Risk Factors" included in Item 1A of this Annual Report on Form 10-K. We do not undertake any obligation to publicly update any forward-looking statements except as otherwise required by applicable law.
Company Overview
We are a financial holding company founded in 2002 and headquartered in Denver, Colorado. We provide a fully integrated suite of wealth management services to our clients including banking, trust and investment management products and services. Our mission is to be the best private bank for the Western wealth management client. We target entrepreneurs, professionals and high-net worth individuals, typically with $1.0 million-plus in liquid net worth, and their related philanthropic and business organizations, which we refer to as the "Western wealth management client." We believe that the Western wealth management client shares our entrepreneurial spirit and values our sophisticated, high-touch wealth management services that are tailored to meet their specific needs. We partner with our clients to solve their unique financial needs through our expert integrated services provided in a team approach.
We offer our services through a branded network of boutique private trust bank offices, which we believe are strategically located in affluent and high-growth markets in locations across Colorado, Arizona, Wyoming and California. Our profit centers, which are comprised of private bankers, lenders, wealth planners and portfolio managers, under the leadership of a local chairman and/or president, are also supported centrally by teams providing management services such as operations, risk management, credit administration, marketing, technology support, human capital and accounting/finance services, which we refer to as support centers.
From 2004, when we opened our first profit center, until December 31, 2020, we have expanded our footprint into eleven full service profit centers, two loan production offices, and two trust offices located across four states. Following the completion of the branch purchase and assumption agreement ("Branch Acquisition") in the second quarter 2020, we added one full service profit center in Lone Tree, Colorado. During the third quarter of 2020, we closed two branch locations which were acquired in the Branch Acquisition during the second quarter of 2020. As of and for the year ended December 31, 2020, we had $1.97 billion in total assets, $92.6 million in total revenues and provided fiduciary and advisory services on $6.26 billion of assets under management ("AUM").
Response to COVID-19
The spread of COVID-19 has caused significant disruptions in the U.S. economy since it was declared a pandemic in March 2020 by the World Health Organization. Disruptions include temporary closures of many businesses that have led to a loss of revenues and a rapid increase in unemployment, disrupted global supply chains, market downturns and volatility, changes in consumer behavior related to pandemic fears, related emergency response legislation and an expectation that Federal Reserve policy will maintain a low interest rate environment for the foreseeable future. The changes have impacted our clients and their industries, as well as the financial services industry. At this time, we cannot predict the impact or how long the economy or our impacted clients will be disrupted.
The Company activated its Business Continuity Plan in early March in response to the emergence of COVID-19 and has continued to adjust as the crisis continues to impact our markets, clients and business. Since March, a majority of our associates have been working remotely. All of our offices are open, functioning, and continue to operate in an appointment only model for client service to limit the risk of potential exposure to COVID-19 for our associates and clients. We are taking additional precautions within our profit centers, including enhanced cleaning procedures and physical distancing measures, to ensure the safety of our clients and our associates.
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A provision in the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") created the Paycheck Protection Program ("PPP"), which is administered by the Small Business Administration ("SBA"). The PPP is intended to provide loans to small businesses to pay their employees, rent, mortgage interest and utilities. The loans may be forgiven conditioned upon the client providing payroll documentation evidencing their compliant use of funds and otherwise complying with the terms of the program. The Bank is an approved SBA lender and began accepting applications for the program on April 3, 2020. As of December 31, 2020, we held 423 PPP loans for a total of $142.9 million with an average loan size of $0.3 million. As of February 28, 2021, the Company had submitted 509 loans with original loan amounts of $142.0 million to the SBA for forgiveness and had received forgiveness on 456 loans totaling $78.5 million all related to the first round of the PPP.
On January 11, 2021 the SBA reopened the PPP, to First Draw PPP Loans and began accepting applications for Second Draw PPP Loans on January 13, 2021. The Bank began accepting applications for the reopened program on January 19, 2021. As of February 28, 2021, we had received 660 applications for the newest round of PPP loans from borrowers for $91.4 million with an average loan size of $0.1 million; of the applications received, 410 applications for $68.7 million have been approved and funded by the SBA under the reopened program.
As a result of the COVID-19 pandemic, a loan modification program was designed and implemented to assist our clients experiencing financial stress resulting from the economic impacts caused by the global pandemic. The Company has offered loan extensions, temporary payment moratoriums, and financial covenant waivers for commercial and consumer borrowers impacted by the pandemic who have a pass risk rating and have not been delinquent over 30 days on payments in the last two years. The Company had eighty-nine loans across multiple industries in the amount of $160.8 million of loans that took part in the Company’s COVID loan modification program. No loans in the loan modification program were delinquent according to Bank policy as of December 31, 2020. Two loans, in the aggregate amount of $2.1 million, were still in the modification period as of December 31, 2020. The CARES Act provides banks optional, temporary relief from accounting for certain loan modifications as a troubled debt restructuring ("TDR"). The modifications must be related to the adverse effects of COVID-19, and certain other criteria are required to be met in order to apply the relief. Interagency guidance from the Federal Reserve and the FDIC confirmed with the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. We believe our loan modification program satisfies the applicable requirements.
The Company will continue to closely monitor the performance of COVID-19 impacted clients. Additionally, the Company will continue to review and revise its provision for loan losses as more information becomes available including the resolution of certain uncertainties some of our impacted clients face related to the government mandated shutdowns and shelter-in-place orders and the resulting financial stress. The extent to which the COVID-19 pandemic and government actions taken in response to the pandemic will impact our operations and financial results is highly uncertain.
The Company is also lending under the Federal Reserve’s Main Street Lending Program ("MSLP") to support lending to small and medium-sized for profit businesses and nonprofit organizations that were in sound financial condition before the onset of the COVID-19 pandemic. As of December 31, 2020, the Company had six loans with a balance held by the Bank of $6.6 million. These loans represent 4.5% of the Commercial and Industrial line. Further details of the MSLP are provided in Note 5 – Loans and the Allowance for Loan Losses of the accompanying Notes to the Consolidated Financial Statements.
Primary Factors Used to Evaluate the Results of Operations
As a financial institution, we manage and evaluate various aspects of both our results of operations and our financial condition. We evaluate the comparative levels and trends of the line items in our Consolidated Balance Sheets and Statements of Income as well as various financial ratios that are commonly used in our industry. The primary factors we use to evaluate our results of operations include net interest income, non-interest income and non-interest expense.
Net Interest Income
Net interest income represents interest income less interest expense. We generate interest income on interest-earning assets, primarily loans and available-for-sale securities. We incur interest expense on interest-bearing liabilities, primarily interest-bearing deposits and borrowings. To evaluate net interest income, we measure and monitor: (i) yields on loans, available-for-sale securities and other interest-earning assets; (ii) the costs of deposits and other funding sources;
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(iii) the rates incurred on borrowings and other interest-bearing liabilities; and (iv) the regulatory risk weighting associated with the assets. Interest income is primarily impacted by loan growth and loan repayments, along with changes in interest rates on the loans. Interest expense is primarily impacted by changes in deposit balances, changes in interest rates on deposits, along with the volume and type of interest-bearing liabilities. Net interest income is primarily impacted by changes in market interest rates, the slope of the yield curve, and interest we earn on interest-earning assets or pay on interest-bearing liabilities.
Non-Interest Income
Non-interest income primarily consists of the following:
Non-Interest Expense
Non-interest expense is comprised primarily of the following:
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Operating Segments
We measure the overall profitability of operating segments based on income before income tax. We believe this is a more useful measurement as our wealth management products and services are fully integrated with our private trust bank. We allocate costs to our segments, which consist primarily of compensation and overhead expense directly attributable to the products and services within the Wealth Management and Mortgage segments. We measure the profitability of each segment based on a post-allocation basis, as we believe it better approximates the operating cash flows generated by our reportable operating segments. A description of each segment is provided in Note 19 - Segment Reporting of the accompanying Notes to the Consolidated Financial Statements.
During the year ended December 31, 2020, we evaluated our reportable segments following the sale of our Los Angeles-based fixed income portfolio management team and certain related advisory and sub-advisory arrangements ("LA fixed income team"). We determined that the income before income tax related to the Capital Management segment was no longer significant and management will no longer be evaluating Capital Management separately for internal reporting. As such, Capital Management is no longer a reporting unit and the Company has discontinued reporting of the Capital Management segment on a standalone basis.The residual assets that remained in the Capital Management segment are now included in the Wealth Management segment. All reported periods are presented under the Wealth Management segment as of December 31, 2020.
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Primary Factors Used to Evaluate our Balance Sheet
The primary factors we use to evaluate our balance sheet include asset and liability levels, asset quality, capital, liquidity, and potential profit production from assets.
We manage our asset levels to ensure our lending initiatives are efficiently and profitably supported and to ensure we have the necessary liquidity and capital to meet the required regulatory capital ratios. Funding needs are evaluated and forecasted by communicating with clients, reviewing loan maturity and draw expectations, and projecting new loan opportunities.
We manage the diversification and quality of our assets based upon factors that include the level, distribution, severity and trend of problem assets such as those determined to be classified, delinquent, non-accrual, non-performing or restructured; the adequacy of our allowance for loan losses; the diversification and quality of loan and investment portfolios; the extent of counterparty risks, credit risk concentrations, and other factors.
We manage our liquidity based upon factors that include the level and quality of capital and our overall financial condition, the trend and volume of problem assets, our balance sheet risk exposure, the level of deposits as a percentage of total loans, the amount of non-deposit funding used to fund assets, the availability of unused funding sources and off-balance sheet obligations, the availability of assets to be readily converted into cash without undue loss, the amount of cash and liquid securities we hold, and other factors.
Financial institution regulators have established guidelines for minimum capital ratios for banks and bank holding companies. The Company has adopted the Basel III regulatory capital framework. As of December 31, 2020, the Bank’s capital ratios exceeded the current well capitalized regulatory requirements established under Basel III.
Branch Acquisition
OnFebruary 10, 2020, the Company entered into a branch purchase and assumption agreement with Simmons Bank, pursuant to which the Company agreed to acquire all of Simmons’ Colorado locations, including three branches and one loan production office located in metro Denver, as well as certain deposits and loans and other assets. On May 15, 2020, the Branch Acquisition was successfully completed. See Note 2 - Acquisitions of the accompanying Notes to Consolidated Financial Statements for additional information.
Recent Events
On September 18, 2020, the Company entered into an agreement to sell its LA fixed income team and certain related advisory and sub-advisory arrangements to Lido Advisors, LLC and Oakhurst Advisors, LLC. On November 13, 2020, the Company completed the sale. On an ongoing basis, the sale of the LA fixed income team is expected to be earnings neutral to the Company, as the revenue decrease will be approximately in-line with the expected expense reduction. The sale is not expected to have an impact on Bank clients but reduced the Company’s assets under management by $330.6 million. As a result of the sale, the Company evaluated its reportable segments and determined the remaining assets following the sale in the Capital Management segment no longer meet the thresholds of income before income tax to be a reportable segment. The residual assets that remained in the Capital Management segment are now included in the Wealth Management segment.
Results of Operations
Overview
The year ended December 31, 2020 compared with the year ended December 31, 2019. For the year ended December 31, 2020, we reported net income available to common shareholders of $24.5 million, compared to net income available to common shareholders for December 31, 2019 of $8.0 million, a $16.5 million, or 206.3% increase. For the year ended December 31, 2020, our income before income taxwas $33.1 million, a $22.9 million, or 224.4%, increase from December 31, 2019. For the year ended December 31, 2020, compared to the year ended December 31, 2019, income before income tax increased primarily as a result of a $14.0 million, or 43.8%, increase in net interest income and an increase of $18.6 million, or 57.1%, in non-interest income. The increase in non-interest income was primarily the result
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of a $691.4 million increase in mortgage loans funded, which resulted in a $18.7 million increase in net gain on mortgage loans during the year ended December 31, 2020 compared to December 31, 2019. The increase in income before income taxes was partially offset by an increase of $5.8 million, or 10.7%, in non-interest expense, which was primarily due to an increase in expenses related to salaries and employee benefits and professional services.
Net Interest Income
The year ended December 31, 2020 compared with the year ended December 31, 2019. For the year ended December 31, 2020, compared to the year ended December 31, 2019, net interest income, before the provision for loan losses, increased $14.0 million, or 43.8%, to $46.1 million. This increase was partially attributable to a $381.8 million increase in average outstanding loan balances compared to December 31, 2019, and a 94 bps decrease in the average rate on interest bearing deposits, partially offset by a decrease in our average yield on loans to 3.94% for the year ended December 31, 2020 from 4.49% for the year ended December 31, 2019. For the year ended December 31, 2020, our net interest margin was 3.09% and our net interest spread was 2.92%. For the year ended December 31, 2019, our net interest margin was 2.99% and our net interest spread was 2.62%.
The increase in average loans outstanding for the year ended December 31, 2020 compared to the same periods in 2019 was primarily due to diversified growth across all loan categories. Net interest income is also impacted by changes in the amount and type of interest-earning assets and interest-bearing liabilities. To evaluate net interest income, we measure and monitor the yields on our loans and other interest-earning assets and the costs of our deposits and other funding sources.
Interest income on our available-for-sale securities portfolio decreased as a result of lower average investment balances and lower average yields on the portfolio for the year ended December 31, 2020 compared to the same period in 2019. Our average available-for-sale securities balance during the year ended December 31, 2020 was $45.5 million, a decrease of $7.6 million from the year ended December 31, 2019. For the year ended December 31, 2020, our average yield on the available-for-sale securities portfolio decreased to 1.93%, from 2.40% the prior year.
Interest expense on deposits decreased during the year ended December 31, 2020 compared to the same period in 2019. Average rates on interest bearing deposits decreased 94 basis points, consistent with the lower interest rate environment. The reduction in cost of deposits was partially offset by an increase in average interest-bearing deposit accounts of $177.1 million compared to the prior year.
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The following tables present an analysis of net interest income and net interest margin for the periods presented, using daily average balances for each major category of interest-earning assets and interest-bearing liabilities, the interest earned or paid and the average rate earned or paid on those assets or liabilities.
As of and For the Year Ended December 31,
Interest Average Interest Average
Average Earned / Yield / Average Earned / Yield /
(Dollars in thousands) Balance(1) Paid Rate Balance (1) Paid Rate
Assets
Interest-earning assets:
Allowance for loan losses (9,945) (7,639)
Noninterest-earning assets 94,935 79,700
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Noninterest-bearing liabilities:
Total noninterest-bearing liabilities $ 404,673 $ 241,569
Total liabilities and shareholders’ equity $ 1,659,243 $ 1,182,366
Net interest rate spread(5) 2.92 % 2.62 %
Net interest income(6) $ 46,102 $ 32,061
Net interest margin(7) 3.09 % 2.99 %
(1) Average balance represents daily averages, unless otherwise noted.
(2) Available-for-sale securities represents monthly averages.
(4) Tax-equivalent yield adjustments are immaterial.
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The following tables present the dollar amount of changes in interest income and interest expense for the periods presented, for each component of interest-earning assets and interest-bearing liabilities (excluding mortgage loans held for sale) and distinguishes between changes attributable to volume and interest rates. Changes attributable to both rate and volume that cannot be separated have been allocated to volume.
Increase
(Decrease) Due Total
to Change in: Increase
(Dollars in thousands) Volume Rate (Decrease)
Interest-earning assets:
Available for sale securities (147) (249) (396)
Total increase (decrease) in interest income $ 15,081 $ (6,798) $ 8,283
Interest-bearing liabilities:
FHLB and Federal Reserve borrowings 526 (192) 334
Total increase (decrease) in interest expense $ 2,025 $ (7,783) $ (5,758)
Non-Interest Income
The year ended December 31, 2020 compared with the year ended December 31, 2019. For the year ended December 31, 2020 compared to the year ended December 31, 2019, non-interest income increased $18.6 million, or 57.1%, to $51.2 million. The increase in non-interest income was attributable to higher net gain on mortgage loans, primarily related to a $691.4 million increase in mortgage loans funded from the prior year.
The table below presents the significant categories of our non-interest income for the year ended December 31, 2020 and 2019.
Year Ended
December 31, Change
Non-interest income:
Trust and investment management fees $ 19,022 $ 18,935 $ 87 0.5 %
Risk management and insurance fees 1,199 1,205 (6) (0.5)
Income on company-owned life insurance 363 377 (14) (3.7)
Net gain on sale of securities — 119 (119) *
Net gain on sale of assets — 183 (183) *
________________
*Not meaningful
Trust and investment management fees— For the year ended December 31, 2020 compared to the same period in 2019, our trust and investment management fees remained relatively unchanged.
Net gain on mortgage loans— For the year ended December 31, 2020 compared to the year ended December 31, 2019, our net gain on mortgage loans increased by $18.7 million, or 176.6%, to $29.3 million. For the year ended December 31, 2020 and 2019, our origination volume of mortgage loans was $1.33 billion and $640.6 million, respectively. The net gain on sale of loans will fluctuate with the amount and type of loans sold and market conditions. The increase in gain on mortgage loans for the year ended December 31, 2020 compared to 2019 was primarily related to the increase in origination volume in 2020 compared to 2019. The increase in origination volume in 2020 was primarily
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related to lower market rates driving an increase in refinance activity, a strong residential real estate market in our footprint, and management’s commitment and ability to capitalize on the mortgage environment.
Bank fees— For the year ended December 31, 2020 compared to the same period in 2019, our bank fees increased by $0.1 million or 12.5% mostly related to additional fees on MSLP loans.
Risk management and insurance fees— Risk management fees include fees earned by our risk management product group as a result of assisting clients with obtaining life insurance policies and fees from the trailing annuity revenue streams. For the years ended December 31, 2020 and 2019, the Company recognized $1.2 million of risk management fees.
Net gain on sale of securities/assets— For the year ended December 31, 2020, the Company did not sell securities/assets. For the year ended December 31, 2019, the Company recognized a net gain on sale of securities of $0.1 million and a net gain on sale of assets of $0.2 million related to the sale of our third party administrator services.
Provision for Loan Losses
We have a dedicated problem loan resolution team comprised of associates from our credit, senior leadership, risk and accounting teams that meets frequently to ensure that watch list and problem credits are identified early and actively managed. We work to identify potential losses in a timely manner and proactively manage the problem credits to minimize losses. For the year ended December 31, 2020, we recorded $4.7 million of provision for loan losses, primarily resulting from an increase based on the additional variability surrounding the loan modifications made during the second quarter along with increased economic uncertainty related to the impact of the COVID-19 pandemic and overall loan growth.
The Company has increased loan level reviews and portfolio monitoring to address the changing environment. We identified clients who could be more highly impacted by the recent COVID-19 pandemic and economic disruption and are meeting regularly with them. The analysis reviewed the borrowers in industries we believe may be more impacted including those the lenders believed would have one or more of the following characteristics: greater than 50% probability of a downgrade, a covenant violation or 20% reduction in collateral position. The Company receives and reviews current financial data and cash flow forecasts from borrowers with loan modification agreements.
Management believes the financial strength of the Bank’s clientele and the diversity of the portfolio continues to mitigate the credit risk within the portfolio. Only two loans remained on modified terms at December 31, 2020.
Non-Interest Expense
The year ended December 31, 2020 compared with the year ended December 31, 2019. The increase in non-interest expense of 10.7% to $59.5 million for the year ended December 31, 2020, was primarily due to higher salaries and employee benefits expense, higher professional services expense, offset partially by a reduction in goodwill impairment charges.
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The table below presents the significant categories of our non-interest expense for the periods noted:
Year Ended
December 31, Change
Non-interest expense:
Technology and information systems 4,035 3,973 62 1.6
Amortization of other intangible assets 14 374 (360) (96.3)
Goodwill impairment — 1,572 (1,572) *
Net loss on assets held for sale 553 — 553 *
Provision on other real estate owned 176 — 176 *
*Not meaningful
Salaries and employee benefits—The increase in salaries and employee benefits of $3.0 million, or 9.4%, was primarily related to added personnel from the Branch Acquisition and to support the growth in our Mortgage segment, and an increase in incentive compensation accruals driven by the strong financial performance of the Company. These increases were partially offset by $2.9 million in deferred compensation in the form of loan origination costs related to PPP loan originations during 2020.
Occupancy and equipment—The increase in occupancy and equipment of $0.4 million, or 8.0%, was primarily driven by the addition of one full service profit center and the closing of two branch locations which were acquired in the Branch Acquisition.
Professional Services—The increase in professional services of $1.5 million, or 43.1%, was primarily driven by additional FDIC insurance expense related to our balance sheet growth, transaction expenses related to the Branch Acquisition, and an FDIC assessment credit offsetting expense in the year ended December 31, 2019.
Data processing—The increase in data processing costs of $0.9 million, or 30.5%, was primarily driven by an increase in core systems cost as a result of an increase in accounts and transactions related to the Branch Acquisition and growth in our Mortgage segment.
Marketing—The increase was driven by higher corporate advertising and agency related expenses, offset partially by lower client meal and entertainment related expenses.
Amortization of other intangible assets—The decrease in amortization of other intangible assets of $0.4 million, or 96.3%, was primarily due to certain intangibles becoming fully amortized during the year ended December 31, 2019.
Goodwill impairment—The decrease was due to a goodwill impairment charge of $1.6 million related to the Capital Management segment during the second quarter of 2019. No goodwill impairment charges were recorded in 2020. See Note 7 – Goodwill and Other Intangible Assets.
Net loss on assets held for sale—This amount represents the fair value adjustment on disposal groups held for sale. In the first quarter of 2020, we recorded an impairment loss on intangibles held for sale of $0.6 million related to the Capital Management segment.
Provision on other real estate owned—This amount represents the fair value adjustment for other real estate owned. During the year ended December 31, 2020, we incurred $0.2 million in losses as a result of sales contracts in place which were lower than the carrying value.
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Other—The increase in other non-interest expense was driven by product related expenses, increased expense due to the growth in our balance sheet, and a $0.2 million SEC penalty in the previously reported Capital Management segment.
Income Tax
During the year ended December 31, 2020, the Company recorded an income tax provision of $8.5 million, reflecting an effective tax rate 25.8%. During the year ended December 31, 2019, the Company recorded an income tax provision of $2.2 million, reflecting an effective tax rate of 21.4%. The increase in the effective tax rate was primarily attributable to a $0.4 million valuation allowance recorded following the sale of the LA fixed income team as a result of the Company’s ability to utilize the full California NOL.
Segment Reporting
We have two reportable operating segments: Wealth Management and Mortgage. Our Wealth Management segment consists of operations relating to the Company’s fully integrated wealth management products and services. Services provided include deposit, loan, insurance, and trust and investment management advisory products and services. Our Mortgage segment consists of operations relating to the Company’s residential mortgage service offerings. Mortgage products and services are financial in nature for which premiums are recognized, net of expenses, upon the sale of mortgage loans to third parties. Services provided by our Mortgage segment include soliciting, originating and selling mortgage loans into the secondary market. Mortgage loans originated and held for investment purposes are recorded in the Wealth Management segment, as this segment provides ongoing services to our clients.
The Company completed the sale of its LA fixed income team in the fourth quarter 2020. The LA fixed income team and the related assets made up a majority of the previously reported Capital Management Segment. As a result of the sale, the Company evaluated its reportable segments and determined the remaining assets in the Capital Management segment no longer met the thresholds to be a reportable segment.
For all periods presented, the Wealth Management segment includes the key metrics of the previously reported Capital Management segment.
The following table presents key metrics related to our segments:
Wealth
(Dollars in thousands) Management(1) Mortgage Consolidated
Year Ended December 31, 2019
Wealth
(Dollars in thousands) Management(1) Mortgage Consolidated
(2) Net interest income after provision plus non-interest income.
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The tables below present selected financial metrics of each segment as of and for the periods presented:
Wealth Management
As of and For the Year Ended December 31,
(Dollars in thousands) 2020(1) 2019(1) $ Change % Change
Assets held for sale — 3,553 (3,553) *
________________________________________
*Not meaningful
The Wealth Management segment reported income before income tax of $12.1 million for the year ended December 31, 2020, compared to $6.2 million, for the same period in 2019. The increase is primarily driven by an increase in average outstanding loan balances and a decrease in cost of funds, offset partially by increasing provision for loan losses and non-interest expense. During the year ended December 31, 2020, average loans increased $381.8 million and the cost of funds decreased to 0.48% from 1.25% compared to the year ended December 31, 2019.
Mortgage
As of and For the Year Ended December 31,
(Dollars in thousands) 2020 2019 $ Change % Change
Total interest income $ — $ — $ — — %
Total interest expense — — — —
Provision for loan losses — — — —
Net interest income, after provision for loan losses — — — —
Depreciation and amortization expense 70 218 (148) (67.9)
The Mortgage segment reported income before income tax of $21.0 million for the year ended December 31, 2020, compared to $4.0 million for the same period in 2019. The overall increase in non-interest income was primarily related to lower market rates driving an increase in refinance activity, a strong residential real estate market in our footprint and management’s commitment and ability to capitalize on the mortgage environment. During the years ended December 31, 2020 and 2019, our origination volume was $1.33 billion and $640.6 million, respectively. During the year ended December 31, 2020, the Company originated $875.8 million in refinance loans compared to $292.7 million the prior year.
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Financial Condition
The table below presents our condensed Consolidated Balance Sheets as of the dates presented:
December 31,
(Dollars in thousands) 2020 2019 $ Change % Change
Balance Sheet Data:
Assets held for sale — 3,553 (3,553) *
Liabilities held for sale — 117 (117) *
*Not meaningful
Cash and cash equivalents increased by $77.4 million, or 98.4%, to $156.0 million as of December 31, 2020 compared to December 31, 2019. The increase in liquidity was driven by organic growth in deposits related to new client relationships, increases in existing client accounts, and corporate initiatives to support current and future balance sheet growth. During the same period, investments decreased by $22.2 million due to accelerated prepayments on mortgage backed securities, or 37.8%, to $36.7 million as of December 31, 2020. The Company elected not to reinvest cash flows into the investment portfolio and instead increased cash balances to support loan growth due to low yield environment in the securities market.
Loans increased by $534.8 million, or 53.6%, to $1.53 billion as of December 31, 2020 compared to December 31, 2019. The increase was driven by three primary factors: organic growth, PPP loan originations and the Branch Acquisition. We experienced growth in our all major loan categories with the largest growth coming in the Cash, Securities and Other category that includes $142.9 million in PPP loans.
Mortgage loans held for sale increased $113.5 million, or 235.0%, to $161.8 million as of December 31, 2020 compared to December 31, 2019. This increase corresponds to the increase in mortgage origination volume as noted in the Mortgage segment activity.
Goodwill and other intangible assets, net increased by $4.5 million as of December 31, 2020 compared to December 31, 2019. The increase was driven by the recording of $4.5 million in goodwill and $0.1 million of core deposit intangibles related to the Branch Acquisition.
Other assets increased by $21.8 million, or 58.4%, to $59.2 million as of December 31, 2020 compared to December 31, 2019. This was primarily related to a $8.7 million increase in balances related to unfunded mortgage IRLC, a $3.6 million increase in accrued interest receivable as a result of payment moratoriums related to loan modifications and PPP loans and a $3.1 million contingent consideration asset recorded as a result of the sale of the LA fixed income team.
Total deposits increased $533.1 million, or 49.1%, to $1.62 billion as of December 31, 2020 compared to December 31, 2019. The increase in total deposits from December 31, 2019 was attributable to organic growth and the Branch Acquisition. We experienced growth in all our major deposit categories with the largest increases coming from non-interest bearing accounts and money market deposit accounts.
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Money market deposit accounts increased $231.9 million, or 37.7%, to $847.4 million as of December 31, 2020 compared to December 31, 2019. Time deposit accounts increased $37.8 million, or 28.0%, to $172.7 million as of December 31, 2020. Negotiable order of withdrawal ("NOW") accounts increased $21.1 million, or 23.0%, to $113.1 million compared to December 31, 2019. This increase in money market deposit and NOW accounts was primarily due to continued organic growth in our market areas.
Total borrowings increased $157.3 million, or 949.8%, to $173.9 million as of December 31, 2020 compared to December 31, 2019. The increase is primarily attributed to participation in the Paycheck Protection Program Loan Facility from the Federal Reserve in the amount of $134.6 million. Borrowing from this facility is expected to match fund the balances of PPP loans. During the year ended December 31, 2020, the Company completed the issuance and sale of subordinated notes in the aggregate principal amount of $18.0 million to support its capital objectives.
Total shareholders’ equity increased $27.3 million, or 21.4%, to $155.0 million as of December 31, 2020. The increase is primarily due to an increase in net income.
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Assets Under Management
Year Ended
December 31,
Managed Trust Balance at Beginning of Period $ 1,750 $ 1,380
New relationships 17 49
Closed relationships (12) (2)
Contributions 98 38
Withdrawals (119) (114)
Market change, net 156 399
Directed Trust Balance at Beginning of Period $ 989 $ 789
New relationships 18 139
Closed relationships (6) —
Contributions 42 32
Withdrawals (96) (64)
Market change, net 4 93
Investment Agency Balance at Beginning of Period $ 2,009 $ 1,846
New relationships 179 109
Closed relationships(2) (451) (72)
Withdrawals (231) (257)
Market change, net 66 238
Custody Balance at Beginning of Period $ 452 $ 356
New relationships 7 11
Closed relationships (4) (4)
Contributions 105 84
Withdrawals (82) (71)
Market change, net 40 76
401(k)/Retirement Balance at Beginning of Period $ 988 $ 864
New relationships 23 7
Closed relationships (60) (69)
Contributions 133 84
Withdrawals (85) (63)
Market change, net 57 165
Total Assets Under Management at Beginning of Period $ 6,188 $ 5,235
New relationships 244 315
Closed relationships(2) (533) (147)
Withdrawals (613) (569)
Market change, net 323 971
Total Assets Under Management $ 6,255 $ 6,188
*Trust & investment management fees divided by period-end balance.
(1)AUM reported for the current period are one quarter in arrears.
(2)Sale of LA fixed income team resulted in closed accounts of $330.6 million.
Assets under management increased $67.0 million, or 1.1%, to $6.26 billion for the year ended December 31, 2020. Assets under management increased $953.0 million, or 18.2%, to $6.19 billion for the year December 31, 2019. The sale of the LA fixed income team resulted in closed accounts of $330.6 million during the year ended December 31, 2020. Excluding the impact of the sale, the increase in 2020 is primarily attributable to net market gains.
Available-for-sale securities
Investments we intend to hold for an indefinite period of time, but not necessarily to maturity, are classified as available-for-sale and are recorded at fair value using current market information from a pricing service, with unrealized
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gains and losses excluded from earnings and reported in other comprehensive income (loss), net of tax. All our investments in securities were classified as available-for-sale for the periods presented below. The carrying values of our investment securities classified as available-for-sale are adjusted for unrealized gain or loss, and any gain or loss is reported on an after-tax basis as a component of other comprehensive income in shareholders’ equity.
The following table summarizes the amortized cost and estimated fair value of our investment securities as of December 31, 2020:
Gross Gross
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
Investment securities available-for-sale:
U.S. Treasury debt $ 250 $ 4 $ — $ 254
The following table summarizes the amortized cost and estimated fair value of our investment securities as of December 31, 2019:
Gross Gross
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
Investment securities available-for-sale:
U.S. Treasury debt $ 250 $ 4 $ — $ 254
FNMA mortgage-backed securities—residential 2,935 11 (29) 2,917
The following tables represent the book value of our contractual maturities and weighted average yield for our investment securities as of the dates presented. Contractual maturities may differ from expected maturities because issuers can have the right to call or prepay obligations without penalties. Our investments are taxable securities. Weighted average yields are not presented on a taxable equivalent basis. Securities not due at a single maturity date are included as after ten years.
Maturity as of December 31, 2020
One Year or Less One to Five Years Five to Ten Years After Ten Years
Weighted Weighted Weighted Weighted
Available-for-sale:
U.S. Treasury debt $ 250 0.02 % $ — — % $ — — % $ — — %
Corporate Bonds — — 1,250 0.17 — — 4,750 0.60
GNMA mortgage-backed securities - residential — — — — — — 23,806 1.59
Corporate CMO and MBS — — — — 43 * 4,035 0.31
* Not meaningful
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Maturity as of December 31, 2019
One Year or Less One to Five Years Five to Ten Years After Ten Years
Weighted Weighted Weighted Weighted
Available-for-sale:
U.S. Treasury debt $ — — % $ 250 0.01 % $ — — % $ — — %
GNMA mortgage-backed securities - residential — — — — — — 45,490 2.28
Corporate CMO and MBS — — — — 52 — 10,373 0.66
As of December 31, 2020 and December 31, 2019, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders’ equity.
Loan Portfolio
Our primary source of interest income is derived through interest earned on loans to high net worth individuals and their related commercial interests. Our senior lending and credit team consists of seasoned, experienced personnel and we believe that our officers are well versed in the types of lending in which we are engaged. Underwriting policies and decisions are managed centrally and the approval process is tiered based on loan size, making the process consistent, efficient and effective. The management team and credit culture demands prudent, practical, and conservative approaches to all credit requests in compliance with the loan policy guidelines to ensure strong credit underwriting practices.
In addition to originating loans for our own portfolio, we conduct mortgage banking activities in which we originate and sell, servicing-released, whole loans in the secondary market. Our mortgage banking loan sales activities are primarily directed at originating single family mortgages that are priced and underwritten to conform to previously agreed-upon criteria before loan funding and are delivered to the investor shortly after funding. The level of future loan originations, loan sales and loan repayments depends on overall credit availability, the interest rate environment, the strength of the general economy, local real estate markets and the housing industry, and conditions in the secondary loan sale market. The amount of gain or loss on the sale of loans is primarily driven by market conditions and changes in interest rates, as well as our pricing and asset liability management strategies. As of December 31, 2020 and December 31, 2019, we had mortgage loans held for sale of $161.8 million and $48.3 million, respectively, in residential mortgage loans we originated.
Loan balances include the impacts of PPP and the Branch Acquisition. See Note 2 - Acquisitions of the accompanying Notes to Consolidated Financial Statements for additional information.
As of December 31, 2020, the Company has $142.9 million in PPP loans outstanding with $1.3 million in remaining fees to be recognized. The remaining fees represent the net amount of the fees from the SBA for participation in the PPP less the loan origination costs on these loans. The current amortization of this income is being recognized over a two-year period, however if a loan receives full forgiveness from the SBA, the remaining income will be recognized upon receipt of the funds from the SBA. As of February 28, 2021, the Company had submitted to the SBA 509 loans for forgiveness with original loan amounts of $142.0 million and had received forgiveness and receipt of funds on 456 loans totaling $78.5 million all related to the first round of the PPP. For PPP balances not forgiven, the remaining net fee is extended and amortized over a 5 year payback period.
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The following table summarizes our loan portfolio by type of loan as of the dates indicated, in thousands:
December 31,
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The contractual maturity ranges of loans in our loan portfolio and the amount of such loans with fixed and floating interest rates in each maturity range, excluding deferred costs (fees), and unamortized premiums/ (unaccreted discounts), as of the date indicated are summarized in the following tables:
One Year One Through After
(Dollars in thousands) or Less Five Years Five Years Total
(1) Includes PPP loans.
One Year One Through After
(Dollars in thousands) or Less Five Years Five Years Total
Loan Modifications
As a result of the COVID-19 pandemic, a loan modification program was designed and implemented to assist our clients experiencing financial stress resulting from the economic impacts caused by the global pandemic. The Company was offering loan extensions, temporary payment moratoriums, and financial covenant waivers for commercial and consumer borrowers impacted by the pandemic who have a pass risk rating and have not been delinquent over 30 days on payments in the last two years.
As of December 31, 2020, the Company’s loans include two modified loans, including acquired loans, across multiple industries in the amount of $2.1 million, representing 0.13% of total loans.
The following presents loans modifications as a result of COVID-19 as of December 31, 2020 (dollars in thousands):
Cash, Securities and Other $ 357,020 — $ — — %
Construction and Development 131,111 — — —
Non-Owner Occupied CRE 281,943 — — —
Commercial and Industrial 146,031 — — —
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The CARES Act provides banks optional, temporary relief from accounting for certain loan modifications as a TDR. The modifications must be related to the adverse effects of COVID-19, and certain other criteria are required to be met in order to apply the relief. Interagency guidance from Federal Reserve and the FDIC confirmed with the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. We believe our loan modification program meets that definition. In accordance with that guidance, the Company is recognizing interest income on all loans modified for temporary payment moratoriums, primarily for a period of 180 days or less.
The Company had eighty-nine loans across multiple industries in the amount of $160.8 million of loans that took part in the Company’s COVID loan modification program. No loans in the loan modification program were delinquent according to Bank policy as of December 31, 2020. Two loans, in the aggregate amount of $2.1 million, were still in the modification period as of December 31, 2020.
All loans modified in response to COVID-19 are classified as performing and pass rated as of December 31, 2020. These loans are included in the allowance for loan loss general reserve in accordance with ASC 450-20. Management has increased our loan level reviews and portfolio monitoring to address the changing environment. The Company continues to meet regularly with clients who could be more highly impacted by the recent COVID-19 pandemic. These are borrowers in industries we believe may be more impacted by the pandemic, for instance those loans where there may be a greater than 50% probability of a downgrade, covenant violation or 20% reduction in collateral position. Management believes the diversity of the loan portfolio is prudent and remains consistent with the credit culture and goals of the Bank.
Interest accrued during the modification term on modified loans is deferred to the end of the loan term. As of December 31, 2020, no allowance for loan loss was deemed necessary on the accrued interest balances related to loan modifications.
Non-Performing Assets
Non-performing assets include non-accrual loans, TDRs, loans past due 90 days or more and still accruing interest, and OREO. The accrual of interest on loans is discontinued at the time the loan becomes 90 or more days delinquent unless the loan is well secured and in the process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on non-accrual status or charged off if collection of interest or principal is considered doubtful.
OREO represents assets acquired through, or in lieu of, foreclosure. The amounts reported as OREO are supported by recent appraisals, with the appraised values adjusted, where applicable, for expected transaction fees likely to be incurred upon sale of the property. We incur recurring expenses relating to OREO in the form of maintenance, taxes, insurance and legal fees, among others, until the OREO parcel is disposed. While disposition efforts with respect to our OREO are generally ongoing, if these properties are appraised at lower-than-expected values or if we are unable to sell the properties at the prices for which we expect to be able to sell them, we may incur additional losses. During the year ended December 31, 2020, we incurred $0.2 million in losses as a result of sales contracts in place which were lower than the carrying value.
The amount of lost interest for non-accrual loans was $0.2 million and $0.4 million for the year ended December 31, 2020 and 2019, respectively.
We had $4.3 million in non-performing assets as of December 31, 2020 compared to $12.9 million as of December 31, 2019. The $8.6 million decrease in our non-performing assets was primarily related to the payoff of a $5.1 million Commercial and Industrial loan, a $0.8 million paydown on another Commercial and Industrial loan, and $2.8 million paydown on a Cash, Securities, and Other loan during the year ended December 31, 2020.
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The following table presents information regarding non-performing loans as of the dates indicated:
As of December 31,
Non-accrual loans by category (1)
Cash, Securities and Other $ 50 $ 2,803 $ 11,252 $ — $ —
Construction and Development — — — — —
1-4 Family Residential — — — 1,171 —
Non-Owner Occupied CRE — — — — —
Owner Occupied CRE 479 — — — —
TDRs still accruing — 5,055 4,848 — —
Accruing loans 90 or more days past due — — 1,217 1,217 —
Potential Problem Loans
We categorize loans into risk categories based on relevant information about the ability of the borrowers to service their debt, such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. We analyze loans individually by classifying the loans by credit risk on a quarterly basis, which are segregated into the following definitions for risk ratings:
Special Mention— Loans categorized as special mention have a potential weakness or borrowing relationships that require more than the usual amount of management attention. Adverse industry conditions, deteriorating financial conditions, declining trends, management problems, documentation deficiencies or other similar weaknesses may be evident. Ability to meet current payment schedules may be questionable, even though interest and principal are still being paid as agreed. The asset has potential weaknesses that may result in deteriorating repayment prospects if left uncorrected. Loans in this risk grade are not considered adversely classified.
Substandard—Substandard loans are considered "classified" and are inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardizes the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loans in this category may be placed on non-accrual status and may individually be evaluated for impairment if indicators of impairment exist.
Doubtful—Loans graded doubtful are considered "classified" and have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. However, the amount or certainty of eventual loss is not known because of specific pending factors.
Loans not meeting any of the three criteria above are considered to be pass-rated loans.
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As of December 31, 2020 and December 31, 2019 non-performing loans of $4.1 million and $12.3 million, respectively, were included in the substandard category in the table below. The following tables present, by class and by credit quality indicator, the recorded investment in our loans as of the dates indicated:
Special Special
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses, which is a noncash charge to earnings. Loan losses are charged against the allowance when management believes that a loan balance is confirmed uncollectable. Subsequent recoveries, if any, are credited to the allowance for loan losses.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and dollar volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and prevailing economic conditions. Allocations of the allowance for loan losses may be made for specific loans, but the entire allowance for loan losses is available for any loan that, in management’s judgment, should be charged off.
We are closely monitoring the changing dynamics in the economy and the client impact driven by the COVID-19 pandemic. We have intensified our portfolio management, focusing on higher impacted industries and commercial property types. Our clientele is generally comprised of high net-worth individuals and commercial borrowers with strong credit profiles and multiple sources of repayment. The portion of our credit exposure to the highest risk industries impacted by COVID-19, such as accommodations, transportation and restaurants, is less than 3.0% of our loan portfolio. The Company has increased our loan level reviews and portfolio monitoring to address the changing environment and continues to engage in more frequent communication with these borrowers to better understand the impact on our borrower’s cash flows and respond proactively. While the length of time some of these businesses are unable to operate or operate at full capacity is unknown, it could have a significant impact on many factors that impact our borrowers and our reserve requirement. During the year ended December 31, 2020, the Company increased its allowance for loan losses to account for the additional variability surrounding the loan modifications made during the year and increased economic uncertainty related to the COVID-19 pandemic. Management will continue to closely monitor the loan portfolio and analyze the economic data to assess the impact on the allowance for loan loss. We believe the allowance for loan losses is adequate as of December 31, 2020.
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The following table presents summary information regarding our allowance for loan losses for the periods indicated:
Year Ended December 31,
Charge-offs:
Cash, Securities and Other 31 248 16 — 124
Construction and Development — — — — —
1-4 Family Residential — — — — —
Non-Owner Occupied CRE — — — — —
Owner Occupied CRE — — — — —
Commercial and Industrial — — — — 687
Recoveries:
Cash, Securities and Other 13 10 — 10 17
Construction and Development — — — — 163
1-4 Family Residential — — — 11 33
Non-Owner Occupied CRE — — — — 135
Owner Occupied CRE — — — — —
Commercial and Industrial — — — — —
Ratio of net charge-offs to average loans(5) — % 0.03 % — % — % 0.07 %
(1) Average balances are average daily balances.
The following table represents the allocation of the allowance for loan losses among loan categories and other summary information. The allocation for loan losses by category should neither be interpreted as an indication of future charge-offs, nor as an indication that charge-offs in future periods will necessarily occur in these amounts or in the indicated proportions. The allocation of a portion of the allowance for loan losses to one category of loans does not preclude its availability to absorb losses in other categories.
As of December 31,
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Deferred Tax Assets, Net
Deferred tax assets, net represent the differences in timing of when items are recognized for GAAP purposes and when they are recognized for tax purposes, as well as our net operating losses. As a result of the Tax Cuts and Jobs Act of 2017, our deferred tax assets, net, are valued based on the amounts that are expected to be recovered in the future utilizing the tax rates in effect at the time recognized. As a result of book and tax basis differences, our deferred tax assets, net for year ended December 31, 2020 increased $1.0 million from December 31, 2019. This increase was primarily driven by higher provision for loan losses along with higher incentive accruals. The increase was partially offset by a $0.4 million valuation allowance related to the California net operating loss carry forward following the completion of the sale of our LA fixed income team.
Deposits
Our deposit products include money market accounts, demand deposit accounts, time-deposit accounts (typically certificates of deposit), NOW accounts (interest checking accounts), and saving accounts. Our accounts are federally insured by the FDIC up to the legal maximum amount.
Total deposits increased by $533.1 million, or 49.1%, to $1.62 billion as of December 31, 2020 from December 31, 2019. Total average deposits for the year ended December 31, 2020 were $1.36 billion, an increase of $338.3 million, or 33.1%, compared to $1.02 billion as of December 31, 2019. The increase in total deposits from December 31, 2019 was attributable to organic growth and the Branch Acquisition. Organic growth was due to our general deposit growth initiatives, the cross-selling of products, the skills of our sales and service team, as well as additional deposits added from our trust and investment management relationships for which we also provide deposit products. The decrease in average rates in 2020 was driven primarily by the lower interest rate environment.
The following table presents the average balances and average rates paid on deposits for the periods below:
As of and For the Year Ended December 31,
Average Average Average Average
(Dollars in thousands) Balance Rate Balance Rate
Deposits
Average noninterest-bearing deposits to average total deposits was 28.2% and 21.7% for the year ended December 31, 2020 and 2019, respectively.
Our average cost of funds was 0.48% and 1.25% during the year ended December 31, 2020 and 2019, respectively. The decrease was driven by a 94 basis point reduction in interest bearing deposit costs consistent with the lower interest rate environment.
Total money market accounts as of December 31, 2020 were $847.4 million, an increase of $231.9 million, or 37.7%, compared to $615.6 million as of December 31, 2019. NOW accounts increased $21.1 million, or 23.0%, to $113.1 million compared to December 31, 2019.
Total time deposits as of December 31, 2020 were $172.7 million, an increase of $37.8 million, or 28.0%, compared to December 31, 2019. The increase in deposits from December 31, 2019 was attributable to organic growth and the Branch Acquisition.
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The following table represents the amount of certificates of deposit by time remaining until maturity as of December 31, 2020:
Maturity Within:
Borrowings
We have short-term and long-term borrowing sources available to supplement deposits and meet our liquidity needs. As of December 31, 2020 and December 31, 2019, borrowings totaled $173.9 million and $16.6 million, respectively.
During the year ended December 31, 2020, the Company completed the issuance and sale of subordinated notes totaling $18.0 million. The increase in other borrowings is primarily attributed to participation in the Paycheck Protection Program Loan Facility from the Federal Reserve with a period end balance of $134.6 million. Borrowing from this facility is expected to match fund the balances of PPP loans. The table below presents balances of each of the borrowing facilities as of the dates indicated:
December 31, December 31,
Borrowings
Federal Reserve borrowings 134,563 —
FHLB
We have a blanket pledge and security agreement with FHLB that requires certain loans and securities to be pledged as collateral for any outstanding borrowings under the agreement. The collateral pledged as of December 31, 2020 and December 31, 2019 amounted to $668.6 million and $515.5 million, respectively. Based on this collateral and the Company’s holdings of FHLB stock, the Company was eligible to borrow an additional $441.8 million as of December 31, 2020.
As of and for the
Year Ended
December 31,
(Dollars in thousands) 2020
Short-term borrowings:
Maximum outstanding at any month-end during the period $ 28,000
Balance outstanding at end of period 15,000
Average outstanding during the period $ 15,880
Average interest rate during the period 0.75 %
Average interest rate at the end of the period 0.32 %
The Bank has borrowing capacity associated with three unsecured federal funds lines of credit up to $10.0 million, $19.0 million, and $25.0 million. As of December 31, 2020 and 2019, there were no amounts outstanding on any of the federal funds lines.
As of December 31, 2019, we had a Restated Revolving Credit Note with a correspondent lending partner and the borrowing capacity associated with this facility was $5.0 million with no balance outstanding. The Company renewed the Restated Revolving Credit Note under a new Business Loan Agreement and associated Promissory Note on October
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28, 2020 to be effective as of June 30, 2020. As of December 31, 2020, the Promissory Note had a borrowing capacity under this facility of $5.0 million and had no balance outstanding.
Our borrowing facilities include various financial and other covenants, including, but not limited to, a requirement that the Bank maintains regulatory capital that is deemed "well capitalized" by federal banking agencies. As of December 31, 2020 and December 31, 2019, the Company was in compliance with the covenant requirements.
Liquidity and Capital Resources
Liquidity resources primarily include interest-bearing and noninterest-bearing deposits which primarily contribute to our ability to raise funds to support asset growth, acquisitions, and meet deposit withdrawals and other payment obligations. Access to purchased funds primarily include the ability to borrow from FHLB, other correspondent banks and the use of brokered deposits.
The following table illustrates, during the periods presented, the composition of our funding sources and the average assets in which those funds are invested as a percentage of average total assets for the period indicated.
Average Percentage for the Year Ended
December 31,
Sources of Funds:
Deposits:
FHLB and Federal Reserve borrowings 7.40 1.03
Subordinated notes 0.83 0.55
Other liabilities 1.29 1.65
Uses of Funds:
Available-for-sale securities 2.74 4.49
Mortgage loans held for sale 4.85 3.34
Interest-bearing deposits in other financial institutions 7.82 6.85
Noninterest-earning assets 5.72 6.74
Average noninterest-bearing deposits to total average deposits 28.19 % 21.75 %
Average loans to total average deposits 97.00 91.75
Average interest-bearing deposits to total average deposits 71.81 % 78.25 %
Our primary source of funds is interest-bearing and noninterest-bearing deposits, and our primary use of funds is loans. We do not expect a change in the primary source or use of our funds in the foreseeable future.
Capital Resources
Total shareholders’ equity increased $27.3 million, or 21.4%, to $155.0 million as of December 31, 2020 compared to December 31, 2019. The increase is primarily due to net income of $24.5 million, $2.5 million of stock-based compensation charges, and other comprehensive income, net of tax of $0.8 million. During the year ended December 31, 2020, the Bank’s capital was also positively impacted by $3.7 million following the closure of the Capital Management segment as a result of the Bank assuming the remaining Goodwill of First Western Capital Management. These increases were partially offset by stock repurchases of $0.4 million and $0.3 million of share awards settled.
On November 3, 2020, the Company announced that its board of directors authorized the repurchase of up to 400,000 shares of the Company’s common stock, no par value, from time to time, within one year (the "2020 Repurchase Plan") and that the Board of Governors of the Federal Reserve System advised the Company that it has no objection to the Company’s 2020 Repurchase Plan. The Company may repurchase shares in privately negotiated transactions, in the open
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market, including pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 promulgated by the Securities and Exchange Commission, or otherwise in a manner that complies with applicable federal securities laws. The 2020 Repurchase Plan does not obligate the Company to acquire a specific dollar amount or number of shares and it may be extended, modified or discontinued at any time without notice.
During the year ended December 31, 2020, the Company repurchased 23,105 shares at an average price of $16.59. See Note 12 – Shareholders’ Equity for a breakout of repurchased shares by repurchase plan.
We are subject to various regulatory capital adequacy requirements at a consolidated level and the bank level. These requirements are administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our consolidated financial statements. Under capital adequacy guidelines and, additionally for banks, the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.
Capital levels are viewed as important indicators of an institution’s financial soundness by banking regulators. Generally, FDIC-insured depository institutions and their holding companies are required to maintain minimum capital relative to the amount and types of assets they hold. As of December 31, 2020 and December 31, 2019, respectively, our holding company and Bank were in compliance with all applicable regulatory capital requirements, and the Bank was classified as "well capitalized," for purposes of the prompt corrective action regulations. As we continue to grow our operations and maintain capital requirements, our regulatory capital levels may decrease depending on our level of earnings. During the year ended December 31, 2020, the Company made a $10.0 million capital injection into the Bank as a result of the growth due to the acquisition. We continue to monitor growth and control our capital activities in order to remain in compliance with all applicable regulatory capital standards.
The following table presents our regulatory capital ratios for the dates noted.
(Dollars in thousands) Amount Ratio Amount Ratio
Tier 1 capital to risk-weighted assets
Common Equity Tier 1(CET1) to risk-weighted assets
Total capital to risk-weighted assets
Tier 1 capital to average assets
Contractual Obligations and Off-Balance Sheet Arrangements
We enter into credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our clients. These financial instruments include commitments to extend credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheets. Commitments may expire without being utilized. Our exposure to loan loss is represented by the contractual amount of these commitments, although material losses are not anticipated. We follow the same credit policies in making commitments as we do for on-balance sheet instruments.
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The following table presents future contractual obligations to make future payments for the periods indicated (amounts in thousands):
More than More than
1 Year 1 Year but Less 3 Years but Less 5 Years
or Less than 3 Years than 5 Years or More Total
FHLB and Federal Reserve $ — $ 149,563 $ — $ — $ 149,563
The following tables present financial instruments whose contract amounts represent credit risk, as of the dates indicated.
December 31, December 31,
Fixed Rate Variable Rate Fixed Rate Variable Rate
Commitments to make loans to sell 370,512 — 47,354 —
Commitments to make loans $ 24,225 $ 25,316 $ — $ —
We may enter into contracts for services in the conduct of ordinary business operations, which may require payment for services to be provided in the future and may contain penalty clauses for early termination of the contracts. We do not believe these off-balance sheet arrangements have or are reasonably likely to have a material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources. However, there can be no assurance that such arrangements will not have an effect on future operations.
Critical Accounting Policies
Our accounting policies and procedures are described in Note 1 - Organization and Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity and Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices and equity prices. Our market risk arises primarily from interest rate risk inherent in lending, investing and deposit taking activities. To that end, management actively monitors and manages interest rate risk exposure. We do not have any market risk sensitive instruments entered into for trading purposes.
Management uses various asset/liability strategies to manage the re-pricing characteristics of our assets and liabilities designed to ensure that exposure to interest rate fluctuations is limited within established guidelines of acceptable levels of risk-taking.
The board of directors monitors interest rate risk by analyzing the potential impact on the net economic value of equity and net interest income from potential changes in interest rates, and considers the impact of alternative strategies or changes in balance sheet structure. We manage our balance sheet in part to maintain the potential impact on economic value of equity and net interest income within acceptable ranges despite changes in interest rates.
Our exposure to interest rate risk is reviewed at least quarterly by the board of directors. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine the change in economic value of equity in the event of hypothetical changes in interest rates. If potential changes to net economic value of equity and net interest income resulting
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from hypothetical interest rate changes are not within the limits established by our board of directors, the board of directors may direct management to adjust the asset and liability mix to bring interest rate risk within board-approved limits.
The following tables summarize the sensitivity in net interest income and fair value of equity as of the dates indicated, using a parallel ramp scenario.
Percent Change Percent Change Percent Change Percent Change
in Net Interest in Fair Value of in Net Interest in Fair Value of
Change in Interest Rates (Basis Points) Income Equity Income Equity
Base — — — —
The model simulations as of December 31, 2020 imply that our balance sheet is slightly more asset sensitive compared to our balance sheet as of December 31, 2019, but maintains a fairly neutral position.
Although the simulation model is useful in identifying potential exposure to interest rate changes, actual results for net interest income and economic value of equity may differ. There are a variety of factors that can impact the outcomes such as timing and magnitude of interest rate changes, asset and liability mix, pre-payment speeds, deposit beta assumptions, and decay rates that differ from our projections. Additionally, the results do not account for actions implemented to manage our interest rate risk exposure.
Impact of Inflation
Our consolidated financial statements and related notes included within this Form 10-K have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.
Our assets and liabilities are substantially monetary in nature. Therefore, changes in interest rates can significantly impact our performance beyond the general effects of inflation. Interest rates do not necessarily move in the same direction or magnitude as prices of general goods and services, while other operating expenses can be correlated with the impact of general levels of inflation.
.
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ITEM 8:FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our financial statements and accompanying notes, including the Report of Independent Registered Public Accounting Firm, are set forth on pages F-1 to F-51 of this Annual Report on Form 10-K.
Audited Financial Statements
Description Page Number
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets as of December 31, 2020 and 2019 F-2
Notes to Consolidated Financial Statements F-7
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Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and the Board of Directors
First Western Financial, Inc.
Denver, Colorado
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of First Western Financial, Inc. (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for the years ended December 31, 2020 and 2019, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for the years ended December 31, 2020 and 2019, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Crowe LLP
We have served as the Company’s auditor since 2013.
Denver, Colorado
March 12, 2021
F-1
Table of Contents
FIRST WESTERN FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
December 31, December 31,
ASSETS
Cash and cash equivalents:
Cash and due from banks $ 2,405 $ 4,180
Interest-bearing deposits in other financial institutions 153,584 74,458
Available-for-sale securities, at fair value 36,666 58,903
Correspondent bank stock, at cost 2,552 585
Premises and equipment, net 5,320 5,218
Accrued interest receivable 6,618 3,048
Other real estate owned, net 194 658
Goodwill and other intangible assets, net 24,258 19,714
Assets held for sale — 3,553